"A European regulatory authority has decided to derecognize as many as six Indian clearing houses that settle trade for European banks like Deutsche Bank and BNP Paribas in India.

The regulator, European Securities and Markets Authority (ESMA), wants to inspect Indian trade clearing bodies. RBI and SEBI have said it has no jurisdiction over the clearing houses. At stake are the businesses of all European banks operating in India. Ministries of finance in India and European countries are trying to convince their regulators to come to a middle ground, given India and the EU’s improving relations. Sebi is willing to relent. RBI is not.Who will blink? TMB host Dia Rekhi and Anirban Chowdhury speak to Viraj Kulkarni, Founder of Pivot, Asia's Largest Consulting Company in the Securities Services Space, and Sugata Ghosh, Associate Editor at The Economic Times to discuss more."

This is an audio transcript of The Morning Brief podcast episode: India vs Europe: Regulatory Rift


Dia Rekhi 0:08
diplomatic digs across country political bashing is something many of us have not just witnessed, but have also enjoyed. But dirty laundry being aired publicly, which is something that has been restricted to the political arena has now found itself in the ring of regulators as well. A fortnight ago, the European securities and Markets Authority or Esma said it wants to govern Indian trade clearing bodies. Unsurprisingly, the RBI and SEBI said nothing doing or like we say in Chennai, Chance illa. Esma retaliated by de recognizing or withdrawing recognition of six Indian clearing bodies. But what is the rift really all about? What is irking the EU regulator? And as the rift increases, who will blink first? The questions are many. And I will be honest, I'm also seeking answers here. Many of you would be familiar with the ET in the classroom segment. I used to write a few of those too. And this episode reminded me of that time, I have a lot of questions, and I decided it would be best for me to take a backseat and learn on this episode with you. It is Friday, November 25. I'm your host Dia Rekhi and you are listening to India versus Europe regulatory drift on the morning brief from the economic times.

Dia Rekhi 1:51
Before I even get started on the deep dive, I had to understand who and what role does the central character play. In this case, it's the clearing house. Well, to put it simply a Clearing Corporation is an organization associated with an exchange to handle the confirmation settlement and delivery of transactions. So basically, if I want to sell 10 shares of reliance, and you want to buy 20 shares of reliance, The Clearing Corporation has the task of helping me sell my 10 shares and to help you get 10 more shares from someone else so that both the transactions take place seamlessly. Well, now that that's out of the way, it's time to seek answers to some of the tougher questions in this regulator rift. Like in a game show in my quest for answers, it was my turn to use the phone a friend option, and on the receiving end of the call was my colleague and the executive producer of TMB Anirban Chowdhury and also ET's Associate Editor Sugata Ghosh who is the go to person at ET for all things, markets and regulation. Thankfully, the two of them broke it down to the basics.

Anirban Chowdhury 3:05
Hi, Sugata very warm welcome to the Morning Brief.

Sugata Ghosh 3:08
Hi.

Anirban Chowdhury 3:09
So, you've been covering the standoff between European financial regulators and Indian regulators such as RBI and SEBI pretty closely now, to a lay reader, it comes across as an overreach where a foreign regulator is imposing its conditions on local regulators. What's the genesis of this?

Sugata Ghosh 3:30
Well, a lot of new rules which we'll see in the market today, go back to the meltdown of 2008. That was when the regulator's felt that they needed a better grip on the markets. They need to know what kinds of transactions are happening. The banks, which are custodian of customer deposits, whether they have the wherewithal to do those trades, are they being too reckless, and particularly the counterparties, which are large institutions that stand as an intermediary between two banks dealing whether they are strong enough to do this transactions, because the regulator's don't want to be thrown into a surprise once again. So that's where the current debate revolves around the stature of the counterparties and the regulatory overlap that is playing out. Now, central counterparties are in the middle of most transactions. Now, they're important because they take the risk, they absorb the risk of settlement and clearing. So you could bank to banks are buying or selling securities. It is the responsibility of the central counterparty or CCPs, as they're called, to see that the seller receives the money and the buyer receives the security, right. Okay, so they assume all the risks. They play a crucial role of an intermediary and given their importance The European regulator, they believe that they must have some supervisory powers over all the CCPs that deal with European banks. So, the central counterparties like The Clearing Corporation of India through which all this bond, forex derivatives, money market transactions happen or the NSE Clearing Corporation through which the stock trades done on NSE which is the India's largest stock exchange those happen, they want to supervise those they want to do on site inspection. They want to see whether they have the risk mitigating measures and you can see they can even find them all this is unacceptable to RBI and sebi.

