## _cr1552 ## Source details **Canonical URL:** [_cr1552](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1552.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1552.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1552.pdf.json) --- ### Introduction and context - South Africa, as a G20 member, is committed to reforming its OTC derivatives market to reduce vulnerabilities and increase transparency. - Reforms implemented through the Financial Market Act (FMA) and Regulations for banks reflect the Basel III capital requirements. - FMA establishes a licensing and recognition regime for domestic and foreign central counterparties (CCPs) and trade repositories that provide services to entities in South Africa. - Implementation of Basel III aims to introduce additional capital and margining requirements in due course to address higher risks related to non-centrally cleared transactions, and incentivize banks to use CCPs. - Secondary legislation still needs to be finalized and will contain requirements for financial market infrastructures (FMIs), such as CCPs and trade repositories, and will introduce the concept of an OTC derivatives provider (ODP) as a new category of regulated person under the FMA for professional entities active in the OTC derivatives market. ### Key facts and market structure - Market size and activity: - Gross notional outstanding value was approximately ZAR 27 trillion (USD 3 trillion) in June 2012. - Trading volumes represent 7.5 percent of GDP. - Currency derivatives and interest rate derivatives are the most actively traded products. - Product exposures: - Around 85 percent of the notional outstanding amounts in the books of the largest five South African banks represent interest rate contracts. - FX contracts represent 12 percent of the notional outstanding amount. - OTC traded equity, credit, and commodities derivatives outstanding amounts are relatively small. - Nearly all OTC derivatives traded between local counterparties are South African Rand (ZAR) denominated. - Market participants: - Interbank 63% | Other financial institutions 35% | Corporate investors 2% (total market distribution, Price Waterhouse Coopers, 2012). - Interbank role: Interbank 59% of Interest Rate, Interbank 4% of FX. - Interbank trading with offshore banks is significant; in 2012 more than half of interbank interest rate transactions of large South African banks involved a foreign counterparty. - Foreign dealers are typically global systemically important financial institutions (G-SIFIs). ### Safcom and CCP arrangements - Safcom is the local CCP for exchange-traded derivatives (futures and options traded on the JSE). - Ten clearing members: eight banks and two non-banks. - Wholly owned subsidiary of the JSE; JSE performs Safcom’s operating functions, risk management and clearing services, and decision-making regarding declaration of defaulting participants via SLAs. - Registrar of securities services of the FSB has approved Safcom as a qualifying CCP. - Safcom made a formal application for recognition by ESMA in September 2013. - Safcom risk resources and settings: - Initial margin methodology: 99.95% confidence level and 1 day holding period for most derivatives; 99.7% confidence level and 2 day holding period for interest rate derivatives. - Margins calculated on an instrument level; offsets allowed on a client level only. - Total size of the default fund is ZAR 500 million. - Safcom’s contribution to the default fund is currently ZAR 100 million. - Default fund designed to withstand default of two average sized clearing members and to cover at least the default of the largest clearing member under stressed conditions. - Safcom has three committed credit facilities of R500m each (total ZAR 1.5 billion) from three local commercial banks. - Recovery time objective: current JSE/Safcom recovery time objective is 48 hours; disaster recovery tests showed systems can be restored within 8 hours; asynchronous data replication may result in data loss of up to 5 minutes. - Safcom accepts only cash (ZAR) as collateral currently; project underway to broaden eligible collateral. ### OTC derivatives market reforms and legislation - FMA passed by Parliament in early January 2013 and promulgated on June 3, 2013. - FMA governs licensing and supervision of exchanges, CSDs, clearing houses and trade repositories. - Draft secondary legislation introduces ODP as a new category of regulated person under FMA and includes reporting obligations for trade repositories. - Draft regulations and timelines: - A first set of regulations was issued for consultation in July 2014; other regulations and board notices expected later in 2014. - Margining requirements for non-centrally cleared derivatives are planned for implementation by the end of 2015. - Reform status and exemptions: - Vast majority of OTC derivatives still bilaterally traded and cleared; no mandatory clearing requirement. - In absence of secondary legislation, no CCP (other than Safcom) or trade repository has received a license under the FMA and no ODPs have been identified. - Transactions of banks with local counterparts are exempted from an additional capital charge for non-centrally cleared derivatives until the end of 2014. ### Market risk, surveillance, and data needs - Risk exposures among local and global participants are partly covered; market vulnerable to potential failure of a bank. - Margining practices unevenly adopted: - Most interbank trades subject to variation margin calls with cash as collateral, but thresholds frequently applied and potential future exposures are not covered. - Surveillance and data needs: - Monthly SARB data provide insight into banks’ size and positions but more information needed for a timely and comprehensive overview consistent with the G20 reform agenda. - Need for information about participants other than banks (non-bank financial institutions and corporate users). - Trade repository recommendations: - Trade repository would significantly improve authorities’ ability to identify and evaluate risks timely and consistently. - Recommendation: establish no more than one trade repository to avoid operational complexities, overlap, duplication of data, and delayed access. - Full reliance on a foreign trade repository is possible if South African authorities face no legal or operational impediments to obtain relevant data. ### Central clearing — options, benefits, and drawbacks - Four main strategic options identified: - Option A — Using only global CCPs - Benefits: optimal netting resulting in reduced cost for clearing members; global CCPs have more clearing members and more “survivors”. - Drawbacks: reduced capacity for South African authorities to supervise and oversee a global CCP; crisis affecting global CCP difficult to manage; global clearing difficult to combine with exchange controls; low domestic direct membership may reduce competition. - Option B — Using only a local CCP - Benefit: authorities have capacity to supervise the CCP. - Drawback: increased cost for foreign banks and potential significant negative impact on market liquidity in local OTC derivatives market. - Option C — Introduce a local CCP on a competitive basis in addition to a global CCP (co-existence) - Benefits: reduces drawbacks of only global CCP; authorities can supervise locally; exchange controls not a hindrance; higher number of clearing members expected to increase competition and keep cost low. - Drawback: netting opportunities reduced for banks participating in both global and local CCPs; local CCP will have fewer clearing members than a global CCP. - Option D — Hybrid model: local CCP becomes a clearing member of a global CCP - Benefit: optimizes netting for all market participants. - Drawback: does not reduce disadvantages of a global CCP; default of a global CCP may directly impact stability of the local CCP. - Use of global CCP considerations: - Clearing at a global CCP reduces exposures via multilateral netting and more potential ‘survivors’ to manage defaults. - Risks include exposure to global shocks, limited domestic supervisory reach, interaction problems with exchange controls, and potential competition issues for client clearing. - Recommendation emphasis: - Authorities should consider benefits of establishing a local CCP in addition to a global CCP; a domestic clearing house role could be assumed by a domestic CCP or a local branch of a global CCP. ### CCP resilience, central bank services and emergency liquidity - Enhance CCP resilience by pursuing central bank services: - Discuss direct access to SAMOS (central bank operated payment system) via an account at the SARB. - Obtain routine access to intraday liquidity and collateral services from SARB to reduce dependence on commercial banks. - Examples cited: de Nederlandsche Bank and National Bank of Belgium providing direct accounts and intraday liquidity to CCPs. - Emergency liquidity assistance: - Central banks increasingly develop policies to provide emergency liquidity assistance to CCPs under certain conditions. - SARB should consider providing liquidity only to CCPs that are sound and adhere to the PFMI; oversight division must have good understanding of CCP adherence to PFMI. - No commitment to provide emergency liquidity should be made to reduce moral hazard. ### Safcom observance of PFMI — main gaps and actions - Improvements already made: - Sound legal framework; independent risk management committee; enterprise-wide risk management framework; a ‘risk waterfall’; work on margin and default fund methodologies; further development of liquidity risk management. - Further work needed (priority items): - Improve robustness of the risk waterfall considering specific liquidation periods and counterparty risks of clearing members. - Further develop liquidity risk management, including daily stress testing. - Enhance operational risk management by including a recovery time objective of two hours and reducing data loss in case of failure. - Develop a recovery plan in line with PFMI and CPSS-IOSCO guidance; SLAs should specify staff, systems and assets dedicated to the CCP in extreme circumstances. - Reduce dependency on the large four banks (general clearing member, liquidity provider, deposit-taking bank, custodian and settlement bank roles); pursue SAMOS account and direct account at Strate; consider replacing commercial credit lines with SARB facilities. - Consider reducing reliance on Fitch in investment decisions. ### Regulation, supervision, oversight, and institutional capacity - Current responsibilities: - FSB: responsible authority under the FMA; Registrar for Securities Services regulates and supervises non-bank FMIs including ODPs, CCPs, CSDs, exchanges, and trade repositories. - SARB: - Bank Supervision Department (BSD): implementation of capital and margin requirements at banks for non-centrally cleared derivatives exposures. - National Payment System Department (NPSD): regulates and oversees payment system safety and efficiency; NPSD operates SAMOS. - Strate is subject to supervision and oversight of both FSB and