Joint Standard on Margin Requirements for Non-Centrally Cleared OTC Derivative Transactions

# JOINT STANDARD 2 OF 2020

## FINANCIAL SECTOR REGULATION ACT, 2017

### MARGIN REQUIREMENTS FOR NON-CENTRALLY CLEARED OVER THE COUNTER DERIVATIVE TRANSACTIONS

The Financial Sector Conduct Authority and the Prudential Authority, acting with the concurrence of the Reserve Bank, hereby, under section 107, read with sections 106(1)(a), 106(2)(a) and (e) and 109(2), of the Financial Sector Regulation Act, 2017 (Act No. 9 of 2017), publish the margin requirements for non-centrally cleared over the counter derivative transactions as set out in the Joint Standard.

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**FINANCIAL SECTOR CONDUCT AUTHORITY**  
**PRUDENTIAL AUTHORITY**

Date of publication: 2 June 2020

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## SCHEDULE

### Financial Sector Regulation Act, 2017  
### Joint Standard 2 of 2020  
### Margin requirements for non-centrally cleared over the counter derivative transactions

### 1. Definitions

In this Joint Standard, “**the Act**” means the Financial Sector Regulation Act, 2017 (Act No. 9 of 2017), and any word or expression to which a meaning has been assigned in the Act bears the meaning so assigned to it, and unless the context indicates otherwise—

“**authorised user**” means an authorised user as defined in the Financial Markets Act;

“**Authorities**” means the Financial Sector Conduct Authority and the Prudential Authority;

“**central counterparty**” means a licensed central counterparty as defined in the Financial Markets Act;

“**clearing house**” means a licensed clearing house as defined in the Financial Markets Act;

“**clearing member**” means a clearing member as defined in the Financial Markets Act;

“**counterparty**” means the following:

(a) an authorised user;

(b) a bank, bank controlling company or branch as defined in terms of the Banks Act;

(c) a financial services provider authorised to provide financial services in derivative instruments¹ as contemplated in the Financial Advisory and Intermediary Services Act;

(d) an insurer licensed or deemed to be licensed to conduct life insurance business in terms of the Insurance Act;

(e) an insurer licensed or deemed to be licensed to conduct non-life insurance business in terms of the Insurance Act;

(f) an investment fund;

(g) a provider;

(h) any other person declared by the Financial Sector Conduct Authority, with the concurrence of the Prudential Authority, to be a counterparty;

“**FMA Regulations**” means the Financial Markets Act Regulations as published in

¹ The FAIS Act definition of financial products includes 'securities as defined in the FMA', which definition includes derivative instruments.

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Government Gazette No. 41433 on 9 February 2018;

“**foreign counterparty**” means a person outside the Republic of South Africa who—

(a) is authorised by a supervisory authority to perform a service or services similar to one or more of the services referred to in the definition of a provider or the services performed by an authorised user; or

(b) is registered, licensed, recognised, approved or otherwise authorised to conduct the business of a bank or of an institution referred to in paragraphs (d), (e) or (f) of the definition of “counterparty” by a supervisory authority with functions similar to those of the Financial Sector Conduct Authority or the Prudential Authority referred to in the legislation listed in paragraph (b), (d) or (e) of the definition of “counterparty” or the Collective Investment Schemes Control Act, 2002 (Act No. 45 of 2002);

“**group**” means a group of companies as defined in the Companies Act;

“**Insurance Act**” means the Insurance Act, 2017 (Act No. 18 of 2017);

“**Investment fund**” includes a portfolio of a collective investment scheme administered by a manager registered in terms of the Collective Investment Schemes Control Act, 2002 (Act No. 45 of 2002) and a private equity fund;

“**netting set**” means a group of derivative transactions between a provider and a counterparty or foreign counterparty that are subject to a single legally enforceable bilateral netting agreement;

“**OTC derivative**” means an OTC derivative as defined in the FMA Regulations;

“**private equity fund**” means a managed pool of capital that—

(a) has as its principal business the making of equity, equity orientated or equity related investments primarily in unlisted companies or ventures to earn income or capital gains;

(b) is managed or advised by a member of the South African Venture Capital and Private Equity Association or other equivalent private equity and venture capital industry body; and

(c) is not open or offered to the public as an investment;

“**provider**” means an authorised OTC derivative provider as defined in the FMA Regulations; and

“**sovereign**” means the central government, and includes the central government in the Republic of South Africa as constituted by the national sphere of government, excluding any national public entity or national government business enterprise as defined in the Public Finance Management Act, 1999 (Act No. 1 of 1999).

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### 2. Application and exclusions

#### 2.1 General application

(1) The Joint Standard applies to a provider entering into non-centrally cleared OTC derivative transactions with a counterparty or a foreign counterparty.

