The code identifies and segregates regulation of operators in the capital market and in the over-the-counter (OTC) market. This is a significant move, as their market dynamics and risk management parameters are not the same. As a result, regulatory jurisdictions of Sebi and RBI over the capital market and OTC market, respectively, are also delineated.
In the process of harmonising different functions of financial markets, the code has encountered a few slippages. These creases can be ironed out after due consultations with stakeholders. However, the focus here is limited to analysis of provisions relating to insolvency of a trading or clearing member, as also of clearing corporations or stock exchanges.
A key rule in the code ensures settlements by clearing corporations are final. Simply put, in the event of an insolvency of a member of a stock exchange or clearing corporation, its liquidator or resolution professional cannot access its settlement and other dues, collaterals and margins owed to the clearing corporation or stock exchange. This is called Settlement Finality Rule. This protection is important in netted settlement systems, where a crisscross of buy and sell transactions are netted and the final obligation for each member is arrived at, and the settlement is required to be completed at the end of the day for each counterparty.
Worldwide, this rule is embedded as part of financial laws to safeguard financial markets from being derailed by vagaries of claims that arise from an insolvency event. The absence of such a provision has the potential to induce systemic risks if the netted settlement obligations are allowed to be reopened by the liquidator or authorities after an insolvency event.
Though there is a provision to that effect in the securities contract regulations, a substantive provision in Clause 68, chapter IX, of the code now operates as a declaratory law overriding the general insolvency law. However, a careful reading of a subsequent provision in the same chapter appears to dilute the effect of this overriding provision by establishing the precedence of clearing corporations over third-party rights and attachment rights through the expression ‘Subject to the provisions of the Insolvency and Bankruptcy Code 2016’. This could create avoidable vagueness and confusion and, hence, requires clarity.
Chapter IX has also crafted a provision for the insolvency of a stock exchange/clearing corporation. The insolvency of financial market infrastructures (FMIs) like stock exchanges and clearing corporations is required to be dealt with differently, as continuity of critical financial operations undertaken by them needs to be maintained for the smooth functioning of the economy even if they are resolved.
Unlike general corporate bodies, liquidation and resolution of financial market infrastructures require a different approach due to:
Failure of a financial market infrastructure can induce a financial crisis and a resultant contagion effect on other parts of markets.
Unlike general insolvency regime, speedier measures are required for failure of FMIs, as continuity of critical financial services cannot be delayed because it could adversely affect the entire market.
Resolution of FMIs should also focus on financial stability and broader public interest, in addition to the interests of their stakeholders.
Finally, as operations of FMIs are complex and technical, creating interdependencies with various limbs of financial markets, they can be handled only by the respective financial market regulators under whose supervision they operate, or by a resolution corporation. All these issues were effectively addressed in the Financial Resolution and Deposit Insurance (FRDI) Bill 2017, redrafted in 2018, which was subsequently withdrawn.
Hence, the need of the hour is to revive the FRDI Bill or its new avatar, addressing the concerns of stakeholders. That alone can provide a robust solution for resolution of FMIs and other financial entities.
The writer is a Mumbai-basedcorporate lawyer.
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