Notice No. 01/GBM/2021, of 4 February - Regulation of Over-the-Counter Financial Derivatives Not Cleared by a Central Counterparty

Banco de Moçambique Governor

NOTICE No. 01/GBM/2021 Maputo, 4 February 2021

SUBJECT: REGULATION OF OVER-THE-COUNTER FINANCIAL DERIVATIVES NOT CLEARED BY A CENTRAL COUNTERPARTY

The growth of the national financial system presents new challenges to interbank markets, which in turn demand greater system dynamism, as well as the need to ensure that the availability of over-the-counter financial products serves as alternatives for risk hedging and liquidity management.

Indeed, there is a need to adopt best practices in interbank markets, with the objective of ensuring the efficiency, integrity, and security of over-the-counter financial derivative transactions, as well as improving and increasing transparency, conduct, and solidity of this market through the reduction of systemic risk and market protection.

Under these terms, the Bank of Mozambique, using the competence conferred upon it by Article 5 of Decree No. 49/2017, of 11 September, determines:

1. The Regulation of Over-the-Counter Financial Derivatives Not Cleared by a Central Counterparty is approved, which constitutes the annex to this Notice and forms an integral part thereof.
2. The sub-paragraph a) of paragraph 1 of Article 3 and paragraph 2 of Article 3 of Notice No. 5/GBM/2019, of 4 April, are hereby repealed.
3. Violation of the provisions set forth in the Regulation of Over-the-Counter Financial Derivatives Not Cleared by a Central Counterparty is punishable in accordance with Law No. 11/2009, of 11 March, the Bills and Promissory Notes Act.
4. This Notice shall enter into force thirty days after the date of its publication.
5. Any doubts arising in the interpretation and application of this Notice must be submitted to the Markets and Reserves Management Department of the Bank of Mozambique.

(Signature) Rogério Lucas Zandamela Governor

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Banco de Moçambique Governor

REGULATION OF OVER-THE-COUNTER FINANCIAL DERIVATIVES NOT CLEARED BY A CENTRAL COUNTERPARTY

CHAPTER I GENERAL PROVISIONS

Article 1 Subject Matter

1. This Regulation establishes the rules and conditions to be observed in transactions of over-the-counter financial derivatives not cleared by a Central Counterparty for the purposes of risk hedging and treasury management, directly arising from the business activities of eligible counterparties.

2. For the purposes of this Regulation, over-the-counter financial derivatives not cleared by a Central Counterparty are hereinafter referred to as OTC derivatives.

Article 2 Scope

This Regulation applies to all financial counterparties that trade OTC derivatives: a) With each other; b) With non-financial counterparties; c) With international financial counterparties; and d) With international non-financial counterparties.

Article 3 Definitions

For the purposes of this Regulation, the following shall be understood as:

a) Risk Hedging - protection against potential market risks arising from movements in exchange rates, interest rates, and other variables; b) Confirmation - verification and validation of the terms of OTC derivative contracts;

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c) Central Counterparty (CCP) - a legal entity that interposes itself between counterparties in contracts traded on one or more financial markets, acting as buyer to all sellers and as seller to all buyers; d) Eligible Counterparties - financial and non-financial counterparties that may be national or international; e) Financial Counterparties - credit institutions participating in national interbank markets; f) International Financial Counterparties - banking institutions that have one of the following characteristics: (i) are affiliated with local financial counterparties; (ii) have a minimum rating of A-/A3 from major credit rating agencies; (iii) finance public investment projects; and (iv) are multilateral financial institutions. g) Non-Financial Counterparties - entities established in Mozambique, holding accounts at a financial counterparty, that are not CCPs and that conduct OTC derivative transactions for the purpose of risk hedging and treasury management directly arising from their business activities; h) International Non-Financial Counterparties - non-resident entities, holding accounts at a financial counterparty, that conduct OTC derivative transactions for the purpose of risk hedging and treasury management directly arising from their business activities; i) Cross-Currency Swap - a contract involving an exchange of corresponding amounts of two currencies and their respective interest, negotiated bilaterally; j) Value Date - the date from which the value of an OTC derivative transaction becomes effective; k) Credit Derivative - a financial instrument (product) that has a credit or a credit-representative security as its underlying asset; l) Financial Derivative - a financial instrument (product) that cumulatively possesses the following characteristics: (i) Its market value is derived from a specific underlying asset and varies as a result of changes in said underlying; (ii) Its initial net investment is zero or less than that required by the contract; and (iii) Its settlement is carried out at a future date. m) OTC Derivative - a financial derivative traded over-the-counter, not cleared by a CCP, non-standardized, traded off-exchange and directly between the parties, at a specific price for a specific future date;

