SEBI Implements New Risk-Management Framework If Commodity Price Turns (-)Ve

By Angel Broking | Published on 24th September 2020 | 85

SEBI Implements New Risk-Management Framework If Commodity Price Turns (-)Ve

What if the commodity price ever hit the negative price zone? Most investors find it hard to wrap their head around the idea of a negative asset price. But there could be a situation, albeit unprecedented, where the value of an underlier slips into the negative zone. How to deal if such a problem arises? Is our market mechanism efficient enough to handle such a crisis? It seems like SEBI is thinking on the same line. The market regulator has put in place a new commodity trading alternate risk management framework to tackle a situation of negative commodity price and also asked exchanges and clearing corporations to abide by the recommendation made by the committee reviewing the case.

The move followed the incident in May when the crude oil price crashed in the global market to negative. It forced the Multi Commodities Exchange (MCX) to settle May contracts on crude oil, which are pegged to NYMEX, at a negative price. In case the situation occurs again in the future SEBI wants to be better prepared next time.

In its circular SEBI cited extreme volatility in commodity prices in recent time in the global market to create a need for an alternative risk-management framework, amend and strengthen the current set-up if commodity price hits zero or negative in the future. SEBI said that in a situation like this, even 100 percent margin isn’t equivalent to cover the steep upward or downward price movements.

To evaluate the situation and make recommendations to efficiently deal with negative asset pricing situation SEBI constructed a committee with representatives from clearing corporations (CCS) and market participants. The committee reviewed the situation and recommended alternative risk-management framework (ARMF).

Following the recommendations, SEBI asked bourses to implement a mechanism in the next sixty days, which will trigger ARMF.

The task force made the following recommendations.

  • The alternate risk management in commodity marketswill trigger in cases of near-zero or negative price situations
  • It will not apply in concurrence with the regular risk-management framework
  • A list has identified commodities which are susceptible to near-zero or negative pricing possibility, such commodities are:

(a) Commodities that need specialised storage space for physical storing, otherwise it can increase the risk of environmental hazards

(b) Commodities that can’t be disposed of or destroyed easily

  • Clearing corporations need to update the market regulator about readiness in implementing ARMF
  • Clearing corporations (CC) not currently involved in settling such commodities in physical form are not required to follow the amended policies

SEBI has also asked exchanges to take necessary steps to amend the bye-laws, regulations, and rules to facilitate the implementation of the new framework.

Conclusion

In a recent situation, the crude oil price in the global market ran into negative, which forced MCX to settle May contracts in negative price, attracting litigation from different players. Until this happened, negative commodity pricing was only a theoretical concept. The market wasn’t prepared to deal with a negative price situation in reality. With the commodity trading alternate risk management framework, the market regulator is trying to evoke a better management mechanism and improve efficiency.