1. The Negotiated Dealing System (NDS) is an electronic platform owned and maintained by RBI. It has been posted on the Indian Financial Network (INFINET) maintained by Institute for Development and Research in Banking Technology (IDRBT), a fully owned initiative of RBI. Originally conceived to facilitate dealings in government securities – Central/State Government securities and Treasury Bills (gilts) and money market instruments, NDS was intended to be mainly used as a trading/reporting system for secondary market gilts transactions and for electronic submission of bids in primary auctions of gilts by RBI. Over time, while the nature and scope of activities carried out in NDS has expanded, as indicated below, its primary focus remains the gilts market.

2. NDS current activity scope includes –

• Reporting of all outright and repo gilt trades concluded in the Over-the-Counter (OTC) secondary market;
• Order entry for quote driven market in gilts;
• Negotiation mode for concluding gilts deals;
• Submission of bids for primary gilts auctions;
• Reporting of call and notice money transactions;
• Reporting of term money transactions;
• Value free transfer of gilts;
• Electronic down-load of security balances in SGL/CSGL Accounts with PDO

3. NDS operations commenced on February 15, 2002. Almost all market participants who maintain Current and SGL Accounts with RBI have joined NDS. Most SGL transactions at the Public Debt Office (PDO), Mumbai are now on electronic mode through NDS. Similarly, bids in LAF, gilts auctions are being generally submitted electronically through NDS resulting in reduced auction bid processing time, besides minimising clerical errors. To provide wider access to the data on the gilts market, information on trades captured by the NDS is being disseminated through the RBI’s website since October 25, 2002 on near real time basis. With mandatory reporting requirement in respect of all call/notice money and term money market transactions, regulatory access to such information is now better with reduced reporting time lags. Although several members fail to report all their money market transactions or report them with considerable time lags, market players have generally benefited from the reporting system in that assessment of market trends are now more meaningful.

4. NDS has helped in achieving paperless and straight through clearing and settlement of secondary market gilts trades through CCIL as a central counterparty. The system has brought about significant improvements in transactional efficiency and transparency. Better dissemination of information on market deals and moves towards deepening the gilts market have also been facilitated as reflected in the better price discovery and increased market turnover. NDS has had its share of woes and problems too. These problems faced by the NDS could be classified into two categories, viz.; technical issues and business related issues.

5. On the technical front, problems have largely hovered around the periodic disruptions in NDS usage, loss of network connectivity, performance related issues, inadequacy of technical/help-desk support, etc. The common perception on business related issues point largely to the lack of user-friendly features and functionalities of the NDS. Resultantly, the core aim of proper development of the domestic gilts market has perhaps not kept pace with the original intent.

6. To review some of these issues as also to bring more transparency in trading of Gilts RBI constituted a Working Group headed by Dr R.H.Patil (Chairman, CCIL) and comprising of the following other members, to study the pertinent issues relating to further development of the government securities market to help bring about greater degree of transparency and make appropriate recommendations:

1. Dr R. H. Patil - Chairman, CCIL - Chairman
2. Shri R.V. Joshi - MD, STCI - Member
3. Shri D.G. Kamath - MD, GSTC - Member
4. Shri K. Unnikrishnan - IBA Representative - Member
5. Shri Jayesh Mehta - PDAI Representative - Member
6. Shri P. Mukherjee - FIMMDA Representative - Member
7. Shri Jasbir Singh - CGM, IDMD, RBI - Member
8. Shri Chandan Sinha - CGM, RBI, Guwahati - Member
9. Ms. Kamala Rajan - DIT, RBI - Member
10. Shri R. Muralidharan - GM (Banking), RBI, Mumbai - Member
11. Shri B.B. Sangma - DGBA, RBI - Member
12. Shri P.J. Thomas - DBOD, RBI - Member
13. Shri T Rabi Sankar - IDMD, RBI - Convener

7. The original terms of reference for the Working Group were as under:

1. To review the current usage of the real time on-screen deal negotiation and anonymous trading capability of the NDS and suggest remedial measures.
2. To suggest the appropriate extent to which such capability should be mandated, as a first step.
3. To indicate the time frame to achieve the mandated use of the facility in stages with a concrete action plan.
4. To recommend technical, institutional and other measures to implement such an action plan.

8. The Group has since submitted its Interim Report to the RBI in February 2004. In its Interim Report, the Group examined in detail the present NDS environment. The major observations, based on the position obtaining currently in the gilts market, were as under:

1. Most of the secondary market gilts trades are effected through brokers. This has resulted in lack of liquidity on NDS, which has remained merely a reporting system;
2. The price discovery process is being achieved through intermediaries, which apart from being non-transparent, does not provide pre and post trade transparency;
3. The existing OTC market dominated by a few brokers does not get to adequately reflect plurality of views of all active market participants;
4. It would be desirable to minimize the influence of brokers on NDS members to mitigate influence in market direction;
5. NDS participants do not currently have facility to gauge market depth in terms of all available quotes;
6. Although NDS provides for a negotiation functionality, deals concluded, if any, have to be re-entered in NDS and are subjected to a validation/confirmatory process leading to possible errors and delays, which are major limitations of the NDS;
7. These shortcomings can be addressed by a screen based trading system with features currently not present in NDS.

9. While concurring broadly with the observations contained in the Interim Report as also the expected improvements and benefits that would accrue from screen based trading, it was felt that the issue needs to be explored in more detail. The Group has now been requested by RBI to submit its advices on the following issues:

1. The problems faced by market participants and RBI in operating present NDS system for various purposes and suggestions in regard to hardware and software to ensure that NDS operates smoothly and efficiently without delays;
2. The specific steps for implementation of an order driven anonymous screen based gilts trading system;
3. The technological requirements for the screen based trading i.e., both hardware and software including related technological issues for its integration with existing RBI systems;
4. Action plan for migration to screen based trading;
5. Issues and steps involved in developing and improving market making and liquidity in gilts market on the exchanges;
6. Issues that need to be addressed to ensure efficient clearing and settlement of trades on NDS and the exchanges;
7. Issues relating to connectivity of depositories with RBI PDO-NDS for speedier value free transfers etc.;
8. Sequencing of steps that need to be taken in regard to trading on NDS and the stock exchanges.

