Creation of the RMD:

The Exchange appointed an international risk management consultant, the WBK International limited in 1995 to conduct a risk management survey of the Stock Exchange, Mumbai and the associated Clearing House, The BOI Shareholding Limited.

The WBK Committee conducted a limited scope Risk Management study and suggested various recommendations with a view to contain the risks of the various departments of the Exchange and also that of the Clearing House. Of all the recommendations given by the committee the most important was the one that proposed the introduction of the Risk Management Function to the organisation.

On the basis of the recommendation of the WBK committee, the Governing Board constituted a Risk Management Committee which was to be responsible for all the pro- active and the retro - active risk management in addition to an operational control function and physical security.

The Risk Management Department is principally concerned with the management of non-trading risks. It seeks to ensure that all risks, which threaten the business, are recognised, controlled and reduced to their feasible economic minimum and not just the risks that are capable of being insured. The department has initiated a number of measures towards the minimisation of risks associated with paper based trading.

Nature of Risks

The Exchange has been exposed to a large number of risks, which have been inherently borne by the member brokers for all times. Since the introduction of the screen based trading the nature of risks to which the members of the Exchange are exposed to has undergone radical transformation. At the same time the inherent risk involved with the trading of paper based securities still remains. Though the process of dematerialisation has already begun, till such that it is made compulsory in all scrips, the risk of trading in fake/forged shares and instances of loss of shares etc. will continue to exist. The safe custody of these shares in physical form in the Exchange as well as in the member brokers offices is of prime importance.

1. Risks associated with Paper Based Trading

   • Lost/misplaced securities

   • damage to securities

   • loss of securities in transit

2. Client Risk

   • Client default

   • Client absconding

   • Fake/ forged/stolen securities introduced by the clients

Reduction and Control of Risks

As a measure of the pro-active risk control several measures have been initiated by the Exchange to reduce the risks to which the Exchange and the member brokers are exposed. In this regard the Exchange has initiated the following measures:

1. Know Your Client Scheme:

   Under the procedure the member brokers of the Exchange are compulsory required to obtain detailed information of clients prior to commencement of any transactions for new clients. A similar procedure is also to be followed for existing clients. This information is to be made available to the Exchange authorities whenever called for. In case the member brokers fails to furnish the same it is viewed seriously.

2. Database of lost, Stolen, Misplaced Securities:

   The Exchange maintains a database on all the shares that have been reported as lost, stolen, duplicate etc. by the Companies / registrars. The information available through the database is time relevant thus the database is modified on a regular basis and is downloaded by the members through BOLT on a weekly basis. This database is also provided to the Clearing House. The member brokers can thus reduce the instances of delivery of shares that have been reported by the Company as bad delivery by checking all the deliveries in their office with the database provided. The Exchange has designed and developed a software module for the above for the benefit of the members.

   The Clearing House also uses the database. At the time of pay-in the members of the Exchange are required to submit the details of the shares being deposited in the pay-in in a softcopy in a prescribed format.. These details are checked against the database and a report is generated in case a match is found. Such shares are then reported as bad delivery in the Exchange. Further follow-up is done with the delivering broker and they are directed to lodge a police complaint against the client introducing the stolen shares.

3. Client Caution Database:

   The Risk Management department in conjunction with the Bad Delivery Cell of the Exchange, has designed and developed a client database. All member brokers whose clients / sub-brokers have introduced fake / forged shares are required to lodge a FIR / Police complaint against their clients and also report the same to the Exchange. The information of such clients is called for in a prescribed format. As per the scheme the members have to collect detailed information about the clients. These details are incorporated in the database, which is downloaded to the members, as a precautionary measure. The member brokers at the time of admitting new clients can refer to the client caution database for further verification.

4. Verification of shares at members office:

   The Risk Management Committee has outlined a process for minimising the risks arising out of Fake/ forged /stolen shares introduced by the clients of the member brokers.

   As per the procedure outlined issued by the Exchange, in case the transaction in a script with one particular client in a settlement exceeds Rs. 10 lakh then the member brokers are required to send the photocopies of the transfer - deeds and the share certificates to the Company / Registrar for verification of the material particulars. The members can select a random sample for the same from the lot. A similar procedure should also be followed in case the shares worth more than Rs. 10 lakh are received from the Clearing House during pay-out in one scrip.

   The basic idea behind the introduction of this procedure is to prevent Fake/ forged/stolen shares from being introduced in the market. The Exchange issued a notice outlining the procedure to be followed. The above procedure is an important Risk Management Tool especially where there exists a large volume of deliveries. The Risk Management Department acts as a facilitator in this regard and has written to all "A" group and B1 group companies in this regard seeking their co-operation.

5. Inspection:

   The department is carrying out inspection of the member brokers records as regards compliance of the risk management procedures.

Insurance - as Risk Transfer

The Exchange presently has in place insurance policies to protect itself in the event of losses on account of fire, damage to computer systems and a comprehensive policy which covers risks faced by the Exchange, its member brokers and the Clearing House.

