Context

In a statement, the European Union’s financial markets regulator European Securities and Markets Authority (ESMA) said it will withdraw recognition of Indian clearing bodies or central counterparties (CCPs).

What are CCPs?

• A central counterparty clearing house (CCP) is an entity that helps facilitate trading in various European derivatives and equities markets.
• Typically operated by the major banks in each country, CCPs strive to introduce efficiency and stability into various financial markets.
• It reduces counterparty, operational, settlement, market, legal, and default risk for traders.
• Function:
  • As the intermediary in a transaction: clearing and settlement.
  • As counterparties to the buyers and the sellers: guarantee the terms of a trade—even if one party defaults on the agreement.
  • CCPs bear the lion's share of the buyers' and sellers' credit risk when clearing and settling market transactions.
• Significance: CCPS offer fixed income to the investors and compulsorily convert into Equity Shares of the issuing company after a predetermined period. The terms of conversion are also pre-decided at the time of issue.
• The CCP replaces the trade at the current market price.

The decision for de-recognition by ESMA:

• ESMA has decided to withdraw recognition of six Indian CCPs which includes;
  • Clearing Corporation of India (CCIL)
  • Indian Clearing Corporation Ltd (ICCL)
  • NSE Clearing Ltd (NSCCL)
  • Multi Commodity Exchange Clearing (MCXCCL)
  • India International Clearing Corporation (IFSC) Ltd (IICC)
  • NSE IFSC Clearing Corporation Ltd (NICCL)
• As per the European Market Infrastructure Regulations (EMIR), a CCP in a third country can provide clearing services to European banks only if it is recognized by the ESMA.

What’s the reason for derecognition?

• ‘No cooperation arrangements’ between the ESMA and Indian regulators i.e. ,The Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI) and the International Financial Services Centres Authority (IFSCA).
• The ESMA wants to supervise these CCPs, which the Indian regulators are not in favour of as they feel that these entities have robust risk management and there is no need for a foreign regulator to inspect them.

How will the derecognition impact on European banks and India?

• Affect clearing and settlement activities: Some of the major European banks dealing in the domestic forex, forward, swap and equities and commodities markets include Societe Generale, Deutsche Bank and BNP Paribas will impact lenders as they will not be able to provide clearing and settlement facilities to their clients.
• Reduce the Portfolio capital generation in India: They will also have to set aside additional capital to trade in the domestic market, reports suggest. Of the total foreign portfolio investors (FPI) registered in India, close to 20 per cent are from Europe.