Additional Dos and Donts for Clients and Investors in Commodity Derivatives

Commodity derivatives are leveraged instruments, so a small lapse in conduct can amplify losses dramatically. SEBI mandates a code of conduct that protects market integrity and safeguards client funds. Understanding the dos and donts ensures that participants act responsibly and remain compliant with the Commodity Derivatives Regulations, 2019.

For the NISM exam, many questions present a brief scenario and ask you to pick the correct action. Knowing the prescribed behaviour lets you eliminate distractors quickly. The exam frequently tests whether you can differentiate between client‑level obligations (e.g., KYC, margin payment) and investor‑level responsibilities (e.g., portfolio diversification, risk monitoring).

In practice, adhering to these guidelines reduces the likelihood of regulatory penalties, margin calls, or forced liquidations. It also builds trust between the client, the distributor and the exchange, which is a core principle of the Code of Conduct.

• Compliance – Prevents legal actions and fines.
• Risk Management – Limits exposure to market volatility.

Maintain up‑to‑date KYC: Before any trade, ensure all KYC documents are verified and renewed annually. This satisfies SEBI’s Know Your Customer norms and prevents account freezing.

Pay Initial and Variation Margin on time: Margin must be deposited within the exchange‑specified window (usually same‑day). Prompt payment avoids forced liquidation and demonstrates financial prudence.

Monitor Position Limits: Stay within the maximum open interest allowed for a commodity. Breaching limits triggers mandatory square‑off by the exchange.

Use Stop‑Loss Orders: Placing a stop‑loss helps cap downside risk, which is especially important in volatile commodity markets.

• Maintain a trade journal for audit trails.
• Regularly review contract specifications (tick size, lot size).

Do not trade without sufficient funds: Entering a position without the required margin leads to margin calls and possible suspension of the trading account.

Avoid excessive leverage: Using more than the recommended leverage (typically >10×) magnifies losses and is a common cause of regulatory breach.

Never ignore exchange notices: Failure to act on circulars about contract expiry, settlement changes or new margin rates results in non‑compliance.

Do not share login credentials: Sharing passwords violates SEBI’s cybersecurity guidelines and can expose the client to fraud.

• Do not manipulate prices or engage in wash trades.
• Avoid speculative bets on commodities you do not understand.

Diversify across commodity classes: Spread exposure among metals, energy and agricultural products to reduce concentration risk.

Set a risk‑capacity limit: Determine the maximum percentage of total portfolio value that can be allocated to derivatives (commonly 20‑30%). This aligns with SEBI’s prudential norms.

Review daily mark‑to‑market (MTM) statements: Understanding MTM helps you gauge unrealised gains/losses and plan margin funding.

Maintain a contingency fund: Keep liquid cash equal to at least one day’s margin requirement to meet sudden variation margin calls.

• Regularly reassess the investment horizon for each commodity.
• Stay informed about macro‑economic factors affecting supply‑demand.

Do not rely solely on past price trends: Commodity markets are influenced by weather, geopolitical events and policy changes, making historical patterns unreliable.

Avoid holding positions beyond contract expiry without proper roll‑over: Failure to roll over leads to physical settlement obligations or automatic cash settlement at unfavorable rates.

Never ignore position limits set by the exchange: Exceeding limits can trigger forced square‑off and penalties.

Do not use borrowed funds beyond the permitted leverage ratio: Over‑leveraging breaches SEBI’s margin norms and can attract punitive action.

• Do not neglect tax implications of gains.
• Avoid ignoring the impact of storage costs for physical commodities.

Accurate margin calculation is a cornerstone of compliance. The client must compute the Initial Margin (IM) before opening a position. The formula uses the contract value and the exchange‑prescribed margin rate.

Understanding each component prevents under‑funding and reduces the chance of a margin call. The exam often provides spot price, contract size and margin rate, asking you to determine the required cash.

Remember: the contract value is the product of spot price, contract size and the number of contracts. Multiply this by the margin rate to obtain the IM.

Both clients and investors must maintain transaction records for at least five years as per SEBI’s Record‑Keeping Requirements. This includes trade tickets, margin receipts, and daily MTM statements.

Timely submission of the Annual Compliance Report (ACR) to the exchange is mandatory. Failure to file the ACR on or before the due date results in a penalty of up to 2% of the total turnover.

For the exam, remember the two‑step rule: (1) Preserve original documents, (2) Upload electronic copies to the exchange portal within the stipulated window.

• Do not destroy records even after account closure.
• Maintain separate folders for client‑level and investor‑level documents to avoid mix‑ups.

The dos and donts are derived from SEBI (Commodity Derivatives) Regulations, 2019, particularly Sections 5 (Code of Conduct), 7 (Margin Requirements) and 9 (Record‑Keeping). Distributors must also comply with the NISM Code of Conduct guidelines issued in 2022.

While the regulations provide the legal backbone, NISM’s study material summarises them into actionable items for exam preparation. Candidates should be able to cite the relevant regulation number when asked for the source of a rule.

Remember that SEBI may issue circulars updating margin rates or position limits; the exam will always use the rates stated within the question stem.