SEBI circular on Framework for Orderly Winding Down of Critical Operations and Services of a Clearing Corporation– December 16, 2022

SEBI, vide its circular dated December 16, 2022 decided that the CCs shall have a policy framework for orderly winding  down  of their critical  operations  and  services.

 In order to enable the Clearing Corporations (CCs) to have a framework for orderly winding down of critical operations and services, Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018 (SECC Regulations, 2018) have been amended vide Gazette Notification No. SEBI/LAD-NRO/GN/2022/104 dated November 15, 2022.

Identification of Potential Scenarios

The scenarios which may potentially prevent a CC from being able to provide its critical operations  and  services  as  a  going  concern  and  may lead to  wind  down of its  critical operations and  services, shall  be  identified.  Some of the reasons for winding  down of CC can be:   1.1. Voluntary: The CC is solvent and is able to meet all its obligations towards Clearing Members  (CMs)as  well  as  other  creditors;  however,  wishes  to  wind  down  its critical operations and services and exit as a strategic or business decision.   1.2. Involuntary: The  winding  down  of  critical  operations  and  services  on  involuntary basis maybe due to various factors including but not limited to the following:   1.2.1. Losses due to default by CM(s): The   default   management   resources maintained  by  the  CC  may  get  exhausted  due  to  default  by  CM(s),  and, consequently,  the CC  fails  to  fulfil  its  obligations  towards  CM(s)and/or  its constituents.   1.2.2. Losses due to other factors: There is no CM default and the settlements have been happening in a timely manner; however, the solvency of a CC may get adversely  affected  as  a  result of  some  large  operational expenses, legal expenses, business  or investment  losses,  etc. thereby rendering a CC unable  in  fulfilling  its  obligations  to  CM(s),  its  constituents and/  or  other creditors.   1.2.3. Regulatory Actions: Directions to a CC to wind down  its critical  operations and services by SEBI or any other statutory authority under applicable laws. SEBI  may  direct  a  CC  to  wind  down  its  critical  operations  and  services including but not limited to the following scenarios:   i. A CC shall be required to continuously meet the annual clearing turnover, aggregated across  segments,  including  by  way  of  interoperability,  of  at least  INR  1,000 Cr. per  annum or any  other  amount  as  may  be  specified by  SEBI  from  time  to  time.  In case  the  CC  fails  to  meet  the  aforesaid requirement  for two consecutive  years,  it  shall  be  liable  to  exit  and accordingly,  apply  for  orderly  winding  down  of  its  critical  operations  and services. Provided that the above  threshold  condition  shall  not  be  applicable to a CC for a period of 5 years from the date of grant of recognition. In case where the CC does not apply for voluntary winding down of critical operations  and  services,  pursuant  to  breaching  the  minimum  turnover threshold  as  mentioned  above,  SEBI  may  proceed  with  compulsory  de-recognition of such CC under applicable laws.   ii. SEBI may also direct a CC to wind down its critical operations and services in case of non-compliance of either the conditions of grant of recognition or renewal, wherever applicable; or any  other condition under the applicable laws.

Summary:   Under the framework, CCs will have to draw up a Standard Operating Procedure (SOP) outlining the manner in which their critical services would be carried out in an orderly manner so as to not cause any disruption to the financial system, upon triggering of any of voluntary or involuntary winding down of operations.   SEBI in the circular said that the reasons for winding down of CC can be voluntary or involuntary.   Involuntary winding down would depend on factors such as regulatory action, losses due to default by clearing member and losses due to other factors like some large operational expenses, legal expense or investment losses.   As per the regulatory requirements, a CC would be required to continuously meet the annual clearing turnover of at le east Rs 1,000 crore per annum.   In case the CC fails to meet the requirement for two consecutive years, it will be liable to exit and accordingly, apply for orderly winding down of its critical operations and services.   The threshold condition would not be applicable to a CC for a period of 5 years from the date of grant of recognition.   In case where the CC does not apply for voluntary winding down after breaching the minimum turnover threshold, Sebi may proceed with compulsory derecognition of such CC under applicable laws.   SEBI has asked CCs to make the policy framework containing the SOP duly approved by their governing boards and make it available on their websites within 90 days.

