PASS Securities Operations and Risk Management Examination Difficulty: Beginner 2 Questions   5 min read
📌 Chapter 4.1 — RISK MANAGEMENT

Consider a situation where a high-net-worth client pledges a large portfolio of equity shares to meet their intraday margin requirements. As a risk manager, you do not simply credit the full market value of these shares to the client’s collateral account. You must apply a haircut, a percentage deduction that acts as a buffer against market volatility and potential price gaps. If a stock is trading at 1,000 INR and carries a 20% haircut, you effectively count only 800 INR toward the client’s liquid assets for margin purposes.

Haircuts are the Clearing Corporation’s primary defense against the risk that an asset might lose value overnight or during a period of market stress. Without this adjustment, the Clearing Member would be perpetually exposed to the risk of a collateral shortfall if the market dropped sharply before the position was squared off. In your daily operations, you will encounter varying haircut levels based on the liquidity and volatility profile of the security.

Blue-chip stocks that are part of the Nifty 50 will typically attract lower haircuts compared to mid-cap or small-cap stocks, which are inherently more prone to price swings.

This process is vital because liquid assets must be readily convertible into cash to settle defaults. When you reconcile the margin file sent by the clearing corporation, you must ensure that your internal systems match the haircut values prescribed by the exchange. If your internal risk system uses outdated valuation parameters, you may erroneously allow a client to take on excessive exposure.

This is not just a regulatory compliance matter; it is the difference between a secure clearing account and one that faces a margin call at the most inopportune moment during market volatility.

Ultimately, viewing collateral through the lens of haircuts forces you to acknowledge that not all assets are created equal. Cash is king because it carries no haircut, whereas pledged securities carry a risk-adjusted value. By maintaining a disciplined approach to these deductions, you protect your firm’s capital adequacy and ensure that the integrity of the market remains intact even when individual clients encounter losses.

Nuance

⚠️ Nuance
Candidates often mistakenly believe that the haircut percentage remains constant for all securities regardless of their market behavior. In reality, clearing corporations dynamically adjust these rates, and failing to update your system’s master data can lead to serious risk oversight. Always distinguish between the market value of the collateral and the net value available for margin coverage, as confusing the two is a common error in both the examination and live operational environments.

Check Your Understanding

Practice Question 1

A client pledges shares worth 5,00,000 INR as collateral for a derivative position. The Clearing Corporation prescribes a 25% haircut for these specific securities. What is the maximum margin value the broker can consider against this collateral?

Practice Question 2

Why does a Clearing Corporation apply higher haircuts to ’less liquid’ or ‘high volatility’ stocks compared to index-based stocks?

This is a companion read for Section 4.1 — RISK MANAGEMENT from PASS Securities Operations and Risk Management Examination by Akhilesh Gururani, available on Amazon Kindle.

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