Page 21 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes 4. The clearing and settlement of derivatives trades shall be through a SEBI approved clearing
corporation/house.

5. Derivative brokers/dealers and clearing members are required to seek registration
from SEBI. This is in addition to their registration as brokers of existing stock exchanges.
The minimum net worth for clearing members of the derivatives clearing corporation/
house shall be ` 300 lakh. The net worth of the member shall be computed as
follows:
Capital + Free reserves – non-allowable assets viz.,
(a) Fixed assets; (b) Pledged securities; (c) Member's card; (d) Non-allowable securities
(unlisted securities); (e) Bad deliveries; (f) Doubtful debts and advances; (g) Prepaid expenses;
(h) Intangible assets; (i) 30% marketable securities.
6. The minimum contract value shall not be less than ` 2 lakh. Exchanges should also submit
details of the futures contract they propose to introduce.

7. The initial margin requirement, exposure limits linked to capital adequacy and margin
demands related to the risk of loss on the position shall be prescribed by SEBI/Exchange
from time to time.
8. The L.C.Gupta committee report requires strict enforcement of "Know your customer"
rule and requires that every client shall be registered with the derivatives broker. The
members of the derivatives segment are also required to make their clients aware of the
risks involved in derivatives trading by issuing to the client the Risk Disclosure Document
and obtain a copy of the same duly signed by the client.

9. The trading members are required to have qualified approved user and sales person who
have passed a certification programme approved by SEBI.

J. R Verma Committee Recommendations for Derivative Trading

The Securities and Exchange Board of India (SEBI) appointed a committee under the chairmanship
of Dr. L.C. Gupta in November, 1996 to "develop appropriate regulatory framework for derivatives
trading in India". In March, 1998, the L.C. Gupta Committee (LCGC) submitted its report
recommending the introduction of derivatives markets in a phased manner beginning with the
introduction of index futures. The SEBI Board while approving the introduction of index futures
trading mandated the setting up of a group to recommend measures for risk containment in the
derivative market in India. Accordingly, SEBI constituted a group in June, 1998, with Prof. J.R.
Varma, as Chairman. The group submitted its report in the same year. The group began by
enumerating the risk containment issues that assume importance in the Indian context while
setting up an index futures market. The recommendations of the group as covered by its report
are as under:

Estimation of Volatility (Clause 2.1)

Several issues arise in the estimation of volatility:

1. Volatility in Indian market is quite high as compared to developed markets.
2. The volatility in Indian market is not constant and is varying over time.
3. The statistics on the volatility of the index futures markets do not exist (as these markets
are yet to be introduced), and therefore, in the initial period, reliance has to be made on
the volatility in the underlying securities market. The LCGC has prescribed that no cross

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