Experts Urge Financial Viability Before Demerger Amid SEBI’s Proposal for Clearing Corporations

Ensure Financial Viability Before the Demerger, Experts Advise on SEBI’s Proposal for Demerger of Clearing Corporations

SEBI’s Proposal for Demerger of Clearing Corporations

The Securities and Exchange Board of India’s (SEBI) recent proposal to demerge clearing corporations has sparked extensive discussions among various stakeholders, particularly the exchanges. The proposal aims to unbundle clearing corporations from their parent exchanges, a move that is seen as crucial to ensuring the independence and financial viability of clearing corporations. However, experts believe that before proceeding with the demerger, SEBI must first assess whether clearing corporations are financially capable of sustaining themselves independently.

• SEBI must ensure that clearing corporations can generate sufficient funds to sustain independent operations before proceeding with the demerger.

Experts suggest that clearing corporations should not only generate funds for operational costs but also for risk management purposes, such as the Settlement Guarantee Fund (SGF). This highlights the need for a clear evaluation of their revenue model to determine if they can independently support these crucial functions.

• Clearing corporations must generate adequate funds for both operational and risk management needs, such as SGF.

Unbundling Transaction Charges: A Vital First Step

One significant concern raised by experts is the structure of transaction charges, which have been a key point of contention in the demerger discussions. A former SEBI board member suggested that the first step in the process should be unbundling the transaction charges between exchanges and clearing corporations.

• Unbundling transaction charges will help SEBI understand the revenue distribution between exchanges and clearing corporations.

Currently, the distribution of transaction fees remains opaque, making it difficult to assess how much revenue is allocated to each entity. Some market participants believe that the existing distribution ratio is skewed in favor of exchanges. For instance, out of one rupee received as part of exchange-clearing fees, approximately 70 paise goes to the exchange, while only 30 paise is allocated to the clearing corporation.

• There is a belief that the current revenue distribution is unfairly skewed in favor of exchanges, with only a smaller share going to clearing corporations.

This unbundling process will enable SEBI to assess how much money exchanges and clearing corporations are each receiving from transaction fees. Experts argue that this clarity will provide the regulator with the insights needed to introduce policy measures that ensure fair and reasonable allocation of revenue.

• SEBI will need clearer revenue data to implement fair policy measures for clearing corporations.

Evaluating Clearing Corporations’ Independence

Once the transaction charges have been unbundled, SEBI must determine the appropriate share that clearing corporations should receive to become financially independent from their parent exchanges.

• SEBI must ensure clearing corporations have enough resources to be independent, reducing their reliance on parent exchanges.

Experts suggest that clearing corporations should be able to generate enough funds to cover both operational costs and capital requirements for their SGF. The stress-test-driven formula for SGF contributions, which measures risk against trade positions, could be a useful tool for evaluating the sufficiency of funds.

• Using stress-test formulas for SGF can provide a clear view of the financial sufficiency of clearing corporations.

Moreover, a comparison of the financial performance of exchanges and clearing corporations—particularly in terms of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and PAT (Profit After Tax)—could provide valuable insights into the financial health of clearing corporations.

• Comparing financial performance metrics like EBITDA and PAT will reveal the financial health of clearing corporations.

Insights from SEBI’s Consultation Paper

SEBI’s consultation paper, issued in December 2024, highlights the importance of self-sufficiency for clearing corporations.

• SEBI aims to ensure that clearing corporations are self-sufficient without increasing the fees for investors.

The paper asserts that clearing corporations should develop a fee and operating structure that allows them to function as independent, robust, and efficient entities, without relying on their parent exchanges for financial support. However, SEBI emphasizes that the overall fees paid by end investors, including those for both exchanges and clearing corporations, should not increase.

• SEBI seeks to balance the financial independence of clearing corporations with the protection of investors, ensuring fees do not rise.

Experts suggest that unless the transaction charges are properly unbundled and the fee structure is carefully examined, it will be difficult for SEBI to determine whether the current arrangement is reasonable or needs adjustment.

• Proper unbundling and review of fee structures are necessary before SEBI can make decisions on the demerger.

They point to the Clearing Corporation of India Limited (CCIL) as an example of a structure where fees for order matching and clearing are separated, providing a clearer view of the revenue generated by each entity.

• SEBI could use CCIL’s fee structure as a model for separating charges between exchanges and clearing corporations.

The Need for Greater Flexibility in Fixing Charges

Former RBI Deputy Governor R. Gandhi, who has been involved in several regulatory reviews, emphasized the need for greater flexibility in the fee structure of clearing corporations.

• Clearing corporations should have the autonomy to set their own charges while remaining under regulatory oversight.

According to Gandhi, clearing corporations should have the autonomy to set charges for their services while still being subject to regulatory oversight. This flexibility will allow them to generate the necessary revenue to remain financially viable and independent.

• Allowing clearing corporations to set their charges will help ensure they generate sufficient revenue to sustain themselves independently.

He also noted that the Settlement Guarantee Fund, which is primarily funded by clearing members, should continue to be a critical source of financial stability for clearing corporations.

• The SGF remains a crucial source of financial stability for clearing corporations and should be maintained.

Governance and Separation of Roles

Another important aspect highlighted by experts is the dual role of market infrastructure institutions (MIIs), which function both as profit-making entities and as regulators.

• Experts suggest separating the roles of profit-making and regulatory functions within MIIs to avoid conflicts of interest.

The Mahalingam committee, which reviewed the governance of MIIs, argued that this dual role creates inherent conflicts of interest. It recommended the creation of separate institutions to handle regulatory functions and profit-making activities, thereby ensuring clearer separation of duties.

• The Mahalingam committee recommends creating separate institutions to ensure a clear separation between regulatory and profit-driven roles.

In line with this, some market participants have suggested that clearing members (clearing brokers) should contribute to the Minimum Required Corpus (MRC) of clearing corporations, as they are directly involved in the risk associated with the clearing process.

• Clearing members should contribute to the Minimum Required Corpus (MRC) due to the risk they pose to clearing corporations.