How do the new laws affect South Africa?
Both in South Africa and in other G20 member states, new regulations have been promulgated to ensure that the OTC derivatives markets are safer and more efficient. One of the new laws requires that any OTC derivatives transactions which are not cleared through a central counter-party, must be subject to additional mandatory margin requirements. In South Africa the laws have been implemented through the Financial Markets Act, 2012 (FMA) and the associated Conduct Standards and Joint Standards for:
1. registration and Code of Conduct for OTC derivatives providers;
2. trade Reporting requirements for OTC derivatives transactions; and
3. draft Margin Requirements for non-centrally cleared OTC derivatives transactions.
What was the problem with our old laws?
South Africa’s Insolvency Act was drafted in the 1930s, at a time when the size and extent of global markets trading in financial instruments was not foreseeable. It was significantly outdated. A secured creditor who held collateral for its claims was, upon the Insolvency of its counterparty, obliged to sell the collateral and then to pay the proceeds from the sale of that collateral over to the liquidator. After a lengthy period of time, the secured creditor would then prove its claim and wait for repayment by the liquidator (following deduction of liquidator’s costs etc). In the context of the global derivatives market, by preventing a secured creditor from accessing the proceeds of the collateral it was holding, that secured creditor is placed at risk of becoming financially distressed or insolvent itself, thus causing a domino effect of failing institutions.
What do the new laws provide
The Prudential Authority and Financial Sector Conduct Authority jointly issued a draft Joint Standard under the auspices of the FMA which requires (among others) that:
- certain covered entities (essentially the large banks and regulated financial institutions) must pledge initial margin as collateral for their obligations arising under an uncleared OTC transaction; and
- that initial margin must be “immediately available” to the secured party in the event that its counterparty goes insolvent.
Whilst the Joint Standard is still in draft form, indications from the Prudential Authority are that it will be finally promulgated by 1 September 2019. More importantly, certain of South Africa’s banks will come into scope for the initial margin requirements prescribed by foreign laws (like Dodd-Frank in the USA) on 1 September 2019.
Thus the introduction of the Bill could not have come at a better time. The Bill seeks to amend the Insolvency Act to specifically provide for a secured creditor under a “master agreement” (including an ISDA master agreement used to document the trade of OTC derivatives) to immediately realize the pledged asset it was holding as collateral, and to retain the proceeds and apply those proceeds to the debt owed to it under the master agreement.
Are we at the end of the road yet?
We are by no means at the end of the road yet. The current draft of the Bill must still go to the National Council of Provinces next week, and then to the president for signature.
Why is this important for the market?
Aligning our laws with those of the G20 will allow South African banks and financial institutions to keep trading derivatives with G20 banks, and more importantly to enable all parties to accept and pledge initial margin as required by the new laws. This enhances the stability of the derivatives market and the banking system as a whole.