We have witnessed clashes between central banks over interest or exchange rates. There have been competitive policies to gain an advantage over rivals. We are now witness to a new kind of clash over monetary control. Surprisingly, it has come out in the open. Rather unusual among central banks.
It all started with a review by the European Securities and Markets Authority (ESMA), the regulatory arm of the EU, of the eligibility of members to continue as a central counterparty clearing house (CCP). CCPs are the hub of the financial system, facilitating trading in all financial instruments such as equity, bonds, swaps, derivatives, etc. Regional authorities regulate CCPs. Due to globalisation, there has been a broad regulatory convergence though there are differences based on the legacy, size and depth of the market, etc.
In its letter dated October 31, 2022, ESMA said, “After conducting its assessment, ESMA established that not all of the cumulative conditions under EMIR for recognition of TC-CCPs are met.” [EMIR is European Market Infrastructure Regulation and TC-CCPs is third country CCPs]. Reports suggested the rejection was due to no cooperation between ESMA and Indian regulators, viz., Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) and International Financial Services Centres Authority (IFSCA). The details of the de-recognition are given below along with the regulator: Clearing Corporation of India (supervised by RBI), Indian Clearing Corporation Limited (SEBI), NSE Clearing Limited (SEBI), Multi Commodity Exchange Clearing (SEBI), India International Clearing Corporation (IFSCA) and NSE IFC Clearing Corporation Ltd (IFSCA).
The seriousness of the de-recognition of CCPs cannot be underestimated. In a way, it cuts at the umbilical cord of Indo-EU economic relations and will hurt the interests of European banks like BNP Paribas, Société Générale, Deutsche Bank, etc. With the spread of globalisation and financial liberalisation, financial flows are several times more than trade flows. They move as derivatives, also fashionably described as OTC (Over-the-Counter) derivatives. Before the bankruptcy of Lehman Brothers in 2008, cross-border flows ran to trillions, and derivatives were the name of the game. Consultants devised complex derivatives and booked them with no assets of value or fraudulent values. The mayhem in the market led to the Global Financial Crisis (GFC). The estimated value of derivatives at the end of 2008 was $598 trillion! The abuse of derivatives by mortgages created the crisis. The unprecedented magnitude of the GFC spurred global leaders to address global cooperation issues, and the G20 attached new urgency to banking reforms. In April 2009, G20 leaders agreed to re-launch the former Financial Stability Forum as the Financial Stability Board (FSB), to promote financial stability, expanded membership, stronger institutional basis and enhanced capacity.
It included central banks, including a few from developing countries like India. FSB had the mandate given by G20 in 2009 at Pittsburgh. G20 did devote attention to the derivatives segment. While the G20 recommended “coordination in standard derivatives”, the FSB attempted a standardisation of derivatives. The FSB tends to lose over the roadblocks and offers a rosy view in its reports. A 2002 Working Paper of the IMF, Applying the Central Clearing Mandate: Different Options for Different Markets, concludes thus: “There can no one-size-fits-all approach—at best, crafting strategy/options for applying the central clearing mandate is at the crossroads of a series of objective drivers….” The paper suggests regional or multiple canters for clearance. The authors list legal, administrative and tax issues that militate against standardisation. If these are the ground realities, why are developed countries in a hurry?
The FSB is biased in favour of big banks and the West. It would try to adopt the standards of the West. A study by Brookings on FSB commented that “in many respects, the FSB has inherited the governance of its previous incarnation.” (The Governance of the Financial Stability Board, Brookings Institution, Washington D.C., 2011). The study recommended that with its expanded membership and increasing role, the FSB needs modernisation in its approaches—the way the FSB is subjecting developing countries to western norms regardless of regional benchmarks.
During talks with the RBI, ESMA was riding a high horse and was sceptical about the standards adopted by India and wanted auditing by its auditors. RBI could not agree. It felt that was interference with domestic autonomy and extraterritorial reach. Rabi Sankar, Deputy Governor, RBI, has expanded the concept of extraterritoriality admirably, which he explains, “A probably unintended consequence of the post-GFC drive towards de-risking OTC derivatives markets has been the tendency of developed economies to contain the risk of their entities by attempting to maintain control of regulation and risk management practices of third countries.”
In such disputes or differences, the chiefs of Central Banks rarely intervene. However, RBI Governor Shaktikanta Das chose to do it. He said that foreign regulators must respect the credibility of Indian rules. He released the Financial Stability Report on December 29 and said, “Such regulations, if implemented by jurisdictions, can create a parallel maze of laws with overlapping requirements or restrictions and show a lack of trust in the capabilities and quality of oversight exercised by the host regulators.” This makes sense, as it would affect the quality of governance. It is not clear how the standoff will resolve. The RBI is said to be negotiating with ESMA. India is also a big market for the EU to lose. Alternative arrangements will be expensive, and Euro banks will become uncompetitive. In the end, ESMA will have to live with the status quo.
Kandaswami Subramanian
Served in the Ministry of Finance, GOI, and retired as Joint Secretary