“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,” Sebi said in a circular.
In April, the price of crude oil turned negative for the first time in history, after demand for oil dried up as lockdowns across the world kept people indoors. Oil producers were paying buyers to take the commodity off their hands amid fears that storage capacity was running out.
Sebi said that in order to enable the risk management framework to handle such a scenario of ’near zero’ and negative prices, it constituted a Task Force of CCs and market participants to review the risk management framework.
The markets regulator said the commodities that need specialized storage space in physical markets, which, if not followed, may cause environmental hazards or have other external implications and commodities that can’t be disposed of or destroyed with ease, and it may cause an environmental hazard or may incur significant cost, will be In principle treated as susceptible to the possibility of near zero and negative prices.
Sebi said that in case the clearing corporation (CC) will activate an ARM for a commodity’s derivatives, it foresees the possibility of negative/near zero prices in any commodity, and such framework should be capable of estimating the risk in the event of negative/near zero prices of the underlying commodity and its futures.
The shift to the ARMF will be based on triggers such as if there is a fall in the commodity prices by more than 50 per cent within 20 trading days, while comparing the intra-day highest and lowest prices, or in case of internationally referenced contracts, the international exchange/clearing corporation having the benchmark contract decides to introduce such measures for negative prices.
The trigger would also be activated if options contracts having strike price values of near zero or negative are introduced by the stock exchange for trading, or if the price of the underlying commodity/futures contract comes down to the level equal to or lower than the maximum price movement observed over the MPOR (Margin Period of Risk) in past 12 months, or it could be any other conditions as per the discretion of the CC.
Subsequently, the CC in consultation with their respective stock exchange will conduct a review and take a formal decision on whether there is a need to activate the ARMF, and such a decision will be communicated to the market, other stock exchanges and CCs.