Almost exactly five years after the Financial Services Board released the first draft board notice on margin requirements for derivatives, the (very) long awaited final “Margin Requirements for non-Centrally Cleared Over the Counter Derivative Transactions” (“OTC Margin Rules”) have been published. The Financial Sector Conduct Authority (“FSCA”) and the Prudential Authority of the South African Reserve Bank (“PA”) published Joint Standard 2 of 2020 on 2 June 2020.
As part of South Africa’s G20 commitments to regulate derivatives, the government has used the Basel Committee on Banking Supervision (“BCBS”) and the International Organisation of Securities Commissions (“IOSCO”) revised framework on margin as an international reference point in formulating the various drafts of the margin requirements. The OTC Margin Rules will require OTC derivative providers to exchange initial margin (“IM”) and variation margin (“VM”) with “counterparties” (defined in the OTC Margin Rules to include, among others, investment funds, brokers, banks, insurers, other providers, etc.) on their non-centrally cleared OTC derivative transactions (“OTCs”).
The key piece of information the industry has been waiting for, the start date for the phasing in of the requirements to post IM and VM, was omitted in the OTC Margin Rules. Instead, in the joint communication accompanying the OTC Margin Rules, the FSCA and PA indicates that they are engaging with stakeholders regarding the commencement date of the OTC Margin Rules. This is in line with the FSCA and PA communication on 29 April 2020, where the FSCA and PA advised the industry in Joint Communication 3 of 2020 that, although they had planned the first phase of margin requirements to become effective from October 2020, the date was being revised in consultation with stakeholders and they expected the phasing in of the requirements to begin in the first quarter of 2021. Notably, it is not clear that any OTC derivative provider authorisations have yet been granted. As a result, the OTC Margin Rules could not, in any case, bind any “providers”.
As seemed to be expected among market participants, the OTC Margin Rules do not differ significantly from the last draft that was published in April of 2019. There are a few definitions that have been clarified. For example, “netting set” no longer refers to a group of transactions between “covered entities”, which was an undefined term.
Corporate groups that pool risk in a single entity will be pleased to see the intragroup transaction threshold has been raised from ZAR50-billion to ZAR100-billion in gross notional exposure. This means that intragroup non-centrally cleared OTCs need not be margined (initial or variation) if the gross notional amount of OTCs between an OTC derivative provider and a group counterparty is less than ZAR100-billion. Many of the key provisions have not changed – the ZAR30, ZAR23, ZAR15 and ZAR8-trillion month-end aggregate of gross notional derivative contract thresholds have not changed for the phasing in of the margin requirements, and each group will be phased-in a year after the previous group begins posting IM and VM. FX forwards and swaps remain outside of the scope of the OTC Margin Rules, and eligible collateral and associated haircuts have not changed.
Unfortunately, the OTC Margin Rules have not given clarity regarding how all of the requirements regarding the holding of IM can be achieved. IM may be reused once by the IM collector to a third party, who may not reuse the IM. Even when IM is reused (rehypothecated), legally enforceable protection must be given to the IM provider from the risk of loss of the IM and the IM must be immediately available to the IM collector. Under current South African law, however, if the IM collector re-pledges the IM to a third party, the IM collector loses its own security interest in the IM and the IM will not be immediately available to the IM collector. The comment matrix published together with the OTC Margin rules did not provide any clarity on this point.
We are one half of a step closer to the phasing in of IM and VM in South Africa. Providers that may fall into the first phase will have to start preparing to implement or repaper its credit support documents in order to be ready for a potential first deadline occurring in the first quarter of 2021.
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