Over-the-counter derivatives play an essential role in balancing out the financial markets, especially for institutions that use the products to hedge their individual risk exposure. But the financial crisis proved dodgy derivative deals can turn the product into a weapon of mass destruction.

To contain the possibility of it ever happening again, regulations were made to have standardised over-the-counter (OTC) derivatives centrally cleared and mandated margins implemented. Before this, such bilateral exchanges were largely unregulated.

These reforms have been enacted through legislative frameworks including the US’s Dodd-Frank Act, the European Market Infrastructure Regulation (EMIR) and the Financial Markets Act in South Africa.

Domestic participants in the over-the-counter market are mainly corporates and banking institutions, which predominantly transact cross-border, and experts say SA laws are consistent with international best practice.

But that is not necessarily the case everywhere else. International watchdogs such as the Financial Stability Board have raised concerns of rules not being implemented consistently in all countries, which could create a fragmented global derivatives market.

In 2019, the Institute of International Finance put the blame in part on “excessive regulatory and supervisory divergence” that trapped liquidity and capital in local markets. Rules for the new margins also vary.

In July, the Basel Committee on Banking Supervision and the International Organisation of Securities Commissions (Iosco) postponed margin requirements, to give authorities more time to finalise the rules.

Meanwhile, South Africa’s main challenge has been the lack of market infrastructure to provide central clearing services.

Alicia Greenwood, JSE director and head of its Post-Trade Services Division, confirms there is no licensed central clearing party (CCP) in SA for over-the-counter derivatives and that the JSE Clear is only licensed to settle listed derivatives. She says the over-the-counter central clearing party has to be an independent clearinghouse, not associated with an exchange’s licence. It has to be an independent licence. 

Bridget King, director in the financial and banking practice of the law firm Cliffe Dekker Hofmeyr says regulators have now also granted an indulgence until 31 December 2021, for the market to use an associated clearing house (like the one the JSE runs for exchange-traded derivatives) if approved by all regulators to perform the role of CCP.

She says by then, it will also be apparent which trades will be prescribed by the regulators as subject to mandatory clearing through a CCP, and which can be elected to follow suit or continue to trade as over-the-counter, and rather be subject to the new (now postponed) margin rules, which is also the more expensive choice.

Meanwhile, the application process for over-the-counter derivatives providers in South Africa to become authorised over-the-counter derivatives providers (ODPs) with the Financial Services Conduct Authority (FSCA) has commenced. The registration process is still ongoing.

The ODPs that submitted their applications to the FSCA by the 14 June deadline may continue to trade derivatives pending receipt of their licence, says Jurgen Boyd, the divisional executive for market integrity supervision at the FSCA.

“However, no new entrants to the market may commence trading OTC derivatives until they are also fully licensed as ODPs,” he adds.

The FSCA has begun assessing the applications submitted on a first-come-first-serve basis, he says and confirms that 49 applications were received by the June deadline. Boyd says each application may take up to 90 business days to assess. BM