India
Financial Sector Assessment Program—Detailed Assessments Report on CPSS IOSCO Recommendations for Securities Settlement Systems and Central Counterparties

This paper discusses findings of the assessments on Committee on Payment and Settlement Systems–International Organization of Securities Commissions (CPSS-IOSCO) Recommendations for Securities Settlement Systems and Central Counterparties in India. The results indicate that, in general, the risk management framework for the securities and derivatives clearing and settlement systems in India is prudent. The operational reliability is high, and the regulation and oversight functions are effective. The National Payments System in India has undergone a major reform, in particular the securities and derivatives clearing and settlement systems. These systems are comprehensive and designed to minimize risks in the rapidly developing securities and derivatives markets.

Abstract

This paper discusses findings of the assessments on Committee on Payment and Settlement Systems–International Organization of Securities Commissions (CPSS-IOSCO) Recommendations for Securities Settlement Systems and Central Counterparties in India. The results indicate that, in general, the risk management framework for the securities and derivatives clearing and settlement systems in India is prudent. The operational reliability is high, and the regulation and oversight functions are effective. The National Payments System in India has undergone a major reform, in particular the securities and derivatives clearing and settlement systems. These systems are comprehensive and designed to minimize risks in the rapidly developing securities and derivatives markets.

I. General

1. The present document is the assessment of securities and derivatives clearing and settlement systems in India based on the Recommendations of the Committee for Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) for Securities Settlement Systems (RSSS) and the Recommendations of CPSS-IOSCO for Central Counterparties (RCCP). This assessment was conducted during a field mission of the Financial Sector Assessment Program to India in September 2011.2

2. The information used in the assessment includes relevant laws, bylaws, regulations, rules and procedures governing the systems, and other available material.3 In addition, extensive discussions were held with regulators, overseers, supervisors and operators, being the RBI, SEBI, FMC, CCIL, NSE, BSE, U.S.E, MCX, MCX-SX, NSCCL, ICCL, NSDL, CDSL and several stakeholders, including primary dealers, banks and broker-dealers active on the government securities market, the corporate securities and the derivatives markets in India as well as clearing banks that facilitate cash settlement for corporate securities and derivatives. A self assessment was prepared by the CCIL. The CFSA assessed the financial sector of India in 2009, including the payment and securities clearing and settlement systems.

II. Overview of the Infrastructure for Securities and Derivatives Clearing and Settlement Systems

3. The securities and derivatives clearing and settlement systems in India are organized around different types of products, which are: (1) government securities, money market instruments and forex instruments; (2) corporate securities and financial derivatives; and (3) commodity derivatives. The three sets of products are subject to different legal frameworks, different regulators and the clearing and settlement systems are operated by different entities. Figure 1 illustrates the securities and derivatives clearing and settlement systems for the first two sets of products.

Figure 1.
Figure 1.

India: Infrastructure of Securities Market in India

Citation: IMF Staff Country Reports 2013, 268; 10.5089/9781484346822.002.A001

4. Government securities are cleared by the CCIL and settled in the books of the PDO system of the RBI. Money market and forex instruments are also cleared by the CCIL. Cash settlement takes place in the Real Time Gross Settlement (RTGS) system of the RBI. Appendix 1 describes the RTGS system of the RBI and provides a summary of the most recent assessment results of the system. CCIL guarantees the settlement of the transactions and as such acts as CCP. The RBI is the regulator and overseer, based on the PSSA.

5. Corporate securities and financial derivatives are traded on the NSE, BSE, U.S.E, MCX-SX, and 17 regional exchanges. Corporate securities and financial derivatives traded on the NSE are cleared by the NSCCL. Corporate securities and equity derivatives traded on the BSE are cleared by the BSE, except for the mutual funds and corporate bonds, which are cleared by the ICCL. The ICCL also clears currency derivatives traded on the U.S.E. The MCX-SX clears the transactions executed on its trading platform by the MCX-SX CCL. NSCCL, BSE, MCX-SX CCL and ICCL act as the CCP for corporate securities and derivatives. The securities leg of transactions is settled in the NSDL and CDSL. The cash leg is settled in one of the commercial banks that act as clearing bank for the exchanges. The SEBI is the regulator and supervisor of these stock exchanges, including its clearing and settlement systems.

