Publication of Joint Discussion Document on Expansion of Eligible Collateral Types and Risk Mitigation Published for Comment

Introduction

In 2015, a policy framework on the margin requirements for non-centrally cleared over-the-counter derivatives (OTC Derivatives) transactions was published by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (the Policy Framework). The Policy Framework required national supervisors to develop their own lists of eligible collateral types based on prescribed key principles set out in the Policy Framework. On 2 June 2020, the Financial Sector Conduct Authority (the FCSA) and the Prudential Authority (the PA and, together with the FSCA, the Authorities) published a Joint Standard 2 of 2020: Margin requirements for non-centrally cleared over the counter derivative transactions (the Joint Standard) which came into effect on 16 August 2021. The Joint Standard was amended on 9 June 2023 where the margin requirements for non-centrally cleared OTC Derivative transactions were set out.

The Joint Standard specified cash and gold as the permissible eligible collateral types in South Africa.¹  This was expanded in December 2022 with the delegation of South African central government bonds with a credit ranking issued by a licensed credit rating agency to constitute eligible collateral.  However, the Joint Standard provides the Authorities with a two-fold authority to:

1. in writing, designate certain assets or instruments as eligible collateral, and
2. impose conditions on risk management, internal controls and assurance for use of non-cash collateral.

On 24 May 2024 the Authorities published, for public comment, a joint discussion document on the expansion of eligible collateral types and risk mitigation proposals for purposes of the determinations to be issued in terms of the Joint Standard (the Joint Discussion Document). In terms of the Joint Discussion Document, the Authorities propose three asset types to be recognised as eligible collateral in satisfying either initial or variation margin requirements. These are:

1. United States of America government bonds;
2. European Central Bank government bonds; and
3. United Kingdom government bonds, subject to the bonds being issued with a credit rating by a registered credit rating agency in South Africa.

The Joint Discussion Paper further provides the proposed minimum risk management requirements to be implemented by providers wanting to make use of no-cash collateral. The Joint Standard requires that providers institute robust processes, procedures and policies to ensure compliance with the requirements of the Joint Standard. In addition to the above, a provider is required, under the Joint Standard, to ensure that the assets or instruments collected or posted as collateral for purposes of initial or variation margin can be liquidated in time in order to generate proceeds to sufficiently protect the provider, the clients of the prover or counterparties.

A provider will only be allowed to make use of non-cash collateral subject to the provider having in place the following minimum risk management requirements:

1. collateral risk management policies, procedures and processes;
2. collateral management systems;
3. valuation collateral ; and
4. limit frameworks.

Collateral risk management policies, procedures and processes

In terms of collateral risk management policies, procedures and processes, the provider is required to have approved collateral risk management policies, procedures and processes which are to be subject to regular review to ensure that they remain effective and appropriate. The policies, procedures and processes are required to include, amongst other things, the terms of the collateral agreements, the types of collateral and collateral enforcement terms, management of legal risk, robust risk management processes relating to collateral management and a duly articulated strategy for the use of collateral.

Collateral management systems

Under the collateral management systems requirement, the provider is required to establish and implement a collateral management system that, amongst other things, is operationally efficient and flexible, allows accurate internal and regulatory reporting of initial and variation margin, and tracks the extent of re-use of securities held as collateral.

Valuation of collateral

In addition to the above, a provider is required to establish and implement policies, procedures and processes to value its collateral at least on a daily basis, monitor the credit quality, market liquidity and price volatility of each asset accepted as collateral, and to apply haircuts to account for market fluctuations and credit risk. Providers are required to review the adequacy of their valuation policies, procedures and processes on a regular basis whenever a material change occurs which affects the provider's risk exposure.

Limit framework

A provider will be required to establish and implement policies, procedures and processes to ensure that the collateral remains sufficiently diversified to allow liquidation within a defined holding period. These policies, procedures and processes are to be applied when the concentration limits are exceeded. As a minimum, the providers are required to determine concentration limits based on due diligence and a consideration of creditworthiness and the overall market stability level of individual issuers, type of issuers, type of asset and jurisdiction. Providers are therefore required to monitor the adequacy of their concentration limit policies, procedures and processes on a regular basis, to regularly review their concentration limit policies and procedures, and to implement policies and procedures in order to rectify any breach of concentration limit set by the provider.

Once the proposals are finalised, the expanded collateral, together with associated risk mitigation conditions set down in the Joint Discussion Document, will be published in a determination by notice on the websites of the Authorities. In order to avoid disruptions to the market integrity, financial stability and consumer protection in relation to withdrawals of the existing determinations, the Authorities will allow for a sufficient transitional period to all the covered entities to comply.

The Joint Discussion Document is accessible on the Prudential Authority's webpage here.

Comments on the proposed directive must be submitted by email to queries.otc@fsca.co.za and marginrequirements@resbank.co.za, by no later than 8 July 2024.

^{1 Paragraph 6(2) of the Joint Standard.
2 Joint Communication 3 of 2022 read with Joint Notice 2 of 2022.
3 Paragraphs 6(2) and paragraph 6(2A) of the Joint Standard.}

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