(2) The Joint Standard does not apply to:

(a) sovereigns;

(b) central banks;

(c) multilateral development banks;

(d) the Bank for International Settlements;

(e) transactions such as repurchase agreements and security lending transactions that are not derivatives but share some attributes with derivative instruments; and

(f) indirectly cleared OTC derivative transactions that are intermediated through a clearing member on behalf of a non-member client, if—

(i) the non-member client is subject to the margin requirements of the relevant clearing house; or

(ii) the non-member client provides margin, consistent with the margin requirements of the relevant corresponding clearing house.

(3) The margin requirements set out in this Joint Standard apply to all non-centrally cleared OTC derivative transactions, including intra-group and cross-border transactions as contemplated in paragraph 2.2 and 2.3 respectively, after the thresholds set out in paragraphs 4.2 or 5(3) are met.

(4) Physically settled foreign exchange forward contracts and foreign exchange swaps are excluded from the initial and variation margin requirements.

(5) In the case of cross-currency swaps, the initial margin requirements do not apply to any fixed physically settled foreign exchange transaction associated with the exchange of principal, that is, for a cross-currency swap, any payment associated with the exchange of principal in respect of a fixed physically settled foreign exchange transaction, which has the same characteristics as a foreign exchange forward contract, is excluded from the requirements for initial margin, provided that—

(a) the provider must ensure that all other risks that affect the cross-currency swap transaction are duly considered in the calculation of the initial margin amount, that is, all payments or cash flows, including interest, that occur during the life of the swap, other than a payment associated with the exchange of principal in respect of a fixed physically settled foreign exchange transaction, shall be subject to the relevant specified requirements for initial margin; and

(b) the variation margin requirements set out in this Joint Standard apply to all relevant components of a cross-currency swap transaction.

#### 2.2 Treatment of intra-group transactions

(1) Subject to subparagraph (2) and (3), the margin requirements set out in this Joint Standard do not apply to non-centrally cleared OTC derivative transactions entered into between a provider and a counterparty or foreign counterparty in the same group.

(2) Non-centrally cleared OTC derivative transactions between a provider and a counterparty or foreign counterparty in the same group are not subject to any margin requirements as set out in this Joint Standard, provided that—

(a) the aggregate outstanding gross notional amount of the non-centrally cleared OTC derivative transactions between the provider and the counterparty or foreign counterparty in the group is below R100 billion at the close of business on each relevant day, or such alternative threshold as may be determined by the Authorities from time to time;

(b) both parties to the transaction are subject to appropriate centralised risk evaluation, measurement and control procedures;

(c) the risk management procedures of both parties to the transactions are adequately sound, robust and consistent with the level of complexity of the respective derivative transactions between them; and

(d) the parties to the transactions comply with any further conditions as may be specified in writing by the Authorities.

(3) Despite sub-paragraph (2), the Authorities may require a provider to exchange variation margin or post or collect initial margin with a counterparty or foreign counterparty in the same group, when deemed appropriate by the Authorities.

#### 2.3 Cross-border transactions

(1) When a provider enters into a non-centrally cleared OTC derivative transaction with a foreign counterparty, the provider is deemed to comply with the Joint Standard provided that the provider has the necessary documentary evidence in place to satisfy itself that—

(a) the relevant foreign jurisdiction has implemented margin requirements based on the Basel Committee on Banking Supervision and the International Organisation of Securities Commissions (BCBS-IOSCO) Margin Requirements for Non-Centrally Cleared Derivatives Framework;

(b) the foreign counterparty is directly subject to the margin requirements of the foreign jurisdiction; and

(c) the provider is required to comply with, or is subject to, the margin requirements in the foreign jurisdiction.

(2) The Authorities may require the provider to furnish the Authorities with the documentary evidence, or such further information as the Authorities may deem necessary.

(3) (a) A provider that enters into an OTC derivative transaction with a foreign counterparty in a foreign jurisdiction of which the relevant legal framework does not permit or recognise the enforceability of a netting agreement upon the insolvency of the counterparty or the enforceability of a collateral agreement upon the default of the counterparty (“non-netting jurisdictions”), is not required to post or collect initial margin or exchange variation margin in respect of such transaction if—

(i) the aggregate outstanding gross notional amount of transactions between the provider and the foreign counterparty do not exceed 2.5% of the total portfolio of derivatives contracts of the provider on a consolidated basis; and

(ii) a legal opinion confirms that the netting agreement or the exchange of collateral is not legally enforceable at all times.

(b) If the aggregate outstanding gross notional amount of transactions between the provider and the foreign counterparty is above the threshold set out in sub-paragraph(3)(a)(i), the provider must obtain the prior written approval of the Financial Sector Conduct Authority, acting with the concurrence of the Prudential Authority, to proceed with any further transactions, provided that the provider has submitted a legal opinion to the Authorities confirming that the netting agreement or the collateral agreement between the provider and the foreign counterparty may not be enforceable in the foreign jurisdiction and any other information as may be requested by the Authorities.