10. The Group has examined each of the above issues referred to it, in the light of the earlier study conducted and the Interim Report submitted by it. While carrying out a comprehensive analysis and careful consideration of all related aspects, the Group is of the view that the way forward lies in critically analyzing each of the issues involved and looking at possible alternatives, timely and cost-effective solutions to them. As an attempt in this direction, the Group is pleased to submit its Report in the subsequent paragraphs, which comprises of four Sections –

Section I - NDS – Technical Issues: Problems and Solutions

Section II - Status of NDS Gilt Market

Section III - Developing Retail Gilts Market on the Stock Exchanges

Section IV - Summary of Conclusions and Recommendations

The technical problems observed could be broadly classified into two categories viz., Issues beyond NDS and NDS related issues.

1. NDS is one of the many applications that use INFINET. Hence problems, if any, in the INFINET have an impact on the performance of NDS. The users of INFINET use it for several purposes of their own (like e-mails) as also those relating to the NDS applications. Further, over time, many RBI applications have been added to INFINET. Some of CCIL’s applications are also hosted on the INFINET. It is therefore necessary to list all such applications running on the INFINET so as to determine a hierarchy of priorities in which such transactions can be handled; this will help in allocating the highest priority, from the technical angle, to the NDS related transactions. A periodic review of bandwidth utilizations for different uses should also be made so that it becomes possible to ensure allocation of required bandwidth for NDS related activities on a priority basis.
2. Another critical issue relating to network that needs to be examined is why some of the members face inordinately long response time in their NDS transactions. Particular attention should be given to the likely problems that may be faced because of combining VSAT traffic with that of the landline traffic when messages travel on the INFINET. Internal studies done by CCIL indicate that some of the packets sent on the INFINET get lost in transit necessitating their re-transmission by CCIL system to ensure that members do receive the communications sent to them. In this context it is worth examining the desirability of putting all the NDS related transactions on another dedicated telecommunication network within the INFINET framework so that all the problems that NDS members currently face can be more satisfactorily resolved. This would also eliminate some of the LAN related problems at the members’ end.
3. It may also be desirable to review the existing technical tools available for network monitoring, their adequacy and scope for improvements. NSE for example has a network monitoring tool for all its VSAT operations that helps in tracking functional quality/health of its satellite communication network as also tracking response time for members when they are transacting on NSE’s trading system. Similarly, the monitoring of NSE’s large leased line network is done by MTNL as part of its MLDN service package. It is desirable that similar services/arrangements are put in place in regard to the INFINET facilities made available to the members, at least in respect of their time and mission critical NDS transactions.
4. IDRBT/RBI should proactively monitor the network infrastructure for maximum uptime. They should be able to have remote access to router at Member end to monitor/test and have control over the network. Member-end LAN traffic should not be allowed to enter INFINET. IDRBT/RBI should regularly check bandwidth utilisation of all links. Members should also regularly monitor their INFINET leased line. Backup leased line should be properly maintained.
5. Most members are connected to INFINET through 64 kbps lines. Prima facie, it appears the delays faced by members in respect of their time critical NDS applications are due to bandwidth constraints. With the number of applications having increased, there is urgent need to review the adequacy of this bandwidth and its possible enhancement to 2 mbps lines. This would need to be mandated as members may come up with the issue of extra cost burden. Going forward, dependence on this Network is only set to increase and if adequate bandwidth is not ensured at all times, failures would be frequent which will have its impact on the system as a whole. Moreover, all NDS members are institutions who can be persuaded to see the overall cost benefit analysis of migrating to a higher band-width. Experience suggests that members who have already installed 2 mbps lines do not have network related issues. In extremely exceptional cases, the alternative could be the provision of an exclusive 64k lease line meant only for the NDS operations.
6. INFINET uses IBM’s MQ Series for its communication protocol. The NDS network has suffered in terms of its operational reliability due to problems associated with the IBM MQ sender/receiver channel issues, viz., both channels being down, sender channel up but receiver channel down or vice versa. Due to this, many a time other Queue Managers have been asked to stop whenever NDS Queue Managers have had problems. Moreover, while IBM MQ is a standard utility used across various networks, its suitability for specific applications such as NDS may need to be reviewed. In this context, it may be appropriate to ascertain global experience with regard to usage of IBM MQ for dealing applications. CCIL’s experience in IBM MQ’s ability to support dealing application communication protocol has not been very encouraging.
7. Given all these problems/issues vis-à-vis the INFINET it may be desirable to arrange for an independent technical study of the operations of INFINET by a reputed and competent agency/body to assess its reliability, performance, connectivity, bandwidth, communication protocols, configuration, network monitoring tools deployed/desirable, scalability, current capacity utilisation, need for augmentation if any for future requirement etc.

At the current stage of the G-sec market it is desirable that an automated screen-based trading system is made available for the NDS members. The desirable functions and features that would need to be built into such a System have been examined and the same is contained in Annexure "A" appended hereto.

The development and operationalisation of a fully automated Screen Based Order Matching System may be introduced in a phased manner so as to build comfort especially among the major players like banks and primary dealers. Given the criticality of the requirement for the development of an efficient and healthy gilts market, it would be prudent to take up this activity in phases.

In view of its domain expertise and proven competence in this area CCIL may be associated with the task of making suitable modifications to the NDS to facilitate creation of requisite functionalities with appropriate linkages to the clearing and settlement processes.

The dealing system should be a part of the existing RBI NDS set-up. However, the same should be housed on a different server and should be kept under the direct control and supervision of IDMD, the RBI Department regulating the gilts market.

Trades could happen in the proposed system amongst NDS members where the buyers and sellers are all NDS members. The proposed system should be an anonymous order matching system wherein identity of parties is not revealed. The order matching should be based on a price-time priority algorithm, meaning thereby that orders with given price would get matched based on the basis of time priority.

