Foreign Exchange trades settlement in India

Introduction

The Clearing Corporation of India (CCIL) commenced its forex clearing operations on
8th November, 2002, offering a multilateral netting system for inter-bank forex dollar-
rupee transactions. CCIL acts as the central counter party and guarantees settlement
of all trades accepted for settlement.

CCIL is guided by the Core Principles for Systemically Important Payment Systems
formulated under the initiative of the Bank for International Settlements in
formulating the design of the system and its risk management features. Settlements
of inter-bank forex transactions, being systemically important, require to be core-
principle compliant. The operations required a prior approval from both the Reserve
Bank of India and the Federal Reserve Bank of New York, and were duly approved.
The Corporation has therefore been granted an ‘Authorized Person’ License under
FEMA 1999 by the Reserve Bank of India for conduct of foreign exchange clearing
and settlement operations and activities related thereto

Under the conventional method of settlement, foreign exchange transactions are

settled by transmission of financial instructions on a gross trade by trade basis
through a correspondent banking arrangement. In such a scenario, one
correspondent bank would receive payment instructions from customer banks during
the day to deliver funds to the account of a second correspondent bank for the credit
of the latter’s customer bank. The second correspondent bank would, likewise
receive instructions to deliver funds to the account of the first. In practice, both
correspondents are uncertain about the existence, time of arrival, and amounts of
these offsetting payments, which are sources of risk to their final cash position each
day.

Multilateral Netting is an arrangement whereby three or more counterparties

agree to aggregate and net their foreign exchange payments, generally through a
clearing house structure. Such an arrangement, will result in only a single payment
or receipt ,in each traded currency, to be made by each of the counterparties on any
given day. The clearing house not only becomes the repository of all the transaction
detail, performing aggregation and netting calculations for the participants, but can
also be substituted as counterparty to each deal, by novation.

To facilitate such clearing and settlement by a process of multilateral netting,

member banks send a copy of the trade confirmations to CCIL over the INFINET
network. CCIL validates and matches trades reported and subjects the matched
transactions to an exposure check. A Net Debit Cap (NDC) assigned to each member
on the basis of the concerned bank’s net worth, its capital adequacy ratio and other
financial parameters, determines the maximum exposure that CCIL is willing to take
on each bank. CCIL computes and settles on the value date, the net position of each
member on both the Rupee and the US Dollar leg.

Banks are required to contribute towards a Settlement Guarantee Fund in US Dollar

funds. The size of the contribution is determined in relation to the NDC. Further, CCIL
has lines of credit for ensuring that settlement will be completed even if there are
temporary shortfalls in fulfilling its settlement obligations by member/s on any given
day. Failure of a bank in meeting its obligation is addressed by withhold or recovery
of counter-value payable/paid to the bank.

Benefits

By choosing to settle their trades through CCIL, market participants gain in the
following ways:

− Assurance of settlement on the settlement date

− Reduction in counterparty exposure. (In case of government securities, the
exposure will get extinguished upon acceptance of trades for settlement; in forex
clearing & settlement, since a Loss Allocation Procedure is stipulated, the exposure
will not get extinguished but will come down from the gross level to the net level.)
− Operational efficiency
− Easier reconciliation of accounts (in case of forex trades)
− Improved liquidity and better leveraging (e.g., shorter holding periods for
government securities)
− Lower operational cost, overall

Settlement Procedure

Clearing Corporation has commenced live operations for settlement of Forex

Interbank deals from value date November 12, 2002 . Currently, CCIL's operations
cover the inter-bank Cash, Tom, Spot and Forward US Dollar-Indian Rupee (USD-
INR) trades.

Connectivity to the RBI's INFINET network is a pre-requisite for members availing of

CCIL's services for settlement of their trades.

No settlement and processing takes place on Saturdays, Sundays and such other
days as are not business days in either Mumbai or New York . There will be at least
one settlement per Mumbai and New York business day.

Members submit deal confirmation files, over INFINET to CCIL.. The deal
confirmation data received from the counter-parties are validated, matched, and
taken up for netting and settlement. Following the procedure of multilateral netting,
one net payable or receivable amount, in respect of both USD and INR, is arrived at.
The Rupee leg is settled through the members' current accounts with RBI and the
USD leg through CCIL’s account with the Settlement Bank at New York .

SGF for Forex Settlement

Introduction

Members of CCIL’s Forex Segment are required to deposit their margin contribution
into CCIL’s Settlement Guarantee Fund (SGF) maintained for this business segment.
Individual member contributions to SGF are a function of the Net Debit Cap allotted
to the concerned member and the margin factor assigned to it.

SGF is received in U S Dollars funds only to CCIL’s dedicated USD Nostro Account
with its Settlement Bank at New York, USA.

Composition

Member contributions to SGF are payable in US Dollars funds only.

Work Process

− Deposits

Members desirous of making SGF contributions are required to intimate CCIL about
the same using a prescribed format within cut-off timings prescribed for the purpose.
The relative contributions are to be remitted directly by the concerned member to
the credit of CCIL’s USD Nostro Account with its Settlement Bank in New York, USA.
Member balances are updated by CCIL upon receipt of relative funds into its USD
Nostro Account. Transaction Reports and Holding Reports are electronically delivered
to the concerned members along with other daily business reports.

− Withdrawals

Members seeking to withdraw from their SGF contributions are required to send a
prior written notice to CCIL about the same using a prescribed format within cut-off
timings prescribed for the purpose. Withdrawal payments are effected by CCIL by
credit of USD funds on relative value date to concerned members’ USD Nostro
Accounts with their correspondent banks under advice to the members, after their
SGF balances have been suitably reduced. Transaction Reports and Holding Reports
are electronically delivered to the concerned members along with other daily
business reports.

− Corporate Actions and Benefits

The funds received from members are invested by CCIL in approved investment
avenues such as US treasuries, Bank Deposits etc. Interest and other income earned
on such investments are distributed amongst members at six monthly intervals net
of costs, based on size and tenor of individual member holdings. This interest is
remitted in the same manner as SGF withdrawals under advice to members.