Since the National Stock Exchange (NSE) was hit by a technical snag last week leading to the longest-ever trading halt in the history of Indian capital markets, various stock market stakeholders, including the regulators and government representatives have been talking about the issue of interoperability in the same way Indians talk about cricket. Which is to say quite a lot. But what exactly is interoperability and why is it important in the context of the glitches at NSE, India’s largest bourse? Here’s an attempt to answer vital questions on the top.
How are trades executed and settled in the stock market?
The Indian stock market has two leading stock exchanges. The National Stock Exchange, which is the dominant bourse with near-monopoly in the derivatives segment and the largest share in the cash segment, and Bombay Stock Exchange (BSE), which is Asia’s oldest stock exchange. There is also the Metropolitan Stock Exchange of India (MSEI) but it sees only a minuscule amount of trading.
Before understanding what is interoperability, one needs to know the trading mechanism on the stock exchanges. Both BSE and NSE are the platforms on which an entity can trade in various forms of securities, including stocks, derivatives and currency.
While the trades are done on stock exchanges, the settlement of trades is handled by a separate entity called a clearing corporation. A clearing corporation plays an important role in the capital markets and hence—just like a stock exchange—has been termed as a ‘Market Infrastructure Intermediary’ by market regulator Securities and Exchange Board of India (SEBI).
Both BSE and NSE have set up their own clearing corporations—NSE Clearing and Indian Clearing Corporation, respectively. Before interoperability was introduced in 2019, both the exchanges used their own clearing corporations to clear the trades executed on their respective platforms.
What is interoperability in the stock market context?
Interoperability refers to a mechanism wherein trades executed on any exchange—BSE, NSE or MSEI —can be settled or cleared through any of the clearing corporations and not necessarily restricted to the clearing corporation of the exchange on which the trade was done. For instance, a trade executed on NSE can be settled through BSE’s Indian Clearing Corporation and vice versa.
While this may sound very operational or procedural in nature, it holds immense importance in the capital market ecosystem as it helps in bringing in a lot of benefits in terms of lower trading costs, operational efficiencies, competitive pricing, better utilisation of capital and, most importantly, settlement continuity during disruptions in any of the clearing corporations.
How does interoperability benefit investors?
An investor may think that it does not make much of a difference whether the trades are settled by BSE’s or NSE’s clearing corporations. But that is not the case. To start with, an investor may benefit from lower trading costs.
Most of the leading brokers are members of both BSE and NSE and also their clearing corporations and hence have to maintain separate margin positions in both the clearing entities. With interoperability in place, brokers can consolidate their margins and collaterals in a single clearing house, thereby leading to better capital utilisation, which, in turn, could lead to lower trading costs.
Further, interoperability increases the competition between clearing houses, which again leads to competitive pricing in terms of a lower cost of clearing the trades. This benefit can also be passed on to the investor. For instance, a clearing corporation of a smaller exchange could lower its fees/charges to attract more business, which again would bring down the overall cost of trading.
What role does interoperability play during trading disruptions?
Interoperability plays a key role if any particular stock exchange or a clearing corporation faces any kind of snag or disruption. With the clearing corporations linked, trades can be settled through another clearing entity if one of the entities faces a disruption.
Take the example of last week’s trading disruption on NSE. While trading came to a complete halt on NSE, there was normal trading happening on BSE and the trades were also being settled through BSE’s clearing corporation.
As stated by NSE last week, the technical snag had also affected the “online risk management system of NSE Clearing.” In other words, both NSE and its clearing corporation faced a disruption.
However, even if the exchange was functional and only its clearing house was affected, settlement of trades done on NSE would not have got affected since BSE’s clearing house was fully functional.
In a scenario wherein one of the clearing corporations faces any kind of disruption, all the settlement activities can be seamlessly switched to the other clearing entity if interoperability is fully functional.