Sri Lanka stock exchange to set up counterparty unit, mulls derivatives

ECONOMYNEXT – Sri Lanka’s stock exchange will set up a fully owned subsidiary to act as a Central Counter Party guaranteeing share transactions, removing the current three-day settlement risk and enabling the Colombo bourse to trade derivatives.

The Colombo Stock Exchange said it expects to launch the CCP in January 2017 with the project entering its third phase in December 2015 with the incorporation of a separate institution to start buying equipment and frame rules and regulations.

It said stringent measures have been imposed by the CSE over the years to minimize settlement risk and none of the stock brokers and custodian banks have defaulted on payments.

But a CPP for Delivery versus Payment (DVP) settlement where the securities and funds are exchanged simultaneously, finally with full irrevocability on the settlement day is the globally accepted mechanism for minimizing settlement risk.

“A central counterparty will strengthen the overall market integrity,” the CSE said. “Having a central counterparty in place is a requirement for CSE to be categorized as an emerging market exchange.

“In addition, to expand to other tradable derivative products such as a futures and options, a CCP is a necessity as the risks associated with the trading of such instruments are relatively high.”

Consultants for the project are BTA Consulting, a UK based firm specializing in capital market assignments.

The CSE said in a statement that in guaranteeing the settlement of a transaction the CCP would act as a buyer to the seller and the seller to the buyer in all secondary market transactions.

“This process is identified as ‘novation’ which refers to the legal act of replacing the original contract between the buyer and the seller with two contracts between the buyer and the CCP and the seller and the CCP, i.e. the CCP substitutes itself as a counterparty to the transaction.”

This does not mean that a CCP eliminates the default risk altogether, but will guarantee settlement by ensuring that it has sufficient resources to handle the risk.

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This will be through a range of ‘exception handling mechanisms’ such as collateral in the form of margins and the ability to cover the delivery failures of securities through a ‘Buy in’ mechanism, stock borrowing and lending and, as a last resort, by way of a cash settlement.

The CPP project began in 2014 with the commissioning of a new generation Central Depository System.

Its second phase began in 2015 with the development of new Broker Back Office systems and Order Management Systems which will be commissioned in full by March 2016.
(Colombo/November 26 2015)

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