RBI should specify the roles and responsibilities of members dealing on the system.

The proposed Order Matching System should follow some general principles of dealing which should be shared with the members. NDS members should adhere to these general principles.

Trades done on the proposed system should flow on-line to the NDS system without any additional confirmation requirement from either the buyer and/or the seller. The trades should follow the existing path for clearing and settlement through CCIL. This will ensure that minimum changes are required at the member end and at the RBI-NDS end while satisfying the objective of RBI-NDS being the repository of all gilts transactions

CCIL will continue to be the central counterparty to each trade done on the system and settlements of such trades would be guaranteed by CCIL subject to members adhering to CCIL’s Bye-Laws, Rules and Regulations. The comfort of a risk mitigated environment with the counter-party risk having been eliminated on account of settlement guarantee provided by CCIL will facilitate such anonymous trading. On the dealing side, the risk could arise from failure of the system due to technical reasons with the result that members may not be able to deal or close out. Such risks could be significantly minimised if a robust and highly reliable communication network is put in place. Moreover, since the present system of reporting trades on NDS will continue until all the trades take place on the NDS efficiently to the satisfaction of all the NDS members, the above problem can be addressed. Besides, the trading on the system being transparent, it will promote better supervision and regulation.

To minimize implementation time for automated screen based trading on NDS the activity can be implemented in phases as follows:

a. Price based order matching system for top 5/10 liquid Central Government Securities

b. All market participants to conclude all deals (unto Face Value of Rs. 25 crores) in these securities on the order matching system. For large deals of more than Rs. 25 crores, as well as for trades with non-NDS members the market participants may be given the option of concluding the same in the OTC market if they so desire.

c. Following functionalities/features should be available in Phase I -

• Place/Modify/Cancel Orders,
• Order Quantity Conditions like All or None/Disclosed Quantity,
• Market Queries like Market Watch, Market by Price, Market by Order,
• Customizable Market Watch Screens to monitor preferred Securities;
• Dealer Queries like Outstanding Orders, Previous trades, Net position
• YTM Calculator;
• Automatic Deal Ticket Generation and Printing;
• Dealer Blotter Generation and Printing;
• User friendly software with easy navigation
• Generation of .csv files of important outputs such as Deal Ticket to facilitate electronic feed into proprietary treasury systems at member-end;
• Provision to generate automatic on-line feeds to facilitate dissemination of trade information to market

d. Mechanism to be put in place to facilitate periodic review of securities by IDMD (if necessary in consultation with FIMMDA/PDAI/CCIL) covered under Order Matching Screen (at weekly/fortnightly intervals) to ensure liquidity

Gradual increase in the number of securities to increase market coverage such that in about three months from implementation of Phase I, all actively traded Central Government securities are brought into the ambit of the Order Matching System

1. Yield based order matching system for Treasury Bills to be part of the existing setup
2. Order Matching activity scope to be increased to cover Treasury Bills and State Government Securities.
3. Following advanced functionalities/features to be introduced in Phase III -

• Customizable Dealer hierarchy set-up,
• Activation of trigger orders viz Stop Loss, Take Profit orders,
• Interface with proprietary Back office software
• Provision to generate automatic on-line feeds to facilitate dissemination of outstanding order as well as trade information to market
• Enhancements and other features as may be required based on market feed-back

The Order matching system will be a plug-in module to the existing RBI-NDS setup.

Trades done on the system will flow to RBI-PDO and from thereon to CCIL for settlement as per existing procedures.

Trades done on the system should be treated as confirmed and not subjected to the current time consuming four-stage confirmation process as existing in the present NDS environment.

Trades will enter RBI-PDO at the Ready for Settlement Status.

The file formats and interface with RBI-PDO will need to be accordingly finalized.

RBI shall specify the hardware and software configuration for installation of the dealing application at the member end.

The hardware and software requirements at RBI and members end for installation of the dealing application are indicated in Annexure "B" appended here to.

Globally, gilts markets are essentially wholesale markets (also often referred to as the inter-dealer markets) with major participants being institutions like banks, primary dealers, financial institutions, insurance companies, mutual funds, pension funds and provident funds. Retail participation from individuals and trusts is generally on a very subdued scale. In India too the scenario is no different. The dynamics of the two markets viz. wholesale and retail as well as the sentiments underlying trading in such markets is quite different. The trading parameters like the market lot size, the price ticks etc also vary across the two markets. It is therefore desirable to have a clear segmentation of the markets into Wholesale and Retail.

At the current stage of development of our G-sec market there is a strong case in favour of keeping the wholesale G-sec market of NDS members separate from the retail or mid segment market. In India the combined fiscal deficit of the Centre and the States as percentage of GDP is very high (well in excess of 10%). Having recognised the risks that the economy faces from continued high level of fiscal deficit GoI is serious about bringing down the level of fiscal deficit to a reasonable level of about 3% as percentage of GDP in the near future. But until that stage is reached the outstanding stock of government debt would have grown to significantly much higher levels. Hence, even after the net fiscal deficit comes down to reasonably acceptable level, the levels of gross market borrowings on behalf of the government would continue to remain at relatively very high levels. So long as the gross levels of government borrowings remain at such high levels the G-sec market will continue to be in a delicate stage; the regulation of such a delicate market would have to be done in such a way undue fluctuations in in G-sec prices (consequently interest rates) are avoided to the maximum extent possible.

