1. finlogIQ
Knowledge for financial IQ
STRICTLY PRIVATE AND CONFIDENTIAL
Chapter 18
Extended Settlement Contracts
August 2012

2. Chapter summary and outline
This chapter outlines the features of ES contracts, what types of
investors would invest in ES contracts, risks, contract
specifications, trading and settlement, calculation of profit and
loss, mark-to-market, margining, managing positions and contra and
margin financing and what types of investors would not invest in ES
contracts.
Chapter outline:
• What is an extended settlement (ES) contract?
• What type of investors would invest in ES contracts
• Risks of trading ES contracts
• Contract specifications and trading and settlement of ES contracts
• Calculation of profit and loss for ES contracts
• Marking-to-market and margining
• Managing positions
• Comparing ES contracts with contra and margin financing
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3. What Is An Extended Settlement Contract
(ES)?
• An ES contract is a stock market transaction between two parties – a buyer
and a seller
• Contract contains details of the transaction:
– The specific quantity (e.g. 1,000) of;
– The specific security (e.g. Company A‟s shares) at;
– The specific price (e.g. $10.00) for final settlement at;
– The specific future date (i.e. when the contract matures or expires)
• Investor taking a long position in an ES contract has the intention to
purchase the underlying shares
– Investor is not required to hold the position to maturity and may choose to
liquidate the position through an offsetting trade in the same ES contract.
– At expiration, if the position has not been offset, the contract is settled by
physical delivery at the contracted price.
• Investor taking a short position sells an ES contract to dispose the
underlying security.
– Can choose to close out the position through an offsetting trade in the same ES
contract before expiration or settle by physical delivery to the buyer at the
contracted price.
• In Singapore, ES contracts are classified as futures contracts
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4. What Types of Investors Would Invest in ES
Contract
Hedgers
• Use ES contracts to manage their cash market exposure by holding
underlying stock and selling ES contracts to lock in prices.
Speculative Investors
• Trade ES contracts for capital gains with the benefit of leverage as well as
an extended period for settlement
Arbitrageurs
• Seek to take advantage of market inefficiencies by making simultaneous
trades that offset each other and capture risk-free profits.
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5. Risks of Trading ES Contracts
Leverage
• High degree of leverage in ES contracts magnifies gains as well as losses
• Loss in percentage terms will be higher than the percentage price
movement in the underlying asset.
Example:
The initial margin of an ES contract on Company ABC stock is 10% of the total
underlying value. The table below shows the impact of a 5% change in price on
the ES investor.
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6. Risks of Trading ES Contracts - 2
Margin Calls
• Entering into an ES contract, investor has to put up “Initial margin”
• If market moves against the investor or margin levels are increased -
additional funds at short notice to maintain the position in the ES contract
• If investor fails to comply with a request for additional funds, broker may
liquidate the position
– Investor will be liable for any resulting deficit in the account
• Risk in trading ES contracts is not just limited to initial margin deposit but to
the entire downside of the fall in value of the underlying stock.
Liquidity
• No assurance that a liquid market will always exist for an ES contract.
• Illiquid market can occur - few willing buyers and sellers
– Can increase the risk of loss by making it difficult or impossible for an investor to
liquidate an open position in the ES contract
• Indicators of liquidity:
– Volume of trading
– Open interest (the number of open ES positions still remaining to be liquidated by
an offsetting trade or satisfied by delivery of stock).
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7. Risks of Trading ES Contracts - 3
Volatility
• Impact of market volatility on risk-return profile of the portfolio
Buying-In
• Taking a short ES position until contract expiration - investor is obligated to
physically deliver the stock for settlement
• If he does not have the required shares in his account on the due date, the
Central Depository Pte Ltd (“CDP”) will buy-in shares on the market to
satisfy the delivery obligation.
• Buying-in starts the day after the due date (last trading day +4)
Changes In Interests
• Potential to translate into changes of interest in the underlying security
• Position held in an ES contract therefore represents an economic interest in
the underlying security and the Member and Trading Representative must
record ES transaction in the register of securities.
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8. Underlying Securities
• General criteria for stock selection include:
– Trading volume and market capitalisation
– Sufficient liquidity
– To mitigate the risks of market misconduct, such as market manipulation and
cornering
• In the event SGX decides, for any reason, that an underlying is no longer
suitable for ES contracts, it shall:
– Not list any new ES contract covering that underlying;
– Have the discretion to prohibit Members from opening, or allowing their
customers to open, any new position in the ES contract covering that underlying;
– Have the discretion to direct Members to take action to offset, or require their
customers to offset, any existing positions in the ES contract covering that
underlying.
– Remove any ES contract from quotation before the Last Trading Day (LTD) if all
positions in such ES contracts have been offset.