6. Commodity derivatives are traded on four national commodity exchanges and 17 regional exchanges. The four national commodity exchanges are the National Multi Commodity Exchange of India Limited (NMCE), the Multi Commodity Exchange of India Limited (MCX), the National Commodity & Derivatives Exchange Limited (NCDEX) and the Indian Commodity Exchange Limited (ICEX). Commodity derivatives are traded on bullion (41 percent in 2009), base metals (23 percent), energy products (20 percent) and agricultural commodities (16 percent). The commodity exchanges provide a trading platform for these securities as well as CCP facilities. Cash settlement takes place in the books of a number of clearing banks, which are the same clearing banks as for the corporate securities. The commodity market is regulated and supervised by the FMC acting under a different Ministry, being the Ministry of Consumer Affairs, Food and Public Distribution. The FMC is a statutory body set up in 1953 under the Forward Contracts (Regulation) Act, 1952. It supervises four national commodity exchanges and 17 regional commodity exchanges.

7. The CCPs and CSDs are user-owned companies and fall under the Companies Act, except for the PDO system, which is owned by the RBI. Table 1 reflects the interest of the NSE and the BSE in the different CCPs and CSDs. The NSDL and CDSL are partly owned by the stock exchanges and partly by professional market participants like banks and institutional investors. The CCPs are fully owned by the stock exchanges, whereas the stock exchanges are owned by banks, institutional investors and other financial institutions. CCIL is owned by banks, institutional investors and primary dealers.

Table 1.

India: Legal Status and Ownership Structure of CCPs and CSDs

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8. The different securities and derivatives clearing and settlement systems handle a large number of transactions and are as such of systemic importance. Tables 2 to 4 show the transaction volumes for the different products. Especially the derivatives segments saw increased activity during the last year. The cash market segments on the NSE and BSE are stable. The government securities and Collateralized Borrowing and Lending Obligations (CBLO)4 saw a decrease in 2010, but volumes are increasing again in 2011.

Table 2.

India: Cash Market Volumes as Percentage of GDP in 2010

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Source: World Federation of Exchanges and CCIL
Table 3.

India: CCIL Forex Market as Percentage of GDP in 2010

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Source: CCIL
Table 4.

India: Derivatives Market Volumes as Percentage of GDP in 2010

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Source: World Federation of Exchanges.

9. The scope of this assessment is limited to the first two sets of products. It is recommended that the clearing and settlement arrangements for the commodity derivatives market be assessed in the near future. The PDO system, NSDL and CDSL are subject to a detailed assessment using the CPSS-IOSCO Recommendations for SSS. ICCL, NSCCL, BSE and ICCL are subject to detailed assessments using the CPSS-IOSCO Recommendations for CCPs. Given the growth and volumes of the commodity derivatives market it is recommended that a more detailed assessment of the commodity derivatives clearing and settlement systems be considered in the immediate future.

A. Clearing and Settlement Arrangements for Government Securities, Money Market, and Foreign Exchange Instruments

10. During the last two decades, the clearing and settlement systems for the government securities market have been subject to many improvements. The DVP model 1 mechanism was introduced in 1995, the CCIL started operations in 2002, the same year as the introduction of the mandatory holding of government securities in dematerialized form. In 2002, the Negotiated Dealing System (NDS) was introduced as a trade reporting platform linked to the CCIL. The introduction of the RTGS system in 2004 enabled settlement in central bank money for government securities. The Negotiated Dealing System Order Matching (NDS-OM) was introduced in 2005 as an anonymous order matching system. A standardized settlement cycle of T+1 has been implemented in 2005 for all outright OTC and NDS-OM transactions in government securities.

11. The current trading, clearing and settlement arrangements allow for straight through processing (STP) of transactions in government securities, CBLOs and forex instruments. Transactions in government securities can be anonymously executed on the NDS-OM platform or traded in the OTC segment. OTC transactions have to be reported on the NDS platform. The NDS-OM and NDS platform automatically confirm the transactions and send them to the CCIL for clearing. The CCIL receives around 20 percent of the secondary market transactions in government securities from the NDS system and approximately 80 percent from the NDS-OM. Repos can be electronically traded on the Clearcorp Repo Order Matching system (CROMS) and OTC transactions in repos have to be reported on the NDS. For transactions in CBLOs, participants may use the CBLO Trading System operated by the CCIL. Transactions in forex and forex forward instruments are mostly conducted bilaterally between market participants using telephone trading. Participants may also use the Electronic Order Matching System (EOMS), Reuters and CCIL’s Fx Clear trading platform.

