The Hindu Business Line : Two cheers for the RBI

As part of financial sector reforms, the clearance of two pieces of legislation, namely, the Payment and Settlement System Bill and the Government Securities Act, are significant not only for the financial market as a whole but also for those entities that deal with them, says O. N. RAVI.

Once the Payment and Settlement System Bill is passed, all existing retail payment systems will automatically be regulated by the RBI under this Act.

There are at least two reasons for cheering the Reserve Bank of India and the Government. One for passing the Payment and Settlement System Bill and the other for notifying the Government Securities Act. In the rush of various financial reforms, the importance of these pieces of legislation may not have got the attention they ought to have.

With the passage of the Bill, the decks have been cleared for the RBI to regulate payment systems in the country through a separate legislation. Simultaneously, the much awaited notification with regard Government Securities Act has been cleared effective from December 1, 2007.

As part of financial sector reforms, these two pieces of legislation will definitely help the market in the long run and are significant not only for the financial market as a whole but also for those entities that deal with them.

Legal limitations

The Government Securities Act, 2006 will help deepen and widen the government securities market, especially the retail segment, which has so far not taken off. Earlier pieces of legislation — the Public Debt Act, 1944 and the Indian Securities Act, 1920 — contained certain legal limitations, which impeded free development of the bond market. Hence, a total overhaul of these Acts was undertaken, which resulted in the Government Securities Act, 2006.

This Act has freed government securities (G-secs) transactions from the clutches of the restrictive regime of legal framework to one of mobility and ease of operation.

Significant features

Some of the significant features of the Act are:

It permits pledging of G-secs. The holders of the securities will be able to pledge the G-secs as collateral towards any bank borrowing. Under the Public Debt Act, there was no specific provision for pledging of the securities.

It allows G-secs to be stripped into different securities. This will allow them to be traded as zero coupon securities. The stripping will minimise the re-investment risk which otherwise is present when coupons in long-dated securities are reinvested. In the process, the stripping helps banks, insurance companies, institutions/pension funds, etc, to reduce their asset-liability mismatches. Stripping will also help individual investors who hold G-secs in planning their cash flows. Similarly, the securities with the same coupon payment and maturity date can be consolidated.

Another important aspect of this Act is provision of nomination facilities to the holders . Prior to this, under the Public Debt Act if the value of the G-secs was more than Rs 5,000 only the executors and administrators and the holders of succession certificates were recognised by the RBI as having title to these securities. There were requests to change this, as obtaining succession certificates was a time consuming and costly affair. A few other changes have also been made, such as summary adjudication by the RBI of disputes. It is hoped that these changes will help strengthen the existing institutional market and in the development of the retail government securities market. The other significant development for the financial market has been the passing of the Payment and Settlement System Bill. The Bill, passed by both the Houses and awaiting President’s assent, contains within its framework a whole catena of provisions of law touching upon various aspects of the functioning of the payment systems.

‘Ten core principles’

The Bank for International Settlements (BIS), Basle has prescribed “Ten core principles” for an efficient conduct of a payment systems. Many countries use these principles to test and rate the health of the payment systems. The foremost amongst the core principles is that any payment system should have a well-founded legal basis under all relevant jurisdictions.

In India, the existing retail payment systems, such as MICR cheque clearing systems, Electronic Clearing Systems card payment system, ATM and large payment systems such as Negotiated Dealing system for G-secs, inter-bank foreign exchange transactions and RTGS, are regulated by the RBI and function only under a contractual framework.

After the passing of the Payment and Settlement System Bill, all these payment systems will automatically be regulated by the RBI.

This proposed legislation is based on the Report of the Committee on Payment Systems in India headed by Dr R.H. Patil. The Committee constituted by the RBI went into various aspects of payment systems keeping in view the international scenarios and recommended this Bill. The object of this Bill is to provide for the regulation and supervision of payment systems in India and to designate the RBI as the authority for that purpose and for matters connected therewith.

The following important provisions in the Bill underpin its significance:

Only payment systems authorised by the RBI can be operated.

The regulation and supervision of the payment system will be done by the RBI.

The person who operates the system is called system provider.

The banks or any person participating in a payment system is called system participant.

The system provider would operate the payments in accordance with the provisions of the Act, the contract governing the relationship between the system provider and participant, and conditions of authorisation laid down by the RBI.

Finality of settlement

The most significant provision in the Act is one that gives finality of settlement. It states that the settlement effected under the rules and procedure of the system provider shall be final and irrevocable.

The law also recognises, for the first time, the concept of multilateral netting. According to the Glossary published by the BIS, multilateral netting “is an arrangement among three or more parties to net their obligations. The obligations covered by the arrangement may arise from financial contracts, transfers or both. The multilateral netting of payment obligations normally takes place in the context of multilateral net settlement system.” Multilateral netting has been found to be 90 per cent more effective than bilateral netting in reduction of risk and liquidity requirements.

The law protects transactions that have entered the zone of finality from the adverse effects of insolvency laws. This is a singular trend-setting provision which will protect those transactions that have become final by making them insolvency remote. In the event of insolvency of a participant in the payment system, the provision goes to the extent of protecting even the collateral deposited by a system participant with the system provider from the liquidator.

The transactions which are covered for these purposes are only G-secs, forex, derivative or other transactions as may be notified by the RBI. The system provides for settlement of disputes through arbitration with a right of appeal.

This legislation will go a long way in promoting a healthy financial payment system in India. It is also expected to benchmark the Indian payment system to international standards.

(The author is Senior Vice-President of Clearing Corporation of India Ltd, Mumbai.)

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