– If there are positions in such ES contracts that are not offset, SGX may require
that such positions be cash settled immediately according to the terms
prescribed by SGX, or restrict trading only to enable those positions to be offset.
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9. Margin Requirement
• Maintenance margin requirements
• Outright and spread margins will be set in fixed tiers depending on stock
volatility
• Example:
– For an ES on the shares of Company ABC, SGX may prescribe a 10%
maintenance margin requirement.
– This means that for an ES contract to buy or sell 1000 ABC Company shares
priced at $10 each, the maintenance margin requirement is $1,000.
– In addition, SGX has set minimum initial margins (IM) to be maintenance margins
(MM) that is, it has prescribed an IM:MM ratio of 1.
– However, Members are permitted to set higher margin requirements, including a
higher IM:MM ratio than that prescribed by SGX.
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10. Contract Months
• ES contracts will commence trading on the 25th of the month that is
immediately proceeding the spot month.
• Each ES series will therefore have tenor of approximately 35 days.
• By structuring the product this way, it provides a consistent overlap period
for customers to „roll over‟ their positions in the ES contracts.
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11. Settlement by Delivery of Underlying Securities
• Settlement of ES contracts takes place by way of delivery of the underlying
securities on the 3rd business day after the Last Trading Day.
• At LTD+3, ES contracts are settled in the same manner as ready market
contracts, and payment and receipt of the purchase and sale consideration
respectively will take place in accordance with the current practice of the
ready market.
• If the seller of the ES contract does not have any or sufficient underlying
securities of the ES contract on Settlement Date, CDP will commence
buying-in of the underlying securities and the current procedures for buying-
in under the CDP Clearing Rules will apply to such buying-in.
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12. Corporate Actions
• SGX may adjust the ES contract accordingly
• Where the corporate action is widely anticipated (for instance dividend
payout) and has a relatively small impact on the underlying, no adjustment
will be made.
• Adjustments may include early expiration of the respective ES contract.
• In such a case, the Last Trading Day of the ES contract will be brought
forward to a date before the ex-dividend date for the corporate action.
Settlement Schedule through Depository Agent
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13. Use of Suspense Accounts and Sub-Accounts
• Members must not:
– Use suspense accounts to trade in ES contracts, and
– Other than joint accounts, allow any account that has more than one beneficial
owner to trade in ES contracts
• Members will be permitted to use customer suspense accounts for trading
of ES contracts provided that such accounts are used solely for the purpose
of warehousing on an individual customer basis.
• This means that one suspense account should not have more than one
beneficial owner.
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14. Contra Trades
• ES series of the same underlying and contract month will be permitted for
contra between the Member and its customers.
• As soon as a contra is specified by the Member, the profit and loss can be
settled immediately between the Member and customer as per the current
contra procedures.
• Members can choose to either:
– Credit (debit) trust account with the profit (loss), and correspondingly debit
(credit) the member‟s own cash balance (i.e. member‟s own money injected into
the pool of customer margin collateral) manually;
– Settle the profit and loss with the customer outside the system as per current
practice.
• For margins imposed by Member to customer, contra contracts will be
excluded from margining.
• However, margin calculation by CDP would include the contra contracts as
settlement between CDP and Member for these contracts would only occur
on LTD+3.
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15. Clearing Fees and GST
• A clearing fee of 0.04% on the value of the contract, subject to a maximum
of SGD 600
• Prevailing Goods and Services Tax (GST) on brokerage and clearing fees
ES Location on the Trading Screen
• ES contracts will appear on the mainboard screen and located immediately
after the respective underlying shares.
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16. Calculation of Profit and Loss for ES contracts
Examples do not take into
account the broker‟s
commissions or CDP clearing
fees which are payable
whenever the investor enters
into an ES contracts trade
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17. Marking-To-Market And Margining
Daily Mark-to-Market
• Process
– At the end of each day, all open positions in ES contracts will be revalued or
marked to their respective Valuation Prices by the CDP ie “marked-to-market”.
– Main objective of carrying out MTM is to limit the exposure of CDP to price
changes and prevent huge losses from accumulating until maturity of the ES
contracts.
– Must have sufficient funds or credit facilities in its accounts to cover MTM losses
• Valuation Price
– In calculating the mark-to-market losses or gains must use the Valuation Price as
determined by SGX
– Represents official price of ES contracts prescribed by SGX
– Valuation Price of an ES contract affected by
• The last traded price;
• Bid and offer spread at the close of market;
• Price data derived from pricing models, as selected or established by SGX
from time to time.
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18. Marking-To-Market And Margining - 2
Key Margining Concepts
• Initial Margins
– Minimum amount required to be deposited by customers for positions in ES
contracts.
– The minimum amount is distinct from and in addition to the Variation Margins
requirement which will also apply to the ES positions.
