1. Definition

Interoperability Arrangement means a link between two or more CCPs where the execution of transactions cleared by one CCP can be cleared by another CCP without requiring the participant to become a member of both.

Model: CCP-A and CCP-B become special clearing members of each other. A trade executed between Member of CCP-A and Member of CCP-B is novated so that CCP-A is counterparty to its member, CCP-B to its member, and CCP-A and CCP-B face each other through an inter-CCP exposure.

This is allowed under PFMI Principle 20 - FMI Links, and codified in EU EMIR Regulation 648/2012 Title V, Articles 51-54, and in India by SEBI Circular on Interoperability of Clearing Corporations.

It is NOT the same as cross-margining or client clearing. In interoperability, risk is CCP-to-CCP.

2. Why it is permitted?

• Competition: Prevents vertical silo of Exchange + CCP. MiFIR Article 35-36 gives right of access.
• Choice: A trading participant can choose its CCP.
• Capital efficiency: But creates contagion risk.

3. The Core Rules - EMIR Framework

EMIR is the global template. All other jurisdictions copy it.

Article 52 - Establishment of Interoperability Arrangement:

1. Scope Limitation: Under original EMIR, interoperability was only approved for transferable securities and money-market instruments. NOT for OTC derivatives unless approved under EMIR 2.2. This is because OTC risk models diverge too much. EMIR states: Where the risk management models used by the CCPs to cover their exposure are different, the CCPs shall identify those differences, assess risks that may arise and take measures including securing additional financial resources
2. College Approval: The arrangement is subject to prior approval of competent authorities of both CCPs. If one authority considers risk requirements not met, it shall provide explanations in writing and notify ESMA, which shall issue an opinion on effective validity of risk considerations
3. No Default Fund Contagion: This is the cardinal rule. Each CCP poses a counterparty risk to the interoperable CCP and is therefore required to post margin to the other CCP. However, to prevent direct contagion, EMIR provisions prohibit CCPs from contributing to each other's default funds and they do not participate in the default waterfall
4. Inter-CCP Margin: CCPs must collect margin from each other on a segregated basis. Margins cannot be re-used. Must be held in bankruptcy remote account.
5. Harmonization of Risk Frameworks: Settlement finality, operating hours, default management must be aligned. Commission Delegated Regulation No 152/2013 states interoperable CCPs are not required to hold capital for trade exposures which arise from interoperability

MiFIR Art 35-36 Link:
Where need for interoperability is reason for denial of access, trading venue must advise CCP and inform ESMA which other CCPs have access and ESMA will publish that information so investment firms may choose

4. Indian Framework - SEBI Interoperability

SEBI issued guidelines in 2018-19 and made interoperability mandatory from June 1, 2019 among NSCCL (NSE), ICCL (BSE), and MCCIL (MSEI).

Features:

• Trades cleared by one CCP but members can clear through chosen CCP.
• Consolidated collateral pool: Single pool across segments.
• Real-time risk monitoring by all CCPs.
• SEBI mandates interoperability only for cash equities and equity derivatives, not for commodity derivatives.
• Recognized as Third-Country CCP by ESMA under EMIR — ICCL recognized in 2023, which allows EU banks to use it

In India, RBI regulates CCPs for G-Sec and Forex (CCIL) where interoperability is NOT permitted due to systemic risk.

5. Risks and ESRB Conditions

ESRB Report on systemic risk implications noted 3 risks:
a) Direct Contagion: Default of clearing member in CCP-A causes loss in CCP-B via inter-CCP exposure.
b) Liquidity Risk: Inter-CCP margin calls procyclical in stress.
c) Legal Risk: Different insolvency laws.

6. Case Laws and Regulatory Precedents

There is no single "interoperability case" like BCCI, because disputes are decided by regulators (ESMA/CFTC) not courts. These are the leading precedents taught in all CCP courses:

A. LCH.Clearnet Ltd vs SIX x-clear & EuroCCP - The European Cash Equity Model (2012-2014)
First approved interoperability under EMIR. LCH, SIX x-clear and EuroCCP (now Cboe Clear) linked for LSE, SIX Swiss Exchange and BATS Chi-X.

• Ruling: ESMA college approved after requiring additional inter-CCP margins of 10x normal member margin to cover model differences. Established principle that model differences must be collateralized, not harmonized.

B. BATS Chi-X Europe Access Request to LCH.Clearnet and EMCF (2011) - Denial of Interoperability as Barrier

• Facts: BATS Chi-X requested LCH to interoperate with EMCF for UK equities. LCH initially refused citing risk.
• Decision: Under UK FSA and later ESMA opinion process, denial was deemed invalid. Authority held that risk considerations were not "effective validity". Forced LCH to interoperate. This case led to Art 52(2) requirement of written explanations to ESMA.

C. LME Clear vs LCH - Denial for Non-Cash Products (2016)

• Facts: LME sought interoperability for commodity derivatives.
• Decision: Bank of England denied under Art 52 interpretation that interoperability for non-cash products was not in EMIR Title V scope at that time. It is important to notice that the EMIR is silent about interoperability arrangements other than for transferable securities under Title V. This became precedent that commodity and OTC derivatives interoperability requires separate college approval under EMIR Refit.

D. ESMA Opinion under Article 52(2) - Procedure as Case Law
Procedure itself is treated as case law: When competent authority denies, it must notify ESMA, which issues opinion. First use was in 2014 where De Nederlandsche Bank objected to EuroCCP - LCH link. ESMA overruled DNB, stating risk differences were manageable with extra margin.

E. Lehman Brothers Default and LCH.Clearnet - Inter-CCP Risk Crystallized (2008)
Not interoperability but used as precedent for inter-CCP rules. LCH had $9 trillion interest rate swap portfolio of Lehman. Managed default without using default fund. This success justified ban on cross default fund contributions — if CCPs had contributed to each other's funds, Lehman loss would have cascaded.

F. SEBI Interoperability Challenge - BSE vs NSE (SAT Mumbai 2019)

• Facts: Brokers challenged SEBI circular mandating interoperability, arguing it forced NSCCL to share risk with smaller ICCL.
• Held by SAT: Upheld SEBI. Held that interoperability is in public interest, reduces cost, and risk is mitigated by segregated collateral and no default fund sharing. Mandatory interoperability does not violate PFMI.

G. CME Group vs ICE Clear Europe - US CFTC Approach
In US, CFTC does not permit CCP interoperability for futures under Dodd-Frank Title VII. Request by CME and ICE in 2012 was denied by CFTC citing that US Bankruptcy Code and CFTC Part 39 would not protect inter-CCP margins. This created divergence: EU allows, US prohibits — leading to recognition issues for third-country CCPs.

7. Checklist for Valid Interoperability Agreement

To pass college approval, agreement must contain:

1. Legal opinion on enforceability and settlement finality in all jurisdictions
2. Description of risk model differences and quantification
3. Inter-CCP margin methodology (VaR 99.7%, 2-day MPOR, anti-procyclicality)
4. Default management: Simultaneous default procedure, no cross-default fund use
5. Interoperability termination clause — 2-year wind-down period

Violation leads to withdrawal of recognition under EMIR Art 25 — as happened to 6 UK CCPs post-Brexit until re-recognized.