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Context

Recently, the European Union’s financial markets regulator European Securities and Markets Authority (ESMA) said it will withdraw recognition of six Indian clearing bodies or central counterparties (CCPs).
These six CCPs are 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) and NSE IFSC Clearing Corporation Ltd (NICCL).

CCPs

A central clearing counterparty (CCP), also referred to as a central counterparty, is a financial institution that takes on counterparty credit risk between parties to a transaction.
It provides clearing and settlement services for trades in foreign exchange, securities, options, and derivative contracts. CCPs are highly regulated institutions that specialize in managing counterparty credit risk.
CCPs acts as a counterparty for both buyers and sellers acting as an intermediary in their transactions. The Central counterparty collects money from both the buyers and sellers, which helps the CCP to guarantee terms of the trade that takes place between both these parties.
As counterparties to the buyers and the sellers, CCPs guarantee the terms of trade—even if one party defaults on the agreement.
The central Counterparty clearing house or CCP hides the identities of the traders as a means of maintaining privacy and it also protects trading firms from buyers and sellers whose credit worth is unknown and who have been defaulters before.
Central counterparty clearing houses mainly work towards establishing efficiency and stability in the financial markets.

Benefits

CCPs protects trading firms against default from buyers and sellers.
CCP is an important factor in the trading industry, which helps to determine and guarantee the terms of the trade even if one of the trading parties which includes the buyers and the sellers, fails to follow through with the initial contract or agreement made between them.

CCPs in India and their Regulation

National Securities Clearing Corporation Limited (NSCCL), Indian Clearing Corporation Limited (ICCL) and MCX-SX Clearing Corporation Limited (MCX-SXCCL) are the Qualified Central Counterparties (QCCPs) in the Indian Securities Market jurisdiction.
A CCP is authorised by the RBI to operate in India under Payment and Settlement Systems Act, 2007.
These clearing corporations have qualified as QCCPs in view of the fact that these are regulated by Securities and Exchange Board of India (SEBI) under SEBI Act 1992, Securities Contract (Regulation) Act, 1956 (SCRA) and Rules and Regulations made there under.
These are also subjected, on an on-going basis, to rules and regulations that are consistent with the Principles for Financial Market Infrastructures (PFMIs) issued by the Committee on Payment and Settlement Systems (CPSS) and International Organisation of Securities Commissions (IOSCO).

Recent Derecognition of Indian CCPs

The decision to derecognise Indian CCPs came due to ‘no cooperation arrangements’ between the European Securities and Markets Authority (ESMA) and Indian regulators — 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 European banks?

Derecognized CCPs will no longer be able to provide services to clearing members and trading venues established in the EU.
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. The derecognition will impact these lenders as they will not be able to provide clearing and settlement facilities to their clients. They will also have to set aside additional capital to trade in the domestic market.
Of the total foreign portfolio investors (FPI) registered in India, close to 20 per cent are from Europe.

Central Counterparties