12. The CCIL is the CCP for all transactions in government securities and CBLOs, whereas only a part of the transactions in forex and forex forwards instruments are settled through the CCIL. Interest Rate Swaps are settled through the CCIL on a nonguaranteed mode. For guaranteed transactions the CCIL nets the positions of its participants on a multilateral basis at the end of every trading day, after which novation takes place. The CCIL has adopted a comprehensive risk management framework to protect itself against the failure of one of its participants. Participants of the CCIL have to comply with specific access criteria. The CCIL has 222 participants in the CBLO segment and 169 in the government securities segment, being banks, financial institutions, primary dealers and mutual funds. The CCIL measures its exposure toward participants on a daily basis and covers this by requesting participants to deposit margins and other collateral. The RBI is the regulator and overseer of the CCIL, ensuring that the legal, risk management and operational frameworks are safe and efficient. The CCIL is owned by banks, financial institutions and primary dealers, with the State Bank of India having a dominant position. The CCIL offers its participants the service of settlement of foreign exchange transactions (14 currencies) in CLS through the CCIL. The CCIL on its turn uses Royal Bank of Scotland (RBS) in London as a settlement participant in CLS.

13. The CCIL coordinates the cash settlement in the RTGS system of the RBI and the securities settlement in the PDO system of the RBI. Government securities are settled using a DVP model 3 mechanism on T+1. Repos are settled on T+0 or T+1. The PSSA supports the final and irrevocable character of the transactions, as well as the netting. Cash settlement takes place in designated settlement banks for those participants who do not have a current account at the RBI.

14. The PDO system is the CSD for dematerialized government securities as well as the registrar. Participants may open own accounts and client accounts. Participants with own accounts may be banks, primary dealers, central and state governments, pension funds, insurance funds, mutual funds, financial institutions and the NSDL and CDSL. Participants who open client accounts and fulfil custody services may be banks, primary dealers, NSDL, CDSL and CCIL. In August 2011 the PDO system counted 233 active own accounts and 88 client accounts.

15. Trading in government securities, CBLOs and forex instruments is dominated by professional market participants.5 Around 80 percent of volumes in government securities originate from banks, 8 percent from funds and 12 percent from other institutions. Retail investors can also trade in government securities on the NSE and BSE. The NSDL and CDSL provide settlement services, by acting as sub-custodians for government securities, having accounts in the PDO system. In practice however, retail participation in government securities is close to zero.

16. Volumes in all products have grown strongly, especially in the forex segment. Figure 2 shows that the average daily volume in 2011 (January to August) was US$19.5 billion for forex instruments, US$9.4 billion for CBLOs and US$5.9 billion for government securities and repos. The volumes in 2011 (January to August) are higher than the volumes for the full year of 2010.

Figure 2.
Figure 2.

India: CCIL Average Daily Volumes

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2013, 268; 10.5089/9781484346822.002.A001

Source: CCIL.

B. Clearing and Settlement Arrangements for Corporate Securities and Financial Derivatives

17. The securities clearing and settlement systems in India have seen significant changes during the last two decades. With the liberalization of the capital market in 1992 the SEBI was established. The SEBI has been supportive of competition in the securities market, and has created an enabling environment for development of new stock exchanges. As an outcome of this policy, the NSE was established. The NSE offered trading on an electronic trading platform, which successfully gained a substantial part of trading. The dematerialization of securities has increased the efficiency of the market the NSDL and later CDSL were established as central securities depositories (CSDs) The CCPs were established and risk management measures were taken to further reduce the clearing and settlement risk, for example by the introduction of rolling settlement, the compression of the settlement cycle to T+2 and the introduction of Delivery versus Payment (DvP) mechanisms.

