SEBI's New Circular: Strengthening Risk Management for Clearing Corporations

Introduction

On May 29, 2024, the Securities and Exchange Board of India (SEBI) issued a circular aimed at strengthening the risk management framework for Clearing Corporations (CCs). This circular introduces revised standards for acceptable collaterals and prudential norms for CCs’ exposure, thereby enhancing their liquidity and overall stability.

Key Changes in the Circular

The circular implements significant changes, including:

• Cash Equivalents:

  • The addition of units from the growth plan of overnight mutual funds qualifies as cash equivalents with a reduced haircut of 5%.
  • Highly liquid equity shares are now categorized under other liquid assets.

• Exposure Limits:

  • Daily exposure limits to single banks have been established whereby:
    • For AAA-rated banks, the exposure shall not exceed 15%.
    • For AA-rated banks, the limit is set at 10%.
  • There is a total exposure cap to any issuer's equity and debt instruments, which is restricted to 15% of total liquid assets received from clearing members.

• Investment Diversification Requirements:

  • CCs are required to diversify their investments and collateral acceptance. Collateral from trading or clearing members’ group entities is explicitly prohibited to maintain integrity and avoid conflicts of interest.

The implementation of these new norms will commence on August 01, 2024, with specific aspects phased in over periods spanning three months to one year.

Circular Details

I. SEBI has, through various circulars, provided guidelines for the risk management of Clearing Corporations and established acceptable liquid assets for meeting margin requirements and other risk management evaluations.

II. The following points detail the enhancements to the risk management framework:

A. Accepted Collaterals by CCs

1. Definition of Acceptable Liquid Assets:

   • Cash Equivalents include cash, bank fixed deposits, bank guarantees, central government securities, and mutual fund units (including overnight mutual funds).
   • Other Liquid Assets encompass Group I equity shares, mutual fund units, and corporate bonds.

2. Changes in Overnight Mutual Funds:

   • Units of overnight mutual funds are recognized as liquid assets with applicable haircuts of 5% for growth plans and 10% for other plans. Enhanced criteria for Group I equity shares include shares traded at least 99% of the time over the previous six months.

3. Modification of Liquid Assets Acceptability:

   • The acceptable liquid assets and their haircuts have been defined in paragraph 1.1.2 of Chapter 4 of the SEBI Master Circular dated October 16, 2023.

4. Provisions for Risk Management:

   • Paragraphs regarding liquid assets, including cash and governmental securities, have been amended for various derivatives segments to reinforce risk management strategies.

B. Prudential Norms for CC Exposure

1. Monitoring Exposures:

   • Exposure types CCs need to monitor include funds invested in bank deposits, mutual funds, T-bills, and G-securities, as well as balances held in clearing banks.

2. Bank Selection Criteria:

   • The selection of banks for exposure through cash or FDs must adhere to stringent financial criteria, including minimum net worth and credit ratings.

3. Single Bank Exposure Limits:

   • Standardized limits for exposure to banks—for both CCs and subsidiaries—require diversification.
   • Daily exposure limits are set at:
     • 15% for AAA-rated banks.
     • 10% for AA-rated banks.

4. Additional Exposure Monitoring Measures:

   • CCs must develop criteria for equity and debt instruments through members, ensuring adequate diversification and compliance with defined limits.

5. Exposure Restrictions on Group Entities:

   • Collateral from trading members and their associated groups is expressly prohibited.

6. Implementation Schedule:

   • A phased timeline is established for compliance, with specific deadlines for various types of exposures.

Conclusion

The SEBI circular on risk management for Clearing Corporations marks a significant advancement in the regulatory framework and aims to enhance market stability through improved risk management and prudential norms. All clearing corporations must adapt their practices accordingly to align with these new guidelines by the designated implementation dates.