Futuristic contours of clearing corporations in India: The horizontal central counterparty (CCP) model

By Indra Chourasia and Natarajan R

The Securities and Exchange Board of India (SEBI) has been considering a reframing of ownership and economic structure of clearing corporations (CCs) in the equities markets to diversify their ownership. Currently, these CCs operate as 100% owned subsidiaries of their parent exchanges. 

Given the vital risk management role played by CCs, strengthening their financial and operational independence, decoupled from stock exchanges, becomes critical for enhanced market resilience. Taking an isolated view of CCs from the equities markets prism alone, disconnected from other segments, may not lead to robust market structure options. With Indian markets emerging as a favourite destination for global investments, setting the future construct of CCs supporting innovative products across asset classes and segments becomes essential. Such a construct must reckon with the contextual intricacies of the existing regulatory architecture and market structure of the Indian financial markets.

Regulatory span

Excluding markets under the IFSCA, domestic securities markets (including commodities) remain under the supervision of the SEBI. However, exchange-traded interest rate and currency derivatives products are overseen jointly by the SEBI (trading, clearing and settlement) and the RBI (product design, risk, and position limits). Further, G-Secs and forex trading and clearing in the interbank markets, facilitated through the CCIL, are under the RBI. 

The Payment and Settlement Systems Act 2007 entrusts the RBI with the responsibility to regulate payment and settlement institutions in India. The Act is not applicable to stock exchanges and clearing corporations promoted by stock exchanges. Also, there are a few regulatory divergences between SEBI SECC regulations governing stock exchanges and CCPs and RBI directions for CCPs. These overlaps and divergences impede the emergence of a horizontal model of clearing catering to a wide segment of products and trading venues. 

Also read: Sebi expands insider trading net

Fragmented market structure and suboptimal performance

The Indian financial markets present a fragmented situation at the clearing layer with the presence of six CCs operating in different segments with varying product remits and regulatory spans. Thankfully, the 2015 merger of FMC with SEBI led to the unified supervision of commodities derivatives and securities segments. However, highly concentrated trading activity for specific asset classes/products along with an integrated trading and clearing offering creates a monopolistic position for an exchange. It leads to suboptimal performance for CCs on account of risk specialization and capital efficiency, as the advantages of interoperability among CCs get limited.

Representation of users in the ownership and governance of CCs 

Globally, some of the leading global CCs indicate a hybrid ownership structure – i.e., ownership held by an exchange or a CSD and user groups. Being wholly owned subsidiaries of exchanges, CCs in India provide inadequate representation to user groups (trading and clearing members) in governance affairs, except public interest directors. Also, SEBI regulations and RBI directions differ in permitting the CC’s ownership and representation on the board to user groups. Thus, the low representation of user groups in the governance creates a less participative environment for product design, operational processes, risk management as well as fee decisions of CCs.

Core Settlement Guarantee Fund (SGF) and Emergency Funding 

Core SGF of CCs entails a Minimum Required Corpus (MRC) based on stress tests, requiring 50% of MRC contributed by CCs’ own funds and the other 25% contribution by the parent exchange. Thus, the risk capital and CCs’ commitment to “Skin in the Game” as a part of default management resources are highly dependent on the parent exchange. Also, lacking well-documented recovery tool options as a part of CPMI IOSCO guided Recovery Plan, CCs remain vulnerable to secure emergency funding or recapitalization after exhausting their own assets and capital in a crisis scenario.

Clearing fee structure and financial independence

Typically, exchanges charge a single unbundled transaction fee covering execution, clearing, and settlement to participants for trades executed on their platforms. In turn, exchanges pass a pre-agreed rate of clearing and settlement fees to their subsidiary CCs for providing such services. Disregarding an independent governance structure, exchanges exert sizable influence in the business affairs of CCs. The non-transparent agreements covering fees or reimbursement of costs paid by exchanges to CCs have critical implications for CCs’ profitability and financial resilience. It also limits CCs’ ability to make infrastructure investments as well as offer users aligned cost structure – mutualized costs and rebates in case of excess profits. Importantly, with requisite financial independence, CCs can get their credit rating based on their independent standing, without the backing of their parent exchanges. 

Considerations for a futuristic construct

Against this backdrop, a pragmatic approach to critically analyze vital structural issues will help in finding the right answer to frame an optimal ownership and governance structure of CCs. These include:

• Regulatory oversight: segmented or unified 
• Ownership dispersion: user-owned stock exchange-owned or hybrid 
• Risk specialization: asset-class /product-focused or cross-asset class specialization 
• Product competition: concentrated or fragmented 
• Profit motive: at-cost basis or for-profit basis 
• Pricing structure: unbundled or segregated fees 
• Access to recovery tools – emergency funding: shareowners or strategic investors 

Looking at global CCs, the DTCC – the holding company of NSCC and FICC, offering horizontal clearing services in the US equity and fixed income segments – provides an idealistic ownership and governance model. It represents the wide interests of clearing members, broker/dealers, custodians and clearing banks, as well as stock exchange and SRO. LCH Group – offering multi-assets and multi-markets clearing can be another example. Its majority ownership is held by the LSE and the remaining ownership is dispersed amongst the clearing participants and other exchanges. 

Amid the rising profile of the Indian markets, envisioning a user-group-aligned CC ownership and governance structure provides a way forward. Pivoted on the horizontal model supporting multi-assets and multi-market capabilities, such a construct can ably meet the evolving needs of investors while safeguarding market stability mandates. Certainly, regulators must keep an open-minded approach to look beyond their limited turfs to devise a forward-looking model that nurtures the long-term interests of the Indian financial markets.

(The authors: Indra Chourasia is an Industry Advisor at Tata Consultancy Services Ltd and Natarajan R, is Advisor, AMC Repo Clearing Ltd. Views expressed are the authors’ own and not necessarily those of financialexpress.com.)