Need for Central Counter Party framework for CSE

THE Colombo Stock Exchange Senior Vice President of Enterprise Risk Management and Post Trade Settlement Dulani Warnakulasooriya in this interview shares insights into the need for a Central Counter Party (CCP) clearing in Sri Lanka, a landmark development aimed at strengthening market stability, reducing systemic risk, and aligning with international best practices.

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What is a Central Counter Party or CCP?

A Central Counter Party (CCP) is a financial institution that guarantees the completion of trades in exchange by becoming the buyer to every seller and the seller to every buyer in a transaction and guarantees the settlement of trades. Replacing the original contracts between buyers and sellers with two separate contracts one between the buyer and CSE Clear, and the other between CSE Clear and the seller. This process, known as 'novation', reduces the counterparty risk, as CSE clearly being the counterpart for all trades. On the settlement day, the CCP ensures the exchange of cash and securities, even if one party defaults.

In the current settlement model, there is no guarantee of settlement; if one party defaults, all other parties are exposed, which can lead to cascading failures in the market. In summary, a CCP plays a critical role in modern financial markets - acting as an intermediary between trading parties, guaranteeing trades, managing risks, and providing the infrastructure to keep exchanges operating safely and efficiently even during times of market stress.

Who serves as the CCP in Sri Lanka?

The Colombo Stock Exchange (CSE) has incorporated a new company, CSE Clear Ltd., which is a fully owned subsidiary of the CSE. CSE Clear will act as the CCP for all equity transactions executed in the CSE. It is a licensed clearing house, regulated by the Securities and Exchange Commission of Sri Lanka (SEC).

Why is a CCP required and what are its benefits?

A CCP enhances the safety, efficiency, and transparency of financial markets by ensuring the smooth settlement of trades through the following:

Risk mitigation: By guaranteeing trades, the CCP eliminates the risk of a party failing to deliver securities or payments.