On 5 June 2015 Treasury released the second draft of the regulations relating to OTC derivatives under the Financial Markets Act, 2012 (the “Draft Regulations”). At the same time, the FSB released a number of draft notices, including a notice relating to margin for non-centrally cleared OTC derivatives (the “Draft Margin Notice”). A stated aim of the new regulatory regime for OTC derivatives is to reduce the systemic risk associated with derivatives. The deadline for comment on the various documents was 6 July 2015.
A number of key concerns with the Draft Regulations and Draft Margin Notice are highlighted below.
Corporates and non-bank participants should note: The Draft Regulations and Draft Margin Notice do not exclude transactions among affiliates from the need to centrally clear or post margin for OTC derivatives. As a result, a central treasury company of a group could find itself being required to become an authorised OTC derivatives provider in South Africa and/or exchanging margin with its South African affiliates.
Comparable legislation in other jurisdictions either excludes such intra-group transactions or provides for a process to apply to the relevant regulator for the exemption of such transactions from central clearing and/or margin requirements, on the basis that transactions among affiliates are not generally for investment or speculation, and therefore pose little or no systemic risk.
Banks and financial institutions should note: The Draft Margin Notice requires authorised OTC derivative providers to exchange margin with all entities with whom it concludes OTC derivatives, including both counterparties and clients as defined in the Draft Regulations. One result is that a financial institution (such as a bank) could find itself posting margin to corporate clients – or even individual clients – with no infrastructure for receiving or holding margin. Other jurisdictions do not require margin to be exchanged with small non-financial counterparties, and there is a strong view that requiring unsophisticated parties to receive and hold margin is unlikely to decrease systemic risk – and may even increase it.
All OTC derivative market participants should note: The Draft Margin Notice prohibits any re-use (re-hypothecation) of initial margin collected in respect of non-centrally cleared OTC derivative transactions. Generally, however, such initial margin is used to establish the receiving party’s hedge to the margined OTC derivative and is used with the posting party’s consent. South African regulators should perhaps follow other jurisdictions’ legislation in allowing such re-use, subject to certain conditions, including that the posting party must consent to the re-use.
Regulation of OTC derivatives in South Africa will soon be a reality, and users of derivatives in South Africa, or with South African counterparties, are urged to consider the effect of the new regulations on their business.