It is well known that underpinning South Africa’s commitment to regulating over the counter (“OTC”) derivatives is the agreement of the G20 Leaders at the Pittsburgh summit in 2009 that “…all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non centrally-cleared contracts should be subject to higher capital requirements.” In November 2011, the G20 Leaders further agreed to add margin requirements for non-centrally cleared OTC derivatives.

INTRODUCTION

The Financial Stability Board (“FSB“) was established by the G20 in 2009 as a body to promote global financial stability by coordinating the development of regulatory, supervisory and other financial sector policies. In particular, its focus is also on enhancing the transparency of the OTC derivatives market and reducing systemic risk by requiring trading platforms, reporting to trade repositories, the establishment of central counterparties between the two parties to a transaction, and by setting minimum capital and margining requirements.

FINANCIAL STABILITY BOARD PROGRESS REPORT

The FSB reported in its Eighth Progress Report on Implementation of OTC Derivatives Market Reforms (7 November 2014) (“FSB Report“) on global regulatory reform initiatives that are underway to implement those measures agreed upon by the G20 Leaders. These global measures include the US Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), the Markets in Financial Instruments Directive/Regulation (MiFID II/ MiFIR) and the European Market Infrastructure Regulation (EMIR).

As a member of the G20, South Africa has also made progress in meeting South Africa’s obligations regarding OTC derivatives by establishing the necessary regulatory framework in the form of the Financial Markets Act 19 of 2012 (“FMA“) which became effective on 3 June 2013, and by issuing the draft regulations regarding OTC derivatives in 2014. The draft regulations deal with –

• requirements for the regulation of unlisted securities, including the categorisation of OTC derivatives;
• the requirement to be authorised as an OTC derivative provider as a category of regulated person;
• securities services to be provided by an external central securities depository (“CSD”) and external clearing members;
• functions and duties that may be exercised by an external clearing house, central counterparty (“CCP”) or external trade repository (TR);
• assets and resources requirements applicable to market infrastructures (a market infrastructure includes a licensed CSD, a licensed clearing house, a licensed exchange and a licensed trade repository);
• regulations applicable to the licensing of TR’s;
• assets and resources requirements and functions applicable to a clearing house that is a CCP;
• requirements with which a CSD must comply for approval of an external CSD as a participant.

According to the FSB Report, it is anticipated that reporting requirements for all interest rate derivatives in South Africa will become effective in the second half of 2015. Other asset classes will be phased in over the following twelve months. Of course, this assumes that by that time, a trade repository will have been established and duly licensed as required by the FMA. All trades in interest rate derivatives will then have to be reported to this trade repository and will be monitored. The intention is that the trade repository will maintain a secure and reliable central electronic database of transaction data pertaining to such OTC derivatives, which will be disclosed to the regulators so that they are able to monitor potential risks.

South Africa is reported to be currently assessing its markets to determine whether and which requirements for central clearing may be needed. It is not clear that any mandatory requirements for central clearing will be set in 2015.

South African banks have already implemented the capital requirements of the Basel III framework in 2013. However, the capital charge for credit valuation adjustment (“CVA“) risk on banks’ exposures to ZAR-denominated OTC derivatives and non-ZAR denominated OTC derivatives transacted purely between domestic entities was zero-rated for 2013 and for 2014. (CVA is the difference between the risk-free value of the derivative and the true value, taking into account the expected loss due to counterparty defaults). It is anticipated that this exemption will also be extended in 2015, since a CCP for OTC derivatives has not yet been established.

The FSB Report further indicates that the margin requirements in South Africa will be implemented in accordance with the framework and timetable agreed upon by the Basel Committee on Banking Supervision (“BCBS“) and the International Organization of Securities Commissions (“IOSCO“). The finalised BCBS-IOSCO margin standards set out timelines to phase in requirements beginning in December 2015.

CONCLUSION

The goals of these regulatory changes are to increase the transparency of the derivatives market, reducing counterparty and systemic risks in trading and enhancing market integrity and oversight. As such, it should be supported. Participants in the OTC derivatives market should also carefully monitor the implementation measures referred to above, since the consequences of non-compliance are severe.

Written by Ina Meiring, Director: Werksmans Advisory Services (Pty) Ltd

Disclaimer:
Nothing in this publication should be construed as legal advice from any lawyer or this firm. Werksmans' Legal Briefs should be seen as general summaries of developments or principles of interest that may not apply directly to specific circumstances. Professional advice should therefore be sought before any action is taken.