Regulatory overreach needs to be balanced with regulatory reforms; India’s presidency of G20 provides the inter-governmental platform to do so
A 31 October 2022 diktat by the EU’s European Securities and Markets Authority (ESMA)— which is tasked with safeguarding the stability of the EU’s financial system—that proposes to derecognise six Indian third country central counterparties (TC-CCPs), effective 30 April 2023, is counterproductive to extant India-EU economic conversations and is a bullet aimed at its own foot. “As of the date of application of the withdrawal decisions, these TC-CCPs will no longer be able to provide services to clearing members and trading venues established in the EU,” ESMA states.
The derecognition of the six TC-CCPs rides on their supervisory regulatory agencies—the RBI (Reserve Bank of India) for Clearing Corporation of India; the SEBI (Securities and Exchange Board of India) for Indian Clearing Corporation Ltd, NSE Clearing Ltd, and Multi Commodity Exchange Clearing; and the International Financial Services Central Authority (IFSCA) for India International Clearing Corporation and NSE IFSC Clearing Corporation Ltd. In other words, the derecognition comes because of the lack of “cooperation arrangements” between ESMA and RBI, SEBI and IFSCA; it has nothing to do with the six firms.
The precise regulatory clause under which the six corporations will be derecognised lies under Paragraph 7 of Article 25 (Recognition of a third-country CCP) in Chapter 4 (Relations with third countries).
This means, if an investor from a member-nation of the EU wants to buy a futures contract in India, for instance, they will not be able to do so because the six clearing corporations that ensure the buy-sell match in India will have been derecognised. It shuts down the free flow of capital from EU investors to India.
The derecognition derives its legal authority from EU Regulation (EU) No 648/2012. The precise regulatory clause under which the six corporations will be derecognised lies under Paragraph 7 of Article 25 (Recognition of a third-country CCP) in Chapter 4 (Relations with third countries). There are four sub-Paragraphs under Paragraph 7 that seek to establish cooperation arrangements; mechanisms for sharing breaches; and procedural coordination in general, and around on-site inspections in particular. Paragraph 6 demands that TP-CCPs comply.
These, in turn, stand on the shoulders of the G20, where multilateral negotiations have expanded the scope of regulatory practices around Over The Counter (OTC) derivatives, hedge funds, and credit rating agencies. “All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end 2012 at the latest,” the 26 September 2009 G20 Leaders’ Statement at the Pittsburgh Summit said. The next year, the 27 June 2010 G20 Toronto Summit Declaration pushed harder: “We committed to accelerate the implementation of strong measures to improve transparency and regulatory oversight of hedge funds, credit rating agencies, and over-the-counter derivatives in an internationally consistent and non-discriminatory way.”
Impact of the derecognition
By derecognising the TC-CCPs, it is not merely over-the-counter derivatives trading that will be impacted; the entire equities and bond markets will be closed to EU investors. While this may reduce the money flow between the two geographies, it will not shake the Indian market. On the equities side, for instance, of the US $625 billion worth of assets under custody of foreign portfolio investments (FPI), there are just two EU member countries—Ireland and Netherlands—in the top 10 for October 2022; their combined share adds up to less than 7 percent of the total size.
Investors from the continent will log out of the world’s fastest-growing economy, and as a result, lose access to one of the world’s highest returns.
If this matter is not resolved before the 30 April 2023 deadline, it will have a short-term impact on India’s markets, as investors from EU member nations are prevented from trading. But effectively, investors from the continent will log out of the world’s fastest-growing economy, and as a result, lose access to one of the world’s highest returns.
With their growing complexity because of the free flow of finance, regulatory jurisdictions have become a game of dominance and showcasing of power. On their part, companies have been playing this game for decades through regulatory shopping, using the most profitable jurisdiction to set up businesses. In fact, as a risk management tool, the boards of FPIs will already be planning their emigration policies towards more conducive jurisdictions. Nobody—not institutions, not corporations, not individuals—wants to be left out of the India play. As the world’s fastest-growing economy, India remains an attractive investment destination. And likely will remain so for the rest of this decade, as it becomes the world’s third-largest economy before 2030.
