Reforming Payment and Securities Settlement Systems – Global Course organised by the World Bank and US Federal Reserve Board Session on Main Environmental

Reforming Payment and Securities Reforming Payment and Securities Settlement Systems – Settlement Systems – Global CourseGlobal Course organised by theorganised by theWorld Bank and US Federal Reserve BoardWorld Bank and US Federal Reserve Board

Session onSession on

Main Environmental Issues inMain Environmental Issues inPayments and Securities Payments and Securities Settlement Systems Settlement Systems

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AgendaAgenda

Issues in Payment and Settlement SystemsIssues in Payment and Settlement Systems Sharing the Indian ExperienceSharing the Indian Experience

Current market structureCurrent market structure The processThe process Regulatory and legal frameworkRegulatory and legal framework Supervisory frameworkSupervisory framework Governance and Ownership structureGovernance and Ownership structure Risk managementRisk management Managing the changeManaging the change

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© Reynolds and Hines, 2000

What drives the reforms• Settlement risks• Iliquidity• Market inefficiency

Basically benefit driven reforms

The strategic process and need for sequencing• PSS reform an integral part of market reforms• Market process integrated end to endHence sequencing needed

Manage the change • Efficient management of change – regulatory support• Take market participants along• Assess end-users’ needs• Use technology and skill set

What drove PSS reforms in India• securities market critical to the economy• Demand from the end usersSEBI – key driver of the change

Issues in Reforming Payment and Issues in Reforming Payment and Securities settlement SystemsSecurities settlement Systems

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Full range of products in cash and derivatives market –

• equity, bonds, government securities, exchange traded funds, index options and futures, stock options and stock futures, interest rate derivatives and propose to introduce currency derivatives.

• OTC market for corporate bonds and government securities, and interest rate derivatives also exist

Sharing the Indian ExperienceSharing the Indian Experience Current market structureCurrent market structure

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The objectives of the reforms in the securities settlement systems –

Reduction and mitigation of systemic, structural and operational risks Increase speed of transaction, execution and settlement of trade and facilitate Quicker settlement of transactions with finality Safety of the settlement process Reduction of transaction costs and thereby Make market more efficient and transparent for investors and participants

Sharing the Indian ExperienceSharing the Indian Experience Current market structureCurrent market structure

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Sharing the Indian ExperienceSharing the Indian ExperienceCurrent market structure Current market structure (contd.)(contd.)

T+2 Rolling SettlementT+2 Rolling Settlement Central Counterparty providing novation and settlement guaranteeCentral Counterparty providing novation and settlement guarantee Electronic Transfer of SecuritiesElectronic Transfer of Securities 99.99% settlement in dematerialised securities99.99% settlement in dematerialised securities Limited Straight Through Processing (not yet mandatory forLimited Straight Through Processing (not yet mandatory for participants)participants) Fine-tuned VaR based Risk Management System for Fine-tuned VaR based Risk Management System for cash and derivatives, including real time SPAN for cash and derivatives, including real time SPAN for derivativesderivatives State of the art information technologyState of the art information technology 100% electronic trading which obviates need for trade 100% electronic trading which obviates need for trade

confirmationconfirmation Finality of settlement from the moment trade is executedFinality of settlement from the moment trade is executed ISIN for securitiesISIN for securities Electronic and automated communication standardsElectronic and automated communication standards

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Sharing the Indian Experience – Sharing the Indian Experience – The processThe process

Market automation –

National Stock Exchange set up in in 1994; SEBI first encouraged and then mandated automation of all 23 stock exchanges, which was completed by

end 1997

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Dematerialisation

began with the setting up of NSDL under an Act in

1996. It gathered momentum from 1998 with SEBI

mandating it for the market in a phased manner. By 2000 the market was settling in dematerialised securities.

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Sharing the Indian Experience –Sharing the Indian Experience – The processThe process

During this period several other measures were taken

Broker domination was reduced from governing boards of exchanges CCPs and Trade guarantee funds were set up at the exchanges to guarantee settlementBUT the trading in securities was still account period and derivatives had not picked up at all.

