Extraterritorial reach of regulators weakens domestic stability: RBI

Amid tussle over supervisory powers with European regulators for domestic central counterparties, the Reserve Bank of India (RBI) said such extraterritorial reach could undermine domestic financial stability.

In the bi-annual financial stability report, the central bank said that to prevent a possible logjam there has been ‘positive dialogue’ with relevant stakeholders, including the European Securities and Markets Authority (ESMA) and the European Commission.

The report said the discussions still continue, so as 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,” the report said.

On October 31, ESMA de-recognised six Indian clearing houses, including the CCIL, which hosts the trading platform for government bonds and overnight indexed swaps. The decision is said to have been taken after RBI’s refusal to grant the foreign body the right to audit and inspect CCIL. ESMA’s decision comes into effect on May 1, 2023. The Bank of England took a similar step following the ESMA’s move.

The report said such extraterritorial reach, 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.

“Such unilateral actions can lead to disruption in local markets and undermine domestic financial stability,” it said.

The report said such actions will also hamper the ability of banks and custodians to participate in forex, government securities, equities, debt and derivative markets where local mandates of compulsory central clearing will be militated, leading to disruption in markets and adverse impact on business interests of these entities.

“With the withdrawal of CCP 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,” it said.

The FSR has observed that the disruptions can lead to instability in market conduct, as also impact the clearing members by way of higher capital requirements, increased margin requirements, enhanced credit risk and lack of multilateral netting benefit.