The China threat and finding common cause
In effect, therefore, this is a tussle that sits on common interests of regulatory oversight and common values of democratic institutions and open markets, but on varying views of financial stability between ESMA acting on and supported by the EU on the one side, and India’s sovereign regulators, the RBI, the SEBI and the IFSCA, on the other. It is straight out the globalisation-versus-nationalism playbook around the power to regulate; this time by denying access to global capital. India is done playing these games.
As India is a signatory to the two G20 leaders’ statements, the EU rules ought to be followed. To that extent, ESMA is pushing in the right direction and India should begin a regulatory conversation around reciprocity of regulatory oversights—devise a system by which the EU has oversight over Indian regulators, and India over EU regulators. The political will for such reciprocity exists. Only the details need to be worked out. While at it, and given that India is the G20 chair, this reciprocity of regulatory conversations must become mandatory across all jurisdictions.
That said, Indian securities markets are amongst the world’s best-governed. So, pushing the exit India button on financial regulation with its concomitant looming isolation will lead to nowhere. It also displays a sublime lack of understanding of India—something like Don Quixote’s attack on windmills in Miguel de Cervantes’ Don Quixote. What the windmills were to Don Quixote (ferocious giants), modern India seems to be to some EU bureaucrats sill living in the past, by the past, for the past.
Indian securities markets are amongst the world’s best-governed. So, pushing the exit India button on financial regulation with its concomitant looming isolation will lead to nowhere.
Ironically, the bigger and the truly ferocious EU enemy, China, has been and is being given a free pass—five CCPs of China stand on Tier 1 (non-systemically important), the same status as CCPs from the US, Japan, and Dubai. These are, Shanghai Clearing House, Hong Kong Securities Clearing Company Ltd, HKFE Clearing Corporation Ltd, OTC Clearing Hong Kong Ltd, and SEHK Options Clearing House Ltd. There is only one Tier 2 (systemically important) country, the UK.
Leaving its investors at the mercy of the whims of the Chairman of Everything in China is not merely a puzzle that the EU investors need to resolve financially, it is the biggest systemic risk to the continent that voters should fix politically. The recent crackdown by China on its entrepreneurs is still fresh. Worse, Hong Kong is facing a talent exodus, even as the once-free part of China is losing its status as an international financial centre. Amidst all these developments, investing in China becomes uncertain, and because of its size and scale, a systemic risk of exponential proportions. For the EU bureaucracy to climb over this risky mountain of financial danger from China to fix its eye on the Indian regulatory systems is beyond belief.
That the EU chooses to ignore this risk, even embrace it, shows a startling lack of awareness of how China functions. It also displays how some leaders and institutions in the EU are being held hostage by China. On 30 December 2020, the European Commission short-sold the Comprehensive Agreement on Investment with China to the EU. It took the European Parliament to reject it through a 20 May 2021 resolution. Addicted to Chinese manufacturing and Chinese markets, both bound together by Chinese finance—a systemic risk—Europe needs a China financial deaddiction centre.
That sanctuary is India.
Europe has become an energy starved, an economically shrinking, a politically cornered, and a strategically imploding geography, the harsh outcomes of which will show themselves over the next few cold months through the politics of discomfort.
Of course, this ongoing regulatory tussle will end faster than we imagine. For a continent that’s looking at flat to negative growth rates, its largest and third-largest economies (Germany and Italy) headed for recession, high inflation driven by rising energy prices, and fears of a potential stagflation looming, working with high-growth partners such as India will not only be a handshake of interests but of values as well. Following the Russia-Ukraine conflict, Europe has become an energy starved, an economically shrinking, a politically cornered, and a strategically imploding geography, the harsh outcomes of which will show themselves over the next few cold months through the politics of discomfort.
If the EU seeks a wider and deeper relationship with India, through a free trade agreement, for instance—the negotiations for which are underway—it will need to be on its best, rather than worst, behaviour. Poking India on non-issues such as financial regulatory jurisdiction will not help.
But this problem can—and should—be seen as an opportunity for global financial sector reforms as well. A global regulatory harmony, with absolute and equal reciprocity for all jurisdictions, is the way forward. Over the next few months, India should drive the G20 agenda towards a principles-based inter-jurisdictional financial regulatory revamp. That is, if the EU or the US regulators want regulatory oversight on Indian firms, India will get a similar oversight on their companies as well. If ICICI Bank is to open its books to European Banking Authority and Federal Reserve, Deutsche Bank and Merrill Lynch will open their books to RBI inspections.
The views expressed above belong to the author(s).