Sebi's new stress testing methods to boost resilience in equity derivatives

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Subscribe to enjoy similar stories. Mumbai: The capital market regulator’s additional methods to assess credit risks in clearing corporations (CCs) will strengthen the equity derivatives segment in the long term but could increase costs in the near term, according to experts. The Securities and Exchange Board of India (Sebi) had first introduced new stress testing methodologies for determining credit exposure in CCs, including both hypothetical and historical scenarios to calculate potential losses when closing out client positions on October 16, 2023.

CCs confirm, settle and ensure delivery of securities for trading on an exchange. To strengthen risk management in the equity derivatives segment for CCs, Sebi on 1 October this year added new methods to determine the minimum required corpus (MRC) for the settlement guarantee fund (SGF), which covers losses from failed trades. Key methodologies include: Stressed value at Risk (VaR): This method uses data from a stress period to calculate price movements in the underlying assets.

The observed volatility is doubled, and simulations are carried out (with an assumption that daily returns follow a normal distribution). The final figure shows the expected price movement for each asset. Filtered historic simulation: Adjusts historical returns based on current volatility.

Factor model: Considers extreme Nifty movements over a three-day period since 2000. For each of the stress testing models mentioned above, the data used to calculate the returns or price movements for each underlying asset will be based on stress periods set by the clearing corporations. In addition, a stress period of risk of three days (and non-overlapping price movements) will be considered for the analysis.