Sebi considers clearing house interoperability
Mumbai: The Securities and Exchange Board of India (Sebi) is weighing interoperability of clearing houses and lower margin requirements in an attempt to reduce trading costs and minimise the impact of trading halts, four people aware of the matter said.
“The issue was discussed extensively by an internal Sebi committee on secondary market on 8 March, which discussed removing the operational and technical constraints in implementing the proposal,” said the first of the four people, all of whom spoke under condition of anonymity.
The market regulator has been weighing the idea for several years, and has lately revived discussions to help soften some of the impact from the return of LTCG tax, a second person said.
Clearing and settlement of share transactions on stock exchanges happens at clearing houses, which are run as subsidiaries of stock exchanges. Traders need to maintain various margins and collaterals with the clearing house. Currently, clearing house services are not inter-operable; so, a trader wishing to settle his trade at a different clearing house needs to put up margins and collateral there too, increasing his costs. With inter-operability, a trader can settle his trades at any clearing house, by paying margins and collateral at only one.
Clearing houses in India are Indian Clearing Corp. Ltd of BSE Ltd, Metropolitan Clearing Corp. of India Ltd of MSEI and the National Securities Clearing Corp. Ltd of NSE.
According to the second person cited above, just like an investor can buy on NSE and sell on NSE or vice versa, the same arrangement should be available for clearing too. This way, investors will not be forced to choose the clearing house which belongs to the same exchange. “It will optimize the use of capital paid by traders; otherwise, they are made to pay separate margins each time they change their venue of trading,” this person added.
“Interoperability among clearing corporations would help to reduce systemic risk and reduce post-trade costs and align our risk management framework with industry best standards. Secondary Market Advisory Committee (SMAC) has formed three sub-committees including one on risk management, technical issues and operational issues. The committees have been tasked to submit reports in two months,” said the third person.
Recently, BSE said in an investor presentation that Sebi has formed four working groups to consider various aspects of interoperability among clearing corporations.
“In case of trading halt, we as brokers are responsible for trades carried out by us on behalf of our clients. In such an instance, we would be unable to square off our open positions (client and proprietary) resulting in high losses. Interoperability will allow the margin/ fund usage across clearing corporations,” said Anil Shah, Director at Association of National Exchange Members of India (ANMI).
National Stock Exchange of India Ltd (NSE) suffered one on 10 July 2017 which led to a trading halt of over three hours, Multi Commodity Exchange (MCX) suffered one on 4 September 2017 for 45 minutes and BSE suffered on 4 July 2014 for nearly three hours.
“This would be a huge move and would pave the way for inter-exchange risk management. It will also rationalise margins across exchanges and products. It will also provide more competition as it eliminates the monopolising effects of network effects which are found in exchanges and clearing corporation. In the longer term, it may also pave the way for consolidation in clearing corporations,” said Sandeep Parekh, managing partner, Finsec Law Advisors.
For various reasons, clearing houses have been resisting Sebi’s attempts at interoperability since 2011. Smaller clearing houses worried that larger peers offering lower fees will take away their business, while large ones feared chaos in the market if risk management systems at smaller ones failed. However, clearing houses which have seen stable business amid fluctuating trading volumes over the past five years are now more comfortable with interoperability, two of the four people cited above said.
“The regulator has asked the clearing houses to do away with or move past these fears and look towards removing the operational constraints in interoperability’s implementation,” said the first person.
An email to Sebi on the matter remained unanswered. BSE declined to comment while NSE did not respond to an email for the story.
In 2015, a Sebi panel headed by K.V. Kamath had suggested keeping the inter-operability option open. “Sebi may keep the interoperability option open and consider the proposal for implementation when ground conditions are met, which, inter alia, include clear intent of the participants coming together and having a suitable framework in place to the satisfaction of Sebi,” the panel had said.
“Inter-operability may also curb chances of disruption in trades if any crisis occurs on one exchange. This is because the traders will be able to transact on other exchanges without paying additional margin,” the fourth person said.
Sebi also feels margins should come down, said the fourth person.
Margins are imposed by exchanges and CCs to ensure that buyers bring money and sellers bring shares. The three main margins are value at risk (VaR) margin, extreme loss margin and mark-to-market (MTM) margin.
VaR margin assumes worst-case scenario of portfolio loss of an individual client and is imposed on the clearing member’s open position at client level. It aims to cover 99% of the value at risk. According to the first person cited above, Sebi is planning to reduce this to 90-95%. “Lowering this margin will reduce the cost for clients,” the second person said.
Extreme loss margin (ELM) is collected on the gross open position of the member. For stocks and derivatives, this is “higher” of 5% (in price movement), or 1.5 times the standard deviation of daily logarithmic returns of the security price in the last six months.
According to the latest plan, the word “higher” may be deleted or the limits of 5% and 1.5 times lowered, said the second person .
The regulator may also scrap the requirement for CCs and exchanges to transfer 25% profits to the settlement guarantee fund (SGF).
“SGF size has grown to at least Rs. 1,700 crore. It may not be any longer required to deposit so much funds in SGF, as the money is sufficient to deal with potential settlement-related risks. Either the stipulated amount of 25% could be reduced or the norm may be done away with. The current risk management structure is robust enough to prevent any major potential default,” said the fourth person.
Parekh of Finsec Law feels reduction of margins should be done with caution and they should be seen not just as security but also as a means of systemic protection against black swan events.
“Also, the size of the SGF should not be mechanically calculated and 25% of profits is not a scientific mechanism to calculate it. If the exchange is not profitable does it mean the fund does not require a larger guarantee fund. Conversely, if the exchange is highly profitable, that is in no way connected to systemic risk for which the fund is created,” added Parekh.
The Indian markets are moving towards one market for both equity and commodities, Sebi has allowed a unified license to brokers and clearing members to operate in commodity derivatives as well as equity markets in April 2017, and allowed exchanges to become universal exchanges where one exchange will trade in all segments including equity, cash and commodities.
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