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'Allowing Interoperability Among Clearing Corporations Is The Need Of The Hour'

The Indian Capital Market should be on par with adopting such global best practices and in embracing innovations

Photo Credit : PTI


Since their origins in the 19th century, Clearing Corporations, which are the most essential part for smooth functioning of the capital market system, have evolved significantly.  In the world's most advanced markets, interoperability of Clearing Corporations has become a norm and its benefits to market participants have been well established.

A detailed assessment on the adoption and subsequent benefits of interoperability of clearing corporations in global markets has also led us to believe that the time is ripe for the Indian Capital Market to also consider introducing interoperability.

Why do we need interoperability?
Interoperability among Clearing Corporations would go a long way in reducing systemic risks, encouraging innovations, facilitating competition, reducing post-trade costs and aligning the risk management framework with industry best standards. Interoperability of clearing corporations would have its benefits and implications in number of ways.

In the event of disruption in the Stock Exchange Functioning
A Stock Exchange may need to halt trading for several reasons like a technical glitch, cyber-attack, natural and man-made calamity, etc. Short sell positions of members are part of any normal trading day. In such an instance, the members would be unable to square off their open positions resulting in high losses. Intraday trading strategies would also be affected in such a scenario.

A derivative contract may prove crucial in limiting the losses of an equity open position when there is uncertainty in the market. In the event, of a trading halt on expiry day, the current month contracts would expire on that day and hence, be redundant the next day. Options would be exercised automatically without the members being able to amend their derivatives open position.
During the Stock Exchange trading halts, the uncertainty and confusion in the market would be greatly abated if interoperability is operational. If there is a market influencing announcement during the halt, investors may be unable to capitalise or retract their positions. Interoperability will allow members to input orders or square off positions in the stock exchanges which have not halted trading. This will garner stability, resilience and confidence in the market.

When there is disruption in the functioning of a Clearing Corporation
A Clearing Corporation default could have a contagion effect on other market participants and also the other functioning Clearing Corporation leading to a systemic meltdown in the market.
A defaulting Clearing Corporation could be easily substituted with a non-defaulting Clearing Corporation in an Interoperable environment due to the similar nature of financial instruments and risk management framework across Stock Exchanges and Clearing Corporations. This will also ensure continuous functioning of the market or minimize the down-time caused by a default event.
For Reducing Cost of Collateral 
Interoperability across Clearing Corporations would allow members to choose their trading and clearing venues without any restrictions. With interoperability in place, members can deposit their collateral with the preferred Clearing Corporation and take advantage of the lower costs provided by the other Stock Exchange. In a stable trading environment, the cost of collateral to be deposited at each Clearing Corporation is quite high and may prove to be difficult for small and medium broking houses.
For infusing higher Netting Efficiency
Interoperability would also help members to consolidate their settlement activities in one Clearing Corporation. Interoperability would lead to higher netting efficiency by reducing the funds and securities pay in obligation. Netting across Clearing Corporations would effectively reduce the quantity of individual financial securities to be delivered and the quantum of funds required to settle such a set of trades.

Interoperability would also reduce membership costs, as to benefit from arbitrage in prices between two exchanges. Additional benefits would also accrue from reduction in administrative cost of processing, technical (connection and running) cost and legal cost.

For Netting of positions across exchanges margins 
Members are required to deposit eligible collateral to cover their exposures to Clearing Corporations. Netting of positions across Clearing Corporations would reduce liquidity costs as the margin calls and in turn the required collateral would reduce considerably.

The aggregate exposure in the market would reduce and thus the notional losses for market participants' and Clearing Corporations. Netting positions across Clearing Corporations would also reduce the counterparty risk faced from the Clearing Corporations. Netting of positions across Clearing Corporations may possibly reduce the contagion effect in case of either a member or a Clearing Corporation default.

Currently, full potential of netting benefit cannot be utilized by investors from the current portfolio margining system as positions are fragmented across Clearing Corporations. The post-trade fees paid by market participants would also reduce with the reduction in aggregate exposure.
The Indian Capital Market should be on par with adopting such global best practices and in embracing innovations. The global Clearing landscape is evolving continuously, and India cannot afford to be a laggard in adopting this change. Our markets should be allowed to define and structure the future path, with the Regulator deciding on prudent risk management measures.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

Tags assigned to this article:
capital market stockmarket stock exchange

Anil Shah

The author is the Director of Association of National Exchanges Members of India (ANMI)

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