RBI, ESMA near solution for bond settlement issue

The European Securities and Markets Authority (ESMA) and the Reserve Bank of India (RBI) have been engaged in talks for some time now, working to find a way to break the logjam.

“The talks between the EU and India to find a solution has been going on both at the government-to-government level and also at the level of the financial regulators. We expect a breakthrough soon,” the first person mentioned above said, requesting anonymity.

The second person mentioned above said that solutions being proposed by India include allowing European banks’ investments in Indian bonds to be facilitated by a designated European bank, acting as a dealer.

“Alternatively, the EU can accept a third-party bond dealer suggested by the Indian central bank that can override the ESMA regulations,” the second person said, also requesting anonymity. “We want the options to be considered and discussed to resolve the deadlock between EU authorities and Indian policymakers regarding audit oversight rights.”

Spokespersons of the RBI, the finance ministry, and ESMA didn’t respond to emailed queries.

What’s the issue?

In October 2022, the ESMA derecognised the Clearing Corporation of India Ltd. (CCIL) and five other Indian clearing houses, because the European regulator did not have the rights to audit or inspect their transactions. (To be sure, the derecognition took effect on 30 April 2023.)

CCIL provides clearing and settlement services to banks and other investors for investments in government securities, foreign exchange, money markets, over-the-counter (OTC) derivatives, and rupee interest rate derivatives.

The strike on CCIL was the result of a regulatory conflict. Under ESMA regulations, services used by European banks from non-European entities must be vetted by it. But India has refused to grant ESMA supervisory authority over its clearing corporations, as it doesn’t allow any such extra-territorial jurisdiction to any global regulator.

Why the ESMA’s move matters

ESMA’s move may have a bearing on India’s bond market growth. Foreign banks are big purchasers of Indian government bonds, and the country’s inclusion in global bond indices such as the JP Morgan Emerging Market Bond Index has only made Indian sovereign bonds more attractive.

According to a report from CCIL, ahead of the inclusion of Indian sovereign bonds in the JP Morgan index, FPIs (foreign portfolio investors) increased their ownership of these bonds by over $10 billion. Since the official inclusion on 28 June, foreign investors have infused ₹10.6 trillion in the debt segment.

A sense of urgency

The first person cited earlier said there is a willingness on the part of the EU to resolve the issue. “We are confident that the present deadlock would not prevent European institutions from participating in the Indian bond market,” the person added.

To be sure, the Federal Financial Supervisory Authority of Germany, BaFin, and French regulator AMF have allowed their countries’ banks to continue to trade on the CCIL platform even after the 31 October deadline, as French and German banks have been granted more time by their home regulators to transact with India’s sovereign bond clearing house, according to a report in The Economic Times. However, banks of other European countries will have to pay penalties for transactions after 31 October.

What experts say

Experts said that by introducing designated dealers or third-party entities with a mutual agreement, Indian authorities can circumvent the regulatory roadblocks without any compromise.

“Such an arrangement could again attract more European FPIs back into the Indian government bond market. Currently, foreign inflows into Indian bonds, particularly government securities, are crucial for maintaining liquidity and stabilizing yields,” said Venkatakrishnan Srinivasan, managing partner at Rockfort Fincap Llp, a financial advisory firm.

“With India’s inclusion in the JP Morgan Emerging Market Bond Index, the demand for Indian debt among global investors has already risen, and providing European investors an alternative route could further accelerate inflows,” he added.

However, Srinivasan warned that while the alternative arrangement seems promising, it is important to ensure that the process remains seamless and transparent for European banks.

“It would also be crucial to ensure that the designated dealers or third-party bond dealers have credibility to handle such high volumes of investment while adhering to global standards on anti-money laundering and transparency,” he added.

The Indian central government has retained its borrowing target for the current financial year (FY25) and plans to raise ₹6.61 trillion through the auction of dated securities in the second half of fiscal year FY25 to fund the revenue gap and boost economic growth.