(c) The legal opinion referred to in sub-paragraph (3) must be in written form and must be obtained from an external legal counsel, but may include jurisdictional opinions obtained on an industry-wide basis by recognised industry associations from external independent legal counsel.

(d) The Financial Sector Conduct Authority, with the concurrence of the Prudential Authority, may grant approval to the provider to proceed with further transactions between the provider and the foreign counterparty, subject to such conditions as may be further specified in writing by the Financial Sector Conduct Authority, including a requirement to post or collect initial margin or exchange variation margin.

(e) In all cases as outlined in subparagraphs (a) and (b) above, the provider must put in place appropriate internal limits and risk management policies and procedures commensurate to its risk appetite to monitor and control the risks of relevant exposures arising from transactions in non-netting jurisdictions.

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### 3. General requirements

(1) Subject to paragraph 2, in order to mitigate the potential systemic risk that may arise from, and to promote effective and sound risk management in respect of, a provider’s transactions in non-centrally cleared OTC derivative transactions, a provider must—

(a) based on the relevant amount of counterparty credit risk exposure arising from its non-centrally cleared OTC derivative transactions, calculate and exchange—

(i) initial margin in accordance with the relevant requirements specified in paragraph 4; and

(ii) variation margin in accordance with the relevant requirements specified in paragraph 5;

(b) have in place sufficiently robust processes, procedures and board-approved policies in respect of the provider’s non-centrally cleared OTC derivative transactions, to ensure, among other things, that—

(i) all relevant transactions between the provider and counterparty are subject to and comply with all the relevant requirements specified in the legal and regulatory frameworks of each relevant jurisdiction;

(ii) subject to sub-paragraph 2.3(3), all relevant netting agreements are effective under the laws of the relevant jurisdictions, and supported by periodically updated legal opinions;

(iii) subject to sub-paragraph 2.3(3), all relevant collateral arrangements in place are effective under the relevant laws and are supported by periodically updated legal opinions;

(iv) the provider that engages in OTC derivative transactions, exchange initial and variation margin on a bilateral basis or to a third party custodian, where applicable, as envisaged in and in accordance with the relevant requirements specified in this Joint Standard;

(v) procyclicality impacts are appropriately mitigated, that is—

(aa) large discrete calls for additional initial margin due to “cliff-edge” triggers, for example, are discouraged; and

(bb) margin levels are sufficiently conservative, even during periods of low market volatility;

(vi) initial margin is provided and collected by no later than the business day following the execution of a non-centrally cleared OTC derivative transaction, and thereafter collected on a routine and consistent basis upon changes in the measured potential future exposure;

(vii) the build-up of any additional initial margin is gradual, and managed over time;

(viii) in case of variation margin—

(aa) the full amount necessary to fully collateralise the relevant mark-to-market exposure of the OTC derivative transaction is exchanged;

(bb) the relevant amount of variation margin for OTC derivative transactions, subject to a single, legally enforceable netting agreement, is calculated and exchanged on a daily basis;

(ix) the provider complies with the relevant requirements specified in paragraph 6, which relates to eligible collateral.

(2) A provider must have in place rigorous and robust dispute resolution procedures with its relevant counterparties involved in non-centrally cleared OTC derivative transactions, before the onset of any relevant transaction, provided that, as a minimum—

(a) in order to reduce the risk of any potential dispute, the provider must ensure, for example, that the specific method and parameters that will be used to calculate initial margin are agreed and recorded at the onset of all relevant transactions;

(b) whenever a margin dispute or dispute over the value of eligible collateral arises, the provider must make all necessary, reasonable and appropriate efforts, including the timely initiation of dispute resolution protocols, to resolve the dispute and exchange the relevant required amount of initial or variation margin in a timely manner.

(3) All margin transfers as contemplated in this Joint Standard may be subject to a minimum transfer amount of which the aggregate or sum of initial margin and variation margin does not exceed R5 million.

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### 4. Initial margin

#### 4.1 General

(1) Initial margin aims to protect the provider and the counterparty from the potential future exposure that may arise from future changes in the mark-to-market value of the derivative contract during the time it takes to close out and replace the position in the event that one or more of the counterparties to the contract default.

(2) The amount of initial margin reflects the size of the potential future exposure and depends on a variety of factors, including how often the contract is revalued and variation margin exchanged, the volatility of the underlying instrument, and the expected duration of the contract closeout and replacement period, and may change over time, particularly where it is calculated on a portfolio basis and transactions are added to, or removed from, the portfolio on a continuous basis.