New margin requirements for non-centrally cleared OTC derivative transactions
A final draft of the South African margin requirements for non-centrally cleared over the-counter derivative transactions seeks to bring South African margin requirements in line with global standards determined by the Basel Committee on Banking Supervision and International Organisation of Securities Commissions (BCBS-IOSCO). To the extent that international counterparties already comply with the global margin requirements, the final draft of the South African margin requirements for non-centrally cleared over-the-counter derivative transactions should not significantly impact their exchange of margin for such transactions.
On 8 August 2017, the Financial Services Board (FSB) published for public comment the final draft of the margin notice for non centrally cleared over the counter (OTC) derivatives in response to the public consultation processes that have been undertaken to date (the Margin Notice). The Margin Notice will apply to prudentially and non-prudentially regulated market participants in South Africa.
Scope of Margin Notice
As currently drafted, the Margin Notice applies to:
covered entities consisting of:
- ODPs which are entities which as a regular feature of their business originate, sell or make markets in OTC derivatives (excluding foreign exchange spot contracts and physically settled commodity derivatives); and
- counterparties which are defined to include other ODPs, South African banks and branches of foreign banks, South African insurers, South African fund managers and South African brokers;
OTC derivatives (however foreign exchange spot contracts and physically settled commodity derivatives will be excluded from the initial margin requirements);
intra-group OTC derivative transactions where the aggregate value of such transactions exceeds R1 billion; and
cross-border transactions (see below).
Cross border OTC derivative transactions
The draft Margin Notice allows for cross-border OTC derivative transactions between a local covered entity and a counterparty in a foreign jurisdiction. A local covered entity could be deemed to comply with the margin requirements that are applicable to the counterparty in a foreign jurisdiction, provided the covered entity has obtained permission from the regulator (and has complied with certain further requirements provided in the Margin Notice). It is unclear whether it is merely the enabling ISDA Master Agreement which must be approved or whether each transaction under the ISDA Master Agreement must be approved.
It is important to note that the proposed equivalence regime in the Margin Notice does not appear to cover South African branches of foreign banks. This means that currently a foreign branch would need to comply with their domestic regulations as well as the Margin Notice.
Initial and variation margin thresholds
The margin thresholds proposed are as follows:
covered entities must exchange initial margin (IM) on a bilateral basis, subject to an initial margin threshold not exceeding R 500 million;
full variation margin (VM) amount must be exchanged on a regular basis;
the transfer of margin is also subject to a de-minimis minimum transfer amount not exceeding R 5 million.
Phase-in of initial and variation margin
Covered entities whose aggregate gross notional outstanding amount for the months of July, August and September 2017 exceeds R 30 trillion must from 1 January 2018 to December 2018 exchange IM on derivative transactions. The thresholds will be reduced per year until January 2022.
Thereafter, there is a four year phase-in period whereby covered entities are required to exchange IM if the aggregate month-end average gross notional amount (AANA) of the OTC derivatives for the period July, August and September 2017 exceeds:
for the period 1 January 2018 to 31 December 2018: R 30 trillion;
for the period 1 January 2019 to 31 December 2019: R 23 trillion;
for the period 1 January 2020 to 31 December 2020: R 15 trillion;
for the period 1 January 2021 to 31 December 2021: R 8 trillion; and
for the period 1 January 2022 onwards: R 100 billion.
An ODP and a covered entity must on a daily and bilateral basis exchange the appropriate amount of VM from 1 January 2018, if the AANA of the OTC derivatives for the period July, August and September 2017 exceeds the threshold amount of R 30 trillion. From 1 July 2018, exchange of VM will be applicable on all non centrally cleared derivative transactions entered into after 1 January 2018.
The proposed timing for implementation of these IM and VM requirements (being 1 January 2018) does not provide sufficient lead time for market participants to develop and build the required infrastructure, legal arrangements and operational processes.
The proposed phase-in of IM does not align with the global framework and the phase-in schedule already established in all other major global jurisdictions, which rolls on September 1 of each year. The problem is that should the Margin Notice retain this misaligned IM schedule, covered entities which trade globally would need to manage two new IM phase-in cycles each year instead of one.
Finally, the calculation period to determine AANA of July, August and September also misaligns with the calculation period in the global framework and existing global margin regulations (ie March, April and May of each year). As a result, covered entities that trade with foreign entities will need to conduct two AANA calculation periods each year and obtain separate representations from their domestic and global counterparties on different time scales.
It is clear there are a number of uncertainties and misalignments between the Margin Notice and global margining standards. It is therefore likely that the FSB will require time to consider the comments received from market participants and prepare a revised final Margin Notice.
This case summary is part of the Allen & Overy Legal & Regulatory Risk Note, a quarterly publication. For more information please contact Karen Birch – firstname.lastname@example.org, or tel +44 20 3088 3710.