New Delhi: The Reserve Bank of India (RBI) has made a case for further tightening the regulatory mechanism for clearing houses saying they are critical for smooth functioning of the markets.
“Central counter-parties have emerged as critical elements for the smooth functioning of the financial markets...they need to be regulated more firmly for robust risk management systems,” RBI said in its financial stability report.
Though clearing houses help in reducing systemic risk posed by derivative markets, they do not make risks disappear, RBI said. They accumulate a large share of the smaller pool of counter-party risks, it added.
“Their capital, margining and collateral requirements need to be assessed from a prudential and systemic stability perspective,” the central bank said.
Clearing houses are central counter-parties (CCPs) that stand between trading partners and guarantee the trade. CCPs serve an important role in reducing counter-party risks and help in reducing the liquidity requirement by multi-lateral netting, RBI said.
“In the wake of the recent financial crisis, regulatory attention shifted to the large swathe of over the counter cash and derivative products, which was perceived to be one of the major factors in perpetrating the financial crisis,” RBI said.
Among the global regulatory efforts to reduce systemic risks include incentivizing the move to guaranteed settlements through CCPs, which are also sought to be put in place even in the OTC markets, the report said.
“In the US, half of the trade in derivatives happen on OTC and this was the key reason for the financial crisis. However, in India, central counter-parties are functioning in most of the financial markets,” SMC Capital equity head Jagannadham Thunuguntla said.
Thunuguntla said there is a need to regularly upgrade the system to keep in line with the new products that hit the market for better functioning of the financial markets.
CNI Research chairman and managing director Kishore P. Ostwal said, “the average daily derivative volume is about Rs75,000 crore out of which the unsettled contract managed by the clearing house is only Rs7,500-10,000 crore a day. The volume goes up in the last few days before the settlement date.”
Ostwal said clearing houses provide the much-needed confidence to the players in the financial market and thus need to be financially sound to handle the large amount of settlements.