THE REGULATION OF OTC DERIVATIVES Developments and Impacts Natalie Labuschagne Head: Public Policy

1 OCTOBER 2015

Improving over-the-counter derivatives markets: All standardized 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 (and margin) requirements. We ask the FSB and its relevant members to assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse.

- G20 Leaders Statement: The Pittsburgh Summit

September 24-25, 2009, Pittsburgh

Where it all began…

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Cannes Summit 2011

What does it all mean in practice…?

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Trade Repository Relevant Regulators

SARB, FSB, NT?

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CCP

Clearing member

Clearing Member

Clearing Member

Clearing member

(Bank B)

Trader A (Non-bank A)

Issuer (Bank B)

Matching/Confirmation Platform

(MarkitWire)

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CCP Waterfall (ISDA, 2013)

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“OTC derivative contracts should be reported…”

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“All standardized OTC derivative contracts should be cleared through CCPs…”

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Non-centrally cleared contracts should be subject to higher capital + margin requirements

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All standardized OTC derivative contracts should be traded on exchanges …

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What’s the problem…?

• Not previously regulated

• legislative/regulatory changes

• IT/systems changes

• Need new standards e.g. UTI, UPI, LEI

• Interconnectedness

• Of many financial market players acting in many different activities

• Banks as issuers, clearing members

• CCPs, exchanges, SEFs, MTFs etc.

• Of jurisdictions – OTC market is inherently cross-border

• Of regulators – FSB, BCBS, CPMI, IOSCO

• Of legislation – banks, FMIs, resolution,

• Unintended consequences

• The rise of the global CCP – SIFI’s are not just banks

• Recovery and resolution

• Collateral management concerns

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KEY LOCAL REGULATORY DEVELOPMENTS

“TWIN PEAKS” FINANCIAL SECTOR

REGULATION (FSR) BILL

FINANCIAL MARKETS ACT (FMA) REGULATIONS + FSB

NOTICES RESOLUTION FRAMEWORK

February 2013 – Roadmap – ‘Implementing a twin peaks model of financial regulation in South Africa’

December 2013 – First draft of the FSR Bill

December 2014– Second draft of the FSR Bill: • FMA consequential amendments • Hints at resolution

July 2014 – First draft of FMA regs No FSB notices

June 2015 – Second draft of FMA regs First draft FSB notices

August 2015 – Resolution Framework Policy Document

FSR Bill and consequential amendments to FMA to be submitted to Parliament shortly

• FSR Bill and consequential amendments to FMA to be submitted to Parliament shortly

• Unclear on next steps for FMA regs

Unclear

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FMA REGS AND NOTICES

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• REGULATIONS ISSUED BY MINISTER OF FINANCE

s5(1)(a): requirements for the regulation of unlisted securities

s5(1)(b): categorising OTC Derivative Providers (ODPs)

s48: additional requirements for a clearing house that is a CCP

• REGISTRAR OF SECURITY SERVICES (FSB-SA)

Board Notices to be issued by the Registrar in terms of s6(7) & (8), s58, s74

Definition and categorisation of OTC derivatives

Definition and categorisation of OTC derivative providers (ODPs), counterparties and clients

Requirements to be authorised as an ODP

Code of conduct for ODPs

Reporting and clearing obligations on ODPs

Margin requirements on ODPs

Key definitions….

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OTC DERIVATIVE Means an unlisted derivative instrument excluding (a) forex spot

contracts; and (b) physically settled/deliverable commodity contracts.

OTC DERIVATIVE PROVIDER (ODP)

Issuer or market maker, as regular feature of business COUNTERPARTY

another authorised ODP; an authorised user of the exchange; a bank; a long-term or short-term insurer; a person outside the Republic rendering a service similar to an ODP; a central bank; a private equity fund/hedge fund.

CLIENT

means any person, other than a counterparty;

FSB Notices – requirements on ODPs

• Criteria to be authorised as an ODP

• Prudential requirements for all ODPs

• Fit and proper requirements

• Compliance function

• Internal control and risk management

• Business continuity plan

• Record keeping and data retention requirements

• Code of Conduct for ODPs

• Categorisation of clients and counterparties

• Appropriateness tests for clients

• Disclosure for clients

• Reporting requirements

• Daily, T0

• ODP reporting

• LEI, UPI, UTI

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Margining requirements on ODPs

• Initial margin – bilaterally, on all OTC trades, portfolio basis

• Variation margin – daily

• Segregation - initial margin must be segregated from proprietary assets on the books and records of a third party holder or custodian, or via other legally effective arrangements made by the collecting counterparty.

• Exclusions on initial margin provision

• Bank - total OTC derivative book < R10 billion.

• Insurer - total OTC derivative book < R350 million.

• Other – total OTC derivative book < R50 million.

• Calculated on group consolidated basis

• Capital and margin strong incentives to clear without mandatory clearing

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THANKS AND QUESTIONS

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