SARB; SARB responsibilities limited to payment and settlement leg of securities transactions. - SARB and FSB have concluded an MOU to coordinate supervisory and oversight activities. - Twin peaks proposals and sequencing: - Introduction of a prudential authority under Twin Peaks; FSB to become market conduct authority. - Oversight of payment systems to remain responsibility of SARB-payment system oversight division. - Implementation sequencing: the parallel rollout of OTC derivatives reforms and twin peaks requires careful planning to ensure sufficient capacity at all stages. - Structural preparations: plans analyzing numbers and profiles of staff needed under different implementation scenarios; planning being developed under the Prudential Authority Implementation Working Group. - Resources and staffing: - FSB capital markets department currently consists of 10 staff members responsible for regulation and supervision of the financial markets. - The FSB will increase the number of staff with 3 to 4 staff members to manage increased responsibilities related to ODPs and OTC derivatives markets. - The NPSD currently consists of 30 staff members, of which 8 are dedicated to NPS oversight. - NPSD will increase the number of staff to manage increased responsibilities; new staff should add knowledge on CCPs and CSDs. - Legal and oversight framework: - FMA section 59 requires the registrar to annually assess licensed market infrastructures for compliance. - SARB’s oversight covers the entire payment process and includes Strate Limited. - Position paper NPS 01/2013 confirms SARB’s support for PFMI implementation; information paper NPS06 09/2013 recognizes FMIs that should adhere to PFMI. ### Main policy recommendations (selected, with timing / priority) - Bilaterally traded and cleared OTC derivatives market - Make swift progress on consultation and issuance of FMA regulations, trade repository regulations and other regulations related to OTC derivatives reforms to create transparency and proceed with reforming the OTC derivatives market. - Timing / Priority: Short term / High - Enhance surveillance activities of the OTC derivatives market. - Timing / Priority: Medium term / Medium - Further implement capital and margining requirements, while balancing the risk mitigating capacity of these measures and potential unintended consequences. - Timing / Priority: Medium term / Medium - Central clearing - The FSB to develop equivalence criteria for recognition of non-local FMIs, including global CCPs. - Timing / Priority: Short term/high - The FSB to conclude a cooperation agreement with the authorities of global CCPs to ensure that the relevant South African authorities receive timely and relevant information about the safety and efficiency of the global CCP. - Timing / Priority: Short term / High - Consider the benefits of establishing a local CCP in addition to a global CCP. - Timing / Priority: Short term / High - Mandate central clearing through regulation leaving market participants a choice through which CCP they clear. - Timing / Priority: Short term / Medium - Safcom to further increase its compliance with the PFMI, in particular regarding its dependency on the large four banks, the robustness of its risk waterfall, liquidity risk management, operational risk management and recovery planning. - Timing / Priority: Medium term / High - Any local CCP to reduce its dependency on local banks, for example by opening an account in the SAMOS system and the local CSD, as well as pursuing access to routine intraday liquidity and other services provided by the central bank. - Timing / Priority: Medium term / Medium - Regulation, supervision and oversight of CCPs - Increase the number of staff in the FSB and SARB with specific knowledge on CCPs, CSDs and OTC derivatives markets. - Timing / Priority: Short term/High - Define oversight responsibilities for payment systems and other FMIs, including CCPs, in the legal and regulatory framework of the SARB oversight division. - Timing / Priority: Medium term/High - Start structural preparations for the simultaneous implementation of OTC derivatives reforms and the twin peaks regulatory structure by the FSB and SARB and prepare for effective coordination and cooperation to ensure a sufficient number of staff with appropriate skills is available at all stages of the reforms. - Timing / Priority: Short term / High - Consider developing a policy to provide central bank emergency liquidity assistance to CCPs under certain conditions to further reduce the probability of default of a CCP. - Timing / Priority: Medium term / High - Timing conventions used in the recommendations - Short term is within six months; medium term is within 18 months. *International Monetary Fund — South Africa: Executive Summary (2014 South Africa FSAP)* ### EXECUTIVE SUMMARY ___________________________________________________________________________ 5 ### EXECUTIVE SUMMARY ### Introduction and context - South Africa, as a G20 member, is committed to reforming its OTC derivatives market to reduce vulnerabilities and increase transparency. - Reforms are being implemented through the Financial Market Act (FMA) and Regulations for banks, reflecting the Basel III capital requirements. - The FMA establishes a licensing and recognition regime for domestic and foreign central counterparties (CCPs) and trade repositories that provide services to entities in South Africa. - The implementation of Basel III aims to introduce additional capital and margining requirements in due course to address the higher risks related to non-centrally cleared transactions, and incentivize banks to use CCPs. - Secondary legislation still needs to be finalized and will contain requirements for financial market infrastructures (FMIs), such as CCPs and trade repositories, and will introduce the concept of an OTC derivatives provider (ODP) as a new category of regulated person under the FMA for professional entities active in the OTC derivatives market. ### Key findings on market risk and surveillance - There is room to further reduce risks in the OTC derivatives market. Risk exposures among local and global participants are currently partly covered. - A combination of high exposures and volatile markets would make participants vulnerable to losses following a failure of one or more of their counterparts. - Authorities are encouraged to further implement capital and margining requirements to reduce risks related to non-centrally cleared OTC derivatives transactions, while continuously balancing the risk mitigating capacity of these measures and potential unintended consequences. - Potential unintended consequences include reduced hedging activity by end-users of OTC derivatives and the creation of an unlevel playing field among CCPs. - The authorities should enhance surveillance activities for the OTC derivatives market to obtain a comprehensive overview of OTC derivatives transactions and positions, and an understanding of potential vulnerabilities. ### Central clearing—benefits, risks, and strategic options - A CCP can help limit potential credit and contagion risk in the OTC derivatives market, but only if the CCP itself is safe. - Global and local central clearing impact the safety and efficiency of the South African OTC derivatives market in different ways. - The note identifies four main options for central clearing in South Africa: - Using only global CCPs. - The largest South African banks are increasingly moving towards central clearing of OTC derivatives transactions in the U.K. and potentially the U.S. - Benefits: optimal netting resulting in reduced cost for clearing members; a global CCP will have more clearing members, and therefore more “survivors”, making it easier for the CCP to manage the default of a clearing member. - Drawbacks: South African authorities will have reduced capacity to supervise and oversee a global CCP and a crisis affecting the global CCP will be difficult to manage; global clearing is difficult to combine with exchange controls; a low number of domestic banks becoming direct clearing members of the global CCP may reduce competition in the market. - Using only a local CCP. - Benefit: provides the authorities with the capacity to supervise the CCP. - Drawback: cost will increase for foreign banks, which may potentially have a significant negative impact on market liquidity in the local OTC derivatives market. - Introduce a local CCP on a competitive basis in addition to a global CCP. - Benefits: reduces drawbacks of using only a global CCP while deriving benefits of a local CCP; authorities can exercise supervision of the local CCP in normal and crisis circumstances; exchange controls will not hinder collateral deposits at the CCP; a higher number of clearing members is expected to increase competition and keep cost low. - Drawbacks: netting opportunities are reduced for those banks participating in both the global and local CCP; the local CCP will not have as many clearing members as a global CCP, and thus less capacity to manage a default due to fewer survivors. - A hybrid model in which a local CCP becomes a clearing member of a global CCP. - Benefit: optimizes netting for all market participants. - Drawback: does not reduce the disadvantages of a global CCP; the default of a global CCP may have an immediate and direct consequence on the stability of the local CCP, potentially impacting the financial stability of all markets that are served by the local CCP. - The authorities should consider the benefits of establishing a local CCP in addition to a global CCP. A domestic clearing house could assume the role of a local CCP or this role could be assumed by a local branch of a global CCP. - The Johannesburg Stock Exchange (JSE) has initiated important improvements to make Safcom, the CCP for exchange-traded derivatives, compliant with international standards. Further work is needed to fully comply with international requirements (the CPSS-IOSCO Principles for FMIs or PFMI). - Safcom should: - Improve the robustness of its risk management waterfall, taking into account the specific liquidation periods for products and counterparty risks of clearing members. - Continue to develop its liquidity and operational risk management. - Develop a recovery plan. - Specific risks of a local CCP should be effectively mitigated: - The highly interconnected financial system of South Africa challenges the local CCP to be a true firewall in stopping contagion following a default of one of its clearing members. - The small number of local banks will generally place a high burden on surviving clearing members to help the CCP in liquidating the defaulter’s positions, provide liquidity and generally support the CCP to maintain operations. - Any local CCP should reduce its dependency on local banks, for example, by pursuing with the central bank the possibility of opening an account in the central bank operated payment system (SAMOS) and a securities account in the local central securities depository (CSD). - A local CCP should also pursue access to routine intraday liquidity and other central bank services. ### Regulation, supervision, and oversight arrangements - The move to a twin peaks regulatory structure is expected to contribute to comprehensive supervision and oversight of CCPs; coordination and cooperation among the authorities is essential. - Regulatory, supervisory and oversight responsibilities may be distributed among two supervisory entities, with the national payment system oversight division responsible for the oversight of FMIs, and the future market conduct authority responsible for market conduct supervision of FMIs and ODPs. - Coordination and cooperation arrangements should be developed, in particular to identify a lead coordinating authority. - The parallel implementation of the OTC derivatives reforms and the twin peaks model requires careful planning to ensure sufficient capacity at all stages of the reform process. ### Main recommendations (Table 1: South Africa: Main Recommendations) - Bilaterally traded and cleared OTC derivatives market - Make swift progress on the consultation and issuance of FMA regulations, trade repository regulations and other regulations related to OTC derivatives reforms to create transparency and proceed with reforming the OTC derivatives market. - Timing / Priority: Short term / High - Enhance surveillance activities of the OTC derivatives market. - Timing / Priority: Medium term / Medium - Further implement capital and margining requirements, while balancing the risk mitigating capacity of these measures and potential unintended consequences. - Timing / Priority: Medium term / Medium - Central clearing - The FSB to develop equivalence criteria for recognition of non-local financial market infrastructures (FMIs), including global CCPs. - Timing / Priority: Short term/high - The FSB to conclude a cooperation agreement with the authorities of global CCPs to ensure that the relevant South African authorities receive timely and relevant information about the safety and efficiency of the global CCP. - Timing / Priority: Short term / High - Consider the benefits of establishing a local CCP in addition to a global CCP. - Timing / Priority: Short term / High - Mandate central clearing through regulation leaving market participants a choice through which CCP they clear. - Timing / Priority: Short term / Medium - Safcom to further increase its compliance with the CPSS-IOSCO Principles for Financial Market Infrastructures (PFMI), in particular regarding its dependency on the large four banks in South Africa, the robustness of its risk waterfall, liquidity risk management, operational risk management and recovery planning. - Timing / Priority: Medium term / High - Any local CCP to reduce its dependency on local banks, for example by opening an account in the SAMOS system and the local CSD, as well as pursuing access to routine intraday liquidity and other services provided by the central bank. - Timing / Priority: Medium term / Medium - Regulation, supervision and oversight of CCPs - Increase the number of staff in the FSB and SARB with specific knowledge on CCPs, CSDs and OTC derivatives markets. - Timing / Priority: Short term/High - Define oversight responsibilities for payment systems and other FMIs, including CCPs, in the legal and regulatory framework of the SARB oversight division. - Timing / Priority: Medium term/High - Start structural preparations for the simultaneous implementation of OTC derivatives reforms and the twin peaks regulatory structure by the FSB and SARB and prepare for effective coordination and cooperation to ensure a sufficient number of staff with appropriate skills is available at all stages of the reforms. - Timing / Priority: Short term / High - Consider developing a policy to provide central bank emergency liquidity assistance to CCPs under certain conditions to further reduce the probability of default of a CCP. - Timing / Priority: Medium term / High - Timing conventions used in the recommendations - Short term is within six months; medium term is within 18 months. *Italicized source attribution:* International Monetary Fund — South Africa: Executive Summary (2014 South Africa FSAP) ### 5. This note is organized as follows: section II describes the OTC derivatives market in South ### _cr1552 - 5. This note is organized as follows: section II describes the OTC derivatives market in South ### Organization and analytical framework - Note structure: - Section II: describes the OTC derivatives market in South Africa. - Section III: contains a risk analysis of the reforms in the OTC derivatives market. - Section IV: concludes with policy recommendations. - Risk analysis in Section III addresses risks related to: - (i) the decentralized phase and the reform process, - (ii) central clearing, - (iii) regulation, supervision, and oversight. - Regulatory, supervisory, and oversight arrangements for Financial Market Infrastructures (FMIs), including CCPs and trade repositories, are assessed using the five responsibilities of the CPSS-IOSCO Principles for Financial Market Infrastructures (PFMI). - Safety and efficiency of Safcom (the exchange-traded derivatives CCP) are analyzed based on a selection of PFMI principles. - Definitions used: - FMIs cover payment systems, securities settlement systems, the Central Securities Depository (CSD), CCPs, and trade repositories. - CSD: provides securities accounts, central safekeeping services, and asset services. - CCP: interposes itself between counterparties, becoming buyer to every seller and seller to every buyer, ensuring performance of open contracts. - Trade repository: maintains a centralized electronic record database of transaction data. ### The OTC derivatives market in South Africa — key facts and structure - Market size and activity: - Gross notional outstanding value was approximately ZAR 27 trillion (USD 3 trillion) in June 2012. - Trading volumes represent 7.5 percent of GDP. - Currency derivatives and interest rate derivatives are the most actively traded products. - Volumes are growing, stimulated by volatility, relatively high interest rates, and high participation of offshore dealers and investors. - Product exposures: - Around 85 percent of the notional outstanding amounts in the books of the largest five South African banks represent interest rate contracts. - FX contracts represent 12 percent of the notional outstanding amount. - OTC traded equity, credit, and commodities derivatives outstanding amounts are relatively small. - Equity derivatives are typically traded on the JSE. - Nearly all OTC derivatives traded between local counterparties are South African Rand (ZAR) denominated. - Market participants: - Banks are the most active players, followed by other financial institutions (pension and insurance funds, asset managers, corporate treasurers). - In 2012, banks had the highest share; other financial institutions accounted for a third of the notional outstanding amount; corporate investors’ share was very small. - Table 2 (distribution of notional outstanding value among participants, Price Waterhouse Coopers, 2012) reports: - Interest Rate: Interbank 59% | Other financial institutions 28% | Corporate investors 1% | Total 88% - FX: Interbank 4% | Other financial institutions 7% | Corporate investors 1% | Total 12% - Other: Interbank 0.2% | Other financial institutions 0.2% | Corporate investors 0.1% | Total 0.3% - Total market: Interbank 63% | Other financial institutions 35% | Corporate investors 2% - Interbank trading with offshore banks is significant; in 2012 more than half of interbank interest rate transactions of large South African banks involved a foreign counterparty. - Foreign dealers are typically global systemically important financial institutions (G-SIFIs). - Financial Market Infrastructures (FMIs): - SAMOS: automated interbank settlement system operated by the SARB; settles large-value payments on a real-time gross settlement basis. - Retail payments: settled as a batch on a deferred basis by BankServ. - Securities traded on the JSE are cleared and settled by the CSD Strate. - JSE operates a CCP for exchange-traded derivatives through subsidiary Safcom. - FX transactions have been settled via the Continuous Linked Settlement (CLS) system since the ZAR became a CLS eligible currency in 2004. - No CCP for OTC derivatives contracts or trade repository has been established in South Africa. ### Safcom and CCP arrangements - Safcom: - Local CCP for exchange-traded derivatives (futures and options traded on the JSE). - Ten clearing members: eight banks and two non-banks. - Wholly owned subsidiary of the JSE. - JSE performs Safcom’s operating functions, risk management and clearing services, and decision-making regarding declaration of defaulting participants via SLAs. - Registrar of securities services of the FSB has approved Safcom as a qualifying CCP. - Safcom made a formal application for recognition by the European Securities and Market Authority (ESMA) in September 2013. ### OTC derivatives market reforms and legislation - Financial Markets Act (FMA) and bank regulations: - FMA passed by Parliament in early January 2013 and promulgated in June 2013. - FMA establishes licensing and recognition regime for domestic and foreign CCPs and trade repositories providing services to entities in South Africa. - Banks Act regulations aim to introduce additional capital and margining requirements in due course, aligned with Basel III, to address higher risks related to non-centrally cleared transactions and incentivize use of CCPs. - Draft secondary legislation and timelines: - National Treasury, FSB, and SARB developed draft regulations and FSB notices on assets and resources for CCPs, trade repositories, CSDs, and exchanges. - Draft introduces OTC derivatives provider (ODP) as a new category of regulated person under FMA for professional entities active in OTC derivatives markets. - Draft regulations include reporting obligations and additional duties for a trade repository. - FSB notices to govern criteria for authorization of ODPs and a code of conduct for authorized ODPs. - A first set of regulations was issued for consultation in July 2014; other regulations and board notices expected later in 2014. - Margining requirements for non-centrally cleared derivatives are planned for implementation by the end of 2015. - Reform status and exemptions: - Vast majority of OTC derivatives still bilaterally traded and cleared; no mandatory clearing requirement. - In absence of secondary legislation, no CCP (other than Safcom) or trade repository has received a license under the FMA and no ODPs have been identified. - Margining requirements for non-centrally cleared derivatives not yet implemented. - Transactions of banks with local counterparts are exempted from an additional capital charge for non-centrally cleared derivatives until the end of 2014. - No mandatory requirement for certain standardized derivatives to be traded on exchanges or trading platforms. ### Regulatory, supervisory, and oversight framework - Current institutional responsibilities: - FSB: responsible authority under the FMA; register for securities services executed through capital markets department of the FSB is regulator and supervisor of non-bank financial institutions and securities markets, including ODPs, CCPs, CSDs, exchanges, and trade repositories. - SARB: - Bank Supervision Department (BSD): responsible for implementation of capital and margin requirements at banks for exposures related to non-centrally cleared derivatives. - National Payment System Department (NPSD): regulates and oversees safety and efficiency of the payment system pursuant to SARB Act; payment system oversight division responsible for oversight; NPSD operates SAMOS through payment system operations division. - Strate is subject to supervision and oversight of both the FSB and the SARB; SARB’s responsibilities limited to payment and settlement leg of securities transactions. - SARB and FSB have concluded a memorandum of understanding (MOU) to coordinate supervisory and oversight activities. - Twin Peaks proposals: - Introduction of a prudential authority under Twin Peaks; FSB to become the market conduct authority. - Oversight of payment systems to remain responsibility of SARB-payment system oversight division. ### Risk analysis — major findings - Systemic risk context: - Majority of derivatives are bilaterally traded and cleared; important to mitigate credit risks among counterparties and to have sufficient information for authorities to analyze risks. - Financial crisis 2007–2008 illustrated that insufficient risk management and opacity in bilaterally cleared markets may contribute to financial stress. - Market safety enhanced by industry initiatives such as increased settlement matching through SWIFT and MarkITWire and participation in portfolio compression exercises. - Counterparty exposures and margining: - Risk exposures among local and global participants are partly covered; market vulnerable to potential failure of a bank. - Margining practices unevenly adopted: - Most interbank trades subject to variation margin calls with cash as collateral, but thresholds frequently applied and potential future exposures are not covered. - Combination of high exposures and volatile markets could make participants vulnerable to losses following a failure of one or more counterparts. - Surveillance and data needs: - Room to improve surveillance practices; monthly SARB data provide insight into banks’ size and positions but more information needed for timely and comprehensive overview consistent with G20 reform agenda. - Need for information about participants other than banks (non-bank financial institutions and corporate users). - Trade repository benefits and recommendations: - Trade repository would significantly improve authorities’ ability to identify and evaluate risks timely and consistently. - Important to adopt regulations for trade repositories and swiftly start application and licensing procedure. - FMA and draft regulations allow for more than one trade repository, but recommendation is to establish no more than one trade repository to avoid operational complexities, overlap, duplication of data, and delayed access. - Full reliance on a foreign trade repository is possible if South African authorities do not face legal or operational impediments to obtain relevant data under their mandates. - Trading platforms: - Trading platforms may increase safety and efficiency by offering price transparency and effective competition. - FMA and draft regulations contain requirements for exchanges, but no mandatory trading requirement for standardized derivatives currently. - Significant differences across jurisdictions in timing and regulatory design of reforms; South African authorities may consider whether specific requirements are appropriate for domestic markets. - Potential unintended consequences: - Increased capital and margining requirements may increase costs and could reduce hedging activities of some corporate investors, making them vulnerable to exchange rate and interest rate volatility. - Anecdotal evidence suggests large banks, non-bank financial institutions, and largest corporate investors are less impacted, but smaller corporates may reduce hedging. - International regulatory uncertainty: - Global reforms expose market to potential legal uncertainty from inconsistencies, overlap, and extraterritorial measures. - So far, legal uncertainty seems limited as FMA reflects a similar interpretation of PFMI as EMIR. - Safcom has no plans to apply for status under the U.S. Dodd-Frank Act in addition to ESMA recognition. - Recommendation: South African authorities should strive for joint approaches with relevant foreign authorities to prevent negative implications of inconsistent legislation and extraterritorialities. ### Central clearing — benefits, risks, and market behavior - CCP benefits and risks: - A CCP can limit contagion and credit risk via multilateral netting and strict risk management; a well-capitalized CCP acts as a firewall in case of participant default. - CCP increases concentration risk by substituting for a network of financial institutions; in extreme circumstances CCP failure may have systemic implications. - CCPs should comply with increased international standards and be subject to strict and comprehensive regulation, supervision, and oversight. - Market moves toward central clearing: - Largest South African banks increasingly moving toward central clearing of OTC derivatives transactions in London. - South African banks are not subject to mandatory clearing requirements domestically (South Africa relies on incentives to motivate CCP use), but foreign counterparts will be subject to mandatory clearing under EMIR, effectively forcing largest South African banks to clear interest rate derivatives and FX derivatives via LCH.Clearnet Ltd in London. - South African banks currently indirect clearing members, with possibility to become direct clearing members in future. *Source: IMF staff note (excerpts).* ### 26. The use of a global CCP ### 26. The use of a global CCP ### Overview - Clearing through a global CCP reduces risk exposures of South African banks by enabling multilateral netting and by providing more opportunities to manage a clearing member default because there are more potential surviving clearing participants to help the CCP in hedging and liquidating the positions of the defaulter. - Clearing through a global CCP also exposes the South African market to global shocks, complicates South African authorities’ supervision and oversight under the FMA, and interacts poorly with exchange controls. ### Benefits of a global CCP - Multilateral netting reduces counterparty credit risk exposures for banks. - More potential surviving clearing participants to manage a clearing member default reduces risk. ### Risks and drawbacks of a global CCP - Exposure to international banks via the global CCP’s default fund, and thus to shocks originating in other jurisdictions. - Exposure to the unlikely but possible failure of the global CCP following extreme situations, such as the default of several large clearing participants; potential residual losses through loss-sharing arrangements or other recovery and resolution tools. - Reduced capacity of South African authorities to supervise, oversee, and manage crisis events under the FMA because a foreign CCP is not primarily regulated locally; limited powers to obtain timely information, induce change or enforce corrective action. - Multitude of jurisdictions increases complexities during crisis events and may limit the ability of South African authorities to intervene during a crisis, especially if authorities have conflicting interests. - Difficulty combining clearing through a global CCP with exchange controls: - LCH.Clearnet Ltd accepts ZAR to cover variation margin obligations; however, deposits in ZAR are not in line with exchange controls. - Deposits of initial and variation margin in global currencies conflict with exchange controls if a bank reaches its macro-prudential limit. - Estimates about margin that South African banks must deposit for clearing at LCH.Clearnet Ltd suggest the potential impact on the exchange rate is not significant. - Competition issues may arise if only a very limited number of South African banks can offer access to the global CCP; exchange controls will limit other South African banks, financial institutions and corporate investors to access the global CCP through a foreign bank. ### Options for structuring CCP access and their trade-offs - Option 1 — Require use of only a local CCP: - Authorities would legally require use of a local CCP for the clearing of specific derivatives contracts, for example all standardized ZAR denominated derivatives contracts. - Provides authorities with capacity to supervise the CCP and gives clearing members full netting benefits. - Drawback: increased cost for foreign banks, potential retrenchment of foreign banks, and significant negative impact on market liquidity in the local OTC derivatives market. - Option 2 — Introduce a local CCP on a competitive basis (co-existence): - A local CCP competes with a global CCP by offering specific benefits to the local market; the use of the local CCP should not be required by regulation. - May limit exposure to foreign shocks and allows direct supervision by South African authorities in normal and crisis circumstances. - Not complicated by exchange controls; collateral can be deposited in ZAR. - Higher number of clearing members expected to increase competition and keep costs low. - Drawback: banks participating in both global and local CCPs will face split positions, reduced netting opportunities and increased cost. - Option 3 — Hybrid model: local CCP becomes a clearing member of a global CCP: - Optimizes netting for all market participants. - Does not reduce disadvantages of a global CCP; default of a global CCP may have immediate and direct consequences for the stability of the local CCP, creating a new channel for risk propagation. - May require additional credit and liquidity buffers, reducing efficiency gains. - International practice examples: - Australia, Singapore and potentially Mexico: clearing members have the option to use either a local CCP or a global CCP; no legal obligation to use the local CCP for contracts denominated in local currency; both CCPs co-exist and promote competition. - Canada: authorities and market participants concluded global clearing provides the most efficient and safe solution if certain conditions are met. - Brazil: market participants are required to clear OTC derivatives through the local CCP BM&FBOVESPA as local currency is non-convertible. - No practical experience exists to date on how links among CCPs clearing OTC derivatives trades should be configured and risks monitored and managed. ### Comparative table (benefits and drawbacks) — key points from Table 4 - Global CCP: - Optimal netting for largest banks – increased efficiency through lower cost - More ‘survivors’ to manage default reduces risk - Reduced capacity of South African authorities to supervise and oversee and manage crisis