Chapter 7: Clearing, Settlement & Risk Management
NISM Series I — Currency Derivatives | ~13% weightage | ~84 questions
What this chapter is about
Second most tested chapter after CH3. Same core concepts as Series VIII CH7 — clearing corporation, margins, MTM, position limits — but with currency-specific numbers and rules. Three things that are unique to currency: the Core SGF (CC contributes 50% from own funds), the minimum liquid networth of Rs 50 lakhs, and the extreme loss margin on calendar spreads (1/3 of far month MTM value). Everything else maps directly from equity derivatives knowledge.
The Clearing Corporation
Acts as CENTRAL COUNTERPARTY to every trade through NOVATION — it becomes the buyer to every seller and the seller to every buyer. This eliminates counterparty risk completely.
What CC does:
- Computes open positions (CLEARING)
- Calculates margin requirements
- Collects and distributes margins
- Guarantees settlement even if a party defaults
- Can disable trading terminals of non-paying members
Settlement vs Clearing:
- CLEARING = computing open positions and determining MTM margin obligations
- SETTLEMENT = actual pay-in and pay-out of funds (cash movement)
Margin system
Initial margin:
- Minimum 1.75% of contract value on Day 1 of USDINR trading
- Minimum 1% thereafter for USDINR
- Deducted from liquid networth on a REAL-TIME basis
Extreme Loss Margin (ELM):
- Computed on INTRADAY (real-time) basis — NOT end of day
- For calendar spread position: charged on 1/3 of far month MTM value
Liquid assets accepted:
- Cash ✅
- Fixed Deposits ✅
- Treasury Bills ✅
- Government Securities ✅
- Bank Guarantees ✅
- Demat shares (equity securities) ✅
- Cash component must be at least 50% of liquid assets
Minimum liquid networth for clearing member = Rs 50 lakhs at all times (after adjusting for initial margin and ELM requirements)
Margins collected GROSS basis — not netted across clients. If Client A is long 10 lots and Client B is short 10 lots, broker must maintain margin on ALL 20 lots, not zero.
Core Settlement Guarantee Fund (Core SGF)
- The Clearing Corporation must contribute at least 50% of the Minimum Required Corpus (MRC) from its OWN funds
- Purpose: Cover losses when member defaults and other funds are insufficient
- Protects market integrity
MTM settlement — timing is everything
Daily MTM: Settled in cash before start of trading on T+1 day
Three MTM scenarios:
- Squared off positions: (sell price − buy price) × lots × lot size
- Open positions (not squared off): (day's settlement price − trade price) × lots × lot size
- Brought forward positions: (today's settlement − yesterday's settlement) × lots × lot size
Final settlement: T+2 from last trading day. Cash-settled at FBIL/RBI reference rate.
Open position for position limits
Trading member open position = proprietary positions + ALL client positions (added, not netted)
Gross open position for monitoring: = |long positions| + |short positions| across all clients and proprietary
Example: Client A: short USD 2,000 Client B: long USD 6,000 Options client: long USD 5,000
Gross open position = 2,000 + 6,000 + 5,000 = 13,000 USD (absolute values — direction doesn't matter for gross calculation)
Position monitoring: Based on PREVIOUS day's total open interest (not real-time)
Pay-in obligation and trading limits
If a member has pay-in obligation but no margin requirement: → Trading is allowed but with REDUCED LIMIT (reduced with respect to pay-in amount) → NOT complete halt, NOT full limit — reduced limit
Interoperability of Clearing Corporations
Enables a clearing member to choose a single clearing corporation for settlement even when trading on multiple exchanges. Applicable to ALL products EXCEPT commodity derivatives.
Key: Currency derivatives segment IS covered under interoperability.
Settlement of funds — novation in practice
- Trade executed on exchange
- CC interposes itself via novation (becomes counterparty)
- Clearing banks receive pay-in/pay-out instructions from CC
- CC debits/credits clearing member accounts
- Clearing bank accounts used EXCLUSIVELY for CC settlement operations
Clearing bank account rules:
- Used exclusively for CC settlement
- CC can raise debit WITHOUT prior permission of clearing member
- Closure requires prior permission from CC
Real market example — MTM calculation
Trader buys 40 lots USDINR at 86.20 and sells 55 lots at 86.35 on Day 1. Settlement price Day 1 = 86.80. He pays MTM accordingly. Settlement price Day 2 = 87.10.
Net position from Day 1: 55 − 40 = short 15 lots at 86.80 (previous settlement) Day 2 MTM = (86.80 − 87.10) × 15 × 1,000 = Rs 4,500 loss (Short position loses when price rises)
Trap Alert
Trap 1: "CC contribution to Core SGF can be from member contributions" — WRONG CC must contribute AT LEAST 50% of MRC from its OWN funds — not member money.
Trap 2: "ELM for currency options computed at end of day" — FALSE ELM is computed on intraday real-time basis.
Trap 3: "Calendar spread ELM = full MTM of far month" — FALSE Calendar spread ELM = 1/3 (one-third) of far month MTM value.
Trap 4: "Clearing bank account can be used for general banking" — FALSE Used EXCLUSIVELY for CC settlement operations — nothing else.
Trap 5: "For gross open position, long and short positions net out" — FALSE Gross = absolute values added. Long 6,000 + Short 2,000 = 8,000 (not 4,000).
Trap 6: "Interoperability covers commodity derivatives" — FALSE Interoperability is NOT applicable to commodity derivatives. All other segments including currency are covered.
Must-remember rules
- Novation = CC becomes legal counterparty to every trade
- Initial margin USDINR: 1.75% Day 1, 1% thereafter
- ELM computed INTRADAY (real-time), not EOD
- Calendar spread ELM = 1/3 of far month MTM value
- Liquid networth minimum = Rs 50 lakhs at all times
- Core SGF: CC contributes ≥50% of MRC from own funds
- Margins collected GROSS across clients (not netted)
- MTM settled on T+1 before trading begins
- Final settlement T+2 at FBIL/RBI reference rate
- TM open position = proprietary + all clients (added)
- Gross open position = sum of absolute values of all positions
- Position monitoring = previous day end-of-day open interest
- Pay-in obligation without margin → reduced trading limit (not stopped)
- Clearing bank account: exclusively for CC settlement; CC can debit without prior permission
- Interoperability: covers currency, NOT commodity derivatives
Weightage note
~13% = ~84 questions. MTM calculations (2-3 per exam), open position calculations (2-3 per exam), Core SGF and liquid networth rules (1-2 per exam), novation and clearing definitions (2-3 per exam). The Rs 50 lakh liquid networth minimum and Core SGF 50% rule are repeatedly tested True/False questions.
Quick revision — 60 second scan
- Novation = CC becomes counterparty
- Clearing = compute positions | Settlement = actual cash movement
- Initial margin: 1.75% Day 1, 1% thereafter (USDINR)
- ELM: intraday real-time | Calendar ELM: 1/3 far month MTM
- Liquid networth ≥ Rs 50 lakhs always
- Core SGF: CC contributes ≥50% from own funds
- Margins: GROSS across clients (no netting)
- MTM: T+1 | Final: T+2 at FBIL rate
- Gross open position: sum of absolute values
- Interoperability: all segments EXCEPT commodity