ESMA logjam: India, EU differences may impact trade between two countries

The differences between the Reserve Bank of India (RBI) and the European Securities and Markets Authority (ESMA), the EU financial regulator, can be considered a precursor of similar controversies in other sectors as Europe tries to tighten standards across all types of markets, from carbon credit, green hydrogen to data. But unlike those on, say, food products or car safety earlier, where European insistence has led to an improvement in Indian standards, the latest one is headed for a stalemate. Newer ones could be headed the same way. 

ESMA has this week said Indian clearing corporations will not be recognised as such in Europe because “no cooperation arrangements” could be signed between it and the Indian regulators, including the RBI, Securities and Exchange Board of India (Sebi) and International Financial Services Centres Authority. The RBI and Sebi officials blame ESMA for insisting on clauses that supposedly dilute Indian sovereign rights on domestic financial markets.

Negotiations have been ongoing since 2017 to sign a memorandum of understanding (MoU) under which ESMA can inspect the six clearing corporations that operate under RBI and Sebi licences. India has a valid objection — that Japan and the US have obtained the rights under which these checks will take place only with prior authorisation from the RBI or Sebi. “My sense is that it will be impossible to dilute our sovereign rights on our market institutions,” said R Gopalan, former secretary, (economic affairs) in the Union finance ministry. India has also objected to demand from ESMA that the six clearing corporations pay a licence fee of Euro 50,000 each per year, to join the ESMA certified panel.

Under the proposed ESMA rules, any investor based in Europe will not be able to use India’s clearing house mechanism to invest in government bonds. Instead, the investor will have to deploy her own capital as a counter-party to guarantee the trade, making it a costly exercise. While the ESMA step affects all financial markets, the primary impact will be on government bonds. Why? Allowing ESMA into the market as an inspector of clearing corporations in this market will circumscribe the role of RBI as the government banker to sell or buy Government of India and state government papers.  

A clearing mechanism brings buyers and sellers on an impartial platform for the trade, offering a secure platform. To play that role a clearing house maintains adequate capital reserves and is inspected by Sebi, for all markets, and the RBI for the government bond market. However, by global standards, Indian entities such as Clearing Corporation of India, Indian Clearing Corporation Limited and NSE Clearing Limited are considered puny — the difference in size is almost 10 times. 

However, India is expanding the market size for government bonds to attract more investors, both here and abroad. But it has found that investors in Europe and even the US have asked for those trades to take place under international clearing houses such as Euroclear, even as India insists on settlements through Indian clearing houses. 

Some of those differences have encouraged FTSE Russell and other global fund managers to drop plans to include India government and public sector bond papers in their index funds. The ESMA regulations could also kick in from April 2023, unless the parties to the negotiations agree to extend the deadline. 

The latest flare-up comes when India has expressed its unwillingness to comply with more such European standards. The European General Data Protection Regulation (GDPR) is one of those. India does not recognise it and insists it will set its own data protection standards under a law to be passed by Parliament. Minister of electronics and IT Rajeev  Chandrasekhar has said “The GDPR is a little bit more absolutist in terms of how they approach data protection. For us, that is not possible, because we have a thriving ecosystem of innovators”.

One major area of difference is the management of crypto assets. India has refused to accept the domain of private crypto, labelling those as equivalent to lottery, while the EU this year has brought issuers and crypto-asset service providers under a regulatory framework for the first time. So if an investor from India puts money into a crypto company, legal under European standards, he will be running foul of anti-money laundering in India. 

There are others. In the proposed global corporation tax, India is opposed to the so-called Pillar One that entails the removal of Digital Services Taxes (DST) such as the one India levies. India levies a 2 per cent DST on revenues generated from digital services offered in India. 

Meanwhile, the European Carbon Border Adjustment Mechanism, essentially a carbon tax, rings in from 2023. It will first apply on any imports of steel, cement, aluminium, and fertilisers from third countries into the EU. The data sheet by the Commission says the rules will become strict by 2026 with plans to “extend its scope to more products and services — including down the value chain”. India’s G20 Sherpa Amitabh Kant has described the upcoming carbon tax as the biggest challenge for Indian exporters. Thus, every exporter will have to show they have paid a carbon tax on their products including the raw materials they obtain, otherwise the EU will levy a suitable tax on such products. 

These clashes have re-opened older differences. For instance, miffed at the crash standards of Euro New Car Assessment Programme, Indian road minister Nitin Gadkari has pushed the road transport and highways ministry to develop comparable Indian standards.  

The European Commission has an elaborate mechanism for standard setting in the continent, to ensure that all the 27 member states can do business on the same platforms. These standards are usually led by the European Committee for Standardisation (CEN). Europe argues that these international standards give its industry and businesses the advantage to establish worldwide partnerships and sell their products or services globally. On Thursday, for instance, the European Commission proposed new standards to reduce air pollution from new motor vehicles. 

All of this leads to the spectre of rising non-tariff barriers even as an India-EU free trade agreement hangs in the balance.

Arpita Mukherjee, professor on international trade at ICRIER, however, noted that the EU does try to use standards but only to promote trade. “EU trade agreements have provision for mutual recognition of standards. If properly implemented it helps business on both sides,” she argued. 

Yet as India expands its economy and consequently trade ambitions, it is not keen to see others set the standards. For Europe those standards offer it an advantage to overcome the disadvantage of low costs elsewhere. The battle lines are clearly drawn. 

Different Strokes

• ESMA wants to inspect six clearing corporations that operate under RBI and Sebi licences for European investors to invest in Indian financial market instruments
• India says it can be done only with prior RBI/Sebi authorisation, as is done with the US and Japan
• ESMA wants the six clearing corporations to pay a licence fee of Euro 50,000 each a year to join an ESMA certified panel
• ESMA proposals will primarily impact government bonds by circumscribing the RBI’s role

Other sectors of divergence

• European General Data Protection Regulation
• Management of crypto assets
• The proposed global corporation tax
• European Carbon Border Adjustment Mechanism, effective from 2023
• Euro New Car Assessment Programme