abroad increases risk. - Difficult to combine with exchange controls. - Competition issues with client clearing reduce efficiency. - Local CCP: - Large banks have reduced netting opportunities if they participate in both a global and local CCP. - Small clearing members have full netting benefits - Few ‘survivors’ to manage a clearing member’s default. - Authorities have capacity to control the CCP in normal and crisis circumstances. - No issues with exchange-controls - Level playing field facilitates client clearing and increases efficiency ### Specific risks of a local CCP and mitigation - Concentration risk: A local CCP must be safe and comply with international standards to reduce concentration risk. - Interconnectedness challenge: South Africa’s highly interconnected financial system makes it difficult for a local CCP to be a true firewall; a default of a large local bank would place a high burden on the few surviving clearing members to hedge, liquidate and help maintain CCP operations. - If an existing market participant develops a local CCP, it will face additional business risks and authorities should closely monitor potential spill-overs to other market infrastructures operated by that participant. ### Enhancing CCP resilience — central bank services and emergency liquidity - CCPs in South Africa could pursue access to central bank services: - Discuss possible provision of central bank services to the CCP, in particular direct access to the central bank operated payment system SAMOS by opening an account in the system. - Obtain routine access to intraday liquidity and benefit from collateral services provided by the SARB. - These measures reduce CCP dependence on commercial banks. - Examples in Europe: de Nederlandsche Bank and the National Bank of Belgium provide direct accounts to CCPs and manage collateral through direct accounts of eligible clearing members and the CCP in TARGET2; intraday liquidity is provided under certain conditions and a link with the national central securities depository enables use of securities as collateral. - Emergency liquidity assistance: - In normal circumstances CCPs manage liquidity risk via high quality liquid collateral, monitoring payment flows, stress tests, and committed credit lines with commercial banks and, if available, central banks. - In extreme circumstances commercial bank credit lines may be insufficient; CCPs are vulnerable to wrong-way risk (likely stressed when clearing participants and liquidity providers are stressed). - Providing emergency liquidity assistance ensures CCPs can continue payments and maintain market stability. - Central banks are increasingly developing policies to provide emergency liquidity assistance to CCPs. - SARB should consider providing liquidity only to CCPs that are sound and adhere to the PFMI; oversight division within the SARB needs good understanding of CCP adherence to the PFMI. - No commitment to provide emergency liquidity should be made to reduce moral hazard. ### Safcom (JSE’s exchange-traded derivatives CCP) — observance of the PFMI and interconnectedness (Box 1) - Recent improvements made by the JSE to increase Safcom’s compliance with the PFMI: - Sound legal framework; independent risk management committee; enterprise-wide risk management framework; a ‘risk waterfall’ to protect the CCP against losses following a clearing participant default. - JSE is working on fine-tuning determination of margin and default fund contributions and further developing liquidity risk management. - Appendix 6 describes Safcom’s risk management framework, rules, procedures and practices in more detail. - Further work needed for full PFMI compliance: - Improve robustness of Safcom’s risk waterfall, accounting for specific liquidation periods and counterparty risks per clearing member. - Further develop liquidity risk management and apply daily stress testing. - Enhance operational risk management, for example by including a recovery time objective of two hours and reducing data loss in case of a failure. - Develop a recovery plan to sustain critical services of the FMI; identify extreme but plausible scenarios that may prevent continuation of operations (e.g., default of one or more large participants fulfilling various roles). - Service level agreements between Safcom and the JSE should detail which staff, systems and other assets and resources are dedicated to the CCP and must be available in extreme circumstances. - Consider reducing reliance on Fitch in investment decisions. - Main challenge: high interconnectedness with its four clearing members: - The large four banks fulfill various roles: general clearing member (clearing for clients), liquidity provider, deposit-taking bank, custodian and settlement bank for Safcom. - They are crucial during a default, helping liquidate and hedge positions and take over clients’ positions. - Risks if a defaulter is also an investment bank of the CCP: loss of access to collateral, credit lines, or settlement services. - Recommended actions: JSE should find alternative solutions for services provided by the largest banks (e.g., invest collateral in government securities, pursue SAMOS account and central bank services, seek to (partly) replace commercial credit lines with a credit line with the SARB, open a direct account at Strate). ### Governance, conflicts of interest and supervision - JSE’s multiple roles (self-regulatory organization, for-profit market participant, and provider of clearing and settlement infrastructure) hamper cooperation and coordination among market participants and may impede market development; authorities have begun investigating the effectiveness of the JSE as an SRO. - Supervision and oversight of FMIs: - Regulation, supervision and oversight by the FSB and SARB are based on statutory law; relevant laws and policies are publicly available. - The recently adopted FMA reflects the PFMI and all systemically important FMIs have been assessed, or are being assessed, against the new principles. - Under the current regulatory framework authorities have sufficient powers and resources, including fining powers. - Staffing gap: the number of staff with specific knowledge of CCPs and OTC derivatives markets should be increased both within the FSB and within the SARB. - Authorities cooperate and coordinate sufficiently with regard to supervisory and oversight activities. *Source: IMF staff* ### 39. The move to a twin peaks regulatory structure is expected to contribute to ### _cr1552 - 39. The move to a twin peaks regulatory structure is expected to contribute to ### Twin peaks structure, oversight and CCP resilience - The move to a twin peaks regulatory structure is expected to contribute to comprehensive supervision and oversight of CCPs; coordination and cooperation among the authorities is essential. - The FMA and secondary regulations bring the supervisory and oversight requirements for CCPs and other financial market infrastructures in line with international standards. - Under the twin peaks regulatory structure: - The SARB is expected to strengthen the oversight of CCPs, which is expected to contribute to their resilience. - Responsibilities may be distributed among two supervisory entities, with the national payment system oversight division responsible for the oversight of FMIs, and the future Market Conduct Authority responsible for market conduct supervision of FMIs. - Coordination and cooperation arrangements should be developed, which, among others, identify a coordinating authority. - Separation and conflict‑management within the SARB oversight function: - The oversight function of the SARB should be further separated from the payment operations division. - There should at least be a separate reporting line from the oversight division directly to another department within the SARB, for example the risk management and compliance department, to manage and mitigate potential conflicts of interest. - Oversight responsibilities for CCPs, CSDs and trade repositories should be clearly defined in the legal and regulatory framework supporting the oversight function of the SARB, in line with Responsibility A of the PFMI and international best practices. - The oversight division should actively seek to enhance its resources to oversee CCPs, CSDs and TRs and ensure that staff has the appropriate knowledge and understanding of these FMIs. ### Regulation and supervision of OTC Derivatives Providers (ODPs) - Regulation and supervision of ODPs will have to be proportional upon the activity of the ODP and the risks it poses to the OTC derivatives market. - ODPs will comprise different types of institutions, including banks and smaller financial intermediaries. - Transitional supervisory responsibilities: - Before the implementation of the twin peaks model, the FSB will be the sole regulator and supervisor of ODPs. - Under twin peaks a prudential authority will be responsible for prudential supervision, whereas the FSB will be responsible for market conduct supervision. - Challenges: - Apply the same requirements to different types of entities and combine the requirements for ODPs with other legal requirements for other types of regulated entities. ### Implementation sequencing, capacity and planning - The parallel implementation of the OTC derivatives reforms and the twin peaks model requires careful planning to ensure sufficient capacity at all stages of the reform process. - These two large reform initiatives coincide, challenging the authorities to ensure a smooth transition of responsibilities and simultaneously ensure a sufficient number of staff with appropriate knowledge during different stages of the reform implementation. - Structural preparations required: - Plans that analyze the numbers and profiles of staff needed under different implementation scenarios. - This planning is being developed under the Prudential Authority Implementation Working Group, a joint task force made up of organizations with a stake in the future Prudential Authority. ### Resolution regimes for FMIs - FMIs should be included in legislation on resolution regimes. - In line with the international guidance on resolution frameworks for FMIs, led by the FSB, the South African authorities should plan for a dedicated resolution regime for systemically important FMIs, in particular CCPs, and designate the SARB to be the resolution authority. ### Policy recommendations — A. Reduce Risks in Bilaterally Traded and Cleared OTC Derivatives Market - 43. Make swift progress on the consultation and issuance of FMA regulations, trade repository regulations and other regulations and notices related to OTC derivatives reforms to create transparency and proceed with reforming the OTC derivatives market. - 44. Improve surveillance activities of the OTC derivatives market in anticipation of its financial stability mandate by collecting information from non-bank financial institutions and corporate users, in addition to the periodic information SARB receives from banks, as well as information about exposures to offshore counterparts. - Rationale: Obtain a