As of today, RBI is not only the regulator but also the merchant banker to the Government, shouldering the onerous responsibility of ensuring that the required level of borrowings for the Central and the State Governments are mobilised. So long as the fiscal deficit in India remains very high it would be too risky to allow the G-sec market to be subjected to the vagaries/forces of a free market that is often subject to the influence of high level of speculative activity. Hence the RBI is keeping a tight vigil on the G-sec market, the trades in which have to be mandatorily reported by all the RBI regulated entities on the NDS that is being managed by the RBI. Given the current delicate stage of the G-sec market, movements in interest rates have to be suitably moderated/calibrated so that RBI is able to satisfactorily discharge its merchant banking responsibilities in respect of Central and State Government borrowings. Hence, even after the introduction of the automated screen based trading on the NDS, RBI should have to closely monitor the G-sec trading, especially of its regulated entities, all of which belong to the wholesale debt market segment. The recent turmoil in equity markets, which witnessed a free and steep fall in equity prices, forcing the exchange authorities to shut down the markets twice during the trading hours on 17^th May 2004, does lend strong support to the argument that the G-sec market cannot be left to the mercy of unbridled speculative activity that is frequently observed on the stock exchanges.

While the wholesale gilts market should continue to remain with RBI it is desirable to initiate necessary steps to develop a retail market in gilts for serving the investors who currently do not belong to the wholesale gilts market. There are a whole range of existing and potential investors like company managed provident funds, corporates, trusts, high net-worth individuals, recently set up insurance companies, the proposed pension funds especially meant for the unorganised sectors of the economy who are not being served satisfactorily in regard to their investment demands for gilt securities. Concerted efforts need to be put in to service this class of investors through the instrumentality of the stock exchanges. The fact that even after the introduction of retail trading in G-sec on the stock exchanges there has been negligible trading on the exchanges proves the point that there are several missing elements in the scheme of things when the gilts trading was started on the stock exchanges. It is a fact that almost the entire G-sec trading is concentrated on the NDS which has been designed essentially for the wholesale G-sec market players, most of which are RBI regulated entities with the final settlements of their trades taking place in their respective SGL and current accounts maintained by them with RBI. Other participants in the G-sec market like provident funds, pension funds, corporates, various trusts, small cooperative banks, which comprise the middle segment presently depend on the OTC deals either through brokers or directly with NDS members. Settlement of securities in respect of the players generally takes place using the CSGL facilities of the NDS members; all G-sec trades including the CSGL trades are cleared and settled by CCIL.

Recently, the retail and mid segments have been extended the facility to trade in government securities on Stock Exchanges through exchange registered brokers. In so far as the individual retail investors are concerned they do not appear to have shown much interest in gilts investments. This is primarily because of the existence of competing instruments which provide better returns than government securities rather than lack of liquidity on exchanges. This, however, is not the case in respect of other investors like provident funds, pension funds, etc. most of whom are obliged to invest in G-secs as part of their investment strategy. The problem, therefore, is how to ensure that the stock exchange mechanism emerges as a preferred and cost-efficient alternative for such class of investors. The exchange platform is best suited for entities who deal in government securities in smaller lots than are the usual lots in the wholesale gilts market of the NDS members. In reality, it is the mid-segment represented by the non-NDS and non-retail players of the gilts market that has significant growth potential. It is desirable that increasingly trades of non-NDS members that belong to the mid-segment of the market are encouraged to shift to the stock exchanges through a well articulated strategy, given the fact that stock exchanges have much greater nation-wide reach.

There is need to pay much greater attention to the needs of the mid segment of the market as almost all these players do not have access to the NDS. It is these players who have to be systematically attracted to the stock exchange if exchange trading in gilts has to take off. This middle segment is already a large market and has the potential to grow at much faster pace than that observed during the recent past. For instance, the pensions market is poised to grow in a big way as it gets extended to all those who are currently outside the organized sector. Similarly, as and when corporates are permitted to enter the repo markets, both for lending and borrowing of funds, there will be demand for government securities from the corporate sector for liquidity management. There is scope for increasing the share of small co-operative banks, NBFCs and other similar players in gilt trading. The solution, therefore, to the problem of negligible trading in government securities on the stock exchanges should not be in terms of shifting the NDS trades to the stock exchanges but to take necessary steps to encourage the non-NDS players to increasingly meet their requirements through the stock exchange mechanism.

The current reality is that satisfactory arrangements do not exist for non-NDS players to buy or sell government securities. Often they have to undertake trades at prices in great variance with the prices prevailing on NDS. They are also required to bear higher transaction costs. The exchanges need to exploit this opportunity to the maximum extent possible. Orderly development of the middle segment of the gilts market should primarily be the joint responsibility of SEBI and the stock exchanges. All that the RBI should be doing is to extend a helping hand to SEBI in this endeavour. It is desirable that regulatory compulsion be brought to bear upon the debt market brokers of the Exchanges. They should be mandated to become market makers on the exchange, to begin with at least in the actively traded gilts.

An important point which is often missed by students of financial markets and market players is that financial markets do not grow out of thin air. Conscious and proactive steps have to be taken before organised markets come into existence, if the desire is to create them in a relatively short period of time. In the early stages of their development the securities markets need a class of specialists who are commonly referred to as the market makers or jobbers. These market makers give two way or buy/sell quotes for stocks of their choice. They thus create a sense of liquidity in their chosen stocks to attract investors to the markets. Once the average investors are assured of an entry/exit route offered by the market makers they may not mind investing in such stocks. The other important feature of the securities markets is that liquidity breeds further liquidity. So the question basically is how to create the initial liquidity. Hence, the crucial importance of the market makers who help to create or germinate initial liquidity that helps to build higher and growing level of liquidity over time.

Simultaneously, Exchanges need to launch awareness programmes to educate the mid segment investors about the services that can be offered by them through the stock exchange trading mechanism. The exchanges should also motivate their members to put in sincere efforts in this direction so that an active market can be developed without much loss of time. Ironically, all brokers who are very active in the NDS market are all members of NSE’s wholesale debt market (WDM) segment. None of these brokers appear to have shown any interest in making NSE’s WDM segment active and provide their services to non-NDS investors. Since all these brokers are earning huge amounts of brokerage by concentrating their attention on the OTC market that serves the NDS members, they have not shown any interest in serving the non-NDS players through the exchange platform despite having a very good idea of market movement, sentiment, trading flavour, volumes etc. Moreover, most of them already employ qualified personnel to provide the requisite services to their principals in the OTC market.

