SEBI comes up with new rules and regulations from time to time to ensure legal practices and the smooth functioning of the stock market. In the year 2019, the SEBI (Securities and Exchange Board of India) has introduced interoperability. In simple words interoperability means to operate in cooperation with each other.
Stock exchange and clearing corporations are stock market participants. Clearing corporations act as a middle man between the stock exchange and the trader. Trades are executed on the stock exchange and are settled in the respective clearing corporation. Each stock exchange has its own clearinghouse/clearing corporation for trade settlement.
Interoperability refers to the settlement of trades bought on one exchange into the clearinghouse of another, if the clearinghouse of the first stock exchange faces any problem. In this blog, we have answered all your questions like what is interoperability, what are the benefits of interoperability? What are the regulations of interoperability? All in all, this blog is the complete package to quench your thirst.
How do stock markets and clearing corporations work in cooperation?
The Indian stock market has two leading stock exchanges NSE (National Stock Exchange) and BSE (Bombay Stock Exchange) along with the MSEI (Metropolitan Stock Exchange of India). In the BSE and NSE trading happens in various forms of securities, including stocks, derivatives, and currency. For settlement of these trades, every stock exchange has its own separate clearing corporations.
What is Interoperability?
A theoretical definition of interoperability means one or more systems, whose interfaces are made in a way to work with other products or systems, at present or in the future, in either implementation or access, without any restrictions. The same concept applies to interoperability in the share market.
What is Interoperability in the share market?
In the year 2019 SEBI (Securities Exchange Board of India) has introduced interoperability. Interoperability in the context of share market means a system where trades executed on any exchange—BSE, NSE, or MSEI —can be settled or cleared through any of the clearing corporations and not necessarily restricted to the clearing corporation of the stock exchange on which the trade was done. It means a trade executed on NSE can be settled through the Clearing Corporation of BSE and vice versa. It ensures a risk-free (at the time of glitch or disruption) operation by separating the execution risk from the settlement risk. Different stock exchanges and their clearing corporations are linked to each other in order to execute the interoperability.
What are the Benefits of interoperability to the investors?
Interoperability is significant in the capital market ecosystem as it helps in bringing in a lot of benefits as follows:
Lower trading costs
As many leading brokers are members of both the stock exchanges (BSE and NSE) and also are the members of their clearing corporations. Because of this, they have to maintain separate margin positions in both the clearing entities. But with the implementation of interoperability brokers can consolidate their margins and collateral in a single clearinghouse. This will result in better capital utilization, which, in turn, could lead to lower trading costs. The competition between clearing houses might increase which again leads to competitive pricing in terms of a lower cost of clearing the trades.
Traders can execute calendar spread strategy
Traders can execute Calendar-spread margins between near- and far-month contracts between exchanges. It gives opportunities to trade in different instruments across exchanges for an investor.
Protection of capital from technical glitches
Interoperability saves market participants from glitches or disruptions in a particular exchange or its clearing platform. It allows market participants to square off their positions in case of stock exchange disruption by separating the execution risk from the settlement risk.
What is the importance of interoperability?
In the share market for every second thousands of transactions (buying, selling and settlement of trades) happens. There is people’s money invested in the market. Just imagine the controversy if any of the processes in NSE halted or face disruption even for a short
period of time. As any such disruption might cause investors to lose huge money SEBI has introduced interoperability. Interoperability ensures a smooth and regular operation if any particular stock exchange or a clearing corporation faces any kind of snag or disruption. Take the example of trading disruption on NSE where the cash and futures markets of the National Stock Exchange (NSE) were shut in the morning due to a technical glitch. The benchmark indices – NSE Nifty and Bank Nifty - weren’t able to refresh the cash market rates. On that day NSE opened at 3.30 pm and closed at 5 pm. When this was happening in NSE and trading came to a complete halt on NSE, there was normal trading happening on BSE, and the trades were also being settled through BSE’s clearing corporation.
Even if the NSE (National Stock Exchange) was functional and only its clearinghouse was affected, due to the existence of interoperability, settlement of trades done on NSE would not have been affected as BSE’s clearinghouse was fully functional.
From this, you must have understood the importance of interoperability. In any circumstance, if one of the clearing corporations faces any kind of disruption, all the settlement activities can be switched to the other clearing entity without any problem, if interoperability is fully functional.
What are the Interoperability Regulations?
To access another trading platform a market participant is required to take membership of another closed group of related entities
Any clash or problem occurring due to interoperable links would require efficient and timely resolution. To ensure smooth, fair, and transparent resolution of the issues that may arise from such interoperable links a powerful dispute resolution mechanism needs to be implemented.
Agreement between the stock exchange and a clearing corporation. The concept of interoperability anticipates a multi-party agreement between the trading corporation and multiple clearing corporations(CCPs). In order to provide a legal basis for this multi-party agreement between the trading venues and multiple clearing venues, it is necessary that the legal framework governing the securities market recognizes and supports such link arrangements.
Regulation 37 of SECC does not support a multi party agreement between stock exchanges and multiple clearing corporations but permits link arrangement between a stock exchange and a clearing corporation. However, to identify and support the multi-party agreement between stock exchanges and multiple clearing corporations, it is proposed to insert a provision to Regulation 37(1) of the SECC Regulations.
The above regulations are with reference to the SEBI’s interoperability regulation document.
This way you must have understood what interoperability in the share market is and how it affects your trading. The introduction of interoperability in the share market brought an assurance to the trader in the scenarios of technical glitches and disruptions. Interoperability allows market participants to square off their positions in case of stock exchange disruption by separating the execution risk from the settlement risk.