comprehensive overview of OTC derivatives transactions and positions and an understanding of potential vulnerabilities in the market. - Use case: Prepare for the collection and analysis of data to be provided by the trade repository. - 45. Further implement capital and margining requirements, while continuously balancing the risk mitigation capacity of these measures. - Objective: Reduce risks in the non-centrally cleared OTC derivatives market while limiting potential unintended consequences, such as a reduction in the use of derivatives to hedge financial and corporate risks. - Caveat: Early implementation may encourage the use of a global CCP, in the absence of a local CCP, leaving a potential local CCP with fewer opportunities to develop a competitive offer. Authorities should carefully plan (exemptions to) regulations. - 46. Analyze whether mandating trading of standardized derivatives on exchanges would contribute to the safety and efficiency of the OTC derivatives market. - Recommendation: First implement the twin peaks and mandatory clearing reforms to enable market participants to adopt reforms gradually and to control unintended consequences. ### Policy recommendations — B. Reduce Risks Related to Central Clearing - 47. The FSB should mitigate risks related to a global CCP by establishing a solid recognition procedure under the FMA and concluding a cooperation agreement with the authorities of global CCPs. - The FSB should develop equivalence provisions for recognition of non-local FMIs that provide services in South Africa. - Objective: Strengthen the responsible authorities’ capacity to supervise and oversee non-local FMIs, such as global CCPs. - Cooperation agreements should be concluded with the authorities of global CCPs that offer services to South African banks and other regulated market participants. - The SARB should be included as one of the signatories with an eye on the implementation of the twin peaks regulatory structure. - The cooperation agreement should contain the formal intention that the South African authorities are informed about all relevant changes regarding the functioning and operations of the global CCP. - South African authorities should be part of a crisis management framework for the global CCP. - Purpose: Provide the FSB with comfort that the global CCP observes the PFMI and that they will receive timely and relevant information about the safety and efficiency of the global CCP. - 48. Consider the benefits of establishing a local CCP, in addition to a global CCP, to reduce risks related to a global CCP. - Authorities may encourage the development of a local CCP, to be offered by a local CCP or the local branch of a global CCP. - Authorities should ensure that the CCP is safe. Business risks should be for the potential operator of the CCP. - 49. Mandate central clearing through regulation, leaving market participants a choice as to the CCP through which they clear. - The regulation in South Africa should mandate central clearing in line with international practices, allowing for competition among different CCPs under the FMA. - 50. The JSE should increase the compliance of Safcom with the PFMI. In particular, it should: - i) reduce its dependency on the large four banks by directly using services of the central bank and local CSD; - ii) further enhance the robustness of its risk waterfall, taking into account liquidation periods per product and specific risks of clearing members; - iii) further develop liquidity risk management by including daily stress testing; - iv) include a recovery time objective of two hours in its operational risk management framework and reduce data loss in case of system failures; - v) develop a recovery plan in line with the PFMI and additional CPSS-IOSCO guidance, specifying, in the SLAs with the JSE, which staff, systems and other assets and resources are dedicated to the CCP and should be available in case of extreme circumstances to ensure continuation of critical operations. - 51. Consider giving a local CCP access to central bank liquidity and collateral services to further enhance financial stability. - Options: A local CCP could have its own account in the SAMOS system to reduce its dependency on settlement banks. - It may have access to intraday central bank liquidity using the CCP’s collateral and capital as eligible collateral. - Legal and operational barriers should be removed. - Preferable arrangement: The local CCP is able to keep cash collateral at an account at the SARB. - The SARB may use the securities collateral of Safcom deposited at the local CSD, if eligible, to collateralize intraday credit. - The SARB is further encouraged to continue discussions with the market to enable the use of ZAR denominated collateral for the purpose of the global CCP. - 52. Further investigate the effectiveness of the multiple roles of the JSE in the South African market and ensure that conflicts of interest are sufficiently managed and mitigated. ### Policy recommendations — C. Reduce Risks related to Regulation, Supervision and Oversight of FMIs - 53. Consider distributing responsibilities for FMIs among two supervisory entities, as part of the twin peak reforms, with the national payment system oversight division responsible for the oversight of FMIs, and the future market conduct authority responsible for market conduct supervision. - The legal and regulatory framework of the national payment system oversight division should be adapted to support the increased oversight responsibilities in line with responsibility A of the PFMI and international best practices. - 54. Start structural preparations for the simultaneous implementation of OTC derivatives reforms and the twin peaks regulatory structure by the SARB and FSB, and prepare for effective coordination and cooperation to ensure a sufficient number of staff with appropriate skills is available at all stages of the reforms. - 55. Increase the number of staff with specific knowledge of CCPs and OTC derivatives markets, both within the FSB as well as within the SARB-payment system oversight division. - Note: The FSB has built capacity through assessing Safcom and Strate against the PFMI. Further capacity is needed to regulate and supervise CCPs and ODPs active in the OTC derivatives market. - The payment system oversight department should increase the number of staff with appropriate knowledge and understanding of these entities. - 56. Include systemically important FMIs in legislation on resolution regimes in line with international guidance from the FSB. *Source: _cr1552 - 39. The move to a twin peaks regulatory structure is expected to contribute to* ### Appendix V. Regulation, Supervision and Oversight of FMIs ### Appendix V. Regulation, Supervision and Oversight of FMIs ### Regulatory, supervisory and oversight framework (Responsibility A) - Under the current structure the FSB regulates and supervises CCPs, CSDs and trade repositories, whereas SARB regulates and oversees payment systems. - FMIs operating in the securities and derivatives market are required to be licensed and supervised by the FSB according to the FMA. Powers are delegated to the Registrar of Securities Services, which consists of an executive director and deputy executive director of the FSB. - Payment-system FMIs are governed by the SARB according to the SARB Act and the National Payment System Act (NPS Act). - All national payment system participants are regulated, supervised and overseen by the NPSD based on the materiality of the risks posed by the participant. - SARB’s oversight covers the entire payment process "from the moment that a payment is initiated until the beneficiary receives the money" and therefore includes Strate Limited. - The supervision and oversight is based on statutory law. Key statutes and instruments: - Financial Market Act 19 of 2012 (FMA) replaced Securities Services Act No 36 of 2004; FMA governs licensing and supervision of exchanges, CSDs, clearing houses and trade repositories and was promulgated on June 3, 2013. - The Registrar for Securities Services is empowered under the FMA to prescribe Board Notices (subordinate legislation) in respect of issues prescribed in the Act; Minister’s powers extended to issue regulations. - SARB Act (1996), section 10 (1)(c)(i) provides NPSD regulatory and supervisory power to manage and oversee the national payment system. - NPS Act (1998) enables SARB functions provided for in the SARB Act and provides for regulatory and supervisory powers to operate SAMOS. - Position paper NPS 01/2013 confirms SARB’s support for and commitment to the implementation of the PFMI. - Information paper NPS06 09/2013 recognizes FMIs that should adhere to the updated PFMI standards. - FMA section 59 requires the registrar to annually assess whether a licensed market infrastructure complies with the FMA, the rules of the market infrastructure and, where applicable, directives, requests, conditions or requirements of the registrar. - The FSB and SARB have taken measures to improve transition of responsibilities under the twin peaks regulatory structure: they signed an MOU to promote closer cooperation and established committees for mutual issues. ### Powers and resources (Responsibility B) - Powers - Authorities have powers to obtain timely information and induce change via information requests and regular meetings. - FMIs under the FMA must provide an annual report containing details prescribed by the registrar and audited annual financial statements. - The FSB Registrar’s supervisory instruments (with statutory references from the FMA): - Registrar may impose conditions on any license, authorization, approval, consent or permission (section 6(3)(h) FMA). - Registrar may issue directives to implement specific practices, procedures or processes; to take specific actions or measures; to desist from specified practices; or to prohibit certain practices (section 6(4)(a) and (b) FMA). - Registrar may direct a regulated person to have its accounts, records and financial statements audited (section 93 FMA). - Registrar may conduct on-site visits or instruct an inspector to conduct inspections; after inspection may apply to the court for winding-up, begin business rescue proceedings, appoint a curator, or refer to the National Director of Public Prosecutions (section 95 and 96 FMA). - Registrar may impose a fine for failure to submit required statements, reports, returns or other documents, "of an amount to be prescribed by the registrar for every day during which the failure continues" (section 97(1) FMA). - Registrar may refer contraventions to the Enforcement Committee (section 99 FMA). - The NPSD may issue directives regarding a payment system or application of provisions of the NPS Act (NPS Act section 12). - Resources - The FSB’s capital markets department currently consists of 10 staff members responsible for regulation and supervision of the financial markets. - The FSB will increase the number of staff with 3 to 4 staff members to manage increased responsibilities related to ODP’s and OTC derivatives markets. - The NPSD