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Macroeconomics and Finance in Emerging Market Economies

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Role of Clearing Corporation in Indian financial market development

Golak C. Nath
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The Clearing Corporation of India Ltd, Trade World C Wing, Kamala Mills Compound, Senapati Bapat Marg, Lower Parel, Mumbai, India Published online: 26 Aug 2008.

To cite this article: Golak C. Nath (2008): Role of Clearing Corporation in Indian financial market development, Macroeconomics and Finance in Emerging Market Economies, 1:2, 307-311 To link to this article: http://dx.doi.org/10.1080/17520840802253140

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Macroeconomics and Finance in Emerging Market Economies Vol. 1, No. 2, September 2008, 307311

POLICY AND MARKETS Role of Clearing Corporation in Indian nancial market development
Golak C. Nath*

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The Clearing Corporation of India Ltd, Trade World C Wing, Kamala Mills Compound, Senapati Bapat Marg, Lower Parel, Mumbai, India (Received 18 February 2008; accepted 26 February 2008) The Clearing Corporation of India (CCIL) was set up with the prime objective to improve eciency in the transaction settlement process, insulate the nancial system from shocks emanating from operations related issues, and to undertake other related activities that would help to broaden and deepen the Money, Gilts and Forex markets in India. The role of CCIL is unique as it provides guaranteed settlement of three dierent products under one umbrella. It has been instrumental in setting up and running NDS-OM, NDS-Call and NDS-Auction system for the central bank that had helped the Indian market to evolve and grow immensely. It had also immensely bolstered CCILs image in terms of ability to provide transparent, ecient, robust and cost eective end to end solutions to market participants in various markets. The success of its money market product CBLO has helped the market participants as well as the central bank to nd a solution to unusual dependence on uncollateralized call market. CCIL has introduced many innovative products/tools like ZCYC, Bond and Tbills indices, Sovereign Yield Curve, Benchmark reference rates like CCIL-MIBOR/MIBID and CCBOR/CCBID. Keywords: Clearing Corporation; clearing and settlement; India; novation; gilts; forex

Introduction The Indian debt market is dominated by Government securities in terms of primary issuance and secondary market trading. Banks are the major captive participants in the debt market mainly because of the Statutory Liquidity Ration requirements. Primary Dealers have been playing a dominant role in this market since 1995 as they have been established to support the Government securities market. Traditionally, debt securities and forex transactions were settled among banks themselves resulting in counter-party risk. All these settlement functions were carried out by the Reserve Bank of India (RBI). The Clearing Corporation of India Limited (CCIL) was set up under the auspices of the RBI, with the involvement of representatives of Primary Dealers Association of India (PDAI), Fixed Income Money Market and Derivatives Association of India (FIMMDA), Association of Mutual Funds in India (AMFI), and Foreign Exchange Dealers Association of India (FEDAI). It was set up with the primary objective to establish a safe institutional structure for the clearing and settlement of trades in Government securities, forex (FX), and money markets so as to bring in eciency in the transaction settlement process, and insulate the nancial system from shocks emanating from operations related issues. The six core promoters of CCIL are the State Bank of India, Life Insurance Corporation of India Limited, ICICI Bank Ltd, Bank of Baroda, and
*Email: gcnath@ccilindia.co.in; gcnath@yahoo.com
ISSN 1752-0843 print/ISSN 1752-0851 online 2008 Taylor & Francis DOI: 10.1080/17520840802253140 http://www.informaworld.com

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HDFC Bank Ltd. CCIL is a user-owned organization. Over the past ve years CCIL has emerged as a systemically important payment system. It has heralded many innovations and changes in the Indian debt and foreign exchange markets and has become a facilitator of growth in the money, debt, and forex markets. CCIL has been created with three distinct objectives: . Creating institutional structure for the Clearing & Settlement in Money, Gilts, and Forex related products. It provides a Structured Settlement System with Central Counter Party services. . Bringing in eciency in the transaction settlement process. This is done by providing Straight through Processing for most of its products and also provides substantial leverage benet to banks and institutions with Multilateral Netting. . Insulate the nancial system from shocks emanating from the operations related issues. This is achieved using Novation by guaranteeing settlement.

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Functions Settlement of transactions in this market commenced from February 2002 and CCIL moved to settling all trades in Indian Government securities including repo deals from April 2003. CCIL started settlement on Delivery Versus Payment (DVP)-II basis but from April 2004, it moved to DVP-III which provided both netting of funds and securities. In the Government securities market, CCIL settles all deals in both outright as well as repo. It undertakes guaranteed settlement of all trades, eliminating counter-party risk in both segments. Through this, CCIL provides to the market assurance of settlement, operational eciency, and overall lowering of operational costs. CCIL undertakes settlement in the Government securities market through novation and the multilateral netting process backed by guaranteed settlement. Through this process the funds settlement of all markets CCIL serves has migrated to a multilateral netting arrangement, whereby individual member obligations to pay or receive funds arising out of every single transaction are aggregated and oset into a single net fund obligation. This has reduced the number and overall value of payments between members, resulting in enhanced eciency of the payment system and reduced settlement costs despite the growth in market volumes (Figure 1). The earlier instances of gridlock and SGL bounce witnessed in the gilts markets due to problems associated with management of funds have become things of

Figure 1.

Business growth of CCIL.

