Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance International and Trade – II - Question Paper

(10 marks) < ans >

7. discuss how CCIL settlement model has helped in risk reduction to market participants.

(8 marks) < ans >

Domestic market in Indian rupee closes before the US dollar market becomes active. Settlement in Indian rupee funds for any Indian rupee/US dollar trade, therefore, happens before settlement of US dollar funds i.e., the settlement is not on Payment vs. Payment (PVP) basis and this kind of settlement is known as continuous linked settlement. A trader who buys US dollar against Indian rupee can therefore loose the entire amount if the counterparty fails to pay US dollar after receiving Indian rupee. The counterparty exposure is therefore a major reason of concern for participants in this market.

Increase in the size of the market over the years has been causing increase of counterparty exposures of the market participants. A possible consequence of a default by any market participant has also been increasing correspondingly. Moreover, with the increase in trade volume, settlement cost has also been mounting. To decrease the risk from any possible failed settlement, banks started changing their settlements from deal-wise settlements to settlements on net-basis with their counterparties (i.e. through bilateral netting).

The Clearing Corporation of India Ltd. (CCIL) was set up in 2001. It came into existence to take over the responsibility of settlements in the Government Securities and Forex markets. It started working for development of a process for settlement of interbank trades in Indian rupee/US dollar. The settlement started in November 2002. The process that was formulated has remained more or less unchanged so far. In the process, the settlement participants are to report their trades to CCIL through electronic mode using RBI's INFINET network. The matching of reported trades of the participants (counterparties) are to happen in the books of CCIL. subsequent this, CCIL sets limits in terms of net US dollar sale positions per settlement date for all settlement participants. Trades within limits are accepted for guaranteed settlement by CCIL as a Central Counterparty. On the other hand, forward trades are taken for guaranteed settlement only after those enter the Spot Window. US dollars payable to the settlement participants are to be released only after receipt of counter-value Indian rupee funds. For US dollar receivables, however, counter-value Indian rupee funds are to be paid to the settlement participants without waiting for receipt of the US dollar funds, causing principal risk to come into play in such cases.

Earning:   Approval pending.