NEGOTIATED DEALING SYSTEM (SSS IN INDIA)

INTRODUCTION
The legal framework for dealing with Government Securities issued by the Bank,
as debt manager to the Government, is provided by the Public Debt Act, 1944
and the Rules framed thereunder in 1946. In order to discharge various debt
management functions, under this legal framework, the RBI functions as a
depository as well as registrar of securities held by various investors. As such,
transactions in the secondary market for government securities have to be
settled in the books of RBI. Since bulk of the secondary market transactions
involve holders of large-scale government securities such as banks, primary
dealers, insurance companies, mutual funds etc., these transactions are reflected
by way of transfers in their securities holdings in the SGL Accounts (Subsidiary
General Ledger Accounts – one of the legally approved forms of holding
government stock in book entry form).

As explained in the earlier chapter on Securities Settlement Systems (SSS), one

of the risks faced by the participants in the system is credit risk which is often
sought to be minimized by the introduction of Delivery versus Payment (DvP)
mechanism. Under the DvP mechanism, the delivery of securities (by the seller)
is linked to the payment of funds (by the buyer), so that even if there is a default
by a counter party neither of them stand to lose their principal. In India, the DvP
mechanism was introduced, in phases, from July 1995 by linking the transfer of
securities in SGL accounts in PDOs to the transfer of funds from current
accounts in DADs. This, however, did not mitigate the liquidity or the pre-
settlement risks that continued to exist in the market.

Meanwhile, the technological developments taking place also brought out the
need for an electronic trading platform to put through government securities
transactions that not only facilitated electronic trading, but also real-time reporting
of transactions so as to ensure better information dissemination to the market
participants leading to price and volume discovery for all participants in the

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market (irrespective of their size). These developments also sought to
simultaneously address the issue of an institutional arrangement in the form of a
central counter party to address the liquidity risk and pre-settlement risks in the
market place. The outcome of these efforts was the operationalisation of the
Negotiated Dealing System (NDS) and the Clearing Corporation of India Limited
(CCIL) to cater to the requirements of the government securities market.

CENTRALISED SGL TRANSACTIONS

Prior to the operationalisation of the NDS, the trades were taking place between
institutional / wholesale investors in the predominantly telephone-based deals
with preferred counterparties or through the medium of stock exchange
registered brokers. These trades were then reported to PDOs through SGL
transfer forms, based on which actual transfers were effected on a Delivery
versus Payment (DvP) mechanism (since July 1995). Such transfers would take
place in the SGL accounts that members / investors had at different PDOs. In
case of shortage of securities in the SGL account at one PDO or to facilitate
purchase and sale of securities between parties having SGL account at different
PDOs, inter-PDO transfers would also take place (it was a time-consuming
process). Thus, in order to provide better facility to market participants and also
to give a fillip to the secondary market development in government securities, the
PDO-NDS application package also brought with it centralization of SGL
holdings. As a result, almost all the SGL accounts at other PDOs were closed
and single SGL accounts opened at Mumbai PDO. Any secondary market
transaction now taking place over the NDS gets settled in this centralized SGL
account only. Such accounts are maintained in the Securities Settlement System
(SSS) component of the NDS application package. In fact, members have an on-
line view of their account balances through the SSS instead of having to rely on
the earlier SGL statement to know their account balances.

NEGOTIATED DEALING SYSTEM

One of the measures that has been instituted by Reserve Bank of India in order

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to develop the infrastructural arrangements facilitating the secondary market
operations in Government Securities has been the introduction of a screen-
based trading platform called as the Negotiated Dealing System (NDS). The
NDS, which went live from 15 February 2002, is the electronic trading platform
through which the deals in the secondary market for government securities are
finalized by the participants, and the deal information is taken up for settlement
directly from the system without necessitating submission of physical transfer
forms by the participants. Apart from facilitating the dealing process (by way of
quotes and negotiations), the NDS also provides for electronic reporting of
trades and on-line information dissemination (thereby aiding price and volume
discovery).

With effect from August 2005, another platform has been made available
through the medium of CCIL called as the NDS-OM (Order Matching) system.
This system is an order matching system as the name suggests. The members
put in their orders for purchase and sale of government securities and the
system matches the trades on a price/time priority basis (just like the stock
exchange mechanism). Irrespective of whether the trade has taken place over
the NDS or NDS-OM, the information is made available to CCIL for further
processing as explained later.