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n) Fundamental Information Document - a document prepared by the financial counterparty, containing a detailed description of the OTC derivative to be traded; o) Affiliated Entities - individuals or legal entities related to the credit institution, within the meaning of paragraph 2 of Article 2 of Notice No. 9/GBM/2007, of 2 May; p) Forward Rate Agreement (FRA) - a financial contract that allows for the forward fixing of an interest rate for an investment or financing, commencing on a specific future date; q) FX Forward - a contract for the purchase or sale of a base currency on a future date pre-defined by the parties, at a price fixed in the present and negotiated bilaterally; r) FX Swap - a contract for the simultaneous purchase and sale, or vice versa, of an identical amount of a base currency with different value dates; s) Margin of Guarantee - the quantity or amount of a specific asset required as collateral to carry out a transaction in the OTC derivatives market; t) Initial Margin - collateral charged by a counterparty to cover its current exposure and its potential future exposure in the interval between the last margin call and the settlement of positions or risk coverage following the default of the other counterparty; u) Variation Margin - collateral charged by a counterparty for the purpose of protecting eligible counterparties from current exposure associated with changes in the market value of OTC derivative contracts; v) Base Currency - all currencies other than the Metical, which have legal tender status in Mozambique; w) Quoted Currency - corresponds to the Metical; x) Nature of the Operation - corresponds to the type of operation carried out in the OTC derivative transaction, being the purchase or sale of the aforementioned instruments; y) Covered Operation - an OTC derivative operation that has as its counterpart: (i) One or more inverse operations of equivalent value, in spot or forward markets; or (ii) Assets or liabilities in the base currency held by the financial counterparty, equivalent to the notional value of the contract, depending on the nature of the operation, and which are liquid and available to close the position. z) Pricing - corresponds to the fixing of exchange or interest rates (prices) forward, on the date of contracting the OTC derivatives to be traded, based on other elements of the transaction;

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aa) Foreign Exchange Market Quota - corresponds to the quotient between the sum of operations of each financial counterparty and the sum of all foreign currency operations in the spot market carried out by banks with the public in a given month, converted into United States Dollars (USD); bb) Risk Receiver - a financial counterparty that hedges the risk of an OTC derivative transaction; cc) Transaction Terms - corresponds, whenever applicable due to the type of contract, to the conditions established for carrying out the OTC derivative operation, such as the contract signing date, payment or settlement date, notional value, currency, underlying instrument, term, interest rate, exchange rate, among other aspects established between the parties; dd) Underlying - asset or instrument that serves as the basis for determining the value of the OTC derivative, which may take the form of an interest rate or exchange rate; ee) Notional Value - reference amount from which contractual payments are determined in the derivatives market.

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Banco de Moçambique Governor

CHAPTER II GENERAL OBLIGATIONS IN OTC DERIVATIVE TRANSACTIONS

Section I OTC Derivative Transactions

Article 4 Purpose of OTC Derivative Transactions

1. OTC derivatives shall only be traded for the purposes of risk hedging and treasury management directly arising from the business activities of the counterparties.

2. Risk hedging under the preceding paragraph relates to the exposure of base and quoted currencies within national territory.

Article 5 Permission for OTC Derivative Transactions

1. Entities covered by this Regulation are permitted to carry out transactions involving OTC derivatives, provided that at least one of the parties is a financial counterparty acting as the risk receiver and whose derivatives are not credit, hybrid, or combinations thereof.

