SEBI’s peak margin rule hits commodity futures

Akhil Nallamuthu | Updated on May 08, 2021

With high transaction cost adding to woes, traders face a double whammy

Leverage is the fuel that keeps speculators going and any clampdown on leverage will result in lower speculative activity. This is the trend playing out in the commodity futures market with the stage-wise implementation of SEBI’s peak margin rules since December last year.

Data from the Multi Commodity Exchange indicate that since November 2020, the average daily turnover (ADT) in commodities futures was down 23 per cent till April 30. March 2021 saw the sharpest fall of 28 per cent month-on-month, thanks to the 50 per cent peak margin requirement that kicked in then.

The new rule is being implemented in four stages beginning December 2020. Between December 2020 and February 2021, traders should have maintained at least 25 per cent of the peak margin. This requirement moved up to 50 per cent between March 2021 and May 2021. It further rises to 75 per cent between June 2021 and August 2021 and to 100 per cent from September 1 onwards.

Peak margin is the maximum margin obligation of a market participant at any given time and applies to both equity and commodity derivatives.

While the impact of higher peak margin requirement is seen in equity futures as well, commodity futures has taken a bigger blow as only few commodities are actively traded, and the spot market is far from vibrant. Higher margin needs can discourage participants and the recent data suggest the same. But that is not the only setback the traders face.


The CTT burden

Transaction costs in India are among the highest in the world and the Commodity Transaction Tax (CTT) constitutes a major portion of this, discouraging big ticket participants like hedgers. Since the introduction of the CTT in 2012, the turnover has seen a steady decline over the years – it has slumped from ₹148.9-lakh crore in 2012 to ₹87.3-lakh crore in 2020. Thus, higher margin requirements and higher costs have become a double blow.

According to Narinder Wadhwa, President, Commodity Participants Association of India, “If the third phase is implemented as planned in June, futures volumes will shrink further and there will be higher impact cost. Once the impact cost is higher, the volumes will again slow down as players will shy away.”

However, higher margin requirements are not always bad because this can limit the amount of trading one can do, thereby reducing the potential losses, especially for new entrants.

Shift to options

While the ADT in futures segment on the MCX shrank by 28 per cent and 4 per cent in March and April, respectively, the turnover in options shot up by 47 per cent and 13 per cent in the corresponding months. Also, the ADT in the options segment has increased 22 per cent since November.

In addition to lower margin requirements, options hold some advantages over futures like lower brokerage and lower expenses.

“There is definitely a traction in options as the cost of carry and the cost of transaction is quite low. But unless we have a deep and vibrant spot market on the underlying, it cannot go beyond a point,” adds Wadhwa.

Also, given the fact that the two derivative instruments have different characteristics and serve different strategies of speculators, this trend may not last.

Published on May 08, 2021

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