Anirban Chowdhury 5:44
Right.

Sugata Ghosh 5:45
Now, this has been brewing for more than a year.

Anirban Chowdhury 5:49
Okay, and how serious is this issue?

Sugata Ghosh 5:53
I tend to believe that as of now it may across as a bit of a regulatory paranoia, but there is no other way for the regulators, but to sit together and sort this out, because you tell me what else is the solution, the European banks, some of which have been for close to 100 years, and they've been doing business here, they will have to cut down their business, the business that particular volumes on this businesses will be taken over by other multinationals like city or JPMorgan, the American banks,

Anirban Chowdhury 6:24
right

Sugata Ghosh 6:25
or the European banks will have to set up a non bank entities and do those businesses right. Now, that means more time, more overhead, more cost and all this does not bode well for some of the Indian financial markets. So it's necessary that the regulator's find a way out too, and this strikes

Anirban Chowdhury 6:46
Sugato, if I understand you correctly, quite a bit is at stake right. So, we are talking about different markets here foreign exchange sovereign bonds, derivatives and even stocks right some of these negotiations have been going on for quite some time. So, why has it reached this stage?

Sugata Ghosh 7:07
So, this cool tussle between European regulators and Indian regulators it has turned into some kind of ego war. So, the stand taken by our regulators like RBI or SEBI, particularly RBI, I mean there may be good reasons for that, RBI may have reasons to refuse as much demands after all what is ESMA asking it wants the right to exercise power over Indian institutions that is central counterparties in India over which legally Esma has no jurisdiction.

Anirban Chowdhury 7:42
Okay.

Sugata Ghosh 7:43
So, it is indeed a regulatory overreach, extra territorial jurisdiction issue.

Anirban Chowdhury 7:50
Got it.

Sugata Ghosh 7:50
Now, one can argue that look and I'm sure RBI may be arguing that, that India deals in INR that is in rupees the rupee is not a fully convertible currency and it is a comparatively closed market. And we are also moving into t plus one settlement in the stock market. That is a settlement where the stocks and money change hands a day after the credits executed. Right. So, where is the big risk? I'm sure this issues are under discussion over the past one year. But probably ESMA. And regulators can be quite obstinate, if I may say a standardized uniform MOU for all countries and they possibly don't want to tweak it or relax it for India. Now, they would say that look other markets like say the Hong Kong monetary authority or the Singapore regulators, if those guys agree, what is the big deal with RBI after all, it is a deal between two regulators let her know the commercial organizations involved here. But I guess that the stakes are too big and they will find a way out. And SEBI indeed is has already hinted that whatever little we learn that it is willing to reach some kind of settlement with certain conditions.

Anirban Chowdhury 9:17
So the RBI is stubborn. While SEBI wants to relent. Now, Sugata, I understand that stock market transactions can't happen without clearing houses, and hence Sebi stance. But shouldn't regulators have a uniform standard?

Sugata Ghosh 9:34
Yes. youre right. Ideally, they should. I mean, all the more because it's the thing that they have a good reason to do. So, I mean, it could appear that RBI stand good if Sebi enters into some kind of an arrangement with ESMA. It seems that the government has taken that kind of an approach. It is willing to wait and see. Find out how the negotiations between the RBI and Esma and Bank of England work out And then while at the same time some formula is being worked out by Sebi and I'm sure Sebi has received the go ahead from the finance ministry to do that, because I don't think the government would want particularly the markets are volatile, the rupee is under the pressure and the government will not want any unsettling developments in the equity market. Because the equity market is like a barometer. Because today, a lot of trades even if these are for a few days, right before a large investors large wholesale investors, between their custodian from one bank to another because one particularl European bank in India is unwilling to offer the custody business that will not send the right signal it can have some impact on the market. And I don't think there's government neither government nor SEBI would want, unlike say, government security trading or Forex derivative trading, which are changes would not be very obvious there. And those are deals which can still be done by latural.