– Must not allow a customer to incur any new trade in ES, unless the minimum
Initial Margins for the new trade are deposited or the Members/Trading
Representatives have reason to believe that the minimum Initial Margins will be
deposited within 2 market days from the trade date.
– Members must not under any circumstances enter into a financing arrangement
with a customer in respect of that customer‟s margins requirements which would
allow the customer to trade without meeting the margin requirements prescribed
by SGX.
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19. Marking-To-Market And Margining - 3
Key Margining Concepts (cont)
• Maintenance Margins
– Component of Required Margins which must be maintained in a customer‟s
account subsequent to the deposit of Initial Margins for that customer‟s positions
in ES contracts.
Required Margin = Maintenance Margin + Variation Margin
– Computed by multiplying the prescribed margin rate with the value of the ES
contract.
– Contract value will be derived based on the last traded price of the underlying
security in the ready market.
– Initial margin is then computed by multiplying the maintenance margin by the
IM:MM ratio
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20. Marking-To-Market And Margining - 4
Key Margining Concepts (cont)
• Variation Margins
– That component of Required Margins comprising the mark-to-market gains and
losses, in relation to the price at which the ES contract was bought or
sold, arising from the daily valuation of the ES position.
– Will have to be computed daily based on outstanding contract and Valuation
Price including intra-day cycle on Settlement Day, i.e. LTD+3.
– Variation Margins are not required for contra trades or if the Member permits a
customer to realise a gain or loss pursuant to executing a trade to offset an
existing position.
– A profit in the ES will reduce the amount of Variation Margins while a loss will
increase the amount of Variation Margins.
– A mark-to-market gain from an ES trade may be used to offset other margin
requirements of the same customer.
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21. Margining on Gross Basis
• CDP computes margin requirement on a gross basis.
• Long and short positions belonging to different customers do not cancel
each other out in the calculation of a Member‟s overall margin requirement.
Example:
• A Member carries 80 long contract positions and 100 short positions for two
separate customer accounts.
• Under gross margining, the Member would be margined by CDP for all 180
open positions.
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22. Margin Calculation
Outright Margining
Example 1: Margin Calculations – Outright Margining
Buying ES Contracts
Company: Company F
Quantity: 1000
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23. Margin Calculation - 2
Spread Margining
• When investors hold both a long and a short position in ES contracts of
different contract months of the same underlying security, they only need to
put up one side of the maintenance margin instead of two separate
maintenance margin amounts
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24. Margins For Positions Which Have Been Offset
• Variation Margins will be collected by CDP from Members for all trades.
• Positions which have been offset will, under normal conditions, not require
Maintenance Margins.
• SGX permits Members to elect to pay gains to or collect losses from their
customers earlier than LTD+3 where such customers have taken action to
offset positions in ES contracts.
Example 1:
• Investor A makes a profit of $400 from buying and selling Company A‟s ES
contracts.
• The investor can use this profit to put up as margin for the next trade.
• For instance, Investor A decides to purchase 5 lots of Company B‟s ES
contracts, requiring him to put up a margin of $1,000.
• Instead of putting up $1,000, Investor A can use the profits from the trading
of Company A‟s ES contracts to offset.
• Therefore, he will only need to top up $600.
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25. Margins For Positions Which Have Been Offset
-2
Example 2: Margin Calculations - New Position
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26. Acceptable Forms of Margin Collateral
• Forms of collateral acceptable by CDP
– Cash;
– Letters of credit to the order of CDP in a form and from a bank
acceptable to CDP (and in accordance with such procedures as may be
prescribed by CDP); or
– Any other instruments as may be approved by CDP from time to time,
all of which must be and remain unencumbered.
• Hair-cut rates prescribed by CDP
– CDP will limit the acceptable forms of collateral that Members post to
cash and letters of credit denominated in SGD.
• Forms of collateral to be provided to members by their customers
– Cash;
– Government securities;
– Selected common stocks
• Haircut apply, where appropriate, to the particular form of collateral
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27. Margin Calls
• If the Customers Asset Value falls below the Required Margins
– Member and Trading Representative must call for additional margins from the
customer to bring the Customer Asset Value to no less than the sum of Initial
Margins and Variation Margins within 2 market days from the date the Customer
Asset Value falls below the Required Margins.
– “Customer Asset Value” refers to the moneys and market value of assets in a
customer‟s account subject to such hair-cut as specified by SGX.
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28. Margin Calls - 2
Example 1:
• The required margin when the valuation price is $9.50 is $1,450. Since the
margin holding of the investor is $1,200, the investor will receive a margin
call. However, the investor has to top up to the level of Initial Margin +
Variation Margin, which adds up to $1,640. Therefore the margin call
amount would be $440 ($1,640 - $1,200).
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29. Margin Calls - 3
Example 2:
• Margin calls shall be made within one market day after the occurrence of
the event giving rise to the margin calls.