currently consists of 30 staff members, of which 8 are dedicated to NPS oversight. - The NPSD will increase the number of staff to manage increased responsibilities potentially under the FMA once the twin peaks structure is implemented; new staff should add knowledge on specifically CCPs and CSDs. ### Disclosure of policies (Responsibility C) - Governing acts and instruments are publicly available. - The FMA, board notices and regulations issued by the Minister are published in the Government Gazette and on the FSB website. - SARB’s website contains relevant laws, the position paper and the information paper. ### Application of the PFMI (Responsibility D) - Both the FSB and SARB are committed to use the PFMI. - The FMA and its draft regulations are based on the PFMI. - SARB confirmed support and commitment to implementation of the PFMI in position paper NPS 01/2013; information paper NPS06 identifies FMIs that should adhere to PFMI, i.e. SAMOS, Bankserv and Strate Limited. - Assessment activity: - FSB requested self-assessments from Safcom and Strate, used those self-assessments to conduct its own assessments and published results on its website. - SARB requested the FMIs it identified to conduct self-assessments against the PFMI; NPSD is in the process of reviewing these self-assessments. - Conflict-of-interest mitigation at NPSD: - NPSD consists of a separate oversight division in addition to the operational division. - NPSD has a policy of “Chinese walls”: staff of the two divisions cannot access each other’s documents and reports. - Both divisions report to the head of the NPSD. The head has reporting lines to the responsible deputy governor and to the risk management and compliance department; the oversight division has no separate reporting line to the risk management and compliance department. ### Cooperation in normal and stress circumstances (Responsibility E) - Coordination platforms among FSB and SARB relevant to FMIs: - Financial Sector Contingency Forum (FSCF): financial-industry-wide crisis management forum chaired by SARB; main forum meets at least twice a year; subcommittees and working groups focus on identification and mitigation of systemic risks. Regulators, JSE, FMIs, banks and non-bank financial organizations are represented. Members signed an MOU to share information required to assess systemic risks, report incidences or disruptions with systemic implications, participate in crisis management and contribute to mitigation of systemic risk. FSCF organized a simulation exercise in March 2014 including SARB, FSB, National Treasury, JSE and FMIs to test coordination; results are used to improve crisis coordination. - Financial Stability Oversight Committee: coordinates management of risk to financial stability; jointly chaired by Governor of SARB and Minister of Finance. - Regular meetings among National Treasury, FSB capital market department and SARB to review FMI assessments and exchange views on international reforms. - Cooperation and coordination explicitly governed by the FMA (e.g., section 6(3)(n)). - International and regional arrangements: - International cooperation agreements relate to payment systems, e.g., SIRESS and CLS. - Regional: Committee of Central Bank Governors of the SADC and the Payments System Oversight Committee (central banks of SADC, SARB lead) ensure cooperation and promote efficiency/effectiveness of the SIRESS system. Domestic and SIRESS self-assessments and reviews planned at least once every 2 years. - SARB is a member of the cooperative oversight committee for CLS with the Federal Reserve Bank of New York as lead overseer. - MOU between SARB and FSB for supervision of Strate. - No international cooperation agreement with UK authorities regarding clearing of OTC derivatives by South African banks in LCH.Clearnet Ltd; FSB intends to initiate explicit coordination in the future. *Source: Appendix V. Regulation, Supervision and Oversight of FMIs (excerpt).* ### Appendix VI. Risk Management and Governance of Safcom ### Legal risk (Principle 1) - Legal framework grounding Safcom: - Constitution and the Promotion of Administrative Justice Act, 2000, rule of law and common-law principles. - Laws and regulations specifically governing Safcom: - FMA: JSE and Safcom operate solely in South Africa under licenses granted by the Registrar of Securities Services of the FSB in terms of the FMA. - JSE derivatives rules: Safcom as a clearing house must adopt and enforce rules consistent with the FMA; JSE has issued "Derivatives Rules" and “Interest Rate and Currency Rules” as secondary legislation binding on FMI, participants and clients. - Insolvency Act: Section 35A of the Insolvency Act, 1936 provides that rules & practices of Safcom are binding on the liquidator or trustee of an insolvent estate. - Potentially FMA regulations: Safcom/JSE will be subject to FMA regulations upon issuance. - Safcom operates solely under South African law, with members seated in South Africa and accepting only cash collateral in Rand. - Legal and regulatory framework addresses key CCP issues: rights and interests of participants, novation, finality and netting at client level, default and insolvency events, and protection of collateral. - Rights and interests of participants in derivatives: securities traded and cleared through Safcom form part of the JSE’s list of securities kept in terms of section 12 of the FMA and section 13 of the JSE derivatives Rules; terms contained in contract specifications. - Novation governed by JSE derivatives rules article 8.30.2. - Netting of cash payments protected under Section 5 of the NPS Act: settlement through SAMOS is final and irrevocable. Protection of netting of derivative transactions in participant default covered under Section 35A. - Default management governed by section 12 of the JSE’s derivatives rules. Section 35A of the Insolvency Act binds JSE’s Rules and practices on trustee or liquidator in insolvency. - Rights and interests in collateral: - Both initial margin and default fund are deposited and managed by the JSE on behalf of market participants. - Funds can only be used for the purpose collected (case of a default of a market participant); Safcom and JSE cannot use these funds to cover operational or other losses. - Collateral deposited is only local currency cash and remains property of the market participant until default or close-out. - JSE’s derivatives rules support use of these funds in case of a market participant default; JSE obtained independent legal opinion confirming use in default. ### Governance (Principle 2) - Safcom is a wholly-owned subsidiary of the JSE and must adhere to the Companies Act, 2008 and the King III Code of Corporate Governance. - Governance framework components: - Memorandum of incorporation, Board Charter, Board Committee Terms of Reference, Code of Ethics. - Operational relationship: - Safcom operates as an integrated part of the JSE and within JSE rules. - Safcom has mandated the JSE (formal contract) to perform operating functions and risk management/clearing services via a Clearing and Settlement Services Agreement and supporting service agreements, providing the Safcom Board some control over JSE resources. - Internal governance bodies and composition: - Safcom Board: responsible for overall management, strategic direction, risk management framework, investment decisions, and significant financial matters. Board consists of: - 3 JSE directors - 1 FSB member - 6 clearing member representatives - 1 secretary from the JSE - Chaired by the JSE CEO - Safcom Risk committee: assists Board on governance of risk, setting risk strategy, risk tolerance and appetite, maintaining risk management framework. Committee consists of: - 3 JSE directors (including the JSE CEO) - 6 clearing member representatives - 1 secretary from the JSE - Chaired by one of the clearing member representatives - Reports directly to the Safcom Board - Safcom Advisory committee: comprises a broad range of market participants to enable consultation and advice on major changes. - Additional support via JSE governance structures: JSE Board, JSE Executive committee (Exco), JSE Exco Risk Committee, JSE Audit and Compliance committee, Remuneration committee, JSE’s Post Trade Services Risk committee. - Organizational roles: - JSE Responsible Officer: Head of Post Trade Services charged (per Safcom Board Charter) with monitoring and reporting on services provided by the JSE to Safcom, day-to-day oversight of Safcom operations, and accountability for proper functioning and regulation of the JSE’s market to ensure effective risk management and clearing of transactions novated by the CCP. - JSE Risk Management Team: responsible for identification, measurement, monitoring and reporting of credit, market and liquidity risks applicable to Safcom-cleared transactions; quantification of initial margin and default fund; stress testing sufficiency and liquidity of financial resources; regular back-testing of margin and default fund. - JSE Clearing and Settlement Operations Team: conducts daily operations per JSE Rules and the SLA between Safcom and JSE including ensuring system availability, calculation of initial margin, valuation of prices for end of day (EOD) processing, running EOD processing, reconciliation with clearing members, generating payment instructions, monitoring payments and default management. - JSE corporate arrangements for conflicts: - JSE is a publicly listed company; JSE Board constituted the Self-Regulatory Organization (SRO) board committee in 2011 to address conflicts between public interest and shareholder interests. - Stakeholder advisory committees balance interests of shareholders, users and the public. - Rules specified in Board Charter and Code of Ethics and Conduct; annual review initiated in case of major changes or breaches. ### Risk management framework (Principle 3) - Safcom uses a risk assessment framework based on the COSO Risk Assessment Methodology. - Initial assessment determined actual risks to which Safcom is exposed. - Risk management framework elements: - Policies and procedures reflect JSE and Safcom risk management framework. - Risk Framework policy statement identifies broad risk categories faced by Safcom. - Risk governance framework adopted by Safcom Board sets governance processes for risk management, approach to risk methodologies, risk appetite and risk self-assessments. - Reporting and reviews: - Risks are quarterly reported to the JSE Exco and Safcom Board, including credit and liquidity risks of the CCP. - Results collected at client level and viewed at client, trading member, clearing member and market levels. - Annual review of all policies undertaken to maintain relevance and accuracy; reviews consider changing business practices, service/product offerings, evolving risk profile, best-practice evolution and regulatory developments. - Regular risk reports and depicted risk profiles used as input to policy review. - Noted gaps: - Safcom has no recovery plan as prescribed by the PFMI. - SARB currently does not provide liquidity to any CCP and JSE or Safcom have no account in the SAMOS system. - Section 10 of the Reserve Bank Act allows SARB to provide liquidity against collateral without limiting types of institutions, but secondary legislation limits access to SAMOS to banks. ### Credit risk and default management (Principles 4, 5, 6, 13, 14 and 18) - Safcom has a comprehensive framework to manage credit risk following the default of one or more clearing members. - In the case of a default, losses will be funded as follows (the Safcom risk waterfall): *Source: Appendix VI. Risk Management and Governance of Safcom (excerpt).