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  • Nov 1st, 2006
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The Karachi Stock Exchange (KSE) is going to implement the new risk management system from November 6, 2006 that includes changes in ready market, CFS market and future market. In this regard, KSE chief manager (operations) Haroon Askari delivered a detailed presentation to members of the exchange about technical aspects of the new management system here, on Tuesday.

Elaborating, he said in Netting Regime, to be effective from November 6, 2006, the open position in CFS market will attract ready market margins. Automated System would ensure that CFS-financed shares are kept in separate CDC account through NCC B/O netting mechanism. CFS-financed securities will not be allowed for pledging and leverage positions in CFS and derivatives not to exceed beyond 15 times of a brokerage houses net capital balance (No Change).

About the netting regime, within ready market, he said that existing netting mechanism allows multilateral netting and its salient features are including in the T+3 system, three days business is netted at member level, scrip-wise to assess member's outstanding position, ready and CFS market are one and risk is managed as per settlement cycle. Opposing order of T day can netted against the same day filled order of the same scrip.

Netting regime, within ready market: The proposed netting mechanism abrogates intra-clearing netting and its salient features are including in the proposed netting regime, three days business is added, in absolute terms, at member-wise, scrip level, to assess a member's outstanding position, ready and CFS markets are separate and risk is managed by ignoring settlement cycle. Opposing order against pending clearing shall not be netted.

Where, the CFS-financed shares are kept in separate CDC account, there would be no margin requirements on such quantum of business. The exchange is seeking a statement of assurance from the apex regulator from risk management perspective.

While referring the new risk management measures, announced by the SECP, he said they are separation of CFS and ready market, new netting regimes for ready, CFS and future markets, removal of cross-settlement netting from ready market, new VAR (value at risk) based margin regime, introduction of special margins for CFS and deliverable futures, introduction of CFS market margins and revision in position limits from futures deliverable and IPO markets.

He said the CFS eligible scrip shall be increased to 40 from November 6, 2006, outstanding in-house badla will be phased out by November 30, 2006. After this date, no broker shall be allowed to provide in-house financing to its clients.

The CFS limit would be enhanced to Rs 30 billion on November 6, 2006; Rs 37 billion on November 13; Rs 45 billion on November 20; and Rs 55 billion on November 27, 2006.

He said restructuring of risk management would be based on best international practices for each open position unless in the same scrip and same settlement period, margins are calculated as per the actual exposures of these positions without netting. In netting, margins are held by brokers and not passed onto the exchange and netting hides actual magnitude of the exposures.

Netting regime for exposure purposes: To be implemented with effect from November 6, 2006: netting shall not be allowed across settlement periods (at present, T+3, three days business in ready and CFS markets is netted at member level), no netting of open positions shall be allowed across the three markets (ready, future and CFA). The only exception is in CFS market and ready market where a member may have an open ready market sales position and an open CFS purchase position in the same scrip and in same quantity. In such cases, netting shall be allowed between the two market positions, provided that CFS purchase position has been released and settlement of both open positions is on the same date.

New netting regime's impact on pre-trade exposure monitoring system: System will calculate separately the previous days exposures and losses which will not be netted with the current trading day exposures, held deposit against margins and losses will be adjusted accordingly, pre-trade margins will remain at five percent for order book margins and executed orders will be scrip-wise bucket-based.

Impact on Capital Adequacy of Members: Capital adequacy is the first trading parameter that system checks at order entry level. Capital adequacy will be impacted with new cross settlement netting, VAR-based scrip-wise margins and new haircut regime for securities deposit.

CFS-financed securities in Blocked CDC account: As per amended CFS regulations 2005, there is a requirement that the CFS-financed securities be kept in a separate CDC account in the name of financier with following restrictions: securities will not be allowed for pledging, CFS financed shares shall only be used for delivery to NCCPL in settlement of CFS outstanding trades.

CFS market for broker financier: CFS financier shall deposit exposure margins as per applicable ready market margin regime on the first ticket buy on the day that its CFS offer is accepted on exchange's automated trading system. The margins will be held till T+3 when first ticket buy is settled by the financier. After settlement, exposure margin shall not be applicable on open second ticket sell positions as stated below: CFS financier shall not pay nay exposure margin on all open CFS second ticket sale contracts; after first ticket buy contracts are settled provided that CFS-financed shares are held in a blocked CDC account, when CFS financed shares are deposited in a blocked CDC account the exposure margins held by the exchange on first ticket buy contract will be released. CFS financed securities will not be allowed for pledging.

