Government of India Volume I: Analysis and Recommendations

Table of Recommendations 13.5 Finality of settlements
FOUNDATIONS OF CONTRACTS AND PROPERTY
The Commission recommends the creation of an exception to normal priority of claims in the following instance:
When a trading member of a clearing house is declared as insolvent or bankrupt, the transactions and obligations of
the member will be outside the jurisdiction of any liquidator or receiver. The claims of the clearing house over assets
earmarked for settlement of claims will be the property of such clearing house till the claims are settled and cannot
form part of the liquidation process.
Table of Recommendations 13.6 Finality of transactions
The Commission recommends:
1. An Infrastructure Institution which does netting and settlements should operate on rules which are approved
by the regulator;
2. The final set of transactions created by the Infrastructure Institution would be enforceable in law and would
be recognised as a settlement for all the trades carried out;
3. The Infrastructure Institution would be allowed to replace contractual obligations between trading parties
with the obligations arising out of settlement system; and
4. Even in the event of a bankruptcy of a person all the collateral of the person which have been deposited to
the Infrastructure Institution must be outside the jurisdiction of a receiver or liquidator. The collateral should
be used to complete the transactions already initiated on the Infrastructure Institution and then any surplus
may be garnered by the liquidator.
13.5.3. Finality of financial transactions
The Commission noted that transactions on an Infrastructure Institution cannot be easily
undone. In netting and settling systems, if any individual transaction is undone, all dependant
transactions will also have to be undone. This would create uncertainty for all
persons using such institutions. Problems could also arise on exchanges where trades
are executed at one point of time but the exchange of securities and money happens at a
later point of time. If a person refuses to uphold the trade or goes bankrupt after making
a trade but before completing it, a transaction may fail. Failure of a transaction in the
exchange may have domino effect on other transactions.
The Commission is of the view that transactions on an Infrastructure Institution should
be final and not undone under any circumstances. Recommendations of the Commission
in relation to finality of transactions are given in Table 13.6.
13.6. Public issue and trade of securities
The Commission found that the public issue and trade of securities have three important
regulatory objectives:
1. The public issue of securities should be done in a manner that adequate information about the
issuer and the security is available (on a continuous basis) to the public to make informed decisions
about investments.
2. The entity issuing the securities must have governance system which ensures that the issuer
treats all purchasers of a specific class of securities in the same way and prevent illegitimate
transfer of any funds from the issuer.
3. The trade of securities require that the rules governing the trading of different securities have
common underlying principles which should apply to all trading of securities. These are required
to prevent regulatory arbitrage between trading different securities and should be based on mitigating
and managing the risk of transactions.
13.6.1. Public issue of securities
An incorporated or unincorporated entity may pool capital from an investor base by issuing
securities. While doing so, the investor relies on the ability of the entity’s manage-
126 FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION