- SEBI has reduced the Z-score threshold for commodity derivatives stress tests from 10 to 5
- The change aims to ease doing business by lowering extreme price scenario severity
- Price movements now capped at a Z-score of 5 replace those beyond that in stress tests
SEBI has halved the Z-score threshold used in stress testing for commodity derivatives, from 10 to five, a move that could reduce the severity of extreme price scenarios used to assess risks and potentially lower associated Core Settlement Guarantee Fund requirements.
The change, effective immediately, follows stakeholder representations, recommendations of SEBI's Risk Management Review Committee and public comments, with the regulator citing ease of doing business.
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Under the revised framework, price movements corresponding to a Z-score of five will replace extreme price movements beyond that threshold in the peak historical return scenarios for all commodities. The calculation will continue to use the mean and sigma of returns over the applicable Margin Period of Risk across 15 years.
SEBI has therefore retained the broader historical stress-testing framework while changing the threshold at which extreme observations are capped. The change relates to the standardised stress-testing framework prescribed for the Core SGF of clearing corporations with commodity derivatives segments.
The framework tests peak historical returns by considering the maximum percentage rise and fall in the price of each underlying over the MPOR during the previous 15 years. The Z-score mechanism determines how extreme those historical movements are for stress-testing purposes.
Under the old system, price movements corresponding to a Z-score of 10 replaced extreme price movements beyond that threshold. In other words, observations beyond 10 standard deviations were capped at the movement corresponding to 10. The revised rule brings that ceiling down to five, making the treatment of extreme historical price movements materially less conservative.
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A lower Z-score ceiling means exceptionally large historical price movements will have a lower prescribed extreme value in the stress test.
This could reduce calculated stress losses and, depending on the commodity and its volatility profile, potentially lower the Core SGF requirement linked to these scenarios.
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