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The automation of exchanges, dematerialisation and CCPs had prepared the market for a major transformation.This happened following an episode of major market misconduct in 2000.From June 2001 account period settlement was abolished by SEBI and T+5 rolling settlement was introduced.Derivatives trading began to take off

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Between 2002 –till date rapid progress in market reforms

Settlement cycles shortened to T+3 in April 2002, to T+2 in April 2003 Derivatives products expanded – to include single stock options and futures. The market picked up Margining system in cash and derivatives – VaR based and real time SPAN Risk management refined STP introduced


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Between 2002 –till date rapid progress in market reforms (contd.)

Further changes in the governance of the stock exchanges Role of brokers in the management of stock exchanges eliminated Demutualisation of stock exchanges with segregation of trading ownership and management rights. Electronic fund transfer introduced by RBI RTGS to be set up soon CCIL settles G-sec trading on NDS


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CSACSA CLEARING BANKS

CUSTODIAN / CM

EXCHANGE

DEPOSITORY

10 5

8

6

1

22 3

4 11

9

7CSA

For reforms of the Securities Payment and Settlement Systems to be effective, reforms must be sequenced so as to embrace every part of this process, as all the parts are integrally related

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Regulatory framework for securities markets :Regulatory framework for securities markets :

Securities and Exchange Board of India Act,1992 (SEBI Securities and Exchange Board of India Act,1992 (SEBI set up under this Act); set up under this Act);

Securities Contract (Regulation) Act, 1956Securities Contract (Regulation) Act, 1956 (Act to establish and regulate exchanges);(Act to establish and regulate exchanges); Depositories Act, 1996 (regulates depositories);Depositories Act, 1996 (regulates depositories); Companies Act, 1956 Companies Act, 1956 SEBI regulates and supervises the securitiesSEBI regulates and supervises the securities markets through 23 Regulations and 2 Guidelines.markets through 23 Regulations and 2 Guidelines. SEBI exercises powers under the first 3 Acts and SEBI exercises powers under the first 3 Acts and some powers under Companies Act.some powers under Companies Act. In addition the bye laws, rules and regulations of exchanges approved by SEBI

Sharing the Indian ExperienceSharing the Indian Experience Regulatory and legal framework Regulatory and legal framework

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Transparent and effective regulation and oversight of securities settlement system is thus largely based on statutes.

These statutes and regulations, together with the bye laws, rules and regulations of the exchanges, which are under constant review provide a well founded, clear and transparent legal basis for trading, settlement, enforcement of securities contracts and protection of investors interests.


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Well founded, clear and transparent legal basis for trading, settlement, enforcement of securities contracts and protection of investors interests.

Transparent and effective regulation and oversight of settlement system largely based on statutes.


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SEBI supervision over the stock exchanges,clearingSEBI supervision over the stock exchanges,clearing houses and corporations, stock brokers, houses and corporations, stock brokers, depositories and depository participants, through depositories and depository participants, through constant dialogue, periodical meetings, reportingconstant dialogue, periodical meetings, reporting and annual inspection and review. and annual inspection and review.

Any change in bye laws, rules and regulations of Any change in bye laws, rules and regulations of exchanges and depositories need the approval ofexchanges and depositories need the approval of SEBISEBI

The risk management of the cash and derivativesThe risk management of the cash and derivatives market laid down in consultation with SEBImarket laid down in consultation with SEBI

Sharing the Indian ExperienceSharing the Indian Experience Supervisory framework Supervisory framework

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Sharing the Indian ExperienceSharing the Indian Experience Governance and Ownership structureGovernance and Ownership structure

InstitutionInstitution OwnershipOwnership GovernanceGovernance

National Stock ExchangeNational Stock Exchange Domestic Financial Domestic Financial Institutions and banks Institutions and banks Owned by financial Owned by financial institutionsinstitutions

Independent and Independent and

Shareholders; no Shareholders; no

broker as office bearer broker as office bearer

Other exchangesOther exchanges Broker owned; in the Broker owned; in the process of process of demutualisationdemutualisation

Independent and Independent and

Shareholders; no Shareholders; no

broker as office bearerbroker as office bearer

Clearing corporationClearing corporation 100% subsidiaries of 100% subsidiaries of exchangesexchanges

