The European Securities and Markets Authority (ESMA), an essential body in the financial markets regulation of the European Union, has recently derecognized six Indian Central Counterparties (CCPs) effective from April 30, 2023. This action is aligned with the European Market Infrastructure Regulation (EMIR). The list of derecognized CCPs includes the Clearing Corporation of India (CCIL), Indian Clearing Corporation Ltd (ICCL), NSE Clearing Ltd (NSCCL), Multi Commodity Exchange Clearing (MCXCCL), India International Clearing Corporation (IFSC) Ltd (IICC), and NSE IFSC Clearing Corporation Ltd (NICCL).
The Concept and Functions of Central Counterparties
Central Counterparties are financial entities that serve as intermediaries for sellers and buyers in various marketplaces for derivatives and equities. In essence, they are arrangements designed to streamline the clearing and settlement process in financial markets. They target the enhancement of efficiency and stability in the financial sectors.
By acting as a counterparty to sellers and buyers in a trade, CCPs collect funds from each party involved. They guarantee the full execution of the trade terms. There are two primary functions of a CCP: clearing and settlement. Clearing involves verification of the trade details – it checks whether both parties have enough funds to finalize the transaction. On the other hand, settlement facilitates the ownership transfer of a security or asset from the seller to the buyer.
Regulation of CCPs in India
In India, CCPs fall under the regulatory oversight of either the Reserve Bank of India (RBI) or the Securities and Exchange Board of India (SEBI). The RBI governs those CCPs associated with foreign exchange derivatives and money market instruments. A CCP needs authorization from the RBI to operate in India as per the Payment and Settlement Systems Act, 2007. On the other hand, SEBI oversees those CCPs dealing with securities and commodity derivatives.
The Rationale Behind ESMA’s Derecognition of Indian CCPs
The ESMA decided to derecognize Indian CCPs due to their failure to comply with all the requirements stipulated by EMIR. The decision arose from the lack of cooperation between ESMA and Indian regulators – the SEBI, the RBI, and the International Financial Services Centres Authority (IFSCA). These Indian regulators hold the view that since these CCPs are domestic entities operating within India and not the EU, they should not be subject to ESMA rules. They argue that these CCPs maintain robust risk management mechanisms, negating the need for foreign regulators’ inspection.
The Implications of ESMA’s Decision
Post withdrawal decisions, these CCPs will no longer be permitted to offer services to clearing members and trading venues established in the EU. This situation will affect European banks operating in India, forcing them to either increase their capital by up to fifty times to facilitate trades involving Indian CCPs or unwind their positions with these CCPs over the next six to nine months.
About ESMA and EMIR
The ESMA is an independent authority within the European Union aimed at enhancing investor protection and promoting financial market stability. It directly supervises specific financial entities, such as trade repositories, securitization repositories, and credit rating agencies.
EMIR, introduced in August 2012, is a regulation adopted by the EU. It aims to reduce operational, counterparty, and systemic risks in the Over The Counter (OTC) derivatives market. In addition, it has set higher prudential standards for both trade repositories and CCPs, enhancing risk mitigation techniques for non-cleared derivatives and establishing a framework for the supervision and recognition of third-country CCPs.
Last Modified: February 20, 2024