Identification of Critical Operations and Services of CCs

2.1. To identify  the  operations  and  services  which  may  be  classified  as  critical,  CCs shall, inter alia, consider  their  risk  profile,  operations,  organizational  structure, financial resources, business practices, interconnectedness and interdependencies, and any other relevant factor as deemed appropriate. As timely clearing  and  settlement  of  trades  is a  core  function  of  CCs,  the  operations  and services   such   as   collateral   management,   risk   management,   clearing   and settlement, etc. shall be deemed to be critical.   2.2. Further, the contractual obligations of CCs with CMs, Stock Exchanges, Depositories and other CCs, arising out of clearing and settlement of trades, shall necessarily be classified as critical or essential.

Summary:   To identify the operations and services which may be classified as critical, CC would have to consider their risk profile, operations, organisational structure, financial resources, business practices, interconnectedness and interdependencies.   Further, the contractual obligations of CCs with clearing members, stock exchanges, depositories and other CCs, arising out of clearing and settlement of trades, would necessarily be classified as critical.

Standard Operating Procedure (SOP)

3.1. The policy framework of CCs shall contain a Standard Operating Procedure (SOP) duly  approved  by  their governing  board, inter  alia, outlining the manner  in  which the  critical  operations  and  services  of  the  CCs  shall  be  carried  out  in  an  orderly manner so as to not cause any disruption to the financial system, upon triggering of any  of  the  scenarios  as  mentioned  at  paragraphs 1.1 and  1.2 above. A notice or intimation  regarding  winding  down  of  critical  operations  and  services shall be issued by  the CC  as  and  when  the  scenarios  get triggered, with  prior  approval  of SEBI.   3.2. The SOP shall, inter alia, include details   of   infrastructure   and   premises, technological  systems  including  back-up,  outsourcing activities/  vendors/  service providers,  etc.  which  would  need  to  be  retained  or  continued  for  orderly  winding down of critical operations and services. The SOP shall also contain details of key employees or staff members, along with their roles and obligations, etc., who shall be retained and responsible for development, review, and ongoing monitoring etc. of the critical operations and services, once the process of orderly winding down of critical operations and services is initiated.   3.3. The CCs shall include the operational modalities relating to transfer or close-out of positions, collateral, etc. in detail considering interoperable or non-interoperable scenarios as  applicable, while  framing  their  policy  for  orderly  winding  down  of critical operations and services. Broad guidelines in this regard are as under:   3.3.1. Voluntary Winding Down– Voluntary winding down of a CC shall be approved by the  governing  board,  its  shareholders  and  SEBI.  The CC shall inform  the  members  and the market  regarding  its  decision  to  wind  down voluntarily  and  shall  also  mention  a  sufficient  notice  period  (at  least  six months)  for  such  winding  down,  after  prior  approval  of  SEBI,  so  as  not  to have a significant impact in financial system. Since the CC shall be solvent, it shall have the choice of continuing full range of operations or providing only critical services during  the  notice  period.  However,  the  CC shall continue  to provide at  least the  critical  services  during  the  notice  period.  Once  the winding down process is initiated, any open positions of the CMs and/ or its constituents at  the  exiting  CC  shall  have  to  be  transferred  to  the  new  CC where the CMs become member within the notice period. Any open positions within  the  notice  period  that  could  not  be  transferred  shall  be  closed-out  at the  daily  settlement  price  and  in  terms  of  the  provisions  of  the  Rules,  Bye-laws and Regulations of the exiting CC.   3.3.2. Involuntary Winding down (due to default by CM(s) or due to other factors) – The procedure for winding down shall be as follows:   i. The CC shall announce a termination date, with prior approval of SEBI. ii. The CMs who have open positions may change their designated CC, or close-out their open positions. iii. All open positions, if any, shall expire at the daily settlement prices of the termination date.   3.3.3. Involuntary Winding down due to regulatory action- In  this  case,  SEBI  on case to case basis may issue appropriate directions for winding down.