18. Corporate securities and derivatives can be traded on four national stock exchanges and 17 regional stock exchanges.6 The BSE is the stock exchange with the largest market capitalization in India (US$1,632 billion), ranking as the ninth largest stock exchange worldwide. The NSE is the second stock exchange in India and the tenth largest stock exchanges worldwide, based on market capitalization (US$1,596 billion). In terms of volumes the NSE is the stock exchange with the highest turnover (US$798 billion in 2010) in India, ranking as the sixteenth largest stock exchange worldwide. The BSE is the second largest stock exchange in India and the twenty-fourth stock exchange worldwide, based on turnover (US$259 billion in 2010).7 The main indices are the BSE Sensex and the S&P CNX Nifty. The derivatives exchanges in India also rank high in international comparisons. Based on the number of contracts traded and/or cleared the NSE ranks fifth, the MCX, including the MCX-SX, ranks ninth, and the U.S.E ranks thirteenth.8

19. The NSE offers trading in equities, government and corporate bonds, warrants, exchange traded funds (ETFs), mutual funds, stock index options and futures, stock options and futures and currency options and futures. Transactions at NSE are executed on the National Exchange for Automated Trading (NEAT). BSE offers the same range of products except for the currency derivatives. Instead, BSE has a stake in the U.S.E that started a trading platform for currency futures and options in 2010. Transactions on BSE are executed on the BSE Online Trading System (BOLT).

20. The NSCCL is the CCP for transactions executed on the NSE. The NSCCL is a wholly-owned subsidiary of the NSE and legally a clearing corporation. The BSE is the CCP for transactions executed on the BSE trading platforms and legally a clearing house. Whereas the BSE offers the guarantee and risk management functions, the BOISL handles the operational processing of BSE transactions. BSE owns 49 percent of the BOISL and Bank of India 51 percent. ICCL is currently the CCP for currency derivatives traded on the U.S.E, as well as mutual funds traded on the BSE. The ICCL is legally a clearing corporation. The ICCL is a 100 percent subsidiary of the BSE. MCX-SX CCL acts as CCP to all the trades, provides full novation and carries out the business of clearing and settlement for currency futures contracts on MCX-SX. NSCCL, BSE, MCX-SX CCL and ICCL net the positions of their clients on a multilateral basis, after which novation takes place real time.

21. The CCPs have comprehensive risk management models to protect itself against the default of one of its members. Exposures and margin requirements are calculated on a real time basis for all client levels. The CCPs calculate several types of margin, including initial margin and variation margin, based on the internationally used VaR/SPAN model. Stress tests calculate whether the CCPs are able to withstand the default of the ten participants with the largest exposures.

22. The CCPs handle the DVP process for corporate securities. Transactions are settled using a DVP model 3 mechanism, with settlement on T+2. The securities leg of the transactions is settled in the books of the NSDL and CDSL. The cash settlement takes place in commercial bank money. The CCPs have appointed more than a dozen settlement banks as designated clearing banks. Criteria exist for their enrollment. Brokers and custodians have to designate one clearing bank for cash settlement purposes. Finality and netting as critical elements of the clearing and settlement process are covered by provisions of the bylaws of the stock exchanges. The PSSA is not applicable to stock exchange transactions.

23. Investors access the markets through registered intermediaries called stock brokers. The NSE has around two to three million investors participating in the market on a daily basis. Retail investors are a substantial part of the total investor based for corporate securities and derivative markets in India. The total number of retail investors was estimated to be eight million in 20079 and the estimate for 2009–10 was 12 million,10 representing the rapid growth in retail participation. Though these numbers are small compared in relation to the population of India, to put this in perspective, the estimated number of tax payers in India is only 26 million. Only intermediaries who have obtained a license from the SEBI are permitted to deal on behalf of investors. Given the vast geographical spread of the country and the large number of retail investors, investor empowerment and protection is a core function of both SEBI and the exchanges. The number of registered stock brokers was 9,325 on March 31, 2011. The NSE counted 1,389 registered brokers, of which 1,239 were corporate brokers and 1,301 on the BSE, of which 1,087 were corporate brokers.

24. Corporate bonds are tradable on the stock exchanges as well as in the OTC segment. The NSE and BSE offer trading in publically issued corporate bonds on the same platform as the corporate equities. Clearing and settlement arrangements are also similar, with NSCCL and BSE acting as the CCP for transactions in corporate bonds. NSDL and CDSL act as the CSDs for corporate bonds. OTC transactions are not guaranteed by NSCCL and ICCL, but the CCPs nevertheless coordinate the DvP settlement for corporate bonds, with cash settlement in the RTGS system of the RBI and the securities settlement in the books of NSDL and CDSL.

