On 2 June 2020, the SA Financial Conduct Authority and the Prudential Authority (the Authorities) published Joint Standard 2 of 2020 under the Financial Sector Regulation Act, 2017, setting out the margin requirements for non-centrally cleared over the counter derivative transactions (the Joint Standards). The Joint Standards have been the subject of public consultation and broadly reflect the standards on margin requirements for non-centrally cleared OTC derivatives that were developed in 2015 by the Basel Committee on Banking Supervision (BCBS) and International Organisation of Securities Commissions (IOSCO). The purpose of these standards is to reduce systemic risk and to promote central clearing of derivatives transactions. Since there is currently no licensed central clearing repository active in SA, the Joint Standard are focused on reducing systemic risk.
The Authorities observed that the Joint Standards are closely aligned to the IOSCO and BCBS standards in order to create a level playing field among OTC derivative participants and to enable local market participants to interact with foreign counterparties from more developed markets such as the European Union (EU) or the United States of America (USA). There are however a limited number of adaptations in light of local market conditions. The effective date of the Joint Standards is currently not known and will be determined by the Authorities in due course.
The Joint Standards apply if an OTC derivatives provider (a provider), defined as a person who as a regular feature of its business and transacting as principal originates, issues or sells OTC derivatives or makes a market in OTC derivatives, enters into a OTC derivatives transaction with , broadly speaking, persons that are professionally active in the financial markets or other OTC derivatives providers. The margin requirements in principle apply to all non-centrally cleared OTC derivative transactions, including intra-group and cross-border transactions, if certain minimum thresholds are met. Both the provider and its counterparty to the transaction should meet these thresholds before the margin requirements are triggered.
Margin can in the context of the Joint Standards be described as the collateral that a party to a derivatives contract (Party A) must provide to its counterparty (Party B) in order to secure the exposure which Party B has in the event of a default by Party A under the derivatives contract. The Joint Standards deal with two types of margin: initial margin (IM) and variation margin (VM). IM, which is posted at the outset of a derivatives transaction, considers the potential future exposure of Party B on Party A. VM looks at the current exposure under the transaction and can therefore vary over the life of the transaction.
The minimum thresholds for the exchange of IM between a provider and its counterparty are set out in the table below and reflect the gradual phasing in of the IM requirements. The threshold amounts refer to the aggregate gross notional amount (as further described in the Joint Standards) of OTC derivatives of the relevant person and its group (as defined in the SA Companies Act, 2008) and must include any physically settled foreign exchange forwards and swaps (even although these transactions themselves are not subject to margin requirements). The calculation of the thresholds is based on the aggregate month-end average gross notional amount of OTC derivatives for March, April and May in the relevant year.
|Year ||Threshold Amount in South African Rands|
|From effective date until 31 August 2021||R30 trillion|
|From September 2021||R23 trillion|
|From September 2022||R15 trillion|
|From September 2023||R8 trillion|
|From September 2024||R100 billion|
The transfer of IM should be effected in accordance with the requirements specified in the Joint Standards. If the amount of IM to be exchanged is less than R500 million, the provider can decide not to collect such collateral amount. It must, however, collect any IM in excess of R500 million. The requirement to calculate and exchange IM applies to all new contracts entered into during a particular period but does not apply to existing derivatives contracts up to that point.
During the first six months of implementation and commencement of the Joint Standards, VM will only need to be exchanged by providers and their counterparties where the gross notional amount of OTC derivatives is R30 trillion and above. After the first six-month period, all providers entering into non- centrally cleared OTC derivatives transactions with qualifying counterparties will be required to exchange VM on all new contracts in accordance with the Joint Standards.
Physically settled foreign exchange forward contracts and foreign exchange swaps are excluded from the margin requirements. In the case of cross-currency swaps, the IM requirements do generally not apply to a fixed physically settled foreign exchange transaction associated with the exchange of principal. Derivative transactions between entities belonging to the same group are not subject to margin requirements if, amongst others, the aggregate outstanding gross notional amount of OTC derivative transactions is less than R100 billion. The transfers of IM and VM may be subject to a minimum transfer amount of which the aggregate sum of IM and VM may not exceed R5 million.
Value and form of margin
The Joint Standards describe the methodologies for the calculation of the IM. The VM is dependent on the size of the actual exposure under the relevant derivative and depends on the mark-to-market value of the derivative contract at any point in time. The Joint Standards describe the type of collateral that can be used as margin and the manner in which its value should be calculated, including the haircuts that apply. They also provide that any cash or non-cash collateral collected as IM may only be rehypothecated, re-pledged or re-used once by the IM collector on the conditions set out therein.
In addition to the margin requirements themselves, the Joint Standards impose various other obligations on providers. For example, they require a provider to have sufficiently robust processes, procedures and board-approved policies in place. It should further ensure that all transactions between the provider and counterparty comply with the applicable laws. Netting and collateral agreements should be effective under the laws of the relevant jurisdictions and are supported by periodically updated legal opinions. However, an exception applies if a provider enters into an OTC derivative transaction with a foreign counterparty in a jurisdiction of which the relevant legal framework does not permit or recognise the enforceability of a netting agreement upon the insolvency of the counterparty or the enforceability of a collateral agreement upon the default of the counterparty. If the aggregate outstanding gross notional amount of transactions between the provider and the foreign counterparty does not exceed 2.5% of the total portfolio of derivatives contracts of the provider on a consolidated basis, it is not required to post or collect IM or exchange VM in respect of such transaction. If this 2.5% threshold is exceeded, then the approval of the Authorities will be required.
In their ‘Statement of the need for, expected impact and intended operation of a regulatory instrument’, the Authorities identified that the SA derivatives market represents less than 1% of the global derivatives market. South Africa’s total gross notional outstanding OTC derivatives in 2018 was estimated at about R44.7 trillion, mainly consisting of interest (74%), foreign exchange (12%), equities (8%) and commodities (5%) derivatives.
Based on a survey conducted by the Authorities, it appears that the majority (99%) of the aggregate outstanding gross notional OTC derivatives were held by banks, with asset managers and insurers accounting for the remainder of the balance, so that the Joint Standards are mainly relevant for banks. It is anticipated that only the larger SA banks will become subject to the Joint Standards, given the minimum thresholds that apply before the application of the rules is triggered. However, since the thresholds apply on a group basis, the margin requirements may apply to the SA branches of foreign banks as a result of their derivatives business outside South Africa.