CLEARING CORPORATION OF INDIA LIMITED

The Clearing Corporation of India Limited (CCIL), set up in April 2001 by banks,
financial institutions and primary dealers, functions as an industry service
organisation for clearing and settlement of trades in foreign exchange,
government securities and other debt instruments. Any component of the
payment system is open to certain risks such as credit risk, liquidity risk,
replacement cost risk etc., which in turn can lead to systemic risks. The
Clearing Corporation plays the role of a Central Counter Party (CCP) to all
transactions and guarantees settlement of trade executed through its rules and
regulations thus eliminating counter party risk. In turn, this will help to mitigate
the other risks in the securities and foreign exchange settlement systems.
CCIL provides guarantee to the settlement of securities and foreign exchange
transactions of the counter parties by interposing itself as the central counter
party to all trades by a process called as ‘Novation’. By this means, the counter

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party risk is not eliminated but is managed by redistribution. Players’ bilateral
risk is replaced by standard risk to the CCP. In order to provide such
guarantee and also minimise the risks that it exposes itself to, the CCIL follows
specific risk management practices, which are also international best practices.
In the g-sec segment, members have to contribute to the Settlement Guarantee
Fund both in cash and in the form securities an amount which is decided by
CCIL for the member depending upon its standing in the market etc. This
amount would be in addition to the membership fees that each member has to
pay to CCIL.

Role of CCIL in settlement of government securities transactions

CCIL commenced operations in this segment for both outright and repo
transactions from 15th February 2002 along with the operationalisation of the
Negotiated Dealing System. Guaranteed settlement was extended from April
2002. Settlement of securities (Mumbai PDO) and funds (Mumbai DAD) is
done through the DVP-III (effective April 2004) mechanism, that is, both
funds and securities are settled on a net basis (security-wise netting). In the
process of clearing and arriving at settlement obligations as above, the
transactions are taken into the system at CCIL and necessary risk
management procedures adopted to verify the members’ exposure limits are
carried out and calls for additional margins are sent out to the members where
required. Thereafter, the final settlement obligation information is sent to
Mumbai PDO for initiating the process of settlement.

Since CCIL acts as a Central Counter Party and steps in to provide guaranteed
settlement where shortages occur (provided the member has fulfilled its
share of obligations in terms of margin requirements etc), it has entered into
Securities Line of Credit and Funds Line of Credit with a few members so that it
has access to securities and funds which can be used for taking care of
shortages. Whenever CCIL provides the necessary securities in case of any
shortfall, it will withhold the payment of requisite funds to the defaulting member/s.
Similarly, securities are withheld from members who default on funds.

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Steps involved in the G-sec settlement process through CCIL
In order to facilitate a better understanding of the securities settlement system,
as also the role of CCIL in the SSS, the typical work flow in securities
transactions is explained below:

1. The Deal details are taken into the PDO-NDS system based on the
transactions taking place in the g-sec market between members. These
deals could be actually negotiated over the NDS itself or could be entered
into by members outside the system and thereafter reported over the
NDS.
2. At the cut-off time, 2.30 pm for T+0 (same day – only for repo
transactions) settlement and 5.30 pm for T+1 (next working day)
settlement, the deal information is extracted from the PDO-NDS system
and sent to CCIL.
3. At CCIL, the deal information so received from NDS will be validated for
preliminary details such as NDS membership id, CCIL membership id,
membership status, instrument details etc.
4. Simultaneously, CCIL also receives the trade details from the NDS-OM
(Order Matching) platform which also need to be accounted in further
steps for the purpose of risk assessment, clearing and settlement with the
guarantee extended by CCIL.
5. The next step at CCIL involves verification of exposures of the members.
For each member, the trades which are to be settled on that day are
taken, margin factors applicable to the security are applied and the initial
margin for all trades for each member is calculated. The total Initial Margin
thus arrived for each member is verified against that member’s
contribution in the SGF. If the margin requirement is within the member’s
contribution in the SGF, all the trades are taken up for settlement with
settlement guarantee by CCIL. However, if the margin requirement
exceeds the member’s balance in the SGF, a suitable report is generated