25. The RBI has taken several initiatives to develop the corporate bond market. However, settlement arrangements for corporate bonds traded in the OTC market are still not fully developed. The corporate bond market in India is underdeveloped compared to the equity and derivatives market. The RBI has supported the development of this market by enhancing the clearing and settlement arrangements, for example by (1) facilitating the settlement of secondary market trades in corporate bonds in the RTGS system, using a DvP model 1 mechanism. The NSCCL and the ICCL have obtained approval to maintain transitory pooling accounts with the RBI. Guidelines have been issued to all RBI regulated entities to mandatorily clear and settle all OTC trades in corporate bonds using the above arrangement with effect from December 1, 2009; (2) facilitating the development of an active repo market in corporate bonds. The guidelines for repo transactions in corporate debt securities were issued early 2010. The guidelines will enable repo in listed corporate debt securities rated ‘AA’ or above. The Fixed Income Money Market and Derivatives Association of India (FIMMDA) is working on the development of reporting platform and also on the Global Master Repo Agreement to standardize the repo transactions in corporate bonds.

26. The RBI has taken initiatives to increase the transparency and safety of the OTC derivatives market in India, in line with international standards.11 The RBI has set up a working group consisting of members of the RBI, CCIL and the FIMMDA to work out the modalities for an efficient, single reporting mechanism for all OTC interest rate and forex derivative transactions. Currently, several types of OTC derivatives are subject to different reporting requirements. The interbank reporting of interest rate derivative transactions is done electronically on CCIL, whereas client transactions are being collected on a weekly basis. Transactions in forex forwards and forex interest rate swaps are published in the Weekly Statistical Supplement of the RBI, with a time lag of two–three weeks. Cross currency derivative transactions are reported on a half yearly basis. The OTC trades in corporate bonds have to be reported on the corporate bond platform of the BSE, NSE or FIMMDA within 30 minutes after the transactions and repos in corporate bonds have to be reported on the FIMMDA platform within 15 minutes after the transaction. In addition, the RBI has proposed to set up a centralized Trade Repository (TR) for credit default swaps.

III. Detailed Assessments

Table 5.

India: Detailed Assessment of Implementation of the CPSS-IOSCO Recommendations for Securities Settlement Systems—PDO System of RBI

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Table 6.

India: Detailed Assessment of Implementation of the CPSS-IOSCO Recommendations for Securities Settlement Systems—NSDL and CDSL

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Table 7.

India: Detailed Assessment of Implementation of the CPSS-IOSCO Recommendations for Central Counterparties—CCIL

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Table 8.

India: Detailed Assessment of Implementation of the CPSS-IOSCO Recommendations for Central Counterparties–NSCCL, BSE, and ICCL

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Table 9.

India: Summary of RSSS Implementation—PDO System

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Table 10.

India: Summary of RSSS Implementation—NSDL and CDSL

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Table 11.

India: Summary of RCCP Implementation—CCIL

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Table 12.

India: Summary of RCCP Implementation—NSCCL, BSE, and ICCL

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Table 13.

India: Recommended Actions to Improve RSSS Implementation—PDO System

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Table 14.

India: Recommended Actions to Improve RSSS Implementation—NSDL and CDSL

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Table 15.

India: Recommended Actions to Improve RCCP Implementation—CCIL

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Table 16.

India: Recommended Actions to Improve RCCP Implementation—NSCCL, BSE, and ICCL

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A. Authorities’ Response

27. SEBI would like to appreciate the effort and time that has been put in by IMF and World Bank team to assess the securities settlement systems and central counterparties in the Indian securities markets. It is felt that the FSAP assessment has taken place at a most opportune time as it has provided us with an opportunity to showcase the architecture of our securities system to the world, especially in the context of the global financial meltdown. In the same breath, we candidly admit that third party assessments and suggestions like the ones provided by the FSAP in this report are also very important to us as it highlights areas that may contribute toward further improvement of the system.