Anirban Chowdhury 11:06
I believe such regulatory squabbles are never made so public right? How do you see the fact that this one's played out in full glare of the world like this, and that prospective governments have had to step in to defuse the situation.

Sugata Ghosh 11:21
When you see time is running out, for instance, by April, the European banks, that is the banks in mainland Europe, they will have to run down their positions. Right. So if they have deals which had done to CCI, and another thing, they let you unwind those deals, and from may, they'll have to do bilaterally, bilateral deals if this differences are not sorted out. So there is not much time and months from now we'll have the Christmas vacation. And for a fortnight all these regulators and banks, they will disappear. And other thing there'll be no negotiations before second week of January. So they want to make it public. Possibly they want the debate to happen, so that the government's the regulators, they are forced to take a decision. So it could well be from that particular point of view. But then I agree with you, regulatory tussles don't normally hit the headlines. In fact, regulators, particularly central banks, have long been perceived as many matured, evolved institutions, if I may say somewhat like a club of Freemasons who quietly sit and sort out their issues over a glass of wine. But the media don't get a whiff of it, even their respective governments. There have been cases where the respective governments are not fully aware of the implications of what they discussed, the two central banks of two countries. But now that you asked me, I'm tempted to think that perhaps it's a reflection of a world that is changing. We don't know yet. But it may have partly to do with the shifts in the nature of politics and international relations. And the general air of protectionism, which is kind of sweeping the globe. Also, between the meltdown and the pandemic, the regulators may have felt increasingly, that they should play it very safe, they should turn conservative, they should reinvent their markets, their constituencies, their institutions so that the blame doesn't boil over to them? At the end of the day, they want to ship themselves

Dia Rekhi 13:35
but here's the thing, is this the first time this is happening, as I realize from my research, no, Indian regulators have had what would be termed beef in internet parlance before. Not just that, I was also wondering if such a public standoff bodes well for both countries. Also, is the RBI being too stubborn in its stance? Should Indian regulators soften a little bit? To answer all this and more Anirban turned to Viraj Kulkarni, founder and CEO of pivot management Viraj has worked with three of the top five global custodians for over 12 years as country head of security services with Citibank India and Switzerland, JP Morgan Chase and BNP Paribas.

Anirban Chowdhury 14:25
Hi, Viraj, welcome to the Morning Brief.

Viraj Kulkarni 14:27
Good morning. Anirban. It's a pleasure to be on your show

Anirban Chowdhury 14:31
pleasure is mine. So Viraj, we are talking about the ongoing India EU regulatory rift right. Now, not many people know that this has happened before. It's actually a history repeat. And it had happened before in 2013. Would you please tell us what that was like?

Viraj Kulkarni 14:51
Yeah, you're right. So this has a precedence. So in 2013 ESMA, which is a regulatory body came out with With E M I R, which is the European market regulations, this regulations required that every Clearing Corporation to which any of the European banks were exposed to, had to be registered under ESMA. Now, in those days, the Clearing Corporation of India, which is an NCS BSEs, other Clearing Corporation came under the purview. This was attempted in 2013, with India, Singapore and Hong Kong. And I recall, I used to be then working for a foreign bank, European bank, it was definitely a shock for many markets, not just India, because ESMA tried to do this with Hong Kong, Singapore. And India, if I remember, in the Asian markets, and India, I remember when this came to Sebi Sebi, engaged the industry in finding a solution. It was also you know, the industry primarily was the European banks and Sebi laid out why they would not be comfortable with such as the oversight by ESMA, which is understood by the custodian banks, and they relate the same to the you know headquarters out there. In Europe, the management, then the global management of the restrictive banks actually understood the issue and engaged with ESMA to see that India was not on the list, because this was a significant impact. So I remember there was this whole part of that whole discussion with Sebi. And they engaged the industry, they thought through it, and it was not a knee jerk reaction saying no. And so I think that approach was good. And I think this the same approach will work this time as well.