Summary:   Further, the contractual obligations of CCs with clearing members, stock exchanges, depositories and other CCs, arising out of clearing and settlement of trades, would necessarily be classified as critical.   With regard to SOP, the regulator said an intimation regarding winding down needs to be issued by the CC as and when the scenarios get triggered, with prior approval of Sebi.   The SOP shall include details of infrastructure and premises, technological systems including back-up and outsourcing activities which would need to be retained or continued for orderly winding down of critical operations and services.   It would also contain details of key employees, along with their roles and obligations, who would be retained and responsible for development and ongoing monitoring of the critical operations and services, once the process of orderly winding down of cri critical operations and services is initiated.

4. The provisions of SECC Regulations, 2018 and various circulars and guidelines issued thereunder, shall continue to apply during the entire period  of  winding  down  of  critical operations  and  services of CCs. This shall be mentioned in the policy framework of CCs. The framework shall be   (i) periodically reviewed, at least on an annual basis, and (ii) published or disclosed on the website of the CC (excluding any confidential details).

5. Return of Assets

5.1. The  exiting  CC  shall  be  permitted  to  distribute  its  assets  subject  to  conditions  as laid  down  in  its  framework,  guidelines  issued  by  SEBI from  time  to  time, or  any other direction issued by SEBI or any other statutory authority.   5.2. For  the  purpose  of  valuation  of  the  assets  of  the  CC,  a  valuation  agency  may  be appointed by SEBI.   5.3. The quantum of assets available for distribution shall be arrived at after payment of statutory dues, including applicable taxes; contribution to SEBI as specified in para 5.4 and 5.5 below, return of  refundable  collateral  and  membership  deposits  of CMs,  return of deposits  to  warehouse  service  providers,  if any,  and  the unutilized Core SGF  contributions  of  CMs  and  Stock  Exchanges,  as  the  case  may  be, depending  upon  the  scenario  triggering  winding  down  of  critical  operations  and services.   5.4. Subsequent  to  exit,  the  CC  shall  also  be  required  to  contribute  upto  20%  of  its assets  (after  applicable  taxes)  towards  SEBI  Investor  Protection  and  Education Fund (IPEF) in order to provide for settlement of any claims pertaining to pending arbitration cases, unresolved complaints or grievances lying with the CC, etc. The contribution  percentage  may  be decided  by  SEBI  taking  into  account  relevant factors such as the governance standards of the CC, estimation of future liabilities, etc.   5.5. The CC shall pay following dues to SEBI:     i. The dues outstanding to SEBI; ii. The outstanding fees of CMs of such exiting CC till the date of such exit:   In this regard, the CC shall recover the dues of the CMs to SEBI out of the CMs’ own deposits/ capital/ share of sale proceeds/ winding down proceeds of CC, etc. available  with  the  CC.  The  CC  shall  be  liable  to  make  good  any  shortfall  in collection of dues of CMs to SEBI.   5.6. Penalties collected from CM(s), issuer(s) contribution in case of Limited Purpose Clearing  Corporation  (LPCC), and interest on these components, forming part of Core SGF shall be used by the CC in a manner as specified by SEBI from time to time.   5.7. An exiting CC shall not alienate any assets without taking prior approval of SEBI.

Summary:   The CCs would include the operational modalities relating to transfer or close-out of positions and collateral in detail considering interoperable or non-interoperable scenarios as applicable, while framing their policy for orderly winding down of critical operations and services.   SEBI said that quantum of assets available for distribution would be arrived at after payment of statutory dues, including applicable taxes and contribution to the regulator, return of refundable collateral and membership deposits of clearing members (CMs), return of deposits to warehouse service providers, if any, and the unutilised Core SGF contributions of CMs and stock exchanges.   Subsequent to exit, the CC would also be required to contribute up to 20 per cent of its assets towards Sebi Investor Protection and Education Fund (IPEF) in order to provide for settlement of any claims pertaining to pending arbitration cases, unresolved complaints or grievances lying with the CC.

