The central bank said there has been continuous dialogue to resolve the logjam to arrive at a mutually acceptable arrangement, which duly recognises the territorial independence of the host regulator.

“In the undesirable event of a possible market disruption, however, remedial measures by way of possible alternate arrangements are under deliberation with the entities likely to be impacted,” RBI said in its Financial Stability Report.

ESMA had on October 31, de-recognised six Indian clearing houses, including CCIL, effective May 2023, after Indian regulators showed reluctance to sign a revised agreement which gave the overseas regulatory body the right to audit, scrutinise and inspect the activities or operations of Indian clearing houses. Later, UK regulators were also reported to take a similar stance.

Earlier this month, Governor Shaktikanta Das had said that while RBI is hopeful of a resolution, it is trying to impress upon foreign regulators that is essential for them to trust the credibility and strength of India’s robust regulations.

Regulatory over-reach

In its report, RBI said that regulations formulated post the financial crisis of 2007-09 allowed some central counterparties governing financial market infrastructures “an extra-territorial reach”.

Such regulations, if implemented by all 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.

They can also lead to disruption in local markets and undermine domestic financial stability while hampering the ability of banks and custodians to participate in various markets where local central clearing norms are applicable, it said.

Market impact

With the withdrawal of CCP (central counter party) recognition, once a large bank moves from a direct participant to an indirect one, it also introduces an element of systemic risk as the concerned large bank operates without access to central bank funding windows.

“Potential inefficiencies get introduced in the system with a possible domino effect when liquidity gets ‘trapped’ on the back of gross settlement of large positions,” the RBI said.

These disruptions can lead to market instability, and impact these banks by way of higher capital requirements, increased margin requirements, enhanced credit risk and lack of multilateral netting benefit.