2. For the purposes of this Regulation, the following OTC derivatives may be traded without the need for authorization: a) FX Forward; b) FX Swap (Cross-Currency Swap); c) Cross-Currency Swap; and d) Forward Rate Agreement (FRA).

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Article 6 Authorization for OTC Derivative Transactions

1. The trading of OTC derivatives other than those described in paragraph 2 of the preceding article is subject to authorization by the Bank of Mozambique.

2. The authorization request must be submitted to the Bank of Mozambique in writing, which may be by email, and must contain the justifications, transaction terms, operation mechanism, and risk mitigation techniques.

3. The Bank of Mozambique shall decide within fifteen business days, counting from the date of receipt of the request.

4. The period established in the preceding paragraph shall be suspended whenever errors or omissions in the processing of the application are found, or when the Bank of Mozambique requests additional information.

5. The execution of OTC derivative transactions between affiliated entities located in Mozambique, solely for liquidity management purposes, shall be carried out when duly substantiated and with the authorization of the Bank of Mozambique.

6. The authorization referred to in the preceding paragraph shall be decided within two business days for the OTC derivatives provided for in paragraph 2 of the preceding article, and five business days for OTC derivatives requiring authorization from the Bank of Mozambique.

Article 7 Conditions for OTC Derivative Transactions

1. Financial counterparties must hold a minimum Foreign Exchange Market Quota to trade OTC derivatives.

2. The preceding paragraph does not apply to Money Market OTC derivatives whose notional value is denominated in the quoted currency.

3. In OTC derivative transactions, financial counterparties must ensure that: a) The transaction has a dedicated underlying asset; b) The underlying risk must be held by the counterparty transferring the risk at the time of contracting, except for transactions related to liquidity management; c) The operations are covered; d) The subject matter of a given transaction's hedging must not be used for another transaction, except in cases where it has a residual value sufficient to cover them; e) The notional value, including any leverage of the OTC derivatives, must not exceed the market value of the underlying asset, liability, or exposure, where applicable; f) The cumulative notional value of OTC derivatives to be contracted in a given month and traded with the same counterparty must not exceed a certain percentage of the Foreign Exchange Market Quota; and g) The person responsible for the OTC derivative contracting area is technically qualified, with internationally recognized certification in financial markets.

4. Financial counterparties have the duty to verify and analyze the financial situation of the counterparty prior to executing the transaction.

5. OTC derivatives must be financially settled, which may be by difference in the quoted currency, where applicable.

6. The trading of OTC derivatives with international financial counterparties must be done with the authorization of the Bank of Mozambique.

7. The Bank of Mozambique shall establish, by Circular, the necessary quotas for the purposes of paragraph 1 and the percentages referred to in sub-paragraph f) of paragraph 3 and sub-paragraph b) of paragraph 1 of Article 11.

Article 8 Pricing

1. Financial counterparties must perform their respective pricing before proceeding to execute OTC derivative transactions.

2. Pricing must be based, where applicable, on all or part of the following elements: a) The notional value; b) The spot exchange rate; c) The interest rate of the base currency; d) The interest rate of the quoted currency; e) The number of days relating to the transaction; and f) The annual calculation base depending on the currencies.

3. The Bank of Mozambique shall define by Circular: a) The spot exchange rate to be used as the basis for calculating the forward exchange rate of the FX Swap; b) The interest rate of the base currency; c) The interest rate of the quoted currency; and d) The calculation formulas relating to the forward exchange and interest rates of the OTC derivatives provided for in paragraph 2 of Article 5.

Article 9 Eligible Currencies

Eligible counterparties may carry out OTC derivative transactions in any base currency and other currency parities with legal tender status in Mozambique.

Article 10 Transaction Terms

OTC derivatives must be traded within a term of 1 to 365 days.

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Banco de Moçambique Governor

Section II Margin of Guarantee

Article 11 Margin of Guarantee Requirement

1. The posting of a margin of guarantee is mandatory for OTC derivatives subject to authorization by the Bank of Mozambique whenever: a) The maturity is greater than 2 months; and b) The notional value is greater than a certain percentage of the Foreign Exchange Market Quota of the financial counterparty involved in the transaction.

