The market regulator has proposed a more diversified shareholding of clearing corporations (CCs), even suggesting an ownership structure in which stock exchanges may not have a stake at all in CCs.
The latter would be a complete overhaul of the current regulations under which a CC has to be majority owned by a stock exchange.
The consultation paper was issued by the Securities and Exchange Board of India (SEBI) on November 22.
Here is a look at why the regulator has suggested this overhaul.
What are clearing corporations?
The main function of a clearing corporation is to settle trade. That is, it ensures that the buyer has released the money to buy securities and the seller has transferred the securities. It also has other functions such as maintaining a fund—the settlement guarantee fund (SGF)—to settle trades in case either party (buyer/seller) is not able to complete their end of the obligation.
What do the current regulations say about CCs' ownership?
They have to be majority owned by one or more stock exchanges. Under Regulation 18 of the Securities Contracts (Regulation) (Stock Exchanges and CCs) Regulations, 2018 (or SECC Regulations), at least 51 percent of the paid-up equity share capital of a regulated CC needs to be owned by one or more stock exchanges.
What is being proposed?
The market regulator has proposed diversification of the CCs' ownership.
It has put two options forward. One is to continue to allow a stock exchange to own the majority stake—51 percent—in a CC and distribute the remaining shares (pro-rata) among other shareholders of the exchange.
This 51 percent shareholding would then be brought down to 15 percent or lower by selling down the stake to other exchanges. Under this first approach, CCs would continue to be majority owned by exchanges, since the sale would be made to other exchanges. Therefore, this approach would be in line with the current regulations, even if the ownership becomes more diversified.
Two is to allot the entire shareholding of the CC to existing shareholders of the exchange and these shareholders can then trade their shares.
This would mean a clean break of the CC from the parent exchange, said the consultation paper, and would need an amendment to Regulation 18 of the SECC Regulations.
Why this need to diversify?
The SEBI consultation paper gives two reasons.
One is to ensure that the risk-management role of the CCs is not compromised for commercial, profit-making considerations.
In India, CCs are subsidiaries of the parent exchanges, which own nearly 100 percent of the respective CCs. This means that CCs can be governed by the commercial interest of the shareholders of the exchanges. But with the changing nature of the capital markets, the CCs may have to invest a lot in their infrastructure and operations, and their settlement guarantee fund. These investments have less to do with improving the CCs' profit and more with the CCs' function as public infrastructure, and therefore may not have the shareholders' backing.
While CCs are prohibited from listing, considering their sensitive role, they are "vicariously listed" by being subsidiaries of listed exchanges, noted the consultation paper.
The second reason is to ensure no conflict of interest when clearing trades, particularly after the interoperability of exchanges.
In 2019, interoperability of exchanges was introduced so that trades that came in through one exchange could be settled even by a CC owned by the competing exchange. Earlier trades that came in through the National Stock Exchange (NSE) would be cleared by the exchange owned NSE Clearing Ltd and those that came in through BSE Ltd would be cleared by BSE-owned Indian Clearing Corp.
As the consultation paper said, the CC owned by the major exchange clears a significant majority of trades across two of the largest equity exchanges in India.
It added, "In this context, CCs need to be, and need to be seen to be, truly independent of exchanges particularly in such interoperable segments."
Could there be any hitches in this overhaul?
There could be one, in implementing the second proposal.
Under the second proposal, a CC may not be majority owned by a stock exchange. If that happens, a CC that is not majority owned by a stock exchange may not continue to be excluded from the Payment and Settlement Systems (PSS) Act 2007.
The PSS Act brings all the payment and settlement solutions providers under the Reserve Bank of India's (RBI) ambit. However, stock exchanges and CCs are not covered under this Act.
If the ownership of the CC is not concentrated in the hands of a SEBI-regulated entity (exchange) then the question arises whether the CC should be regulated by the RBI.
As the consultation paper states, SEBI is discussing the matter with the RBI. If SEBI gets a confirmation that CCs would continue to be excluded from RBI's supervision, even if they are not majority exchange-owned, then the second option would be preferred, said the consultation paper.
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