The tussle between Indian financial market regulators and their peers in developed countries over ‘extra-territorial jurisdictions’ is playing out on multiple fronts, leaving a dozen MNC banks trying to figure out the way forward.
The Reserve Bank of India (RBI) and Clearing Corporation of India (CCIL), which settles large volumes of trades on bonds, derivatives and foreign exchange, are trying to resolve a standoff with Bank of Japan (BoJ) and Financial Services Agency, Japan (JFSA) which are keen on having inspection rights over CCIL.
A similar demand has been made by the European Securities and Markets Authority (ESMA) and Bank of England (BoE) too.
Even as this inter-regulatory dialogue between Indian and Japan is underway, several European banks in the country have reached out to their headquarters, seeking legal opinion on whether they can use other banks in India as intermediaries and clearing members to avoid ‘directly’ dealing with CCIL as a central counterparty in the event Indian regulators are unable to strike a deal with ESMA and BoE.
Deals Outside CCIL
“Certain trades such as foreign exchange forwards of less than 13 months and government securities must be done through CCIL. There is no regulatory clearance to do these transactions outside CCIL on a bilateral basis. So, the question is: can we do forward trades where we deal with an Indian bank which then clears it with CCIL? Here, instead of making CCIL as CCP, we would be dealing with a local bank which will act as an intermediary between my bank and CCIL. We are trying to find out from legal and compliance whether such indirect deals with CCIL would fall foul of BoE or ESMA rules,” a senior official of a European bank told.
Unlike the European banks which have a large presence in India, the hurdles faced by Japanese banks — with only three of them running branches — may be comparatively easier to overcome. BoJ and JFSA have been unwilling to recognise CCIL as a ‘qualified central counterparty’ (CCP) in the absence of certain supervisory rights.
“The matter has been under discussion for two years and regulators have been sticking to their respective stands. However, about a week ago, RBI and CCIL have asked BoJ and JFSA to consider giving an exemption to CCIL as volumes of transactions through CCIL are below a certain threshold level. So, the issue here is whether CCIL could be spared of the conditions that Japan insists should apply to qualified CCP whose volumes are above this threshold level, Japanese authorities are yet to respond,” said a regulatory official.
According to industry circles, due to Japan’s regulatory stance, Japanese banks in India such as MUFG, Mizuho and Sumitomo Mitsui Banking Corp have been carrying out transactions like inter-rate swaps (IRS) on a bilateral basis with other banks outside the framework where CCIL acts as the counterparty.
“This is possible because RBI never finalised a draft regulatory mandate that required IRS trades to have CCIL as counterparty. But, for forex forward trades (up to 13 months) Japanese banks are still using CCIL because RBI regulation clearly requires them to,” said a dealer of a local private bank.
‘Not Much Time Left’
Besides currency forwards done to hedge currency risk of clients, a bank treasury is required to use CCIL in transactions like repo (or, repurchase of securities to borrow or lend money against gilts) and purchase and sale of government bonds.
While repo can be done in bilateral deals, the trades must be reported to CCIL; and government bonds — traded on faceless, order matching platforms like that for repos — are settled through CCIL. Other foreign currency trades like ‘cash’, ‘tom’ or ‘spot’ — settled on the same day or next day or after two working days, respectively — are done bilaterally. Also, forex forwards above 13 months are settled bilaterally. But a chunk of a bank’s dealing room volumes is contributed by shorter maturity forex forwards, government bond trades, and repo where CCIL plays a significant role.
“If RBI allows all trades to happen bilaterally, we can settle deals outside CCIL, though capital requirement would go up a little. But I doubt whether RBI would permit this as it would be considered as a retrograde measure,” said another person. Indeed, after the 2008 meltdown, regulators across the world, particularly in advanced markets, favoured clearing and settlement of trades along with regular reporting of transactions, with a CCP. This led to framing of uniform regulations for all qualified CCPs in Europe, US and in other countries.
Differences cropped up with European regulators revising the rules that would come into effect from May 1 under ESMA regulations and July 1 under BoE regulations. “There is a feeling that these overseas regulators have unilaterally drafted the rules. Sharing of information by Indian CCPs is one thing. But Indian authorities will not accept if overseas regulators have the powers to impose penalties on CCPs in India. Sebi has suggested a framework of joint inspection and foreign regulators obtaining NOC before initiating inspection,” said a source.
Since a similar impasse with one of the US authorities could not be resolved, US banks in India avoid CCIL for ‘interest rate swaps’ (IRS) deals. So, if an Indian bank or a European bank does an IRS to hedge risks arising from adverse interest rate movements with a US bank, it is settled bilaterally.
“But this is not the case for forex forwards, or gilts. Actually, the months from now to May 1 and July 1 is the ‘run-off period’ for these overseas regulators during when European banks have to unwind their positions. So, there isn’t much time left,” said a banker.
Besides CCIL and NSE Clearing Corporation, which clears trades on India’s largest stock exchange NSE, ESMA has derecognised four other CCPs in India. Besides significantly impacting banks’ treasury and custody business, the move could affect some of the stock trades by foreign portfolio investors (FPIs) from Europe which account for 18% of the total AUM of FPIs.