6. Financial Resources

6.1. Regulation 14(3)(b) of SECC Regulations, 2018 stipulates that every CC shall hold additional  capital to cover  costs  required  for  orderly  winding  down  or  recovery  of operations.  Further,  SEBI vide circular dated April 10, 2019 has, inter alia, stipulated that while computing the capital  requirements for winding  down,  a  CC shall consider a minimum time span of six months for ensuring an orderly winding down  or  restructuring  of  its  activities  and  thus,  hold  liquid  net  assets  equal  to  at least six months of gross operational expenses.   6.2. As the instant policy proposal is intended to serve the purpose as envisaged under the above  mentioned regulatory provisions, the said capital requirements for CCs shall be required to be  maintained at  all  times,  and  shall  be  used for  carrying  out critical  operations  and  services  of  the  CCs, once  the  process  of  orderly  winding down of critical operations and services is initiated.

7. Oversight

The Regulatory Oversight Committee (ROC) of the CC shall oversee the implementation of steps or processes involved in orderly winding down of critical operations and services of the CC and shall submit a report to SEBI after approval from the  governing  board,  in  a  manner  as  may  be  specified  by  SEBI,  upon  completion  of necessary steps or processes.

Summary:   The regulatory oversight committee (ROC) of the CC would oversee the implementation of processes involved in orderly winding down of critical operations and services and would submit a report to Sebi.

8. Directions to be issued by SEBI

Appropriate directions by SEBI shall be issued to CCs for orderly winding down of their critical operations and services.

C. Obligations of Exchange(s) and Clearing Member(s)

1. For non-interoperable segments, if the exchange (whose trades are cleared by the exiting CC) intends to continue to offer trading in the concerned segment(s), then it shall engage with another clearing corporation within the notice period.   2. For both non-interoperable and interoperable segments, the CMs of exiting CC shall have to  become   members   of   new or another CC   within   the   notice  period. Alternatively, such CMs may close-out their open positions within the notice period.

D. Modification to SEBI circular on Core-SGF dated August 27, 2014

1. With  regard  to  paragraph 6.1 above,  it  may  be  noted  that  the  existing  regulatory provision in SEBI circular No. SEBI/HO/MRD/DRMNP/CIR/P/2019/55 dated April 10, 2019,  stipulates  that  while  computing  the  capital  requirements for winding  down,  a CC  shall  consider  a  minimum  time  span  of  six  months  for  ensuring  an  orderly winding down or restructuring of its activities and thus, hold liquid net assets equal to at least six months of gross operational expenses.   2. Since the abovementioned capital requirement for carrying out winding down in an orderly manner shall be maintained by CCs at all times, clause V of paragraph 16 of SEBI circular No. CIR/MRD/DRMNP/25/2014 dated August 27, 2014 read with SEBI circular No. SEBI/HO/MRD2/DCAP/CIR/P/2020/01 dated January 03, 2020, on “Default Waterfall” of CCs has been modified as follows:   “Default waterfall 16. The  default  waterfall  of  CC  for  any segment  shall  generally  follow  the  following order: I………….. V. Proportion of remaining CC  resources  (excluding  CC contribution  to  core  SGFs  of other  segments  and  higher  of INR  100 Crore  or the  capital  requirement  towards  orderly winding down of critical operations and services) equal to ratio of segment MRC to sum of MRCs of all segments.*”   3. Similarly, clause VI of paragraph 16A of SEBI circular No. CIR/MRD/DRMNP/25/2014 dated   August 27, 2014, read with SEBI circulars bearing No. SEBI/HO/MRD2/DCAP/CIR/P/2020/01 dated January 03, 2020 and No. SEBI/HO/MRD2/DCAP/CIR/P/2020/245  dated  December  21,  2020, pertaining to “Default Waterfall of LPCC” has been modified as follows:     “Default waterfall of LPCC   16A) The default waterfall of CC shall generally follow the following order – I……….. VI. Remaining LPCC resources (excluding higher of INR 100 Crore  or the  capital requirement towards orderly winding down of critical operations and services). *”

Summary:   It will have to hold liquid net assets equal to at least six months of gross operational expenses for an orderly winding.

E. Applicability:

The  CCs shall have  the policy  framework containing  the  SOP  duly approved  by  their governing boards and make it available on their websites within 90 days from the date of issuance of this circular.

Link to the Circular:

https://www.sebi.gov.in/legal/circulars/dec-2022/framework-for-orderly-winding-down-of-critical-operations-and-services-of-a-clearing-corporation_66268.html