28. Since the last FSAP assessment in 2001, Indian securities market has undergone a sea-change with major improvements in areas of regulatory framework, range of products, growth and reach of market, technology, investor participation, etc. The current FSAP assessment recognizes the significant progress made by SEBI, stock exchanges, clearing corporations, and depositories in the implementation of the IOSCO Principles since the 2001 assessment.

29. SEBI welcomes the recommendations that the legal backing of the clearing and settlement process be improved by addressing the issues of finality and netting at the level of law. SEBI has already taken action to recommend amendments to the Securities Laws to provide for finality of settlement obligations and netting. New laws are also in the process of being issued in order to provide for formal recognition of clearing corporations. Meanwhile the bylaws of the exchange/clearing corporations deem all settlements completed by them as final and irrevocable and support netting. They specify default procedures and provide the clearing corporation full powers over the collateral placed with the clearing corporation to provide for orderly conduct of the securities settlement process. The applicability of these bylaws have also been upheld by a few Supreme Court rulings—Vinay Bubna Vs. Bombay Stock Exchange, Supreme Court, 1999; and, Bombay Stock Exchange vs. Jaya I. Shah and another, Supreme court, 2004. Novation is supported by the Contract Act. Thus the existing legal framework is time tested and has proven to be robust.

30. The assessment has acknowledged the comprehensive risk management framework prescribed by SEBI as one of the pillars of the Indian securities settlement system. The system of online real-time margining, requirement for participants to deposit liquid collateral with the CCPs, real-time disablement of trading facility of the participants on exhaustion of the collateral, default management procedures including segment-wise settlement guarantee fund to cover the residual risk associated with defaults, inter-linkages between depositories, market-wide circuit filters and security specific price bands, etc, have prevented occurrence of any major defaults in the last decade.

31. SEBI has also taken note of the suggestion of the FSAP mission to “replace the commercial bank settlement model with the central bank settlement model.” The same was also highlighted in the recent FSDC meeting. Suitable market-wide consultation viz. consultation with stock exchanges/clearing corporations, stock brokers/trading members, clearing members and RBI will be undertaken in future to examine the issue.

32. While SEBI agrees with most of the recommendations/suggestions highlighted by the FSAP team in this report, it is felt that the following points will provide better perspective of assessment:

  • The assessment has suggested CSDs to maintain the fee schedule in an easily comparable format. It may be noted that SEBI has prescribed requirement to make available details of fees/charges of various services of depositories/depositories participants on the website of depositories for over five years as on date.

  • While assessing the observance of RCCP 4 by NSCCL, BSE, and ICCL, the FSAP team has highlighted in the report that the participants have to pay on a daily basis (T+1) the sum of initial, extreme loss and mark-to-market margin. It may be noted that the aforementioned description provided by FSAP team does not accurately reflect the strength of the margining system in Indian securities market. Initial and extreme loss margins are adjusted upfront, post-trade, from the collateral deposited by the participants with the CCP. Mark-to-market losses are collected in cash on the same day or latest before trading starts on the next day.

  • It is felt that the rating attributed to observance of RCCP 5 by NSCCL, BSE, and ICCL does not adequately reflect their level of observance of the CPSS-IOSCO recommendation. The recent tests undertaken by the CCPs to ascertain the adequacy of the liquid funds available with the CCPs have highlighted that the amount assured by the credit lines and the cash margins are sufficient to ensure timely settlement. Further, irrevocable credit lines with the major clearing banks of the CCPs (BSE and NSCCL) have been established with the objective to manage liquidity risk. With regard to the observation of FSAP team on revocability of credit lines established by CCPs, it may be noted that BSE and NSCCL have informed that their credit lines are irrevocable in nature and the same was informed to the FSAP team vide our earlier comments on the report.

    Further, the assessment report also suggests strengthening of the stress testing procedures of the CCPs and to improve the liquidity risk management. It may be noted that SEBI has initiated the process to strengthen the stress testing procedures of CCPs.

  • SEBI has also suggested upgrading the rating attributed to observance of RCCP 6 by NSCCL, BSE, and ICCL for the following reasons:

    • The bylaws of NSCCL and BSE provide details on situations when a member may be declared as a defaulter, utilization of funds including margins and the settlement guarantee fund in the event of default, etc.