[Vaibhav Gautam is a third year student at NALSAR University of Law, Hyderabad]
Clearing corporations (“CCs”) are integral to the securities ecosystem, as they serve as central counterparties for the trades executed on exchanges. Their primary role involves guaranteeing the settlement of trade by managing risks and providing finality to the settlements. Their nature as risk managers comes along with heightened scrutiny, particularly with respect to their ownership structure. In India, the majority of the CCs are wholly owned subsidiaries of the parent exchanges.
Against this backdrop, the Securities and Exchange Board of India (“SEBI”) issued a consultation paper titled “Review of Ownership and Economic Structure of Clearing Corporations,” (“Paper”) on November 22, 2024. Through this, SEBI responded to the growing need for having independent and self-sufficient CCs. Accordingly, SEBI proposed two alternative approaches through which the diversification of the CC’s ownership structure could potentially take place.
This post provides a comparative analysis of the two potential approaches of SEBI for restructuring the ownership of CCs. The discussion emphasizes how one of the approaches offers a more definitive solution to the issue of their ownership structure than the other approach which inherently suffers from critical gaps. The potential drawbacks of the preferred approach, and how they are outweighed by its advantages, have also been explored in this post.
Problems Inherent in the Present Ownership Structure
Presently, under the regulation 18 of the Securities Contract (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018 (“SECC Regulations”), at least 51% of the paid-up equity share capital of the CCs must be owned by one or more of the recognized stock exchanges. This framework has led to major CCs, such as the NSE Clearing Limited, and the Indian Clearing Corporation Limited (“ICCL”), being constituted as wholly owned subsidiaries of parent stock exchanges of the National Stock Exchange (“NSE”) and the Bombay Stock Exchange (“BSE”), respectively.
Although such a governance structure allows for operational alignment between the CCs and the stock exchanges, it also leads to significant conflict of interests between the two. The commercial interests of the stock exchanges could potentially influence the operations of CCs, thereby undermining their operational independence, and their role as public utilities. In the paper, SEBI has also acknowledged that CCs require significant financial support from the parent exchanges to either develop their infrastructure and human resources or to augment their Settlement Guarantees Fund (“SGF”). In meeting the capital requirements of its subsidiaries, the parent exchanges might also suffer a conflict of interest with the commercial interest of its own and its shareholders.
Under the current guidelines, CCs are prohibited from listing; however, when the stock exchanges are listed, it also leads to a sort of vicarious listing of the CC itself. Additionally, the market’s observed growth also highlights the need for having well organized and independent CCs, since they also implicitly affect other market players and intermediaries, as noted by SEBI in its paper. The 2018 report of the Gandhi committee also acknowledged that the market infrastructure institutions (“MIIs”) must have a dispersed ownership. It also recognized that CCs by their very nature are risk bearing MIIs, and hence it is highly desirable that their ownership should also be widely held.
Globally, where there are multiple exchanges such as in the United States or the European Union, the CCs tend to be widely held. On the other hand, in the United Kingdom, since there is one major parent exchange, the CCs are its subsidiaries. Following the global context, the CCs in India should ideally be dispersedly held by different stakeholders, such as in the case of the Clearing Corporation of India (“CCIL”) which is held by several banks, insurance companies and corporate bodies. However, most of the CCs in India continue to be wholly owned subsidiaries of stock exchanges, rather than being widely held by several stakeholders in the market.
Weighing the two Approaches
Recognizing the importance of the diversification of CCs’ ownership, SEBI proposed two alternative approaches to potentially secure independence of CCs and uphold market integrity. The first approach involves a pro-rata distribution of 49% of the shares of the CC to existing shareholders of the parent exchange. The parent exchange would retain a majority stake of 51% initially; however, it would be obligated to gradually reduce the stake to either 15% or less. According to SEBI, this would ensure a smooth transition of shares while maintaining compliance with the current SECC Regulations.
However, the first approach fails to provide specific timelines for divesting the shares of the parent exchanges in CCs, which could pose the issue of indefinite delays in transforming the ownership structure and risk a fallback to the status quo. The absence of enforceable timelines could allow the shareholders of the exchange to indefinitely prolong the divestment of their shares, effectively defeating the vision of independent CCs. Additionally, the continued involvement of the stock exchanges in the CCs does not resolve the persisting issue of conflicting interests of the exchanges and the CCs. By allowing partial ownership, this route could also potentially lead to fragmented governance and operational inefficiency in the equity market. The feasibility of this approach is further complicated by the lack of incentives for the existing shareholders of the parent exchanges to voluntarily reduce their shareholding in the CCs.
On the other hand, the second approach offers a more definitive solution, through complete decoupling of the entire shareholding of a CC to the existing shareholders of the exchange. This would entail a complete break of the operational linkage between the CC and the parent exchange. This approach, though, would require significant amendments to regulation 18 of the SECC Regulations, which mandates at least 51% of CCs ownership to be held by one or more stock exchanges. However, such challenges would be outweighed by the long-term benefits of this approach. Primarily, the issue of conflicting interests would be resolved significantly since parent exchanges would not be linked with the CCs operationally. Secondly, this approach would help recognize the vision of truly independent, and self-sufficient CCs, which is ultimately the objective behind SEBI’s consultation paper. Thirdly, this transformative structural change would also enhance trust and uphold market integrity among different participants and stakeholders, owing to the reinforcement of neutrality and impartiality. The second approach also prevents vicarious listing of the CCs, owing to the complete break from the parent exchanges, which was one of the major concerns of the SEBI. Lastly, the second approach also aligns with global practices, as it widely distributes the ownership of several CCs in the Indian context.
While this approach is clearly preferrable over the first, it is important to acknowledge that it is not a perfect solution. Apart from the significant amendments to the regulation 18 of the SECC Regulations, this approach could also lead to dual regulatory oversight from the SEBI and the Reserve Bank of India (“RBI”), due to the implications arising from the Payment and Settlement Systems Act, 2007 (“PSS Act”). SEBI’s position that the second approach would only be preferred if the RBI clarifies that PSS Act would be inapplicable to the CCs is a cautious but flawed stance. This position undermines the primary objective of independence and self-sufficiency of the CCs over regulatory ambiguity.
Even if the PSS act is applicable, regulatory alignment between SEBI and RBI can still be achieved without necessarily compromising the primary objective of diversification. To address such ambiguity, a joint framework or a Memorandum of Understanding can be entered into between SEBI and RBI, to streamline the compliance requirements for CCs, without undermining the main objective behind the reform. It is the author’s view that the second approach must be preferred, irrespective of the applicability of the PSS Act.
Concluding Thoughts
Despite its implementation challenges, it can be concluded that the second approach stands as the most definitive option to realize the vision of independent and self-sufficient CCs. While the first approach offers a much smoother transition, it suffers from critical shortcomings such as undefined timelines, persisting conflict of interests, and lack of enforceable mechanisms. On the other hand, the second approach ensures operational autonomy of the CCs, and significantly reduces the conflict of interests between the CCs and the parent exchanges.
One of the major concerns is that of regulatory ambiguity, however the same can be overcome by coordinated efforts between SEBI and the RBI. Apart from the implementation hurdles, questions also arise regarding the financial viability of truly independent CCs, given that the capital support from exchanges would be withdrawn. But such hurdles would significantly be outweighed by the long-term advantages achieved through complete decoupling of the shareholding of the CCs from the parent exchanges. It is the author’s view that SEBI should focus extensively on the independence on the CCs, rather than placing reliance on external regulatory factors such as the PSS Act, which can be overcome through coordination between the financial authorities.
– Vaibhav Gautam