* ### 1. Initial margin of the defaulting clearing member ### 1. Initial margin of the defaulting clearing member ### Access criteria for clearing members - First line of defense: access and participation requirements set out in the JSE Derivatives Rules. - Clearing members must comply with specific capital requirements. ### Margin - Second line of defense: system of margins to manage daily price risk. - Initial margin is required for each transaction booked. - Daily variation margin is called for on a client account (lowest) level to account for daily gains and losses. - In case of high volatilities or if the JSE deems it otherwise necessary, Safcom may initiate an intra-day margin call. - Margins and risk parameters: - 99.95% confidence level and 1 day holding period for most derivatives. - 99.7% confidence level and 2 day holding period for interest rate derivatives. - Margins are calculated on an instrument level; offsets are allowed on a client level only. - An initial margin review was started last year and will be implemented in 2014. - A conceptual paper has been issued to the market on proposed introduction of Portfolio VAR. - Current clearing system cannot accommodate margin offset; the integrated clearing solution will make this possible. - Risk team investigating alternative means of providing offset prior to the go-live of the new clearing system. ### Default fund - Third line of defense: JSE’s own resources and the Safcom Default Fund. - Total size of the default fund is ZAR 500 million. - Safcom’s contribution to the default fund is currently ZAR 100 million. - Safcom’s contribution amount will be reviewed annually by the Safcom board or more frequently as Safcom’s financial position, market conditions or the nature of the market changes. - Safcom Default Fund is set up to withstand the default of two average sized clearing members and to cover at least the default of the largest clearing member under stressed conditions. - Surviving clearing members can be asked to replenish the fund twice within a 12 month period for other loss events. - Safcom implemented and operationalized its distinct, prefunded default fund in 2013. - During 2014 the risk function will propose an updated contribution methodology and review the calculation of the Safcom Default Fund; this work should be completed in Q3 2014. - The Safcom Default Fund is rebalanced on at least a quarterly basis. ### Stress testing - Stress testing is conducted on a daily basis. - Results compared to the current default fund size to ensure sufficiency to cover the default of the largest clearing member under stressed conditions. - Stress tests include sensitivity testing on individual risk factors, historical stress scenarios and hypothetical stress scenarios. - If fund size deemed insufficient, Safcom can ask clearing members to increase their contribution to the default fund. ### Back testing - Formalized back-testing implemented and conducted on a daily basis. - Back-testing compares number of exceptions to the stated confidence level in the margin methodology. - Portfolio coverage test: - Sums number of exceptions on each day across all clients active in the JSE’s derivative portfolio. - Days aggregated at monthly periods; total number of exceptions in each period compared to total number of test points (each trading day for each active client). - Test done at a client account level due to JSE’s margining structure, and aggregated at trading and Clearing Member levels for information purposes. - Back-testing results have led to various improvements to Safcom’s margining methodology. ### Independent validation - FSB is determining an appropriate frequency for independent validation; a period of once every 2 years is being contemplated. - External consultants validated all risk management models, including margin calculations, stress testing and back testing in December 2012. - Outcome of the validation is shared with and should be endorsed by the supervisors and overseers. ### Collateral - Currently only cash (ZAR) is accepted as collateral. - A project is underway to broaden the range of acceptable collateral. - No haircuts are applied. - Collateral is deposited with local banks according to an investment mandate governing credit quality of banks and required liquidity of funds. - Safcom has started to invest part of its cash collateral into government securities. - Discussions are underway to investigate possibility for a CCP to place funds with the SARB to diversify away from commercial bank credit risk. ### Default management and portability - Safcom and the JSE have initiated default simulations on an annual basis with clearing members, alternating each year between tests for the derivatives and equities markets. - The equities default simulation is planned to take place in Q3 of this year. - Operations team evaluates default management tests to identify areas to streamline the default management process. - Safcom has portability arrangements to transfer accounts and positions between a defaulting and surviving clearing member to reduce client risk. ### Liquidity risk (Principle 7) - JSE developed a liquidity framework for Safcom consisting of: - A liquidity policy specifying ongoing management of Safcom’s liquidity profile. - Dedicated JSE’s derivatives and interest rate and currency derivatives rules for use of liquidity facilities. - Establishment of three committed credit facilities of R500m each, provided by three local commercial banks. - Safcom’s daily liquidity flows: - Clearing members make or receive net variation margin payments to/from Safcom based on client position movements; these flows are processed through Safcom’s settlement bank. - New positions entered or closed require net initial margin to be paid or received by Safcom; initial margin is managed by Safcom and deposited into investment bank accounts to be paid out when a position is closed out or used in case of a default. - Potential liquidity risks: - Operational issues at or the default of a clearing member may cause liquidity shortages at Safcom’s settlement bank. - Operational issues at or default of a settlement bank may expose Safcom and clearing members to loss of account balances and short-term liquidity shortages. - Operational issues at or default of an investment bank may prevent Safcom from accessing its investments. - Liquidity risk management: - Daily monitoring of liquidity flows by JSE finance department; Safcom is aware of settlement status for all instructions sent to paying banks for derivative payments. - SARB sends daily messages on in and outflows of payments; once settlement is completed SAMOS sends messages to payer, beneficiary, and Safcom to confirm settlement. - Quarterly liquidity risk stress testing to identify peak historical and possible future liquidity needs; regime aims to quantify maximum liquidity requirement of the CCP based on maximum liquidity requirement observed historically under each scenario. - Dedicated and committed liquidity lines in place with three local banks to total value of ZAR 1.5 billion accessible in case of liquidity stress. - In determining liquidity need the CCP considers failure of one and two clearing members but has set risk appetite to cover a portion thereof. ### Money settlements and physical deliveries (Principles 9 and 10) - Safcom carries out daily cash movement of initial and variation margin as well as booking fees through central bank money. - Safcom is recognized as a Payment Clearing House (PCH) under the SAMOS rules since October 2012. - Clearing participants without a SAMOS account must access SAMOS via a direct member of SAMOS. - Safcom has no direct account in SAMOS but receives messages from SAMOS via a Swift link confirming settlement of derivative payment instructions. - Safcom facilitates delivery process for commodities, bonds and equity physical deliveries; for commodities Safcom administers invoicing, approves silo facilities, and vets silo operators. ### Investment and custody risks (Principle 16) - Safcom’s investment policy is captured in the Safcom Investment Guidelines; primary aim is to maximize investment income while minimizing investment risks. - All funds managed by Safcom are administered and managed by Safcom. - Current investments: - All funds invested in a variety of accounts spread across a number of banks with a minimum of a “F1+” or “F1”. - Terms between call and 90 days with an average not exceeding 40 days. - Safcom relies on independent ratings by Fitch Ratings and has no internal credit rating procedure. - Safcom investment guidelines are publicly available. ### Operational risk (Principle 17) - Safcom has fully outsourced its operations system to the JSE; the JSE operates IT systems and applications with no Safcom resources involved. - An SLA is in place between the JSE and Safcom; compliance is monitored daily and the Safcom Risk Committee receives quarterly compliance reports. - JSE provides service delivery reporting for systems supporting Safcom operations, covering system availability, incidents and service levels. - No key system has failed in the last year. - Operational risk framework at the JSE covers Safcom operations and serves as the basis for JSE’s internal operational risk management activities. - Physical vulnerabilities managed per JSE Physical security policy; information security managed per JSE IT and User security policies. Most JSE policies are reviewed annually. - Capacity of systems managed and tracked and incorporated into service delivery reporting. - Annual internal and external audits include general IT controls. - JSE IT disaster recovery plan, JSE business continuity management policy, and crisis communication manual in place; same document used to manage a clearing member’s default. - Full tests of business continuity management arrangements are carried out at least annually and include market participants of the JSE and Safcom. - JSE has a backup site and second processing center at a distance of approximately 7.4 kilometers; no third center, but offsite backup tapes and data replication between sites as well as backup copies on disk are maintained. - Asynchronous data replication may result in data loss of up to 5 minutes. - Recovery time objective for the JSE, including Safcom, is 48 hours. - Disaster recovery tests simulating failure of all JSE systems showed systems can be restored within 8 hours. *IMF staff report excerpt.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1552.pdf_