RBI-ESMA standoff: Time for India to demand its pound of flesh

The simmering dispute between Indian and European regulators on supervisory control over financial intermediaries in India may blow over, but not before Indian regulators establish their position on the high table of global financial markets.

The Reserve Bank of India Governor did not mince words on what he wants the European Securities and Markets Authority (ESMA) to realise and accept — that India is not a pushover anymore.

“India is very different from what it was 10 or 30 years ago… our regulations today are very robust,” Governor Shaktikanta Das said. “We are compliant with the CPMI (Committee on Payments and Infrastructures) guidelines under the aegis of the Basel framework. We comply with all international standards. I think it is very necessary for regulators from the other side to appreciate and trust the credibility and strength of the Indian regulations.”

At the heart of the dispute is ESMA’s right to inspect, penalise and de-recognise any Central Counterparty Clearing Houses (CCPs) in systemically important countries where European banks are involved. This the RBI sees as an extraterritorial provision that violates the sovereignty of the nation.
“We hope to achieve some sort of understanding,” said deputy governor T Rabi Sankar. “The fundamental point of divergence is the fact that an Indian entity that does not operate in the European Union and operates entirely in India is being subjected to regulation by the European Union regulator.”

This provision came into being in what is called the EMIR-2, or European Markets Infrastructure Regulations, which was born to protect the continent’s financial institutions post-Brexit. While this was designed on the basis of the Commodity Futures Trading Commission (CFTC), unlike the US regulator, ESMA added the cash market as well instead of just the derivatives.

Under EMIR-2 markets are divided into two categories. Category 1 countries don’t need to be subject to ESMA inspection, but they are not significant markets. But in Category 2, the systemically important markets need to comply with tight norms. To escape European banks getting cut off from Indian markets, ESMA could classify India as Category 1. But the question is how long? As the size and importance grow, India would have to be in Category 2.

When jurisdictions such as Australia, Japan and others have ceded ground, can India hold on? ESMA in its power has done many adjustments for some jurisdictions, say experts. But many of them are smaller markets and also on procedural issues and not substantive.

European banks may be a vital part of the Indian financial system, but they need the Indian markets as much as the country needs them. Over the years they have been shrinking and are minuscule in overall banking, but they are estimated to be about 15-20% of the bonds and currency markets and the business is extremely profitable. That may well be a lever for the RBI to make ESMA cede ground.

Other than violating a country’s sovereignty, the cost of compliance and enforcement rights when there are lapses are also a challenge for Indian CCPs. The fee charged by ESMA is too high and exposes them to penalties and derecognition that could cripple domestic institutions. Some question whether ESMA has the budget to even inspect without the funding by these institutions.

While opinions mostly lean towards the impossibility of a Memorandum Of Understanding between the RBI and ESMA because of it being in the statute, the European regulator could find a way out because its institutions could be at a disadvantage. After all, the US banks are not present in the derivatives market.

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