SEBI

Framework on Winding down Of Critical Operations and Services of CCs: SEBI

The SEBI has issued a circular on the orderly winding down of critical operations and services of clearing corporations (CCs) on 16^th December 2022. The said circular is issued in pursuance of the Securities Contracts (Regulation) (Stock Exchange and Clearing Corporations) Regulations, 2018. SEBI has amended the said regulations to enable the Clearing corporations to have a framework for the orderly winding down of critical operations and services. Further, in order to provide a policy framework on the said issue, the SEBI has made it mandatory for the CCs to include specific provisions in their policy framework. The present article will discuss in detail the mandatory provisions which shall be included in the policy framework.

Identification of Potential Scenarios

The Clearing Corporation shall identify the potential scenarios that may lead them to wind down their critical operations and services. They may also identify scenarios that prevent them from providing critical operations and services on going concerns.

Types of Winding down of Clearing Corporations

The reasons for winding down of clearing corporation are:

1. Voluntary:  The Clearing Corporation can wind down its critical operations and services by taking strategic or business decision even though it is solvent and meet all the obligations towards clearing members and creditors.

2. Involuntary:  The involuntary winding down of critical operations and services may take place due to the following factors:

a. Losses due to default by clearing members: Due to default by the clearing members, the clearing corporation’s default management resources get exhausted, resulting in the Clearing corporation’s failure to fulfil its obligation towards CM and constituents.

b. Losses due to other factors: Due to some operational expenses, legal expenses, business or investment losses etc. the clearing corporation cannot fulfil its obligations to clearing members, its constituents and creditors.

3. Regulatory Actions: The critical operations and services of clearing corporations is wind down by the SEBI and other regulatory authorities, including but not limited to the following scenarios:

a. Annual clearing turnover: The clearing corporation must meet the annual clearing turnover aggregated across segments of at least Rs 1,000 Crore P.A or any other amount specified by the SEBI from time to time. If the CC cannot meet the criteria for a continuous period of 2 years, in that case, it can exit and apply for an orderly winding down of its critical operations and services.

However, such a condition only applies to the clearing corporations for 5 years from the grant of recognition date.

Moreover, if the CC does not apply voluntarily for the winding down of critical operations and services in pursuance of a breach of the minimum turnover threshold, in that case, SEBI may compulsorily derecognise such CC.

b. Non-compliance: The SEBI may direct the clearing corporation to wind down its operations and services if the conditions of the grant of recognition or renewal or any other conditions are not satisfied by the CC.

Identification of Critical Operations and Services of CCs

The operations and services which are classified as critical are:

• Risk profile of CC
• Operations of CC
• Organisational Structure of CC
• Financial resources
• Business practices
• Interconnectedness and interdependencies
• Collateral Management
• Risk management
• Clearing and Settlement
• Contractual Oblations of CCs with clearing members, Stock Exchanges, Depositories and other clearing corporations.

Standard Operating Procedure (SOP)

It is required that the clearing corporation shall include Standard Operating Procedure in its policy framework, which the governing board will approve. It must state how the critical operations and services of the clearing corporations shall be conducted with the aim of avoiding any disruption to the financial system. Further, the clearing corporation should issue a notice or intimation in the event of any trigger of any scenarios with the prior approval of the SEBI. The standard Operating procedure shall include the following details:

• Details of Infrastructure and Premises.
• Details of Technological systems, including back-up.
• Any outsourcing activities or vendors or service providers etc. 
• Key employees or staff members who shall be responsible for review, development and ongoing monitoring etc.

The clearing corporation shall further include operational modalities relating to the transfer or close out of collateral, positions etc. while considering the interoperable or non-interoperable scenarios when framing the policy for winding down critical operations and services. The broad guidelines in this regard are enumerated below:

1. Voluntary Winding Down: The voluntary winding down of CC shall take place with the approval of the board and SEBI. In this regard, the CC shall inform the members and market by issuing the notice at least 6 months before not to impact the financial system. Since the clearing corporation must be solvent, it can undertake critical operations and services during the notice period. During the winding down process, any open positions of the clearing members or their constituents at the existing clearing corporation should be transferred to the new clearing corporation where the clearing members becomes a member. Further, any open positions that are not transferred should be closed out at the daily settlement price.