Anirban Chowdhury 16:59
Viraj, I wanted to ask you, I mean, it seems that custodians, will face the biggest impact of this, can you give our listeners an idea of, you know, what they do? Sort of how big is the business? And how big will the impact be?

Viraj Kulkarni 17:14
Anirban It's a very interesting question, because a lot of people still do not understand what custodians do custodians globally, present in over 100 countries and manage over $246 trillion of assets on behalf of institutions. So what do they do they primarily act on behalf of the investor, we're talking of institutional investors across the globe. And their actions relate to clearing settlement as well as managing cash and engaging in effects for the clients. Now, in India too the custody business has been in existence for over 32 years and custodians in India manage $2.1 trillion of assets of the total 3.3 trillion market cap that we have in India. Now, who loses in this what is the impact on the custodians? Before I get there, let me also share, India has 10,900 Plus foreign portfolio investors invested in India, of which approximately 2500 foreign portfolio investors come from Europe. Okay, now, it's not necessary that a foreign portfolio investor will invest through a European bank, they could come through any of the global custodian. So we have a concept called a global custodian who can be seen as more like a wholesaler. And then we have a country custodian, which is more like a retailer just an analogy that I'm using. Now, what's the impact? The impact is, if, ESMA coming with these regulations, it creates uncertainty in the minds of the clients who are the fpi's who are with the European custodian on the continuity. So, the first thing they would do is because India still an attractive destination for foreign portfolio investors, the fpis would just pull out the plug from the European banks and go on to a global custodian

Anirban Chowdhury 19:30
okay.

Viraj Kulkarni 19:30
So, first is you know, the impact on the European banks is the possibility of losing business to their competitor non european custodians. The second part is it also impacts them from participating in domestic mandates. Mind you, when I say domestic mandates, our insurance sector provident fund sector, mutual funds sector are significantly large, and the European custodians are engaged in having them as Client, this would mean that they, they would have to let go of these clients. And obviously, that's a big hit. So from a perspective of what would change is the custodian, the European custodian would neither be able to participate in the clearing and settlement for the foreign portfolio investor clients of theirs, or for the domestic clients, and in effect, they may lose business. Now, this also has to be seen from a background of the fact that India is the most profitable jurisdiction in the world for a custodian. So I guess I see the European custodians, and one of them is very prominent, which is , I'm sure, they will definitely take it back to the management and probably, you know, figure a way out with Esma to let things lie as it is.

Anirban Chowdhury 20:53
So what is the impact of such a rift on any jurisdiction? And also, can you give us a your candid views on whether you think Esma has really overstepped?

Viraj Kulkarni 21:05
So that's a very interesting question Anirban. now, every single regulatory body in the capital market is a member of Isco. And that applies for Esma applies to sebi as well. esma being the nodal body, it determines how capital markets has to be run, lays down the framework, then it leaves it to each of the respective members to run the jurisdictions. And if you look at, let's say, coming into India, SEBI has done a marvelous job, I would say so in the last 30 years being the one which has ushered probably the maximum changes. So, in a sense, where India's mood, let me use some examples, you know, India moved to T plus two, way back in 2003. Whereas, the European markets went live, though their advanced market, they went live only in 2014. Today, we're the only country in the world to have t plus one and t plus two running successfully. And t plus one you know with 4000 scripts has no parallel anywhere else in the world. So in a sense, there is an overreach, I think, from ESMA. On trying to regulate the Indian capital markets. I mean, if they wanted to regulate the performance of the European banks, that's understood, but why try to regulate Clearing Corporation of another jurisdiction? So I think this is a significant overreach. And it does not help build relationships between Esma and any of the market. It's trying to impose such conditions.

Anirban Chowdhury 22:49
How do you see this playing out? And how do you think this will be resolved?