2. The margin of guarantee is composed of initial margin and variation margin.

3. Eligible assets for posting the margin of guarantee are: a) Cash, in the form of funds credited to a bank account; b) Treasury Bills; c) Treasury Bonds; and d) Other financial instruments approved by specific legislation or by the Bank of Mozambique.

4. The Bank of Mozambique shall establish, by Circular, the calculation methodology for: a) Initial margin; and b) Variation margin.

Article 12 Initial Margin and Its Calculation

1. The initial margin must be posted by the counterparty transferring the risk, based on the gross values calculated for each contract, and must be maintained until the eventual closure or substitution of the position.

2. The posting of margin of guarantee for initial margin requirements must be carried out by written agreement, the clauses of which must establish, at a minimum: a) Timely settlement or transfer of ownership of the asset received as initial margin of guarantee in case of counterparty default;

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Banco de Moçambique Governor

b) Segregation of assets used as initial margin of guarantee from the assets of eligible counterparties, ensuring their timely availability in the event of insolvency, bankruptcy declaration, or application of the resolution regime by competent authorities; and c) Prohibition on the alienation or reuse of assets received as collateral for any other purposes, including for the posting of collateral for new operations by eligible receiving counterparties, whether for own or third-party financing.

3. Without prejudice to paragraph 1, eligible counterparties must calculate the value of the initial margin based on open transactions.

Article 13 Variation Margin and Its Calculation

1. Without prejudice to Article 12, paragraph 1, the variation margin must be posted by the counterparty transferring the risk.

2. Financial counterparties must calculate the value of the variation margin with their respective counterparties whenever there is movement in the underlying that alters the gross value of open contracts up to the business day prior to the calculation date.

Article 14 Duty to Inform

1. Financial counterparties must, prior to contract signing, present to non-financial counterparties a fundamental information document of the OTC derivatives.

2. The Bank of Mozambique shall establish, by Circular, the model of the fundamental information document for OTC derivatives.

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Banco de Moçambique Governor

Section III Special Obligations in OTC Derivative Transactions

Article 15 Techniques for Risk Management and Mitigation

Eligible counterparties in OTC derivative transactions must, at a minimum, carry out the following procedures: a) Timely verification and confirmation of the terms of the OTC derivative contract, after execution of the transaction and whenever possible via electronic means; b) Consistent recording of the transaction terms; c) Detailed analysis of the transaction portfolio from the perspective of its counterparty, with the objective of immediately identifying any discrepancies regarding the transaction terms; d) Reduction of the number of contracts, depending on circumstances, such as portfolio size with a counterparty, maturity dates, purpose, and degree of standardization of OTC derivative contracts, where applicable. e) Daily valuation at market prices of open transactions; f) Timely, accurate, and segregated posting of the margin of guarantee; g) Agreement on dispute resolution mechanisms that may arise from OTC derivative transactions; and h) Creation of an audit-trail information archive.

Article 16 Form and Clauses of Contracts

1. OTC derivative transactions must be concluded in writing between the counterparties.

2. The clauses must establish the actions to be taken in the event of default by one of the counterparties.

3. The OTC derivative contract must contain, at a minimum, clauses covering the following aspects: a) Interpretative matters; b) Main obligations of the parties; c) Guarantees provided; d) Contract preservation; e) Events constituting default and causes for termination;

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f) Regime applicable to default situations; g) Status of contractual position termination; h) Contractual currency; i) Other matters, such as communication methods, contract amendments; and j) Domicile for the receipt of periodic payments.

4. Eligible counterparties may resort to the contractual rules and principles established by the International Swaps and Derivatives Association (ISDA).

Article 17 Recording and Reporting of Transactions

1. The recording of OTC derivative transactions must be carried out immediately upon their execution and submitted to the Bank of Mozambique through an IT platform.

2. The recording of data regarding OTC derivative transactions must not contain duplications, errors, or omissions.

3. The information and all documents relating to executed transactions must remain in the possession of financial counterparties for a period of no less than fifteen years after the termination of the business relationship.

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