New margin rule: Now hedge your commodity positions at 75% discount

NEW DELHI: After revamping the margin structure in equities to eliminate unnecessary risks from the system, Sebi is making changes to the margin rules in the commodity segment aiming to increase liquidity.

The markets regulator is making changes to the margin rules, which will benefit those who hedge their positions in individual commodity derivatives and related commodity index futures.

“This shall reduce the cost of trading and may lead to enhanced liquidity in both the commodity index futures and its underlying constituent futures or its variants,” Sebi said in its circular.

In order to understand what exactly is the change and how it will impact the commodity market, ETMarkets talked to Anuj Gupta, VP from

, and another official from a top brokerage, who did not wish to be named.

What is the new rule?

The new rule will allow a cross margin benefit of 75 per cent on initial margin for eligible offsetting positions of index futures and futures of its underlying constituents or its variants.

For example, suppose you bought Gold contracts worth Rs 10 lakh, and to hedge that position, you have taken a short position in MCX Bulldex, which tracks gold and silver, worth Rs 10 lakh. Assume the total margin required for both positions is Rs 1 lakh, then under the new rule, the applicable margin will be Rs 25,000 only — a ‘discount’ of 75 per cent!.

So, to calculate your margin requirement, just add the total margin required in simultaneous offsetting positions and slash 75 per cent. Once it becomes applicable, this calculation will be done by your broker’s terminal. So you can rest easy.

Will it be valid for any month contract?

No. Both short and long positions should be for the same month contract and up to the next three months. The benefit on the eligible positions shall be entirely withdrawn latest by the start of the tender period.

What is the rationale behind such ‘discount’?

Before explaining that, mind you, this rule is applicable only if you take simultaneously opposite positions in index futures and any or all of its constituents, and not any other trade in commodities. The basic idea is that hedging, or taking opposite positions, reduces the risk considerably.

In the example given above, if gold drops 5 per cent in a day, meaning losses for your individual position and eats into your margins; since you have shorted the index that correlates with the movement of gold, your losses will come down accordingly. Hence, overall margin requirement, if any, will also come down.

From when will this rule become applicable?

Sebi has not provided any date. Brokers say it is up to individual exchanges now. Whenever their systems are ready for this, they will notify the dates for this rule to be effective.

But, why did Sebi come out with it now?

In the last couple of years, commodity exchanges have launched a number of indices. MCX came out with Bulldex and Metldex while NCDEX released Agridex. MCX also has a composite index of all derivatives traded on the exchange.

Industry insiders in off the record conversations say these new indices are hardly getting any attention from traders and volumes remain very low. According to them, MCX had been requesting Sebi to come out with encouraging rules so these index futures could be more popular.

Is it good for the traders?

Ideally, it is a good rule that follows something that has existed in the international market and equity segment in India for a while now. For those who deal in arbitrage, this will cut down the need of capital drastically. But, the number of such traders is very low, say brokers.

So, will it have any impact on volumes?

If we believe brokers, it will likely have no or little impact on volume or the popularity of the index contracts. One executive said he has not “encountered a single client who is hedging positions using index futures”.

Moreover, Sebi has tried similar moves in the equity segment as well, but there are questions on its success. For the first time, Sebi, in December 2008, allowed cross-margining across cash and exchange-traded equity derivatives segments. Just last year, NSE introduced the cross-margining facility to offset positions in correlated equity indices. Internationally, cross-margining is available on various products, including between Indices.