SEBI Lowers Stress-Testing Threshold for Commodity Derivatives to 5

The commodity derivatives market will use a revised approach for assessing extreme historical price movements after the Securities and Exchange Board of India (SEBI) reduced the applicable Z-score threshold from 10 to 5, as per The CNBC TV18 news report. 

The change applies to the methodology used for calculating peak historical returns and takes effect immediately. 

Threshold Reduced From 10 to 5 

Under the earlier framework, price movements corresponding to a Z-score of 10 replaced extreme price movements beyond that level when determining peak historical returns. 

The revised framework brings this threshold down to 5, meaning movements corresponding to a Z-score of 5 will now replace extreme observations beyond that level. 

The calculation will continue to use returns measured over the applicable Margin Period of Risk (MPOR) across the preceding 15 years. 

Historical Methodology Remains Intact 

The revision does not alter the broader historical framework. Clearing corporations will continue to consider the maximum percentage rise and fall in the price of each underlying during the applicable MPOR over the 15-year period. 

The mean and standard deviation of returns across this period will also continue to form the basis for calculating the Z-score. 

Change Follows Stakeholder Representations 

SEBI said the revision followed representations from stakeholders seeking a review of the existing provision. The decision also considered recommendations from the Risk Management Review Committee (RMRC) and public comments. 

The stated objective is to facilitate Ease of Doing Business while changing the methodology used for stress-testing commodity price movements. 

Stress Testing and Settlement Resources 

Stress testing is used to assess the potential effect of sharp historical price movements on market positions and the resources available to meet obligations.  

It is linked to the adequacy of the Core Settlement Guarantee Fund (SGF) for commodity derivatives. 

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Conclusion 

SEBI has reduced the commodity derivatives stress-testing Z-score threshold from 10 to 5, while retaining the 15-year historical period, applicable MPOR and existing mean and standard deviation methodology. 

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