SEBI Revises Commodity Derivatives Stress Testing Framework, Cuts Z-Score To 5

The Securities and Exchange Board of India (SEBI) has lowered the Z-score threshold used in historical stress testing for commodity derivatives to 5 from 10, reducing the impact of exceptionally large price movements considered by clearing corporations while assessing market risks.

The revised rule will take effect immediately. It forms part of the standardised stress-testing framework for the Core Settlement Guarantee Fund (Core SGF) maintained by clearing corporations.

What Is Under The New Framework?

Under the new framework, price movements corresponding to a Z-score of 5 will replace extreme price movements above that level in the peak historical returns of all commodities.

A Z-score shows how far a price movement is from its historical average. A higher score points to a larger deviation from normal price movements. Clearing corporations use the measure to find out if they have enough financial resources to withstand sharp market movements and meet settlement obligations.

Understanding Revised Rules

Price movements beyond five standard deviations will no longer be used at their full historical magnitude for the specified peak historical-return scenario.

Instead, clearing corporations will use the price movement corresponding to a Z-score of 5. The calculation of the Z-score will continue to use the mean and standard deviation of returns over the applicable Margin Period of Risk (MPOR) across the previous 15 years.

SEBI said it received representations from stakeholders seeking a review of the existing threshold. The earlier Z-score of 10 had been a point of discussion among market participants. They had sought a lower threshold, saying the existing level could create exceptionally high stress scenarios and increase the capital requirements of clearing corporations.

Capital Requirement Impact

The proposal had remained under discussion as commodity markets faced periods of higher volatility and geopolitical uncertainty, according to market participants.

Market participants had estimated that a lower threshold could reduce provisioning requirements for the settlement guarantee fund maintained by commodity exchanges. This could potentially free up capital for other uses.

SEBI said the measure was intended to protect investors, support the development of the securities market and facilitate ease of doing business.

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