For undertaking the market making responsibility, it is not essential for the brokers to hold proprietary stocks of securities. This issue could be resolved if brokers are permitted to have arrangements with Primary Dealers and/or Banks for supply of stocks of government securities at prevailing NDS market prices. The market price risk involved in market making on the stock exchange would have to be borne by the brokers themselves. These costs can be factored into the bid/offer quotes made by them on the exchange. It is felt that the existing expertise available with the brokers could be used for good measure in developing a gilts market for the mid/retail segment on the Exchanges through the implementation of the following arrangements:

1. All market intermediaries/fixed income brokers registered with the National Stock Exchange (NSE), having a share of at least 5% of the aggregate market turnover in the wholesale debt market segment of the NSE during the current year as well as the previous financial year should be required to provide two-way buy/sell quotes;
2. All such entities (hereafter to be referred to as "market maker") to be allowed to act as principal counterparties to trades subject to individual trades not exceeding Rs. 1.00 crore (face value) initially. This amount could be increased over time based on experience after ensuring stability of operations and adequacy of requisite surveillance, control and safeguards;
3. Market maker to have not more than say ten trades remaining uncovered at any point of time;
4. Market maker to provide two way quotes in not more than three liquid securities at any point of time. Exchange to ensure that their systems do not permit the matching of two counter market making quotes;
5. Market maker to be permitted to open a CSGL Account and Current Account with an NDS member (preferably one of the PDs) of its choice subject to extant CSGL guidelines;
6. Market maker to be further permitted to open a CSGL Account with one of the depositories viz., NSDL or CSDL;
7. All quotes provided by market maker to be for T+2 settlement only;
8. Market Maker to be permitted to act as counter-party and finalize trades with a primary NDS member for cover operations in respect of trades matched on Exchange;
9. Such cover trades as per (h) above for values T+0 up to a maximum of T+2 only
10. Settlement of trades as per (h) above to be settled via the NDS mechanism (directly at RBI PDO outside CCIL settlement mechanism) through the NDS member with whom market maker maintains CSGL and Current Account as per (e) above;
11. Appropriate funding of securities transactions to be arranged by market maker
12. All trades matched on the Stock Exchanges to be settled through Clearing Corporations of the respective Exchanges and concerned Depository where market maker maintains CSGL Account

Detailed flow-charts covering both dealing/settlement of the exchange trade as well as the relative cover operation is enclosed at Annexure "C" appended hereto.

In this context it is worth examining whether banks should also take up membership of stock exchanges in addition to PDs, who have already been permitted to do so. In so far as PDs are concerned market making in gilts is one of their major responsibilities. Hence it is appropriate that the market savvy PDs are encouraged to take up membership -preferably through the subsidiary route - of a stock exchange of their choice and help in building an active gilts market through market making. Since PDs actively bid in the primary auctions conducted by RBI they should use a part of the stock of gilts thus acquired for active market making on the stock exchanges. But as regards banks taking up membership of stock exchanges there appear to be a number of strong reasons why banks are not the right type of entities to take up exchange membership. It may be recalled in this context that RBI took active interest in creating a totally new type of entities called Primary Dealers basically for the reason that banks are not at all well suited for taking active interest in the development of a vibrant and sufficiently broad-based government securities market.

Because of the high SLR requirements in India, historically banks have been investing heavily in gilts as an investment proposition. The core activities of banks all along have been to act as financial intermediaries to mobilise saving of the community and lend them to a wide range of borrowers and economic activities. Banks are required to lend sizeable part of their disposable funds to priority sectors comprising small industry, agriculture, SRTOs, etc. They continue to be the main source of working capital funds for all range of industries; they also provide finance to export-import activities, besides helping their clients to manage their foreign currency transactions. In so far are the PDs are concerned their core function shall always be to function as active dealers in gilts and other debt instruments, In contrast the core activity of banks is to mobilise deposits and lend them to a wide range of economic activities. Banks are being entrusted with a number of social responsibilities, all of which are related to their basic lending functions. While the business goals of the top managements of PDs is to remain active in the primary and secondary markets in gilts the primary business objectives of the top managements of banks would and should continue to be with their role as the pre-eminent financial intermediaries in the Indian economy. In short, it is not desirable to burden banks with an additional responsibility of stock exchange membership for developing gilts markets when there are as many as 16 active primary dealers and a couple of dozen wholesale debt market members of the stock exchanges.

The worries about likely securities settlement failures if banks do not take up membership of stock exchanges appear to be misplaced. Since the stock of gilts with the primary dealers at any point of time is quite large (in relation to the size of the retail and the mid segment markets for gilts) it is unlikely that there would be settlement failures on account of security shortages. It would not also be fair to the PDs to assume that they would enter into sale transactions on the exchanges without having stocks of relevant securities. Given the relatively large size of the wholesale gilts market on the NDS the PDs can always cover their security requirements, if necessary, by entering into purchase transactions on the NDS before becoming sellers on the exchanges. Development of an active gilts market on the exchanges should be the primary responsibility of the professional debt market brokers of the stock exchanges and to some extent also of the PDs who are being actively encouraged by RBI to build vibrant gilts markets. In view of this there does not appear to be any justification for persuading banks to take up exchange membership. So long banks are expected to shoulder the onerous responsibility of being the primary mobilisers of the savings of the community for deploying them into a number of priority activities, it would not be desirable to expect that the banks should also take up membership of stock exchanges for developing a gilts market for the retail and mid segments.

Any move to either compel or persuade banks to take up exchange membership for trading in gilts on the exchanges is not desirable as it would lead to avoidable diversion of the attention of the top management from their core or basic activities to stock exchange trading. A number of senior bankers are under the impression that large profits can be earned through trading on the stock exchanges. Once banks become active on the stock exchanges RBI’s efficacy to regulate them with reference to its prime policy concerns will get considerably weakened vis-à-vis banks’ trading in government securities. With their money power banks may create avoidable gyrations in interest rates if they join the bandwagon of speculative trades in G-secs on the stock exchanges. Given the delicate stage in which the G-sec market is currently placed it would not be desirable to allow banks to get entangled with speculative trades in gilts on the stock exchanges.

