SEBI Lowers Z-Score Threshold For Commodity Derivatives To 5

The Securities and Exchange Board of India (SEBI) has reduced the Z-score threshold for commodity derivatives stress tests from 10 to 5, effective immediately.

This change aims to ease compliance requirements and improve capital efficiency for market participants.

The Z-score threshold is used to calculate the potential impact of extreme price movements on commodity derivatives.

Under the previous framework, price movements beyond a Z-score of 10 were replaced with movements corresponding to that threshold.

The new threshold of 5 will continue to be calculated using the mean and standard deviation of returns over the applicable Margin Period of Risk (MPOR), based on 15 years of historical data.

A Z-score indicates how far a price movement is from its historical average, and the revised threshold does not restrict commodity prices to a 5% movement.

Instead, it limits the effect of exceptionally large historical price shocks used in stress-testing calculations.

The revised framework applies to the standardised stress-testing mechanism under the Core Settlement Guarantee Fund (Core SGF) for commodity derivatives.

According to experts, the move could lower the capital that Clearing Corporations need to maintain against extreme market scenarios, particularly for highly volatile commodities.

The revised framework effectively caps historical price shocks at five standard deviations, potentially releasing capital that can be deployed elsewhere while retaining significant protection against severe market movements.

A Z-score of 5 covers more than 99.9999% of normal market conditions, suggesting that the change continues to provide substantial risk protection.

The impact of the revised threshold will vary across commodities, with those that have experienced unusually large historical price shocks likely to see a greater reduction in stress-test inputs and potentially lower capital requirements.

Relatively stable commodities, which have not recorded extreme price movements, are expected to see limited impact.

The decision by SEBI is expected to have a positive impact on the commodity derivatives market, as it will allow for more efficient use of capital and reduce the burden of compliance on market participants.

The move is also seen as a step towards aligning the Indian commodity derivatives market with international standards, which could attract more foreign investment and participation in the market.

Overall, the reduction in the Z-score threshold is a significant development in the commodity derivatives market, and its impact will be closely watched by market participants and regulators alike.