Viraj Kulkarni 22:54
See, It has multiple factions, I'm sure the regulator's on either side, which is ESMA, SEBI, RBI are seized with us. They work on many areas. And I'm sure this will also pan out to the satisfaction of everybody, the way I look at it as maybe ESMA would look at collaborating with the SEBI and RBI to look at the best practices. And if India and sort of convinced themselves that India has better practices, it's a safer country, it is a better country too, it manages its risk better. And probably, you know, that's the learning they will take away and back off. I mean, that's the thing. If I look at the 42 countries, which are on the list, they're all small compared to India, So India is a significant market for European investors and European banks. Second is India, in fact, stepped up in 2013. By requiring its clearing corporations to register, just do a registration with ESMA. Though there was no need this was done to facilitate European banks to do business in India. The second important thing to know is since 2013 to 2022, the Indian Capital Markets have only grown and we expect growth to happen by another 50% on the custody space. So it's in the interest of Esma to resolve this as soon as possible, because this will primarily impact the European banks participation in the Indian markets. And to that extent, India is a significant jurisdiction for most of the European banks. And I'm sure they would not like to lose the business, whether domestic or the foreign portfolio of FBI Space to the competitors. So I think this is where the banks would have to step up and again, reach out to ESMA. To see a revisit to what they are seeking now.

Anirban Chowdhury 24:53
Viraj, what can be done you think, to make our own banking sector more prolific in this space?

Viraj Kulkarni 25:00
It's time for India to start looking at developing its own banks. You know, I say this because up maneuver is what we talk about, but let's bring up maneuver into our capital markets just as ESMA engages, you know, on behalf of European banks, I think it's an India's interest to develop single country custodians. A single country custodian is the custodian who is present only in one or two countries you know we have quite a few of them ICICI HDFC AXIS of the world etc, who are very good expertise on the custody business. So, the way to strengthen the European participation is allow limited banking license as subject which RBI tabled in 2014 to happen now, what does this mean? So, we have quite a few custodians, which are India based India centric, which do not have a banking license. However, they're equally good, if not better than some of the European banks for doing custody business. And these are, if I have to just name a few of them. It's stockholding, it's Edelwise, best, and few others are totally about five of them. what's happened with these banks is they do not have a banking license. The moment they have a banking license, which is a limited banking license on the lines of what globally exist in our straight st. And the Northern Trust, or a Bank of New York Mellon are limited bank license holders, then it allows them to start offering high quality services and reduce the risk. So I think RBI has to really bring this up, start giving them limited banking license to the institutions and I think we will make our markets more secure.

Dia Rekhi 27:00
I started off wondering if it was hard to believe that regulators were squabbling in the open. But after listening to what our guests had to say, a lot has been cleared up. It seems to me too, that the otherwise mature institutions would only fight it out in public. If they knew they couldn't sort it out through dialogue behind closed doors. The Sebi might be softening its stance, but it looks unlikely that the RBI will give it and from what I can tell, it seems like they have every reason to stand firm considering this could be termed regulatory overreach. One thing is for sure, though, a lot is at stake, as 20% of foreign investors that buy Indian securities are in Europe, finance ministries in India and European countries are trying to convince their regulators to come to a middle ground, given India and EU's improving relations. But will this happen? Or will there be more drama? Who will blink first India or Europe? Keep listening to the morning brief as we stay on top of all that's happening in business, economics and finance in India and across the globe? A big thanks to Anirban for the breakdown and insights with in house experts Sugata and industry veteran Viraj Well, that's it for today.

Dia Rekhi 28:17
It's Friday, November 25. I'm your host Dia Rekhi and you are listening to India versus Europe regulatory rift on the morning brief from the economic times. This episode was produced by Sumit Pande sound engineer Indranil Bhattacherjee, Executive Producers – Anupriya Bahadur, Anirban Chaudhary & Arijit Barman. Do share this episode if you liked it. And listen to new episodes of the morning brief every Tuesday, Thursday and Friday on all your favorite listening platforms, including Amazon music, gaana.com, Spotify, Apple and Google podcasts, the Economic Times website, and of course our very own audio platform et play. Also, tune in to the latest podcast from et startup school with Suresh Venket. Your 12 Step Guide. from idea to enterprise with marquee startup founders. Catch the latest episode every Friday on your favorite listening platforms.

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