Proposals to strengthen the clearing corporations

The core of risk management for any clearing corporation (CC) is collateral deposited by the stockbroker or trading or clearing member with the CC. Participants bring risk to the system by way of trades which the CC is obligated to settle with guarantee and the CC in turn tries to mitigate this risk by collateralization. The present system in India has certain unaddressed risks and further steps could be taken to mitigate them.

The Bankruptcy Law Reform Committee (BLRC), set up by the Department of Economic Affairs to study the “corporate bankruptcy legal framework in India”, has submitted a report on reforming the system, which contains a detailed analysis of safe harbour provisions in response to a submission received from the Securities and Exchange Board of India (SEBI). The BLRC agrees with SEBI’s proposal to amend the Securities Contracts (Regulation) Act, 1956 (SCRA), to provide safe harbours for CCs and stock exchanges in the event of the insolvency of clearing or trading members in the interest of settlement finality in the markets.

Key features

The salient features of SEBI’s proposals are: (1) In case of bankruptcy of clearing members, the collateral/assets which they have kept with a CC as mandated under the securities laws will not be subject to any other claim. (2) A CC’s priority rights to the collateral, deposits and assets of a clearing member in case of winding up or insolvency of a clearing member become essential, because the CC provides novation and counterparty guarantee to all trades, like a buyer to every seller and seller to every buyer. (3) Settlements in accordance with the rules, bye-laws and regulations of a CC/stock exchange before any order declaring any client or stockbroker or clearing member or the CC itself as bankrupt should be final, and any bankruptcy order should not have the effect of reversing such settlements, unwinding netting and recalculating net positions. (4) Settlement of trades which are executed to terminate or close out/square off open positions, after a bankruptcy order, should also be final and irrevocable. (5) A CC should have the first right over the collateral, deposits and other monies in whatever form contributed by a client or trading or clearing member towards its settlement or other obligations and any order of bankruptcy should not affect this right of a CC. However, any excess collateral left after defraying the settlement or other obligations should be returned to the defaulter or official liquidator.

Suhail Nathani is a partner and Yogesh Chande is an associate partner at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.