The Integrated Comprehensive Insurance Policy

It is a unique and the first of its kind of policy in India. This policy insures the risks pertaining to all the member brokers, the Exchange and the Clearing House. The policy covers members of cash segment, derivatives segment and internet trading. The policy has been operational for the last five years. The policy period is from July to June. The current policy for the year 2002-2003, provides a basic cover of Rs.50 million for the various risks faced by the members. An additional cover of Rs.5 million each has also been taken for the Exchange and the Clearing House a to insure only losses on account of physical damage to securities, theft, etc. Along with the pro-active risk control measures, this insurance policy will go a long way in minimising losses incurred by the member brokers, Clearing House and the Exchange. The risks covered under the basic cover of the policy are detailed as below:

• Loss to members on account of Infidelity of employees

• Loss to the member on account of Fake/ Forged/ Stolen shares being introduced by his client

• Direct Financial loss suffered by the Member broker on account of physical loss, destruction, theft or damage to securities & cash

• Loss on account of Securities lost in transit

• Loss suffered on account of incomplete transaction

• Loss sustained as Final receiving member on Exchange on account of default of the introducing members

• Loss on account of Errors & omissions

• Director's & Official's Liability Cover

TRADE GUARANTEE FUND

While approving the proposal of the Exchange for expansion of BOLT terminals to cities other than Mumbai, SEBI had, interalia, stipulated that the Exchange should introduce a system of guaranteeing settlement of trades or set up a Clearing Corporation to ensure that market equilibrium is not disturbed in case of payment default by the members.

The Exchange has accordingly formulated a scheme to guarantee settlement of bonafide transactions of members which form part of the settlement system.

The Exchange has constituted a Trade Guarantee Fund with the following objectives :

1. To guarantee settlement of bonafide transactions of members of the Exchange inter-se which form part of the Stock Exchange settlement system, so as to ensure timely completion of settlements of contracts and thereby protect the interest of investors and the members of the Exchange.

2. To inculcate confidence in the minds of secondary market participants generally and global investors particularly, to attract larger number of domestic and international players in the capital market.

3. To protect the interest of investors and to promote the development of and regulation of the secondary market.

The Scheme has come into force with effect from May 12, 1997.

The Scheme is managed by the Defaulters' Committee, which is a Standing Committee constituted by the Exchange, the constitution of which is approved by SEBI. The declaration of a member, who is unable to meet his settlement dues, as a defaulter is a pre-condition for invoking the provisions of this Scheme. The Exchange has contributed an initial sum of Rs.60 crores to the corpus of the Fund. All active members are required to make an initial contribution of Rs.10,000/- in cash to the Fund and also contribute Re.0.25 for every Rs.1 lakh of gross turnover in all the groups of scrips by way of continuous contribution which is debited to their settlement account in each settlement.

The active members are required to maintain a base minimum capital of Rs.10 lakhs each with the Exchange. This contribution has also been transferred to the Fund and has been treated as refundable contribution of members. Each member is also required to provide to the Fund a bank guarantee of Rs.10 lakhs from a scheduled commercial or co-operative bank as an additional contribution to the Fund. Thus, the initial contribution to the TGF of about Rs.170 crores has been contributed by the Exchange as well as members in the manner discussed above. The total corpus of the Fund as on August 31, 2001 was Rs.981 crores.

The creation of TGF has eliminated counter party risk so that if a member is declared a defaulter, other members do not suffer as was the case in the past.

Brokers' Contingency Fund (BCF)

The Exchange has set up a Brokers' Contingency Fund (BCF) with a view :

1. to make temporary refundable advance(s) to the members facing temporary financial mis-match as a result of which they may not be in a position to meet their financial obligations to the Exchange in time;

2. to protect the interest of the investors dealing through members of the Exchange by ensuring timely completion of settlement; and

3. to inculcate confidence in the minds of investors regarding safety of bonafide transactions entered into on the Exchange.

The scheme has come into force with effect from July 21, 1997.

The Fund is managed by a Committee comprising of the President, Executive Director, Vice-President, Honorary Treasurer and three non-elected directors. The Exchange has contributed a sum of Rs.9.51 crores to the corpus of the Fund. All the active members are required to make an initial non-refundable contribution of Rs.1,000/- to the Fund and also contribute Re. 0.125 for every one lakh rupees of gross turnover by way of continuous contribution which is debited to their settlement account in each settlement. The members are eligible to get advance(s) from the Fund upto a maximum of Rs.25 lakhs at the rate of 21% per annum. The corpus of the fund as on August 31, 2001 was Rs. 31 crores.

Thus, by creation of the BCF, it has been ensured that the settlement cycles at the Exchange are not affected due to the temporary financial problems faced by the members. Thus, it is presumed, will help in increasing the credibility of the stock exchange settlement system.

Market Wide Circuit Breakers

• It would be noted that earlier Circuit Filters at individual scrip level used to restrict the excessive movements of indices as well. In the revised scenario, where there are no Circuit Filters on the scrips forming part of popular indices like Sensex and Nifty there is a need to contain such excessive market movements. Therefore, in order to contain large market movements, SEBI has mandated that the Market Wide Circuit Breakers (MWCB) which at 10-15-20% of the movements in either BSE Sensex or NSE Nifty whichever is breached earlier would be applicable. This would provide cooling period to the market participants and assimilate and re-act to the market movements. The trading halt on all stock exchanges would take place as under;

• In case of a 10% movement of either index, there would be a 1-hour market halt if the movement takes place before 1:00 p.m. In case the movement takes place at or after 1 p.m. but before 2:30 p.m. there will be a trading halt for 1/2 hour. In case the movement takes place at or after 2:30 p.m. there will be no trading halt at the 10% level and the market will continue trading.

• In case of a 15% movement of either index, there will be a 2-hour market halt if the movement takes place before 1:00 p.m. If the 15% trigger is reached on or after 1:00 p.m. but before 2 p.m., there will be 1-hour halt. If the 15% trigger is reached on or after 2:00 p.m. the trading will halt for the remainder of the day.

• In case of a 20% movement of the either index, the trading will halt for the remainder of the day.

The above percentage would be translated into absolute points of the Index variation on a quarterly basis. These absolute points are revised at the end of each quarter. The Market Wide Circuit Breakers at a national level have been introduced in the Indian markets for the first time. This is on the lines of the system prevailing in the US markets.