Developments relating to collateral in South Africa’s securities lending and derivatives markets
15 Nov 2016
The introduction of new, amended and draft legislation over the last couple of years, coupled with heightened requirements for banks under Basel III and the Twin Peaks model of bank regulation, is changing the ways participants in the South African securities lending and derivatives markets provide and accept collateral.
This legislation includes the Financial Markets Act, 19 of 2012 (the “FMA”), which came into effect on 3 June 2013, and the Securities Transfer Tax Act, 25 of 2007 (the “STT Act”), which was most recently amended in January 2016. On 24 June 2015, drafts of a number of pieces of subsidiary legislation were introduced, including the Draft Board Notice on Margin Requirements for Non-Centrally Cleared OTC Derivative Transactions (the “Draft Margin Notice”), and, on 21 July 2016, the third draft of the regulations under the FMA were published together with a few explanatory notices.
Historically, participants in South Africa’s securities lending and derivative markets were somewhat restricted in the ways they could post and account for collateral. Market participants did not regularly transfer equity or debt securities outright as collateral to cover exposures due to:
- a lack of clarity at common law regarding the validity of such transfers, and
- the imposition of securities transfer tax under the STT Act in respect of equity securities. While other major financial jurisdictions were able to rely on a method of giving security that was similar to an outright transfer, South African market participants were forced to make do with pledges and cessions in securitatem debiti of such security.
The effect was that banks could not, in all circumstances, consider themselves to have fully net positions on their securities lending and derivative exposures and could not rehypothecate collateral provided to them. Both of these aspects of collateral are important for smoothly functioning markets and are regular features of such markets.
However, the introduction of the FMA and the subsequent amendment to the STT Act to provide an exemption from securities transfer tax for certain outright transfers of equity securities, has made outright transfers of equity and debt securities as collateral feasible and increasingly common in the South African markets. As a result, more banks are able to consider their securities lending and derivatives exposures to be net positions, which gives the banks better capital treatments and, in some instances, may result in lower prices for end users. We have seen a growing number of market participants using outright transfers of collateral for precisely the reasons mentioned above.
In addition, outright transfers of collateral allow the recipients to rehypothecate (ie, to use) the collateral received. This is an attractive feature for banks, which can use the collateral to collateralise the banks’ related transactions or for any other purpose. In the context of derivatives trading, however, the Draft Margin Notice looks set to close the window on rehypothecation in respect of initial margin collected on transactions. This is in line with regulations being enacted in various offshore jurisdictions that are subject to G20 commitments to regulate over-the-counter derivatives (as in South Africa). Variation or top-up margin would remain available for rehypothecation by recipients. The Draft Margin Notice is expected to come into effect and phase in the margin requirements during the second half of 2017.
This article was first published by ENSafrica (www.ENSafrica.com) on 8 November 2016.
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