ESMA logjam: EU regulator's move may disrupt bond, derivatives markets

RBI stand on Clearing Corp audit rights behind decision

The Reserve Bank of India’s (RBI’s) refusal to allow the European Securities and Markets Authority (ESMA) to audit the Clearing Corporation of India (CCIL) resulted in the European regulator derecognising six central counterparties – a move that could lead to disruptions in the domestic bond market, sources in the know said.

The six central counterparties (CCP) that have been derecognised by ESMA are the CCIL, Indian Clearing Corporation Limited (ICCL), NSE Clearing Limited (NSCCL), the Multi Commodity Exchange Clearing (MCXCCL), the India International Clearing Corporation (IFSC) Limited (IICC), and the NSE IFSC Clearing Corporation Ltd (NICCL).

Of these, the CCIL, which is the platform for government bond trading and certain derivative transactions, is supervised by the RBI, and the rest are within the purview of the Securities and Exchange Board of India (Sebi) and the International Financial Services Centre Authority (IFSCA). ESMA’s decision comes into effect from May 1, 2023.

“Basically, it’s a question of ESMA wanting to have rights on auditing the CCIL data. India’s position is that inspection rights will be with us. ESMA can tell the domestic bodies what assessment they want and that can be provided,” a source aware of the development said.

“It’s a regulatory-level difference of opinion which will have to be resolved by them. If each regulator is to have their own right to come and inspect our institutions, that is not the correct approach at all. The scope for more discussions will always be there,” the source said.

Negotiations on the matter were being carried out for over a year.

If no compromise is reached between the RBI and ESMA, European banks with operations in India would face major difficulty in carrying out derivatives transactions from May 1 onwards, bank sources said.

“US banks are already not present in swap derivative trading on the CCIL because the CFTC (US Commodity Futures Trading Commission) has not recognised the CCIL as a DCO (derivatives clearing organisation). Now, if the European Union also brings in European banks into this, then the impact is larger,” a senior official with a foreign bank said.

“After ESMA’s decision, there will be almost seven-eight European banks which will be ruled out and the derivatives market is mainly foreign banks. It will impact bonds as well -- if the derivatives market is impacted, then the cash market will inevitably see an impact,” the official said.

For European banks with operations in India, ESMA’s decision would mean that financial transactions would not be settled through the CCIL. This would only leave scope for bilateral transactions between banks, resulting in the loss of advantages and benefits of netting transactions that are provided by the clearing house.

Moreover, the removal of the CCIL as a counterparty would result in a much higher capital requirement for transactions in accordance with Basel norms. Traders said the increased capital requirement could be as much as 50 times.

“If the move comes into effect, the Indian OIS (overnight indexed swap) market will almost collapse because the swap market is almost entirely a foreign bank market,” another foreign bank treasury official said. The OIS market is a derivative market which counts the government bond market as the underlying.  European banks with operations in India include HSBC, BNP Paribas, Credit Agricole, Credit Suisse, Deutsche Bank, and Societe Generale.

Several banks are already said to be in discussion with the RBI regarding the matter, sources said. An HSBC spokesperson declined to comment on the issue. Emails sent to other banks and the RBI did not elicit any response till the time of going to the press.

The implications of ESMA’s move are not just restricted to derivatives markets but could affect other transactions too.

“One has to remember, clearing and settlement is not just restricted to the stock, bond and currency market. There is clearing and settlement involved when it comes to Real Time Gross Settlement (RTGS) and National Electronic Fund Transfer (NEFT) transactions,” a source said.

“If European banks are not allowed to clear rupee related transfers, they virtually cannot operate as banks,” the source said.

Regulatory Tussle

• European Securities and Markets Authority (ESMA) has derecognised its six counterparties in India – CCIL, ICCL, NSCCL, MCXCCL, IICC, and NICCL
• Only CCIL is supervised by RBI; the others are within the purview of Sebi and IFSCA
• ESMA wanted to inspect these institutions; negotiations were being held for over a year
• ESMA’s decision will come into effect from May 1, 2023
• European banks with operations in India would face major difficulty in carrying out derivatives transactions
• CCIL removal to result in higher capital requirement for EU banks, as much as 50 times