In today’s Finshots, we give you a simple explainer of why the European Authorities have threatened to derecognise Indian clearing houses.
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The Story
Imagine you’re trying to buy a few stocks on a broking platform. It’s not like the broker can magically whip up the stocks you need and sell them to you. They don’t have inventory. Instead, every time you make a request the broker tries to find sellers on your behalf. So at the end of it all, you may end up buying 5 stocks from person A and 5 stocks from person B.
Once the order matching is complete, the trade goes through. And this is when our protagonists step in to “settle” the matter once and for all — A clearing corporation or a clearing house if you will. They’ll look at everyone’s transactions and see who owes what. They’ll send you the stocks you wanted and they’ll give the sellers the money they’re owed. And they assume all the risk in the event something happens. Say somebody defaults on their obligations.
They’re the mediators making sure everything goes through without a hitch. And they mediate transactions that involve all kinds of financial contracts— stocks, derivatives, foreign exchange, or commodities. They’re a crucial cog in the financial system.
But two weeks ago, something major happened.
The European Securities and Markets Authority (ESMA), a financial market regulator in Europe, said that it wouldn’t recognise six Indian clearing houses anymore. The likes of Clearing Corporation of India (CCIL) and the Indian Clearing Corporation Limited. Two entities regulated by the RBI and SEBI respectively.
And it’s big news because 20% of all foreign investors who dabbled in Indian securities originate in Europe.
Without an Indian clearing house in between, European entities will have a tough time buying and selling all securities in India. Things could get complicated.
So the big question is — Why does the ESMA want to drop our clearing houses off their list?
Well, clearing houses have been around for a long time. And since every country has its own very specific requirements, they also had different regulations. Unfortunately, this is an era of globalism. We are all interconnected. And the 2008 financial crisis proved this rather unequivocally. Contagion in the US spread quickly to other parts of Europe. Regulators quickly realised they needed to cooperate better.
And so they came up with something called the European Market Infrastructure Regulation or the EMIR to cover everyone in the EU.
The thing is, the ESMA also wanted clearing houses located in other countries to abide by their rules. After all, when a clearing house settles foreign transactions (between buyers and sellers in India and Europe), they have to deal with European banks in the process. So it kind of made sense for the ESMA to be extra cautious.
But that’s precisely what’s causing the issue right now.
The ESMA believes Indian clearing houses aren’t complying with their rules and they want more oversight!
Sure, getting a clearing house in a foreign country to submit some compliance reports is one thing. But directly overseeing transactions and inspecting a clearing house in India? Well, that’s a different matter. It’s like the ESMA wants to infringe upon the authority of the RBI and SEBI. And you can imagine that the RBI is not pleased with that. It doesn’t want a foreign body supervising or auditing its entities.
And it makes sense you know?
So the RBI simply went, “sorry, we won’t cooperate with you on this matter.”
Unfortunately, the ESMA doesn’t want to budge either. And in their ultimatum, they’ve made it clear that if we don’t cooperate, our clearing houses cannot serve as intermediaries while settling certain foreign transactions.
Now here’s the thing. This impasse could hurt folks on both sides
You see, European banks such as Deutsche Bank, Societe Generale, BNP Paribas and Credit Suisse will have to set aside more capital to function. Nearly 40–50 times what they have now. Simply because they’ll need to deal with clearances and settlements themselves. It’s like setting up their own clearing houses and taking all that risk we alluded to earlier. For all you know, they could choose to exit the country instead.
And as we noted, 20% of all “foreign trades” originate in Europe alone. And some of our clearing houses could lose a large chunk of their business.
So, what’s the way out of this now?
We don’t know yet. Someone has to cede ground. European banks won’t want to lock up more capital. And Indian clearing houses will want to keep their business running. So the only way out seems to be — Compromise! And one suggestion is that we create another entity that’ll act as a go-between. This entity will be approved by the ESMA. But, it’ll be set up in India to monitor our clearing houses. And since we’ve done something similar in the past for the US, we can do it again for Europe, no?
We’ll just have to see if the RBI is onboard now.
Until next time…
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So why is this happening?
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There’s another reason why millennials should probably consider looking at a term plan — Debt. Most people we spoke to have home loans, education loans and other personal loans with a considerable interest burden. In their absence, this burden would shift to their dependents. It’s not something most people think of, but it happens all the time.
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