Shareholder and Shareholder and independent directorsindependent directors

NSDL, CDSL andNSDL, CDSL and

CCILCCIL

Financial Institutions and Financial Institutions and banksbanks

RBI RBI

Shareholders and Shareholders and independent directorsindependent directors

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All risk management measures need the approval of the Securities and Exchange Board of India

Capital adequacy norms Trading and exposure limits On-line exposure monitoring Automatic disablement of members VaR and MTM margining Margining at client level Market wide circuit breakers Trade/settlement guarantee funds History maintenance of members activities Contingent plans Inspection and investigation

Sharing the Indian ExperienceSharing the Indian Experience Risk management Risk management

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Sharing the Indian ExperienceSharing the Indian Experience Risk management Risk management (contd) (contd)

Margining For the Cash Market – Margining For the Cash Market –

Securities categorised on measures of liquidity and volatilitySecurities categorised on measures of liquidity and volatility For liquidity - using mean impact cost analysis on the For liquidity - using mean impact cost analysis on the

basis of random snapshots (4 time a day) of daily order basis of random snapshots (4 time a day) of daily order book over past six months on a rolling basis;book over past six months on a rolling basis;

For volatility- using index sigma and stock sigmaFor volatility- using index sigma and stock sigma Computation methodology disseminated to public through Computation methodology disseminated to public through

the web sites of the exchangesthe web sites of the exchanges Margins are on a gross basis – gross across securities for Margins are on a gross basis – gross across securities for

the same client, but netted for the same secuirtiythe same client, but netted for the same secuirtiy All calculations systems driven – no manual intervention at All calculations systems driven – no manual intervention at

any stage, except for setting the algorithmsany stage, except for setting the algorithms Above methodology validated by extensive back testingAbove methodology validated by extensive back testing

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Margining For the Cash Market – Margining For the Cash Market –

VAR margin covers a confidence interval of 99% over a VAR margin covers a confidence interval of 99% over a one day time horizonone day time horizon

Second line of margining for the balance 1% scenarioSecond line of margining for the balance 1% scenario In addition Mark to market marginIn addition Mark to market margin

Margins collected on T+1, before trading begins next dayMargins collected on T+1, before trading begins next day Inability to pay margins results in automatic switching off ofInability to pay margins results in automatic switching off of member terminal denying access for fresh ordersmember terminal denying access for fresh orders

In addition members have gross exposure limits related to theirIn addition members have gross exposure limits related to their capital which is on line monitored real time by the exchangescapital which is on line monitored real time by the exchanges Margins to be brought in cash and government securities Margins to be brought in cash and government securities (with hair cut) and bank guarantee from selected banks(with hair cut) and bank guarantee from selected banks

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Both models of CCP available – Clearing Corporation of National Stock Exchange set up by the exchange as wholly owned subsidiary, acting as CCP to all trades and novation with multi lateral netting

Stress tests done to check the adequacy of trade guarantee funds of the CCP

So far no occasion in which the CCP has failed on account of inadequacy of capital. The clearing corporation of NSE has back stop liquidity facility with the central bank by way of line of credit which it had no occasion to draw upon in the last 7 years even under conditions of extreme market volatility

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Sharing the Indian ExperienceSharing the Indian Experience Risk management Risk management for the Derivatives Market

CCP SPAN system Real time SPAN monitoring Gross margining Margins paid upfront – cash or cash equivalent Clearing member margin Client level margins Exposure limits – over all market wide position limits,

clearing member position limits, client level position limits Possible loss on entire portfolio of entire portfolio estimated under a variety of price and volatility scenarios Entire margin system with automatic shut off of terminals in case of breach of exposures or non payment of margins

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Extensive consultative process with the market participants – helps build up consensus

Various consultative and advisory committees set up by SEBI comprising of market participants, experts, academics Reports of the committees put out for public comments

Consultation and coordination with other regulators

Frequent meetings with the stock exchanges and intermediary associations, chambers of commerce

Extensive programme of investor awareness.

Sharing the Indian ExperienceSharing the Indian Experience Managing the change Managing the change

Documents

Reforming Payment and Securities Settlement Systems – Global Course organised by the World Bank and US Federal Reserve Board Session on Main Environmental