• If a Member or Trading Representative, as the case may be, is unable to
contact a customer to call for margins, a written notice sent to the customer
at the most recent address furnished by the customer to the Member shall
be deemed sufficient.
• Members may impose stricter requirements than those prescribed by SGX
on Initial and Maintenance Margins, hair-cut rates for collateral, payment
periods for customers to deposit collateral, and the frequency of valuations
of customers‟ positions and collateral.
• Trading Representatives are required to comply with such stricter
requirements imposed by their Members.
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30. Acceptance of Orders During Margin Call
• Only allow a customer who has been subject to a margin call to incur a new
trade when the additional margins are on deposit or forthcoming within two
market days from the trade date or date on which the margin call is
triggered (T+2).
• After it calls for margins from a customer, if it fails to obtain the necessary
margins from the customer by the close of the market on T+2:
– The member will not accept orders for new trades for the customer.
– orders which would result in the customer‟s Required Margins being reduced
may be accepted by the Member or Trading Representative;
– may take actions as the Member or Trading Representative deems
appropriate, without giving notice to the customer, to reduce its exposure to the
customer.
– May include liquidation all or such part of the customer‟s collateral or taking
action to offset all or such part of the customer‟s positions
– Immediately take such action to offset all or such part of the positions of the
customer to rectify the deficiency.
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31. Acceptance of Orders During Margin Call - 2
Definition of terms
• Risk increasing trade
– Establishment or closure of a position in an ES contract which increases a
customer‟s Maintenance Margins requirements (e.g. closing one leg of a spread
position);
• Risk neutral trade
– establishment of a position in an ES contract which does not impact a
customer‟s Maintenance Margins requirements (e.g. spread trades that do not
impact Maintenance Margins requirements);
• Risk reducing trade
– Closure of a position in an ES contract which reduces a customer‟s Maintenance
Margins requirements (e.g. liquidation of a naked open position).
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32. Acceptance of Orders During Margin Call - 3
• During the period of T+1 and T+2 (i.e. within the T+2 Period)
– If the Member or Trading Representative receives indication from the customer
that margins are forthcoming within T+2:
• During the period of T+1 and T+2 (i.e. within the T+2 Period)
– If the Member or Trading Representative receives indication from the customer
that margins are forthcoming after T+2 or that no funds are forthcoming:-
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33. Acceptance of Orders During Margin Call - 4
• During the period of T+1 and T+2 (i.e. within the T+2 Period)
– Beyond the T+2 Period, allowable trading activity beyond the T+2 Period:-
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34. Excess Margins
• Refers to amount of Customer Asset Value in excess of the sum of the
Initial Margins and Variation Margins.
• May allow their customers to withdraw Excess Margins provided such
withdrawal will not cause the deposited collateral or Customer Asset Value
to be less than zero.
Example:
• Using the same illustration (Investor A in Company A shares), when the
Valuation Price rose to $10.20, the margin holding for the customer is
$1,640.
• Excess Margin is the amount in excess of Initial Margins + Variation
Margins = $616 ($1,640 - $1,024).
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35. Excess Margins - 2
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36. Reporting of Under-Margined Accounts
• Members shall immediately notify the MAS and SGX when any account of a
customer (other than the licensee‟s own proprietary account) does not
comply with the Required Margins or is under-margined by an amount
which exceeds the Member‟s aggregate resources.
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37. Managing Positions
New Position Reporting Requirement
• As a safeguard against market manipulation and cornering:
– report positions, at the customer level, which are in excess of certain prescribed
thresholds.
• Monitoring thresholds may be imposed on any account: and may include:
– Maximum number of lots of long positions that have not been offset, in gross or
net, in any ES contract; and
– Maximum number of lots of short positions that have not been offset, in gross or
net, in any ES contract.
Global Position Limits
• SGX will monitor the level of global or industry-wide positions throughout
the ES contract life
– Especially period leading up to the expiry of the contract
– When delivery of the underlying will take place if the contracts have not been
offset
– Critical to management of settlement risk
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38. Managing Positions - 2
Global Position Limits (cont)
• Excessive positions threaten market integrity or create the risk of a
cornered market in the underlying, SGX shall have the right to impose on
the Member such measures as it deems necessary or desirable, such as:
– Maximum number of lots of long positions that have additional margin
requirements;
– Offsetting existing positions
• In determining the monitoring thresholds and appropriate risk management
measures, considerations include:
– Matters relating to any position, including the number of issued shares, free
float, liquidity or volatility of the underlying;
– Financial position of the Trading Member;
– The Trading Member‟s credit exposure to a single customer;
– Any such other factors that SGX deems necessary to maintain a fair, orderly and
transparent market.
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39. Comparing ES Contracts With Contra and
Margin Financing
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