SEBI Cuts Z-Score Threshold For Commodity Derivatives Stress Tests From 10 To 5

The Securities and Exchange Board of India (SEBI) has reduced the Z-score threshold used in stress testing for commodity derivatives from 10 to 5. The change, effective immediately, is aimed at easing compliance requirements and improving capital efficiency for market participants.

Under the earlier framework, price movements beyond a Z-score of 10 in the peak historical returns of commodities were replaced with movements corresponding to that threshold. SEBI has now lowered the limit to 5.

The regulator said the Z-score will continue to be calculated using the mean and standard deviation of returns over the applicable Margin Period of Risk (MPOR), based on 15 years of historical data.

A Z-score indicates how far a price movement is from its historical average. The revised threshold does not mean commodity prices are restricted to a 5% movement. Instead, it limits the effect of exceptionally large historical price shocks used in stress-testing calculations.

Lower threshold could reduce capital requirements

The revised framework applies to the standardised stress-testing mechanism under the Core Settlement Guarantee Fund (Core SGF) for commodity derivatives.

According to experts, the move could lower the capital that Clearing Corporations need to maintain against extreme market scenarios, particularly for highly volatile commodities.

The revised framework effectively caps historical price shocks at five standard deviations, potentially releasing capital that can be deployed elsewhere while retaining significant protection against severe market movements.

A Z-score of 5 covers more than 99.9999% of normal market conditions, suggesting that the change continues to provide substantial risk protection.

The impact, however, will vary across commodities. Those that have experienced unusually large historical price shocks are likely to see a greater reduction in stress-test inputs and potentially lower capital requirements. Relatively stable commodities, which have not recorded extreme price movements, are expected to see limited impact.