The various risks in the trade is managed at exchange level by introducing Initial Margin (IM), Mark to Market (MTM) Margins, Margin Calls, Daily Price Movement Limit, Daily Final Settlement Price and finally employing a Settlement Guarantee Fund at exchange level .
The initial margin (IM) is specified on all open positions (Buy or sell positions) of the Members and their clients. The IM calculation on each commodity varies depending upon its market volatility. The margin so calculated is reduced from the total margin of the Member that is available with the exchange and accordingly, further exposure is given on the balance amount. As the IM increases, the exposure shall decrease.
Mark to Market (MTM) Margins
MTM is a mechanism devised by the exchanges to prevent the possibility of the potential loss accumulating to the level, where the participants might willingly or unwillingly commit default. All trades done on the exchange during the day and all open positions for the days are marked to closing price for the respective contract and notional gain or loss is worked out. Such loss/gain is debited/credited to respective Members account at the end of each day. The outstanding position of the Member is then carried forward the next day at the closing price.
Daily Price Limit
Daily price limit is the maximum and minimum level that a price of any contract is permitted to move on a particular day. It is the maximum amount of gain or loss that can occur on a particular contract/s. If a price of the contract reaches the daily price limit, trading on that contract shall be suspended for certain time period or may be for the remainder of the day. This is also called locked market.
Daily and Final Settlement
On the daily basis open positions are settled by calculating the daily settlement price. Here, the calculation methodology for the daily settlement price is included in the trading rules. Similarly, on the expiry of the futures contracts, the settlement of the contract is performed by the exchange specified final settlement technique, as mentioned in the trading rules. Here the single price is derived, which shall be used to calculate the final adjustment for the particular contract.
Settlement Guarantee Fund (SGF)
This is a pool of assets used as a guarantee to the successful settlement of all trades executed on the exchange. In the event of a clearing member being unable to pay for his commitments, the SGF shall be used to meet the payment obligation of such CM. The SGF exists solely for the protection of Clearing Members, in general and all other participants, in particular. Further, the SGF is intended to avoid the default of one clearing member producing a "snowballing" effect of defaults among other clearing members and their customers. An SGF does not provide a 100% insurance against all settlement generated problems nor does it reduce the risk of settlement default by a clearing member, but it serves as the last resort to complete settlement process, which acts to save the system from collapsing. In the unlikely event of a default, the SGF will act as an essential element of a comprehensive settlement-risk-containment system.
Creation of an SGF provides the Clearing, Settlement and Depository Institution with the resources to meet its obligations, even when a participant fails to make good on a payment obligation. The SGF essentially absorbs the amount of the default and thereby addresses the liquidity of the participant's payment default, since both the firm defaulting and the firms receiving the benefits of payment from the SGF are members of the settlement system. In general, an SGF should be viewed as mutual insurance for all participants.
At MEX , we have decided that the SGF should be used for short-term liquidity problems, its use by a clearing member should be limited and only under unusual and extenuating circumstances the SGF should be allowed to play its role. The Exchange with the active help of Clearing and Settlement Dept. shall maintain Settlement Guarantee Fund(s), with respect to different clearing segment(s) for such purposes, as may be prescribed by the Exchange from time to time.
The MEX will prescribe the norms from time to time, the procedures, the terms and conditions governing SGF, which may, inter-alia, specify the amount of deposit or contribution to be made by each clearing member/participant to the SGF, the manner and mode of deposit or contributions, conditions of repayment of deposit, or withdrawal of contribution from the SGF, charges for utilization, penalties and disciplinary actions for non-performance thereof. Further the Bye-Laws and Rules of the exchange, empowers the MEX, on the mode and manner utilization of the Settlement Guarantee Fund.