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 and the member will be advised to make additional contribution within a
stipulated time, failing which the deals which are in excess of the SGF
balance are sent for settlement without the settlement guarantee given by
CCIL. A suitable report to this effect is sent to the concerned member.
6. The next step is that of Novation. Novation is a process by which the
contract between the original trading counterparties is replaced by a
standard contract each party has with CCIL. In other words, CCIL replaces
the single original contract with two contracts where CCIL acts as the
buyer to the seller and as seller to the buyer. Thus, the bilateral
counterparty risk which existed in the deal stands replaced by a standard
risk which each party has with CCIL.
7. Thereafter, the settlement obligations are arrived at by CCIL by netting the
securities as well as funds obligations so as to enable final settlement on
DvP-III basis. (DvP-I is where both funds and securities are settled on
gross basis; DvP-II where funds are settled on net basis while securities
are settled on gross basis and DvP-III is a process by which funds are
settled on net basis and securities’ obligations is also netted – security-
wise).
8. The final settlement position thus arrived at are sent to RBI (PDO-NDS
system) by CCIL so as to facilitate actual settlement of transactions.
9. The settlement data received from CCIL is taken up for further processing
by Public Debt Office, Mumbai where the investments of all major players
in the government securities market is held in the form of centralized SGL
accounts as well as Constituent SGL accounts of NDS members under
the Securities Settlement System component of the PDO-NDS.
10. The settlement data thus obtained from CCIL is processed by PDO and
Deposit Accounts Department, Mumbai under the Delivery versus
Payment mechanism. For this purpose, the ‘Securities Pay-in’ takes place
first wherein the members’ who have a net obligation to pay securities will
pay the securities to CCIL (because of Novation). The members’ balance

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 for respective loans will be debited in their SGL account and the account
of CCIL will credited.
11. Where members do not have sufficient balance of any security in their
SGL account, the entire settlement file will be sent back to CCIL. At CCIL,
the deal status for settlement guarantee will be verified and thereafter,
CCIL will change the settlement details in such a manner as to debit the
SGF account for the concerned security where default has occurred. In
case the security is not available with CCIL, the Securities Line of Credit
arrangement entered into by CCIL with a few members will be invoked
and securities pay-in details will be altered so that the required securities
are taken from these accounts. In either case, the funds to be paid to the
defaulting member will be withheld. In case the transaction is not under
the umbrella of CCIL guarantee, it may be withdrawn from settlement by
CCIL, in which case it will be treated as SGL bouncing and any arbitration
arising out of such a situation will be settled outside the NDS system.
12. After the securities pay-in at PDO, the next step is to ensure payment of
funds by the members who have a net payment of funds obligation before
the securities are released by PDO. For this purpose, the funds obligation
details are sent to DAD Mumbai
13. The funds pay-out takes place with net paying members paying funds
from their current accounts to the CCIL account (because of Novation).
14. In case of funds shortage, the CCIL has made arrangements for funds
Line of Credit with a few members having current account with Mumbai
DAD and standing instructions have been given to RBI to make use of
these lines of credit so as to complete the settlement.
15. The next step is that of Funds Pay-out wherein the funds are paid out from
CCIL current account to those members who are net receivers of funds in
that settlement. (Here of course, in case of securities default by any
member, funds are suitably withheld by CCIL and the corrected settlement
instructions sent to RBI as explained above)

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 16. DAD Mumbai then forwards the completed settlement instructions to PDO
Mumbai where the utilization of lines of credit, if any, are automatically
recognized by the securities settlement system. In such instances, the
status is reported to CCIL for appropriate measures (of withholding
securities to members who have defaulted in funds) at their end.
17. In case of no default in funds or after receiving the corrected instructions
from CCIL, PDO Mumbai then proceeds with Securities Pay-out whereby
the securities held in CCIL account during the securities pay-in are
credited to members SGL account who have to receive securities as their
net position for the settlement.
18. The final status of the deal after settlement has to be updated in the deal
related information in the NDS system. For this purpose, the status update
of each deal takes place based on the settlement completion information
received from PDO Mumbai (SSS module).
19. The updated deal status is also made available to the concerned
members so that they can verify the deal status as well as available
balances in their SGL accounts directly from the SSS.

(Prepared by Smt.C.S.Kar, Member of Faculty, RBSC)

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