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A SOUND risk management system is integral to an efficient clearing and settlement system. NSE introduced for the first time in India, risk containment measures that were common internationally but were absent from the Indian securities markets. NSCCL has put in place a comprehensive risk management system, which is constantly upgraded to pre-empt market failures. The Clearing Corporation ensures that trading member obligations are commensurate with their net worth.

Risk containment measures include capital adequacy requirements of members, monitoring of member performance and track record, stringent margin requirements, position limits based on capital, online monitoring of member positions and automatic disablement from trading when limits are breached, etc.

NSCCL SPAN

The objective of SPAN is to identify overall risk in a portfolio of futures and options contracts for each member. The system treats futures and options contracts uniformly, while at the same time, recognising the unique exposures associated with options portfolios such as extremely deep out-of-the-money short positions, inter-month risk and inter-commodity risk.

Because SPAN is used to determine performance bond requirements (margin requirements), its overriding objective is to determine the largest loss that a portfolio might reasonably be expected to suffer from one day to the next day. In standard pricing models, three factors most directly affect the value of an option at a given point in time: 1. Underlying market price; 2. Volatility (variability) of underlying instrument; 3. Time to expiration As these factors change, so too will the value of futures and options maintained within a portfolio. SPAN constructs scenarios of probable changes in underlying prices and volatilities in order to identify the largest loss a portfolio might suffer from one day to the next. It then sets the margin requirement at a level sufficient to cover this one-day loss.

Mechanics of SPAN

The complex calculations (e.g. the pricing of options) in SPAN are executed by the Clearing Corporation. The results of these calculations are called Risk arrays.

Risk arrays, and other necessary data inputs for margin calculation are then provided to members in a file called the SPAN Risk Parameter file.

This file will be provided to members on a daily basis. Members can apply the data contained in the Risk parameter files, to their specific portfolios of futures and options contracts, to determine their SPAN margin requirements. Hence members need not execute complex option pricing calculations, which would be performed by NSCCL. SPAN has the ability to estimate risk for combined futures and options portfolios, and re-value the same under various scenarios of changing market conditions.

Risk Arrays

The SPAN risk array represents how a specific derivative instrument (for example, an option on NIFTY index at a specific strike price) will gain or lose value, from the current point in time to a specific point in time in the near future (typically it calculates risk over a one day period called the `look ahead time'), for a specific set of market conditions which may occur over this time duration. The specific set of market conditions evaluated, are called the risk scenarios, and these are defined in terms of: (a) how much the price of the underlying instrument is expected to change over one trading day, and (b) how much the volatility of that underlying price is expected to change over one trading day.

(Edited extracts from NSE Web site)

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