Consultation Paper on Review of Ownership and Economic Structure of Clearing Corporations by SEBI

In recent years, India’s securities market has experienced remarkable growth, marked by increased investor participation, product innovation, and trading volumes. At the core of this dynamic market are Clearing Corporations (CCs), which function as central counterparties for all trades conducted on stock exchanges, ensuring smooth operations.

To fortify market infrastructure and sustain the stability of the securities ecosystem, the Securities and Exchange Board of India (SEBI) has initiated a public consultation on proposals aimed at diversifying the ownership structures of Clearing Corporations (CCs). This consultation paper outlines the rationale for these proposals and examines their potential impact on the broader market landscape.

Background

Clearing Corporations play a pivotal role in mitigating systemic risk by serving as a safety net for the market. As central counterparties, CCs assume the risk of counterparty default, guaranteeing trade settlements even in adverse circumstances. To fulfill this role effectively, CCS must operate with independence and maintain robust financial health.

Currently, CCs in India are largely subsidiaries of stock exchanges, with the exchanges holding significant ownership stakes. While this model has supported the market’s development, there is growing consensus on the need to diversify ownership to bolster the independence of Clearing Corporations.

Recommendations from key committees, including the Gandhi Committee and the Mahalingam Committee, have underscored the importance of a strong and autonomous framework for CCs. These bodies have advocated for measures such as ownership diversification and enhanced capitalization to improve governance and financial resilience.

The Case for Diversification of Ownership

The existing ownership structure of Clearing Corporations — where stock exchanges are the principal shareholders — raises concerns about potential conflicts of interest. Dominant ownership by parent exchanges may incentivize decisions that align more closely with the commercial objectives of the exchanges than with the long-term stability of the market.

Additionally, this structure can constrain the ability of Clearing Corporations to secure capital for infrastructure upgrades and advanced risk management systems. Given the rapid growth of India’s securities market, CCS need to have sufficient capitalization to meet increasing demands. Relying solely on parent exchanges for funding, particularly during periods of market stress, is not a sustainable solution.

SEBI’s proposal to diversify ownership seeks to address these challenges by introducing a broader base of shareholders, including institutional investors, foreign participants, and other market entities. A diversified ownership model would reduce reliance on a single entity, enhance financial independence, and support decisions that prioritize market stability.

Globally, various ownership models for Clearing Corporations exist, ranging from wholly-owned subsidiaries of stock exchanges to fully independent entities with diverse shareholder bases. By examining these international frameworks, SEBI can draw valuable insights to shape an optimal ownership structure.

Potential Routes for Initial Divestment

To transition to a diversified ownership structure, SEBI is considering two potential approaches:

1. Pro-rata Distribution of Shares:

• A portion of the CC’s shares would be distributed pro-rata to the existing shareholders of the parent exchange.
• This approach would maintain the parent exchange’s majority ownership in the initial phase, allowing for a gradual reduction in its holding over time.
• However, this approach may require regulatory amendments to accommodate the reduced ownership stake of the parent exchange.

2. Full Distribution of Shares:

• All shares of the CC would be distributed to the existing shareholders of the parent exchange.
• This approach would lead to a complete separation of the Clearing Corporations from the parent exchange, enabling it to operate as an independent entity.
• However, this approach would require significant regulatory changes, including amendments to the Payment and Settlement Systems Act, which governs the operations of payment and settlement systems in India.

Other Proposals

To ensure the financial health and operational efficiency of CCs, SEBI proposes to maintain certain key principles:

1. Profit-Making and Dividend Distribution: CCs will be allowed to operate as profit-making entities and distribute dividends to their shareholders, subject to existing governance controls. This will enable CCs to incentivize talent, reward investors, and reinvest profits in their business.
2. Prohibition on Listing: To maintain their focus on risk management and systemic stability, CCs will continue to be prohibited from listing on stock exchanges. This will help shield them from short-term market pressures and ensure their long-term viability.
3. Self-Sufficiency: CCs will be required to develop a sustainable fee structure that allows them to cover their operational costs, invest in technology and infrastructure, and build adequate reserves. This will reduce their reliance on external funding and enhance their financial resilience.
4. Consolidation of CCs: SEBI is open to the idea of consolidating certain CCs to achieve economies of scale and operational efficiencies. However, it is important to maintain a competitive landscape with multiple CCs to ensure market diversity and reduce systemic risk.

Conclusion

SEBI’s initiative to diversify the ownership structure of Clearing Corporations marks a critical step towards fostering a more resilient and transparent market ecosystem. By addressing potential conflicts of interest, ensuring adequate capitalization, and promoting independent decision-making, these reforms aim to align the operations of CCs with the long-term stability and growth of India’s securities market. Stakeholder feedback on these proposals will be instrumental in shaping a robust framework that meets the evolving needs of a dynamic financial landscape.

King Stubb & Kasiva,
Advocates & Attorneys

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