BS BFSI Summit: Sebi WTM Ananth Narayan for strengthening of MII ecosystem

Sebi whole-time member says regulator to float consultation paper to consider demerger of equity clearing corporations from exchanges

The focus on commercial objectives by market infrastructure institutions (MIIs) can potentially lead to de-prioritisation of their role as the first line of regulator and public utility provider, cautioned Ananth Narayan, whole-time member (WTM) of the Securities and Exchange Board of India (Sebi).

 

Speaking at the Business Standard BFSI Insight Summit on Thursday, Narayan detailed the steps under consideration to strengthen the MII ecosystem. They include independent evaluation, possible demerger of clearing corporations, and the appointment of key officials including public interest directors (PIDs).

 

MIIs — stock exchanges, clearing corporations and depositories — are considered the backbone of the stock market ecosystem. They play a vital role in ensuring its stability, efficiency, and investor protection.

 

 

Calling for better strengthening their governance framework, Narayan said, “MIIs are not regular commercial entities. Competition, public shareholding, and listing can create incentives that give primacy to commercial outcomes, over the intended core and primary statutory role of the MII as a first-line regulator and public utility provider.”

 

He said as commercial entities, most MIIs enjoy high operating margins with profit margins of more than 60 per cent, high price-to-earnings multiples and make significant dividend payout.

 

The senior Sebi official voiced concern that the potential investments into appropriate security, technology, risk and operations could get de-prioritised due to commercial factors.

 

“There is the potential that products or securities are launched and persisted with, without adequate safeguards around investor protection, suitability, and appropriateness, and with a view to maximising MII throughput and revenues. To foster long-term confidence in the capital markets ecosystem and to ensure financial stability of our capital markets, not only must all this be avoided, but they must also be seen to be avoided,” said Narayan.

 

Given their roles and responsibilities, MIIs have to comply with stringent norms of transparency and governance. They are under the keen eye of Sebi for their operations due to their systemic importance.

 

The former banker announced that Sebi will soon float a consultation paper to consider demerger of equity clearing corporations (CCs) from stock exchanges. At present, the CCs are fully-owned by stock exchanges.

 

Narayan said the full ownership of CCs by a single exchange raises questions of the potential for actual or perceived conflict of interest.

 

“As on date, the dominant equity clearing corporation, owned by the dominant exchange, clears over 85 per cent of all cash and derivative equity market trades dealt on each of the large exchanges. In this context, 100 per cent ownership of CCs by a single exchange does raise questions of the potential for actual or perceived conflict of interest,” he said.

 

While MIIs such as stock exchanges are allowed to list and have public shareholders, clearing corporations, which are fully-owned subsidiaries of stock exchanges, are not allowed to do so.

 

BSE Ltd is already listed, while its larger peer — the National Stock Exchange (NSE) — has applied for a no-objection certificate from Sebi to move forward in the listing process. 

 

Narayan said listing of the parent exchange leads to de facto listing of the CC as “shareholders of the parent exchange consider the consolidated financials of both the exchange and its CC.”

 

Earlier, a CC used to clear the trades of only its own exchange.

 

However, with the introduction of interoperability, a clearing corporation can clear trades of multiple exchanges, rather than the parent alone.

 

“This interoperability has improved the ease of trading and settlement for investors, while allowing for better back-up and redundancy in our securities ecosystem. It has also materially altered the implications of 100 per cent ownership of a CC by a single exchange,” added Narayan.

 

Highlighting the need for the independence of clearing corporations, he said that CCs in India are dependent on the parent exchange for equity infusion, default fund management and other resources such as technology and people.

 

Further, in India the clearing members do not contribute to the Settlement Guarantee Fund (SGF) of the CC and thus do not have the skin in the game like those in other jurisdictions.

 

Instead, the CCs and the exchanges themselves constantly enhance the SGF on their own.

 

“There is a need to fundamentally review this construct of our CCs. There is a case to consider making the CCs truly independent and self-sufficient, with broad-based ownership, and with clearing members having a risk-based skin in the game. All this may be crucial to ensure that there is an actual and perceived level-playing field across all MIIs,” said Narayan.

 

He said, “Some form of demerger of the equity stock exchange and the equity clearing corporation may perhaps be a way out, though there may be some legal and regulatory challenges to navigate. We will come out with a public consultation on all this shortly and seek your considered views on this subject.”

 

The Sebi official highlighted that the regulator is looking at its involvement in the appointment process of key officials at the helm of the MIIs.

 

At present, the market regulator selects a PID from a suggested list of candidates by the MII.

 

Narayan disclosed that after Sebi had sought public feedback on the need for change in the process for these appointments, the views from MIIs and expert working group was to continue with the current mechanism.

 

He added that Sebi is exploring ways to improve ease of doing business for PIDs and making the appointment process more institutionalised.

 

At the same time, Sebi is also exploring its own involvement in the appointment of key managerial persons. This is the same way it is involved in the appointment of managing directors (MDs) and chief executive officers (CEOs) of MIIs.

 

“Sebi has advised governing boards of MIIs to upgrade the key managerial positions (KMPs) of these key verticals over time as necessary. Sebi will also require the chief technology officer, chief information security officer, chief risk officer and chief compliance officer of MIIs to independently interact with the appropriate governing board committees, which would also directly contribute to their annual appraisals,” added Narayan.