Benefits Of Interoperability Of Clearing Corporations

Interoperability of clearing corporations is a mechanism which allows one clearing corporation to execute and settle trades of any other exchange. It allows market participants to choose any clearing corporation to settle their trades, irrespective of the exchange where the trades are executed. On 27 November 2018, SEBI had given exchanges and clearing corporations a deadline to implement it from July 3, (revised). Currently, trades executed on the NSE are cleared and settled only through its subsidiary — NSE Clearing Corporation (NSE Clearing - NCL). Transactions on the BSE are settled through its subsidiary — Indian Clearing Corporation (ICCL) — and those on Metropolitan Stock Exchange through Metropolitan Clearing Corporation of India.

Thus, participants who trade on multiple exchanges had to necessarily arrange for margin and capital separately at each of the three stock exchanges and their respective clearing corporations. This led to a practice wherein broker members had to keep margins with each clearing house as all equity and derivative brokers are members of the BSE and the NSE, along with the Metropolitan Stock Exchange of India (MSEI). The stringent arrangement for clearing trades resulted in inefficient use of capital and high costs. Hence SEBI’s decision to link all the clearing corporations in the securities market and allow consolidation of the clearing and settlement function at any one of them. 

All the three exchanges — NSE, BSE and MSEI — are now test-running their risk management framework and surveillance systems and establishing default handling and dispute resolution processes to ensure no disruption in regular trade when they go live with interoperability. Once live, the Indian securities markets will be the first to bring about interoperability in the derivatives market where risk management is carried out in real-time. Globally, though many bourses have tried interoperability, it has been on a smaller scale. If India manages a smooth roll-out, it will make heads turn. Further, the move may unleash more competition for market shares among clearing corporations. It will also indirectly promote healthy competition among the stock exchanges which is currently missing.

The framework of interoperability consists of a peer-to-peer link and participant link that may be established across the CCPs (Clearing Corporations). In a peer-to-peer connection, a CCP maintains special arrangements with another CCP and is not subject to the normal participant (membership) rules. Risk management between the CCPs is based on a bilaterally approved framework, which is different from that applied to a normal market participant and ensures coverage of inter-CCP exposures. CCPs exchange margins and other financial resources on a reciprocal basis, based on mutually agreed to margin models. The linked CCPs incur current and potential future exposure to each other as a result of the net positions between the CCPs.

The accrued benefits of interoperability will be higher if a large number of exchange-traded products are available for trading, clearing and settlement under the interoperable framework. Currently, NSE has almost 100% market share in equity futures and options, and 95% of cash trades also happen on NSE. Now, with interoperability, this may change. Interoperability opened new opportunities for CCPs, with BSE being a listed stock, investors are talking about its clearing arm ICCL  revenue growth in the near future. 

Interoperability allows market participants to consolidate their clearing and settlement functions at a single clearing corporation, irrespective of the stock exchange on which the trade is executed, resulting in a reduction in compliance costs, and thus bringing down the trading costs or impact cost as well. Also, the efficient allocation of funds would lead to cost-effective trades and make exchange transactions more affordable. Member-brokers keep their funds and collateral with high buffer across exchanges and across different segments. Under interoperability of clearing corporations, broker-member will be able to consolidate and reduce buffer, lowering their overall collateral requirement, which definitely helps to reduce transaction cost for settle trades across the segment. This will be a big plus. Trading members will find it easy on margining.

Let say, if a broker has a ₹50 crore margin in NSE’s clearing corporation, can use that margin to trade on the BSE or MSEI as well under interoperability. This significant reduction in margin requirements is expected to bring down overall trading costs.

Interoperability among clearing corporation will save participants from glitches in case of issues in a particular exchange, or at the broker level for a specific exchange, it will separate the execution risk from the settlement risk and allow market participants to seamlessly square off their positions in case of outages of exchanges or at the broker level. Therefore, the execution risk can be decoupled from settlement risk as there can be an ‘arm’s length’ relationship between the exchange and adjunct clearing corporation.

The interoperability can catalyze competition among existing clearing houses in terms of prices and services they offer and can affect their margin requirement from the members and commission they charge on clearing. Also, it can potentially discourage the possibilities of inter-exchange arbitrage and agency risk since the working of clearing corporations together may bring down the inefficiency issue and improve market microstructure.

The author is the Co-Founder and CEO, FYERS