The real worry, however, is that lured by speculative profits top managements of banks may divert their prime attention from core banking activities to stock exchange trading. There is also another risk that needs to be kept in view in so far as the public sector banks (PSBs) are concerned. Given their HRD policy they are obliged to mandatorily rotate their staff periodically from one department to the other and from one geographical location to the other. In the absence of good grounding in stock exchange trading, staff of PSBs may get unwittingly entangled with manipulative/speculative trading activities on the stock exchanges. Unless the concerned staff members are in the market for a long period of time they would not be able to develop necessary market intelligence about different players in the markets and the games they play; the PSB staff would have limited time to develop their trading skills and market intelligence that would help them to keep away from manipulations that some of the unscrupulous market players may indulge.

Banks’ trading on stock exchanges should not be merely for generating trading volumes on the stock exchanges as it would lead to fragmentation of liquidity of the wholesale players between the two markets, viz., the NDS and the stock exchanges. To borrow the terminology of the Customs Union literature, the trading volume that is generated on the stock exchanges should be of the type of trade creation and not trade diversion. As of today, the wholesale gilts market represents the most sensitive of all interest rate markets in the country and events in this market have a significant bearing on the events in all other markets including equity and currency markets. Market fragmentation and its potential to unfavourably affect liquidity in the wholesale gilts markets would not have highly favourable implications for the system as a whole. It will not, therefore, be desirable to mandate banks to compulsorily operate on the exchange gilts market.

With the NDS gilt market set to progressively move to an electronic screen based trading, the WDM brokers currently active in the OTC market would realize that they have to search for alternate revenue pastures. This would translate into their evincing real interest in developing the exchange gilt market. It is therefore recommended that the essential nature of the wholesale and retail markets need to be preserved. The wholesale market (also referred to as the inter dealer market) should function on the NDS as existing now and the mid/retail segment may be gradually shifted to the exchanges without causing any hardship to any of the mid segment investors like provident funds, small cooperative banks, etc. in the process. PDs may be expected to build an umbilical linkage between the two markets by being active on both of them and exploiting arbitrage opportunities. To ensure that the price variations and consequential arbitrage opportunities between the NDS and exchange markets are at an acceptable level, mid-segment investors should also be allowed access to the wholesale market through NDS members as is allowed currently.

Clearing and settlement of trades done on NDS will happen as per existing process. Trades done on the order matching system will enter NDS Settlement Module at the "Ready for Settlement" stage and thereafter follow the same settlement process as with other trades.

CCIL will act as the central counterparty for settlement of all gilt trades on NDS. The guaranteed clearing and settlement service provided by CCIL is subject to the provisions of its Bye Laws, Rules and Regulations, as applicable from time to time.

Settlement of trades executed on the stock exchanges could be done by their respective clearing entities. There is no need to club the exchange settlements with the settlements of CCIL.

Any attempt at linkage between the clearing systems of the Exchanges and CCIL through a distribution of clearing responsibilities between them would create two parallel central counterparties which bristle with severe operational complications and legal complexities. The exchanges primarily deal in equities and equity related derivative instruments. On the other hand, CCIL’s mainstay is clearing and settlement in gilts, currency and money markets. Apart from significant differences in volatility in the markets served by the exchanges and that served by CCIL, activities/movements in CCIL serviced markets are very closely monitored by RBI (as is the practice in most countries) who may even intervene in situations of extreme volatility. The same normally does not hold good in respect of equity markets.

Further, CCIL guarantees trades on the basis of margins maintained by its members. These margins are held by CCIL directly in the form of cash and/or specified highly liquid government securities. The clearing corporations of the Exchanges do not receive and maintain margins exclusively of cash and/or government securities. The credit quality and liquidity of collateral maintained by them are not of the same high quality.

Moreover, CCIL’s membership comprises of highly regulated entities who maintain their accounts with RBI. Access to CCIL is, therefore, restricted to the highest quality from a risk perspective. Exchange trades on the other hand could flow from all classes of market players. Treating the entire spectrum of market players with the same risk perspective would be undesirable.

However, if a linkage between the settlements in both the wholesale and retail markets are completely unavoidable, the best possible alternative that could perhaps be considered, if acceptable to RBI, could be permitting the respective clearing corporations of the Exchanges to be admitted as members of NDS and CCIL with trades happening on the Exchanges flowing to the NDS environment for clearing and settlement. The respective clearing corporations of the Exchanges could act as principals in respect of trades reported by them for settlement with requisite margins, as prescribed, being required to be maintained with CCIL. The above would ensure the parallel existence of both sections of the wholesale and retail markets and relative settlements being subjected to same quality risk management.

For settlement of trades done on Exchanges, its members are required to open demat accounts with depository participants of NSDL/CSDL. RBI has issued guidelines for value free transfer of securities from SGL/CSGL accounts to the depository accounts. Settlement of trades done on Exchanges happens on a T+2 basis. The transfer of securities from SGL/CSGL accounts to demat accounts happen on T+1 day. NDS already provides an electronic value free transfer module. Proper interfaces need to be built between the exchange clearing corporation/clearing houses and PDO-NDS for electronic transfer of pay-in/payout files. Such electronic transfers should be facilitated to be carried out on on-line basis

1. There is need to urgently review the existing performance and technical capabilities of INFINET as it has significant bearing on the performance of NDS. An independent technical study of INFINET can be entrusted to a corporate Agency or body.

2. Technical issues relating to NDS itself as pointed out in the Report need to be urgently examined and effectively addressed. There are a number of issues as indicated in the report relating to both Hardware and Software which need to be addressed immediately to enhance the tradability of the system

3. There is need for the immediate introduction of a Screen Based anonymous order matching system on NDS, to ensure transparency, better price discovery among various other things.