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the past because of netting coupled with guaranteed settlement by CCIL. The netting factor has steadily increased and currently the netting factor for funds is around 80% and for securities is around 60%. These gures are comparable to the global standards. Facilitator in growth CCIL has leveraged its expertise in the Indian xed income market and has developed trading platforms in the Government securities and money market. It has developed the Negotiated Dealing System Order Matching (NDS-OM), an electronic, screen-based, anonymous, order driven trading system under the aegis of the RBI to facilitate transparency, better price discovery, liquidity, and increased operational eciency. The intrinsic features of this system like anonymity, online dissemination of market information, and its extension in terms of features like when issued trading and short selling and to participants like provident funds, pension funds, mutual funds, insurance companies other than the NDS members has resulted in an average of 80% of trading in the Government securities market shifting to this platform. The settlement of forex transactions started from 8 November 2002. This segment accepts the inter-bank Cash, Tom, Spot, and Forward USD-INR transactions for settlement through a process of multilateral netting. CCIL guarantees settlement of such trades and oers banks the benet of settlement eciency, considerable reduction in settlement and operational risk, reduction in intra-day liquidity requirements, and savings on settlement costs. CCIL has also developed a trading platform for forex trading called FX-CLEAR which commenced operations on 7 August 2003. The platform covers the inter-bank US dollar Indian rupee (USD-INR) Spot and Swap transactions and transactions in major cross currencies (EUR/USD, USD/JPY, GBP/USD, etc.). This trading platform has helped to reduce the cost of forex transactions as it is provided free of cost to members and has helped to enhance the depth of the market through wider participation of more banks. There is reduction of counter-party risk as all deals in this platform ow automatically to CCIL for settlement through Straight through Processing. Further, the introduction of CLS (Continuous Linked Settlement) for facilitating settlement of cross-currency transactions of all Indian banks is viewed internationally as a model to emulate, and has enabled banks in India to settle their cross-currency deals with reduced risk and liquidity. Collateralised Borrowing and Lending Obligation (CBLO) is a money market product developed by CCIL and approved by RBI to address regulatory concerns arising out of market dependence on the largely unsecured call and notice money avenues for funding operations. It was launched on 20 January 2003. The CBLO market is Indias rst success in the use of anonymous electronic trading in the money/bond market in India. As a repo variant, CBLO enables borrowing/lending of funds of various maturities fully backed by collateral in the form of Central Government Securities/Treasury Bills. The borrowing and lending takes place through an electronic anonymous order matching platform. Overcoming the limitation of the traditional repo, CBLO facilitates unwinding of both borrowing and/or lending positions. It also does not entail physical transfer of relative securities from borrower to lender or vice versa. CBLO settlements are guaranteed by CCIL as the central counter-party. This innovative money market instrument has beneted the entities that have been phased out from the inter-bank call money market. Volumes in this market exceed the combined volumes of the other segments of the money market like repo and call and it sets the rate for the other segments of this market (Figure 2). Further, the introduction of the

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Figure 2.

Distribution of short term money market activity in India.

CBLOi system has enabled trading through Internet platform for entities that cannot access the trading system through INFINET. CCIL also developed the NDS-CALL platform operationalized from 18 September 2006 to facilitate greater transparency and better rate discovery in the call money market. The system has also helped to improve the ease of transactions, increase operational eciency, and resolve problems associated with asymmetry of information. Despite trading on this platform being optional, the NDS-CALL segment has captured more than 80% of the trading in this market. CCIL has put in place a system for reporting all deals in Interest Rate Swaps and Forward Rate Agreements among banks and institutions as mandated by RBI. The system became operational from September 2007. This will help banks to overcome their reconciliation problems pertaining to IRS/FRA transactions. Robust risk management CCIL has a robust risk management system with checks like adequate exposure management, margining system, and loss allocation procedures. It has adopted Lamfalussy Standards for Risk Mitigation and all its operations are compliant with CPSS-IOSCO Principles. It has further fortied the risk management systems through back testing, stress testing with adequate BCP planning and supported by robust IT infrastructure. The risk system of CCIL is regularly evaluated by the central bank. The margins are based on exposures management principles on the basis of upfront capital contributed by market participants to the Settlement Guarantee Fund. For the forex segment, the concept of Net debit Cap is used to allow exposure to the members. Regular margins are collected using various principles like Mark to market, Volatility, and Concentration. The process keeps the system free from risk. In terms of international best practices, Lamfalussy Standards are used for allocation in the forex segment. Other initiatives Research activity in CCIL has thrived to address the data and analytical needs of the market. It releases the daily statistics on the trading and settlement activities pertaining to money, debt, and forex markets to newspapers, infovendors, and as well publishes the same on its website. This data is widely used by market participants to take informed decisions. CCIL also releases daily indices like Bond Index, CASBI, and T-Bill Index tracking the market movement in the Government securities market. It releases

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benchmark reference rates like the CCBOR/CCBID and CCIL MIBOR/MIBID tracking the order book of the CBLO and NDS-Call market, respectively, with two xings in a day to capture the movement in these markets. CCIL also releases weekly and monthly publications providing analytics on the debt and forex markets and research articles on these markets. The publications which are provided free of cost, have been greatly appreciated and utilized by members and other market participants as well as regulators. Since September 2004, CCIL has embarked on providing educational support to its members in the form of interactive training programmes as a part of its market development initiatives to spread knowledge in the money, Government securities, and forex markets. It caters to the need of ocers from banks, institutions, mutual funds, and primary dealers. These programmes have been conducted with the faculty support of CCIL senior ocials, ocials of RBI and banks, and faculty from management institutes like IIMs, IIT, etc. To date CCIL has imparted training to over 2400 participants through 47 programmes. The informational content and the practical relevance of these programmes in day-to-day operations have been greatly appreciated by the participants.

Notes on contributor
Golak C. Nath is a Senior Vice President in The Clearing Corporation of India Ltd.