BY Kelle Gagné
Margin requirements for OTC derivatives – the final draft of the Joint Standard?
On 8 April 2019, the South African Financial Sector Conduct Authority and Prudential Authority (collectively, the “Authorities”) published yet another draft of the Joint Standard on Margin Requirements for Non-Centrally Cleared OTC Derivatives (the “Margin Requirements”). The last draft had been published in August 2018.
Implementation of the Margin Requirements has been delayed numerous times. Two of the final hurdles to the Margin Requirements’ finalisation have been the need to amend the Insolvency Act, 1936 in relation to a secured creditor’s ability to realise pledged collateral on the insolvency of a derivatives counterparty and the need for OTC derivatives providers (“ODPs”) (who are the subject of the Margin Requirements) to be authorised.
After much behind-the-scenes work by the Finance Committee, a B version of the Financial Markets Amendment Bill, 2018 (containing the required Insolvency Act amendment) was passed by the National Council of Provinces on 28 March 2019 and looks set to be signed by President Ramaphosa. The latest extended deadline to apply for authorisation as an ODP is 14 June 2019. It does not appear that any ODP authorisations will be granted prior to that date. It is not, therefore, a surprise that the new draft of the Margin Requirements was published now, setting the stage for implementation of the regulation of ODPs later this year.
Despite having published numerous drafts of the Margin Requirements over the last couple of years, the Authorities have made noteworthy changes in this new draft.
A significant concept in the Margin Requirements has been the list of “covered entities”, ie, those entities with whom OTC derivative transactions concluded by ODPs fall into the Margin Requirements. In this draft, the Authorities have changed the terminology from “covered entities” to “counterparties”. The new draft Margin Requirements clarify that a collective investment scheme is a counterparty (the previous version listed the manager of a collective investment scheme as a covered entity, creating uncertainty as to whether the collective investment scheme itself was a covered entity and/or whether a manager acting in another capacity was a covered entity). As per the previous draft of the Margin Requirements, corporates and pension funds remain outside the scope of counterparties. It has also been clarified that the Margin Requirements apply to OTC derivative transactions concluded between two ODPs and between an ODP and a counterparty.
Market participants will be pleased to note that, in line with international norms, physically settled FX forwards and swaps will now be exempt from both initial and variation margin (rather than only initial margin) and the catch-all provision that previously required two counterparties, with an end-of-day gross notional exposure between them in excess of ZAR3-billion, to exchange margin, has been removed.
Market participants will also be relieved to see that ODPs will no longer be required to provide transaction and jurisdictional details to the Authorities each time they conclude OTC derivative transactions with offshore ODPs or counterparties. Instead, ODPs must satisfy themselves that they have documentary evidence showing that the foreign counterparty is in a jurisdiction with BCBS-IOSCO type margin requirements, the foreign counterparty is subject to such margin requirements and the transaction with the ODP is subject to such margin requirements in the foreign jurisdiction. ODPs may be required to produce such evidence if requested, but need not provide it automatically in respect of each cross-border transaction. Furthermore, the Authorities’ approval to enter into transactions with a foreign counterparty in a non-netting jurisdiction will only be required if the ODP’s gross notional amount of transactions with such foreign counterparty exceed 2.5% of the ODP’s total derivatives portfolio.
Finally, corporate groups will be relieved to see that the Margin Requirements do not apply to intra-group OTC derivative transactions except where:
- one of the parties is an ODP; and
- the aggregate outstanding gross notional amount of non-centrally cleared OTC derivative transactions between the ODP and the counterparty equals or exceeds ZAR50-billion.
In previous drafts, the Margin Requirements could have applied to intra-group transactions between two covered entities, and the threshold had been set at a lower ZAR30-billion level.
The first phase-in group for the Margin Requirements (ODPs and counterparties with a group aggregate month-end average gross notional amount of OTC derivatives exceeding ZAR30-trillion) are now set to begin exchanging initial margin from 1 September 2019. The phase-in thresholds for initial margin and variation margin are consistent with the previous version of the Margin Requirements, while ODPs contracting with counterparties below the ZAR30-trillion gross notional level will now have six additional months before they are required to begin exchanging variation margin in March 2020.