4. Operationalisation of NDS order matching system needs to be spread over sequential phases for proper implementation and smooth migration, allowing members to gain sufficient experience in handling an order matching system.

in favour of keeping the wholesale G-sec market of NDS members separate from the retail/mid segment market that would be developed on the stock exchanges. Since movements in G-sec prices reflect the level of interest rates in the financial system the G-sec market of NDS members should remain under the close regulatory scrutiny of RBI on a near real time basis. Therefore, so long as the levels of gross government market borrowings remain high it is desirable that management and regulation of wholesale debt market remain with RBI.

6. SEBI and Stock Exchanges need to initiate steps to build awareness especially amongst the mid-segment investors about the facilities available for gilt trading in the Exchanges. Brokers of WDM segment of Exchanges should be compelled to engage in market making of gilts on the Exchanges with appropriate cover operations being permitted to them through conclusion of deals with NDS members. While PD’s may be asked to facilitate trading on the exchange for the retail segment (preferably through their subsidiaries, Banks should confine themselves to the NDS market.

7. Creation of appropriate electronic interfaces between the Exchanges, Depositories and RBI-PDO is imperative for speedier value free transfer capabilities to facilitate settlement of securities trades concluded on Exchanges.

The secondary market in Indian government securities is presently an Over-the-Counter telephone market. Deals are concluded with the help of brokers and are reported on RBI-NDS. The NDS is an electronic platform developed by RBI, intended to facilitate dealings in government securities and money market instruments. In absence of a screen based order driven system on the NDS, direct dealing on the NDS has failed to pick up and the market continues to trade in the telephone market.

Introduction of a screen based Dealing System would facilitate better price discovery, liquidity, efficiency and transparency. Other benefits include widened geographical access, reduced intermediation, enhanced pre and post trade transparency, reduced trading costs, and better regulation and supervision.

The screen based Dealing System should essentially possess the following broad features:

1. Orders Driven: The Dealing system should be purely order driven with all orders from market participants being matched based on strict price/time priority.

2. Anonymous: The Dealing system should be an anonymous order matching system wherein identity of parties is not revealed. CCIL will be the central counterparty to each trade done on the Dealing System.

The Dealing system should provide timely information, both pre-trade (for example, bid,

offer and depth) and post-trade (for example, last trade price and volume), and disseminate it widely real-time to all market participants.

The Dealing system should allow straight-through processing (STP), i.e. the seamless integration of the different parts of the trading process, starting from displaying pre-trade

Information and ending with settlement and risk management. Trades done on the system should be treated as confirmed and not subjected to the four-stage confirmation process as existing in the present NDS environment.

The Dealing System should provide for the following functionalities:

1. Order Management
   

Place Bid/Offer
Modify Order
Cancel Order


2. Market Query


Market Watch
Market by Price
Market by Order
Snap Quote


3. Dealer Query


Outstanding Orders
Previous trades
Dealer Blotter
Net Position
Activity Log


4. Reports and Analysis

The functionalities are explained in detail in the subsequent chapters.

The Dealing System should support dealing in all Central and State government securities for T+0 and T+1 settlement. Both Proprietary and Constituent deals should be permitted.

A dealer should be in a position to place an order (Buy/Sell) in a CG/SG instrument specifying the settlement type, amount (Face value) and price at which trade has to be executed. The dealer especially market makers should also have the facility to place simultaneous Bid/Offer (two-way quotes) in the system at a Set Spread. The spread should be a parameterisable function at the dealer level such that once the dealer specifies the Bid price, the Offer price is automatically populated on the screen.

The order so placed will be identified by unique identification number for audit trail purposes. These orders after validation such as quantity and price ticks will be accepted for matching in the Dealing system as confirmed orders. In case of unsuccessful validation, the order will be rejected. Dealer placing the order should get a notification for either confirmation or rejection.

The system should also allow the dealer the option to place conditional orders with respect to the amount or time as follows:

a) ALL OR NONE (AON) – By selecting an AON condition, a dealer specifies that all of the order amount should be and no partial trades would be acceptable. AON orders are indicated by a special ‘#’ sign in the system.

b) DISCLOSED QUANTITY (DQ) – Disclosed Amount is the part of order amount which the Dealer is willing to disclose to the market. The remaining amount of the order is hidden from the market and is released to the market only after the first lot is fully traded.

a) DAY – By specifying a Day condition, the dealer agrees that the order can remain in the system till it finds a match or is cancelled by the dealer or till the end of the day. At the end of the day all outstanding day orders are cancelled by the system.

b) IOC – Immediate Or Cancel: An order with an IOC condition scouts the order book for a match. If a match is found, it gets traded or partially traded as the case may be. The remaining order gets cancelled immediately and does not remain in the order book.

The system should facilitate modifications of orders which are not fully traded or are partially traded. The dealer should be in a position to modify the amount, price, special conditions specified, if any and the constituent name. The dealer should get a notification of the successful modification of the order.

A dealer should be in a position to cancel his orders which are not fully traded or are partially traded. The system should provide a facility to cancel a particular order, cancel all orders in a particular instrument and cancel all outstanding orders across instruments. The dealer should get a notification of the successful cancellation of the order.

The Market Watch screen should allow a dealer to continuously monitor his preferred set of securities. The Market Watch screen should be customizable in the sense that the dealer can save his set of securities which remains in the Market Watch even after log off. The dealer can add, Modify or delete any instrument from the Market Watch. Information such as the Best Bid Price and YTM, Best Offer Price and YTM, Last traded Price and YTM, Last traded quantity and Total Traded quantity for a particular instrument should be available on a real time basis to the dealer. The Market Watch should allow immediate pickup of the Best Bid or Best Offer from the Market Watch screen. The Market Watch should also allow easy navigation to other Market Query screens like Market Inquiry, Market by Price, Market by Order and Dealer Query Screens like Outstanding orders and Previous trades.

