Sebi puts in place framework to handle near zero, negative prices in commodity futures

Sebi noted that in recent times extreme volatility has been observed in commodity prices globally, particularly in the case of crude oil, wherein the prices had unprecedentedly gone down to zero and subsequently even negative. In such a scenario, margins equivalent to even 100 per cent of the futures price would not have been sufficient to cover the steep upward or downward price variations in the futures market, it added. 

In order to enable risk management framework to handle such a scenario of 'near zero' and negative prices, Sebi constituted a task force of clearing corporations and market participants to review the risk management framework in such cases, the regulator said in a circular. Based on the recommendations of the task force, Sebi said it has been decided that alternate risk management framework (ARMF) will be applicable in such cases of near zero and negative prices for any underlying commodities / futures. 

To begin with, the commodities that need specialised storage space in physical markets, which, if not followed, may cause environmental hazards or have other external implications and those commodities that cannot be disposed of or destroyed with ease may be in principle treated as susceptible to the possibility of near zero and negative prices. The clearing corporations (CCs) will have to ensure the readiness of their systems to implement the prescribed framework within 60 days. However, CCs which do not presently provide for the clearing and settlement services of any such susceptible commodity, are not required to update their systems for the prescribed framework. 

This is subject to certification by their risk management committees that none of the products being presently cleared by the CC are susceptible to near zero and negative prices, it added. However, before the launch of any such susceptible commodities in future, they will ensure that their systems are updated for the ARMF. In case the clearing corporation foresees the possibility of negative/near zero prices in any commodity, then for such commodity derivatives, it will activate the ARMF which will be capable of estimating the risk in the event of negative or near zero prices of the underlying commodity/futures. 

The shift to the ARMF will be conditional, based on triggers indicating the likelihood of near zero or negative prices.  The CC will strive to intimate to the market well in advance the threshold price level below which the ARMF will be activated. With regard to deactivation -- switching from alternate to regular risk management -- Sebi said deactivation of the ARMF will be done when the conditions that triggered the activation of the framework no longer prevail.  "The exit from the ARMF shall be done after a reasonable time lag so as to avoid frequent switching between alternate and regular frameworks," Sebi said. "In case the entry and exit of the ARMF is defined in terms of specific price points, the exit point shall be kept sufficiently above the entry point to avoid frequent switching between alternate and regular frameworks," it added. The deactivation of the ARMF and re-activation of regular framework will be done when the margin requirement under the two frameworks sufficiently converges, the regulator said.