The Reserve Bank of India (RBI) on 12 October released a draft framework for authorization of platforms for electronic trading of regulated financial instruments. In a statement on 4 October advising financial sector entities of the proposed move, the RBI had noted that electronic trading platforms (ETPs) encourage transparency in pricing and discourage unfair trading practices. The objectives of the directions include: (a) promoting fair, equitable, and non-discriminatory access to markets; (b) ensuring financial integrity; and (c) reducing “information asymmetry” by improving dissemination of trading information.
The draft directions define an ETP as an electronic system or facility, other than a recognized stock exchange, that facilitates the buying and selling of eligible instruments. Eligible instruments are defined as securities, money market instruments and prescribed foreign exchange derivatives. An ETP operator would need to be authorized by the RBI to operate an ETP. An ETP operator that offers clearing and settlement services would also need to be authorized by the RBI under the Payments and Settlement Systems Act, 2007.
The draft directions appear to have been carefully prepared. In addition to the regular suite of prescriptions on eligibility criteria and the conduct of an ETP operator, the draft directions also contain prescriptions that reflect the RBI’s astute perception of an ETP not only being a financial but also a technological platform. For instance, in line with global best practice, the draft directions contain prescriptions on data security infrastructure, periodic systems audits, data preservation, and business continuity processes. Notably, the draft directions also contemplate ETPs offering high-frequency or algorithmic trading solutions to their members.
Further, similar to stock exchanges, ETP operators must maintain pre- and post-trade controls. ETP operators must put in place a comprehensive risk management framework that covers all aspects of the ETP’s operation. The trading rules of the ETP (such as order matching) would need to be approved by the RBI. Any changes to such approved rules would also require the RBI’s approval. ETP operators are also required to conduct due diligence prior to inducting members.
The draft directions prescribe eligibility criteria for an ETP operator such as: (a) it must be incorporated in India and “full managerial and operational control” must be exercised in India; (b) it must have a minimum paid-up capital of ₹250 million (US$3.8 million); and (c) it must hold an amount equal to six months’ operating expenses in liquid assets in the form of cash, government securities and bank deposits. Additionally, the ETP operator should preferably have at least three years’ experience in operating infrastructure related to trading in financial instruments.
The criterion of full management and operational control in India may discourage foreign bodies with experience in ETPs from establishing a presence in India. The purpose of this condition is also unclear. As the intent of the RBI is to foster the establishment of ETPs to deepen the securities markets in India, it doesn’t appear sensible to block access to overseas bodies that may already have experience in operating ETPs.
Further, without the ability to exercise managerial control, overseas organizations or institutions would be reluctant to transfer/license the significant intellectual property that would be required to establish and operate an ETP in India. Notably, the draft directions are also silent on what constitutes full managerial and operational control.
To deepen the pool of potential ETP operators, this condition should be revisited. For instance, the RBI could consider removing this condition and instead providing that the chief executive officer and chief operating officer of the ETP operator must be Indian citizens as well as residents of India.
Further, the condition on maintaining six months’ operating expenses in the form of liquid assets would also deter aspirants from seeking to establish ETPs. Indeed, this condition is particularly jarring because it could be argued that by making experience a “preferable” and not a mandatory criterion, the RBI had intended to foster financial sector innovation through technology.
While the RBI’s intent to ensure the financial security of an ETP is understandable, this can also be achieved by obtaining a guarantee from a highly rated bank or financial institution, so that the cash resources of an ETP operator are not blocked or rendered idle.
Overall the draft directions are a step in the right direction and reflect the continued emphasis on promoting depth in India’s financial markets and introducing more sophisticated products and systems in a gradual and controlled manner.
Sawant Singh and Aditya Bhargava are partners at the Mumbai office of Phoenix Legal.
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