The system should also have a facility which enables a dealer to track instruments not specified in his Market Watch. The facility should display the same information as the Market Watch and also provide for order pickup.

There should be an online ticker which should display the last traded price of each instrument. The display should include the instrument description, traded price, settlement type and traded time.

The dealer should be in a position to view the depth of the market in a particular instrument in terms of price and orders. i.e Market by Price and Market by Order.

MBP should display atleast best five prices quoted and outstanding amount available (which are derived by accumulation of orders at the same price) at each price quoted in the market. MBP should also display the Open Price/YTM, High Price/YTM, Low Price/YTM, Last Traded Price/YTM, Last Traded Amount and Total Traded Amount. The total amount of Bids and Offers should also be displayed. The system should provide the facility to pick up orders from the MBP screen.

MBO should enable the dealer to view atleast best five outstanding orders available in the market arranged in the price / time priority. The orders with best price are shown first. For orders with the same price, the orders entered first are displayed first. There is no aggregation of order amounts as in Marker by Price screen. MBO should also display the Open Price/YTM, High Price/YTM, Low Price/YTM, Last Traded Price/YTM, Last Traded Amount and Total Traded Amount. The total amount of Bids and Offers should also displayed. The system should provide the facility to pick up orders from the MBO screen.

A dealer should be able to view his outstanding orders in a particular security as well as all his outstanding orders across securities. An outstanding security is an order that has been entered by a dealer but which has not yet been completely traded or cancelled. The dealer should be above to modify/cancel the orders from the outstanding orders screen.

A dealer should be able to view the trades done by him in a particular instrument. The trade information should also include the broken period interest and settlement consideration in addition to price and quantity details. The trade number should be unique and system generated for facilitating audit trails. The dealer should have the facility to reprint the deal tickets from the previous trades list. A Flat File (.CSV file) should also be generated to facilitate interface with dealer’s back office software.

A dealer blotter should be provided containing details of orders placed by the dealer, the trade details and other relevant information. The dealer blotter should be across instrument types and contain all data for audit and reconciliation purposes. A Flat File (.CSV file) should also be generated to facilitate interface with dealer’s back office software.

A dealer should be able to view his net position (Total Buy – Total Sell) in a particular instrument. Net position should be displayed for all instruments. This would indicate as to whether a dealer is holding a long or short position on a security.

A Deal Ticket should be printed immediately on the matching of an order. The Deal Ticket should contain details about the security traded, the unique order and trade number, settlement date, the quantity and price details, the broken period interest, the settlement consideration and the constituent name, if any. A Flat File (.CSV file) should also be generated for each trade to facilitate interface with dealer’s back office software.

Activity Log gives the details of all the order and trade related status that an order undergoes throughout its life, like order entry, modification and cancellation that dealer has performed for an instrument or the trade execution resulted by order match. This will facilitate audit trails. Activity log should be available for a particular instrument and across instruments. A Flat File (.CSV file) should also be generated to facilitate interface with dealer’s back office software.

There should be a provision of a YTM Calculator in the system to facilitate pre-order analysis by dealers. The YTM Calculator should follow the market bond conventions for various instruments. For e.g for instruments with less than six months to maturity, the yield should be calculated following the money market convention.

The ADMIN will be responsible for maintaining the Dealing System including instrument and member creation, setting up of operational parameters and managing trading sessions. The ADMIN Terminal will be accessible to authorized users only. The following functionalities will have to be provided in the ADMIB terminal:

The ADMIN will create the instruments to be made available for trading. This would involve capture of information about ISIN ID, description, maturity date, coupon, coupon date, shut period, etc. Suspension/Termination of an instrument on account of shut period/maturity should be automatically done by the ADMIN system.

The ADMIN will add new members and users to the Dealing System. This would involve capture of information about Member NDS ID, CCIL Member ID. ADMIN would also be responsible for suspension/termination of a Member.

The ADMIN will have to set up dealing parameters that would be applicable to members. This would include setting up the minimum lot size, the quantity tick size, the price tick size and the maximum and minimum price range.

The ADMIN will manage the trading sessions applicable to the system. There will be different trading sessions for T+0 and T+1 settlement. There should also be a facility to extend the session timings whenever required.

There could be instances of technical failures of the Dealing system in which case the dealer would require the ADMIN to cancel his outstanding orders. The ADMIN should have the facility to view all outstanding orders of a member and cancel orders as instructed by the dealer.

The ADMIN should have the facility to generate all member related reports when required. The reports would include Previous trade reports and Activity Log as well as the Daily Market update of all trades.

1. Introduction

The Application Software for GILTS trading platform shall be client server based architecture with Oracle 9i as back-end database and VB as front-end. The architecture of the proposed GILTS trading platform and the interfaces with other applications is given in Annexure – I.

2. Hardware Requirement

The hardware for the GILTS system shall be based on open system like, Unix operating system and related layered software. The hardware shall have clustering and redundancy features to ensure high availability. It is suggested that there should be a disaster recovery (secondary) site in order to handle any eventuality of disaster at the primary site. Also, there should be separate environments for production, mock-testing and user acceptance testing to facilitate smooth release of new versions/upgrades. The suggested specification for the hardware is given in Annexure – II.

3. Software Requirement

The proposed GILTS platform shall be developed using 3-tiered architecture viz. Oracle database at the back-end, VB at front-end and IBM MQ series at middle as communication layer. The details of software requirements at Member location and Host location for GILTS trading platform are given in Annexure III.

4. Application Architecture

The application architecture for the proposed GILTS platform will be the trading terminals and member server at member end connecting to the host at RBI end via INFINET. Hence, the users of GILTS trading platform would necessarily be a member of INFINET with a 2 mbps lease link connectivity to the nearest node and with backup communication line. It may also be ensured, incase of failure of the primary site, the members transparently changeover to the DR server without affecting their business operations.

Settlement Flow Chart

Cover Operation for Broker – Market Maker – NDS Dealing

NDS Deal Settlement Operations Flow Chart with linkage to Depository for ultimate settlement of Exchange Deal