For Broker Finance: Netting shall be allowed between all unsettled CFS trades in the same scrip for the same amount, ie, first ticket sell and second ticket buy. Financee shall not deposit exposure margins and mark to market losses on first ticket sell contracts for the three days up to settlement, as he is already paying the ready market margins on the ready open purchase position. After settlement date the margins shall be payable on second ticket purchase in CFS market.

Financee shall pay exposure margins as applicable to ready market (including special margin) on all open CFS second ticket purchase contracts after first ticket sale contracts are settled.

CFS Financier and Financee, same Member: Such broker shall not net his second ticket purchase and second ticket sell open positions in the same scrip. Netting shall be allowed between all unsettled CFS first/second ticket buy and CFS second/first ticket sell positions in the same scrip for the same amount in the same contract period and where settlement date is the same for first ticket buy and first ticket sell. This situation will arise where the broker is providing the finance for his own client. This netting shall typically take place from transaction date for three days to settlement date only where the four contracts are identical.

While defining what is the VAR (Value at Risk) system, he said:

-- In stock market, the value at risk, or VAR, is a measure used to estimate how much the value of shares or of a portfolio of shares could decrease over a certain time period (usually over 1 day or 3 days) under daily movement of share prices.

-- It is used by stock exchanges to measure the market risk or volatility risk of the transacted but unsettled shares. Banks and other financial institutions also use VAR-based system for their risk management regimes.


-- VAR is typically calculated for one-day time period known as the holding period.

-- A 99 percent confidence level means that there is (on average) a one percent chance of the loss being in excess of that VAR.

-- Value at Risk (VAR) calculates the maximum loss expected (or worst case scenario) on an investment over a given time period and given a specified degree of confidence.

SCRIP-WISE VAR MARGINS: Full implementation of a VAR-based margining system would take some time, as it would require us to install new computer software that will calculate VAR at the end of each day for all scrip on client-wise basis. The new VAR-based margin will then be applicable. This setup will be operative by January 31, 2007.


-- Rather than publishing the exact calculated margin rate to be used for each security, all companies will be categorised into VaR margin-based categories. The following categories with an associated margin rate for each category will be used:

-- Valuation of securities which are eligible to be held as security (to be implemented from November 6, 2006):

-- In order to categorise collateral effectively and as opposed to the current practice, which only considers turnover and EPS of the scrip for ranking of eligible securities against deposit.

-- Selection of securities are categorised on measures of liquidity and volatility.

-- The stocks will be categorised into three broad groups:


-- Group one will consist of stocks which have been traded on at least 80 percent of the days in the previous six months and whose impact cost is less than or equal to one percent.

-- Group two shall consist of stocks, which have been traded at least 80 percent of the days in the previous six months and whose impact cost is greater than 1 percent and less than two percent.

-- The remaining stocks which don't fall into group for two shall be classified as group three.


-- Companies on defaulters counter of the stock exchange.

-- Companies whose free float is not in CDC.

-- These lists will be reviewed on a quarterly basis.

A maximum limit per scrip, as a percentage of free-float, shall apply to all scrips deposited as security. Exchanges will notify the market when these limits in a scrip are reached.

Mark-to-market will be conducted on a daily basis for scrips held as deposit against exposure and mark-to-market loss based on the day's closing prices in the ready market and mark-to-market losses on existing security will be topped up. Daily closing price of scrip is defined as the volume weighted average price of the scrip for the last 30 minutes prior to close of trading in the ready market. A special margin shall be payable where the transaction price of a scrip in a particular market, ie, CFS or Future Deliverable Markets is different from 26 weeks moving average price of that scrip in that market.

In case the difference between transaction price and the 26 weeks moving average price of that scrip in that market is within 10 percent, special margin shall not be payable.

However, where such difference is greater than 10 percent (on either side) then these margins shall be applicable in phased manner. Phased application of these margins means that only 50 percent of such margins will be applicable form November 6, 2006, 75 percent will be applicable from March 6, 2007 and 100 percent from July 6, 2007.

Copyright Business Recorder, 2006

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