Implementation of a Central Counterparty System

 

Overview

Enhancing post-trade settlement risk management and aligning with international capital market standards, the Colombo Stock Exchange (the “CSE”) established a central counterparty (“CCP”) for the clearing and settlement of identified transactions on the CSE – operational from 01st August 2025. The CCP mitigates counterparty default risk, as referred to below, thereby improving market stability, investor confidence, and the overall resilience of the financial system. The transition marks a key milestone in the CSE’s long-term strategy to strengthen market infrastructure and facilitate future growth and investment.

The Securities and Exchange Commission Act, No. 19 of 2021 (the “SEC Act”) defines a central counterparty to mean ‘a legal person who engages in clearing and settlement of trades on a securities market by becoming the buyer to every seller and the seller to every buyer by guaranteeing each trade’.

CSE Clear (Private) Limited (“CSE Clear”), a wholly owned subsidiary of the CSE, is licensed by the Securities and Exchange Commission of Sri Lanka (the “SEC”) to function as a licensed clearing house. CSE Clear provides clearing and settlement services as a CCP that guarantees the clearing and settlement of securities transactions in terms of its rules.  As such, all transactions on the CSE are cleared and settled in accordance with the rules of CSE Clear (“Clearing House Rules”).   The Clearing House Rules constitute a binding contract between the clearing house, i.e. CSE Clear and clearing members licensed by the clearing house, to whom clearing and settlement services are provided by CSE Clear.

It is pertinent to note that only equity trades denominated in LKR are cleared and settled by CSE Clear, in its capacity as a CCP (“CCP Settled Trades”), at present. In the above context, the Clearing House Rules draw a distinction between trades cleared and settled by CSE Clear as a CCP, and trades that will not be cleared and settled by CSE Clear as the CCP –

  1. CCP Settled Tradesmeans trades to be cleared and settled by CSE Clear in its capacity as the CCP, in accordance with the Clearing House Rules. For the time being these are trades of equity securities listed on the CSE, denominated in LKR.
  2. Non – CCP Settled Tradesmeans trades cleared and settled by CSE Clear in terms of the Clearing House Rules which are identified as trades that will not be cleared and settled by CSE Clear as a CCP, i.e. the CCP will not guarantee settlement of trades identified as Non – CCP Settled Trades. Such trades include securities denominated in designated foreign currencies, securities traded in the debt market of the CSE and Excluded Crossings.

Note: Excluded Crossings are equity transactions with a minimum trade value of LKR 100,000,000 and are classified as such by CSE Clear, on the agreement and at the request of the two clearing members.

Novation of Market Contracts

The novation of contracts, to which recognition is given in the SEC Act, is the fundamental legal concept that enables CSE Clear to interpose itself as a buyer and as a seller, as relevant, in every CCP Settled Trade.

Novation is the act of substituting for an old obligation a new one that either replaces an existing obligation with a new obligation or replaces the original party with a new party.

Accordingly, the contractual rights and obligations of the buying/selling clearing member with regard to settlement of the trade, at the point of recording, is novated to CSE Clear. The novation results in CSE Clear interposing itself between the selling clearing member (“Selling CM”) and the buying clearing member (“Buying CM”), in its capacity as the CCP, thereby extinguishing the relationship between the Buying CM and the Selling CM and replacing the same with two contracts –

  1. A contract between CSE Clear and the Selling CM which entitles CSE Clear to receive the securities from the Selling CM and to settle funds due to the Selling CM; and
  2. A contract between CSE Clear and the Buying CM which entitles CSE Clear to receive funds from the Buying CM and to deliver securities to the Buying CM.

What this means in effect with regard to every CCP Settled Trade is that the CCP becomes the buyer for every sale and the seller for every purchase of shares on the CSE together with the relevant obligations to make payment and to deliver securities, respectively.

The novation of contracts takes place instantaneously at the point of recording the trade, as reflected in the Clearing House Rules.
 

Establishment of the Contributory Guarantee Fund

In terms of the SEC Act, a licensed clearing house is required to operate a safe, efficient and effective clearing facility for clearing and settlement of securities transactions and to prudently manage the risks associated with its operations. Further, Section 36(4)(f) of the SEC Act mandates the establishment of a settlement guarantee fund and the implementation of a prudent risk management system.

In line with its statutory obligations under the SEC Act, CSE Clear, in its capacity as a licensed clearing house, has established a Contributory Guarantee Fund as a risk management measure to ensure the settlement of any defaults in CCP Settled Trades.

Authors

Afra Laffar
(Senior Associate)

Maduvanthi Pathmanathan
(Associate)