ESMA-Indian regulators logjam: European banks' loss may aid US peers

Foreign investors may switch to custodians backed by American banks for India exposure

The derecognition of domestic clearing corporations by the European Securities and Markets Authority (ESMA) may come as a bonus for US-based banks providing custodial services for foreign portfolio investors (FPIs) to gain access to the Indian market. The move by the financial markets regulator of the European Union (EU) would mean Europe-based banks can no longer act as custodians in India come April 2023.

Banks — such as Société Générale, Deutsche Bank, and BNP Paribas — have a fairly large custodian business. If there is no agreement, their clients may switch to US-based banks, such as Citibank and BofA, said industry players.

On October 31, the ESMA announced that it has withdrawn recognition granted to six Indian clearing corporations due to “no cooperation arrangements” between ESMA and Indian regulators – the Reserve Bank of India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).

“All European banks can only clear and settle trade by central counterparties (CCPs) recognised by the ESMA. If the recognition of Indian CCPs is not restored, clients using European banks will be impacted. These clients would look for alternative arrangements, which may mean shifting to American banks where there is no such problem,” said an official at a custodian.

Custodians are essentially global banks that form a vital link when it comes to providing FPIs access to a foreign market. They handle funding, trade execution, and settlements on behalf of the overseas fund. Typically, FPIs opt for banks from their home market as custodians. However, a lot of European banks, acting as custodians, manage FPIs based out of the US, as well as other popular jurisdiction, thanks to their global presence.

The reason for derecognition cited by the ESMA is non-compliance of certain provisions of the European Market Infrastructure Regulation (EMIR). These include granting ESMA powers to monitor and supervise CCPs established in India.

Sources said the RBI and Sebi are on board with providing any data sought by ESMA but circumspect over providing a foreign regulator any direct authority over domestic institutions.

According to legal experts, the new version of the EMIR was drafted after Brexit to ring-fence European banks from risks emanating due to their exposure to foreign markets. The rule was mainly aimed at the UK, which was considered the most critical “foreign geography” for European banks.

In September 2020, the ESMA and the Bank of England (BoE) signed an MoU for cooperation on the monitoring and supervision of CCPs established in the UK.

Experts said the ESMA intends to have a similar arrangement with Indian regulators as with BoE, even as risk levels and exposure are much less.

People in the know said the RBI and Sebi have been in talks over watering down the requirements for signing an MoU. While the ESMA has revised the terms of the MoU, the language didn’t appear very different, causing disagreement, particularly between the EU regulator and the RBI, said the person quoted earlier.

“The biggest impact of this could be on European banks if there is no solution to this issue before March 31, 2023. We expect them to lobby with their regulator to force an agreement with Indian authorities over the next few months,” said a regulator source.