2. Involuntary winding down: The procedure for winding down shall take place in the following manner:

1. The clearing corporation shall, before the approval date, announce a termination date.
2. The clearing member holding open positions can change their designated clearing corporations or close out their open positions.
3. All the open positions will expire at the daily settlement price of the termination date.

3. Regulatory Action: The SEBI will decide the directions for winding down on a case-to-case basis.

Applicable guidelines and Periodical Review: The provisions of Securities Contracts (Regulation) (Stock Exchange and Clearing Corporations) Regulations, 2018 should continue to apply during the whole period of winding down of critical operations and services of Clearing Corporations which shall also be mentioned in the policy framework for winding down. Further, the policy framework shall be periodically reviewed on an annual basis and the reports of it shall be disclosed on the website of the Clearing Corporation.

Return of Assets

The existing clearing corporations are allowed to distribute their assets in accordance with the conditions laid down in its framework and according to the guidelines issued by SEBI. The valuation of such assets shall take place by the valuation agency appointed by SEBI. 

Quantum of assets: The quantum of assets for distribution shall be determined after the payment of:

a. Statutory dues

b. Applicable Taxes

c. Contribution to SEBI:Upon the exit, the clearing corporation is required to contribute 20% of its assets towards IEPF for the settlement of any claims relating to the pendency of arbitration cases, unresolved complaints or grievances etc. The percentage of contribution will be decided by the SEBI by taking into account many factors such as governance standards for CC, estimation of future liabilities etc. Further the CC is required to give following dues to SEBI:

1. Dues outstanding to SEBI.
2. Outstanding fees for clearing members till the date of exit.

The clearing corporation can recover the dues of the CM out of the CM’s own deposits or capital or share of sale proceeds or winding down proceeds of CC etc.

d. Return of refundable collateral and membership deposits f clearing members,

e. Return of deposits to warehouse service providers

f. Unutilised core SGF contributions of CMs, including penalties collected from CM, issuer contribution in case of Limited Purpose Clearing Corporation and interest thereon in these components.

However, it is also required that the existing CC must only alienate assets with the prior approval of the SEBI.

Financial Resources

According to Regulation 14 (3)(b) of the SECC Regulations 2018, it is required that every Clearing corporation shall have additional capital in order to cover the costs required for winding down critical operations and services. Further, it is required that while computing the capital requirement, the CC must consider a minimum period of 6 months and hence hold liquid net assets equal to meet the operational expenses during such period. Such capital requirements are necessary and it should be maintained at all times. It shall be used for carrying out critical operations and services once the winding down process is initiated.

Oversight Committee

There shall be a Regulatory oversight committee (ROC) of CC that shall oversee the implementation of the processes involved in the orderly winding down of critical operations and services. After completing the winding down process, they shall submit the report to SEBI after getting the approval from the governing board.

Obligations of the Stock exchanges and Clearing Members

The obligation of the stock exchange and clearing members are:

1. For Non-interoperable Segments: If the stock exchange whose trade is cleared by the existing CC intends to continue trading in the concerned segments, in that case, such stock exchange shall have to engage with another CC within the notice period.

2. For non-interoperable and interoperable Segments: The clearing members of the existing Clearing Corporation must become members of the new or another CC within the notice period.

Applicability

The clearing corporation shall have the policy framework containing the Standard Operating procedure duly approved by their governing boards. It must be made available on the website within 90 days from the circular date. i.e. 16^th December 2022.

Conclusion

To regulate the orderly winding down of critical operations and services of Clearing Corporations, the SEBI^[1] has required that the winding down shall include specific provisions. The SEBI has mandated the CC to include the provision in its policy framework for an orderly winding down. It shall maintain homogeneity in the winding down process among the clearing corporations and also protect the interest of the clearing member and creditors. The SEBI, by making it mandatory to hold additional capital during the winding process has put an obligation towards the CC. This will not only protect the interest of the creditors but also reduces the chances of getting the CC insolvent. Therefore, the CC is required to incorporate the above provisions in its policy framework for orderly winding down.

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