The government, together with regulators Securities & Exchange Board of India (Sebi) and the Reserve Bank of India (RBI), is examining the possibility of expanding the facility under which foreign institutional investors (FIIs) are allowed to submit foreign sovereign securities as collateral when trading in derivatives.
Currently, FIIs are allowed to submit AAA-rated US government securities as such collateral. In another important development, Sebi is also preparing a paper on the impact of commodity market developments on the financial markets. For this, Sebi had been asked to take inputs from the Forward Markets Commission (FMC), the commodity markets regulator, and RBI.
The last meeting of the high-level coordination committee (HLCC) of the financial markets, which includes Sebi and RBI, on August 1, discussed the possibility of expanding this facility now that it has been in place for some time.
Sebi had, through a circular in September 2007, made AAA-rated notified US government securities eligible for being submitted as collateral by FIIs. On May 30 this year, the National Stock Exchange (NSE), the country?s largest exchange, also specified to its clearing members and custodians the methodology for accepting foreign sovereign securities as collateral.
Sebi has now asked NSE to submit a report to it by September 15 on the experience gained by the exchange over the period of three months from May 30, on the usage of this facility. Once the report comes in from NSE, Sebi will brief the government on the experience, so that there can be a discussion at HLCC on expanding this facility for FIIs.
The commodity markets are being seen as increasingly influencing the financial markets these days. Sebi has decided to prepare the technical paper and present it to HLCC at its next meeting. RBI?s inputs were also being sought on gold since gold is considered a surrogate for foreign exchange reserves.
In the September 2007 circular on collateral for FIIs, Sebi had said that before accepting sovereign securities as collateral from an FII, the clearing member shall enter into a written agreement with the FII and also with the clearing corporation, containing, inter alia, the conditions that in the event of any dispute regarding liquidation or return of the sovereign securities tendered as collateral, or any other incidental matter, the courts in India will have jurisdiction to decide such disputes. Alternatively, the agreement may contain an arbitration clause. The agreement will also contain the right of the clearing corporation as well as the clearing member to liquidate the sovereign securities tendered as collateral, in the event of default by clearing member or FII, as the case may be. The clearing member will take due care to ensure that the sovereign securities tendered as collateral are available for liquidation in the event of insolvency of the FII or any intermediary or any other person located overseas through whom the securities are held. The clearing corporation will also take due care to ensure that sovereign securities tendered as collateral are available for liquidation in the event of insolvency of the clearing member or any intermediary or other person located overseas through whom the securities are held.
The clearing corporation will value the collateral tendered by applying due ?haircuts?. The haircut may either be a fixed percentage or be based on value-at-risk (VaR). A higher haircut may be considered to cover the expected time frame for liquidation. A market-determined price as obtained from an internationally recognised data vendor shall be considered for valuation. The prices will be converted into rupee terms on a daily basis, the regulator said.
The sovereign securities tendered as collateral will be treated as part of the cash component of the liquid assets of the clearing member, and shall be subject to the condition that the value of the sovereign securities shall not be more than 10% of the total value of the cash component of the liquid assets of the clearing member, Sebi had said.