India needs a commodity derivatives market where firms can hedge risks arising from commodity price fluctuations effectively and at reasonable cost. Commodities, unlike equities, are globally traded. So, if hedging is too costly in India, large firms may shift abroad and smaller firms may stay away.
Indian commodity derivatives markets fall short on this count. Margins (the collateral a trader must deposit to hold a position) are often higher here than those charged by global peers in similar commodities, gaps large enough to raise the cost of hedging materially. This high cost reduces participation, thins liquidity, and raises transaction costs.
But India’s regulator cannot simply cut margins. Margin is what ensures that if a counterparty defaults, the clearing corporation can still guarantee settlement and protect market integrity. The challenge is one of balance: charge too little, and defaults threaten the clearing system; charge too much, and genuine hedgers avoid the market. A competitive exchange must set margins high enough to guarantee settlement of open positions, but not so high that hedging becomes prohibitively expensive. The question, therefore, is how Indian commodity derivatives markets can operate at globally competitive margin levels while keeping the clearing system safe.
2 main resources
A clearing corporation (CCP) has two main resources to manage a member default. The first is the margin collected from market participants. The second is the Settlement Guarantee Fund (SGF), a capital pool built in normal times to absorb losses if a defaulting member’s margin is not enough. It creates a stronger cushion against future defaults and supports long-term market stability. If margins are reduced, the clearing corporation must have a stronger SGF. So the policy debate should shift from “how high should margins be?” to “how can clearing corporations build enough default resources to safely support lower margins?” Several options are available.
First, clearing members can make risk-based contributions to the SGF. Many global CCPs require clearing members to contribute to default funds. Members that create higher default risk through large positions, concentrated exposures, or less liquid portfolios should contribute more. This would align each member’s SGF contribution with the risk it brings to the clearing system and broaden the default-resource base.
Second, SEBI should allow clearing corporations to maintain committed lines of credit with banks and financial institutions, as many global CCPs do. Such lines of credit help the clearing corporation meet temporary liquidity needs during stress. A similar facility in India would strengthen the default resources available to clearing corporations during market stress.
Additional protection layer
Third, SEBI may consider allowing contingent assessment powers to CCPs. Under this arrangement, non-defaulting clearing members can be required to contribute additional funds Classification: Public up to a pre-specified limit in an extreme default scenario. This is not a substitute for pre-funded resources, but it provides an additional layer of protection beyond the regular SGF.
Finally, SEBI, in consultation with RBI, should examine whether systemically important clearing corporations need limited-purpose liquidity access during extreme stress. Some global CCPs have access to central-bank accounts or services, though usually with strict prudential safeguards. While this is not currently available in India, it should be part of the long-term policy discussion as commodity derivatives become more important for the real economy.
The policy choice is not between high margins and unsafe markets. A stronger SGF and better backup resources can let Indian exchanges charge lower, risk-sensitive margins without weakening settlement safety – cutting hedging costs, drawing participants, and deepening liquidity. India has the scale for a world-class commodity derivatives market; it needs a regulatory design that delivers both safety and capital-efficient participation.
The authors are professors at IIM Bangalore