Risk management systems of stock exchanges are set up to mitigate the risk of members of the exchange defaulting on payment or delivery obligations. The share market tips daily provided by the research houses take extra care to overcome and bypass these risks. Stock exchanges have risk management systems to ensure against the event that members of the exchange may default on payment or delivery obligations.
a. Capital Adequacy Norms
In order to be eligible to be trading and clearing members, individual and corporate entities have to meet and maintain minimum paid-up capital and net worth norms prescribed under the regulations. Members of a stock exchange have to deposit and maintain liquid assets with the stock exchange and the clearing corporation.
A margin is a number of funds that one has to deposit with the clearing corporation in order to cover the risk of non-payment of dues or non-delivery of securities.
Risk Management in Share Market
c. Circuit Breakers
If there is an abnormal price movement in an index, defined in percentage terms, the exchange can suspend trading. This is called hitting the circuit breaker.
d. Pay-in Shortfall Penalties
If the member has a shortfall in the pay-in amount due, and the shortage exceeds the BMC, then his trading facilities are withdrawn and securities pay-out is withheld. The same penalty is levied if the shortage in pay-in funds is greater than 20% of BMC but less than the BMC, but occurs six times in a period of 3 months. The exchange will also levy a penalty equal to at least 0.07% of the shortfall on a daily basis.
e. Settlement Guarantee Mechanism
The clearing house is the counterparty to all trades in the stock exchange. This implies that it assumes counterparty risk completely, by settling all trades even if the trading member defaults on pay-in or pay-out. Some of this counter party risk is managed through the levy of margins. Any residual risk is funded by a separate pool of funds known as the Trade Guarantee Fund (on BSE) or Settlement Guarantee Fund (on NSE).
f. On-line Monitoring
Regular on line monitoring of brokers’ transactions and positions and the recommendations extended by the MCX free tips providers is carried out. The system is designed to give alerts if members build up abnormal sale or purchase positions or if margins are inadequate relative to exposure. The clearing house can pro-actively carry out a detailed check of members trading and reduce his open positions, if necessary. Any news or media information that leads to unusually large price/volume movements are also scrutinized and investigated by surveillance officers of the stock exchange.
g. Price Monitoring and Action
On surveillance of abnormal price movements, stock exchanges can take the following actions to minimize volatility:
Imposition of special margins on scrips that have shown unusually large movements in price or volume. Depending on the situation, the margins may be imposed on client-wise net outstanding purchases, or sales or both.
Circuit filter limits may be reduced to keep prices under control. This will ensure that trading will halt with a smaller rise in prices than usual.
Shifting a scrip from settlement to the trade-to-trade segment forces members to give/take delivery in that scrip, and so minimizes any volatility due to intra-day closing.
h. Inspection of Books
The stock exchange conducts an inspection of the books of trading members of each market segment at least once a year. The purpose of the inspection is to check member compliance with the applicable rules and regulations. Any violations observed result in disciplinary action by the Exchange.