In order to enable over-the-counter (OTC) settlements in corporate bonds on a real time basis, the Reserve Bank of India (RBI) today decided to allow the clearing houses of the exchanges to have a transitory pooling account facility with the central bank.
The move comes close on the heels of a recent announcement by the Securities and Exchange Board of India (Sebi) Chairman C B Bhave to route OTC corporate bond transactions through clearing entities to mitigate risks in such deals while bringing in more transparency in OTC settlements.
Under the proposed transitory pooling mechanism, settlements of corporate bonds can be done through the real time gross settlement (RTGS) system with the corresponding central clearing house. The buyer of corporate bonds will transfer the funds through his bank to the transitory account, while the clearing house will be able to transfer the securities to the buyer's account from the seller's account and release the funds to the latter's account.
According to the central bank, this settlement mechanism will be done on a trade-by-trade basis or delivery versus payment-I (DvP-I) basis that was earlier recommended by the R H Patil Committee at RBI.
The government had constituted the high-level committee on corporate bonds and securitisation to identify the factors inhibiting the development of an active corporate debt market in India and recommend necessary policy actions. The committee made a number of recommendations relating to rationalising the primary issuance procedure, facilitating exchange trading, increasing the disclosure and transparency standards and strengthening the clearing and settlement mechanism in secondary market.
In OTC corporate bond deals, prices are quoted over the phone, which often prevents an efficient price discovery, as the buyer or the seller might be unaware of the best price available for the debt paper in the market.
A central clearing house will enable a guarantee in OTC payment and settlements and mitigate counter-party risks. This will also encourage a larger participation from foreign investors, which in turn may enhance volumes in the slow-growing corporate bond market.
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Banks, the Stock Holding Corporation of India, the Clearing Corporation of India, National Securities Depository, or any quasi-government financial organisation can play the role of central clearing house in OTC corporate bond settlements.
Corporate bond trades are currently reported to the Bombay Stock Exchange (BSE), the National Stock exchange (NSE) and the Fixed Income, Money Market and Derivatives Association of India (FIMMDA). In the financial year ended March 2009, trades worth Rs 1,48,747 crore took place in corporate bonds on BSE, NSE and FIMMDA combined compared with Rs 96,119 crore in 2007-08.
While announcing the annual monetary policy, RBI suggested that the financial institutions to continue strengthening their infrastructure for OTC derivatives.
The central bank said that efforts should be made to standardise credit derivatives contracts to enable their clearing through a central counterparty.
For the use of central counterparties to clear OTC credit derivatives, the authorities were asked to enhance incentives.