2 www.jse.co.za Discussion points What is Post-Trade services? What is the role of the clearing house during a default? Have clearing houses ever defaulted? How have the regulators reacted? G20 mandate Regulatory changes What will our world look like in 5 years? How is the JSE responding?
3 www.jse.co.za Context: the crisis changed our approach The markets before the crisis were like a bowl of spaghetti:... disorganised, but they served a purpose...
4 www.jse.co.za Context: the crisis changed our approach... the problem...... people ate too much spaghetti...
5 www.jse.co.za What is Post-Trade Services? Trade Post- Trade Reduce systemic risk Ensure efficient, fair markets Protect investors Ensure orderly markets Promote transparency Provide credible information - Post-Trade Services - Providing settlement assurance and credible information
6 www.jse.co.za Macro factors affecting Post-Trade Services Social: Recent losses have educated man in the street - Main Street v Wall Street Laymen now understand the negative impact of risk High demand for credible information Technology: High-speed trading increasing settlement risk IT improvements enable integrated clearing, margin offset, cross-collateralisation Legal/Regulatory: Increased regulation puts PTS in the spotlight G-20 Basle III Dodd-Frank EU Draft Reg, ISDA JSE Post-Trade Services Economic: Losses from 2008 caused sovereign debt burdens, increased flows to emerging markets and low risk debt products Political: Politically motivated regulation of risk mgt trend to on-exchange standardisation, transparency capital sensitive trading Separation of duties (Volcker Rule)
7 www.jse.co.za Clearing house defaults France (Caisse de Liquidation) – 1974 Malaysia (KL Commodity Clearing House) – 1983 Hong Kong (Hong Kong Futures Exchange) – 1987 Brazil (BM&F) – 1999 Hong Kong (Hong Kong Futures Exchange) - 2012 Defaults by clearing houses are typically characterised by sharp intraday moves, a lack of coordination between traders, clearing house and the regulator, concentration and inadequate margin Notable clearing house defaults:
8 www.jse.co.za The role of the clearing house Source: Oliver Wyman 2012 Market protection: monitor and manage open positions to ensure orderly markets Settlement Assurance Comprehensive risk management standards Margin management to protect against intra day losses Default management
9 www.jse.co.za OTC Derivatives Clearing: Context, current situation Unprecedented defaults led to losses and destabilised the global economy: Lehman Bear Stearns AIG MF Global... this led to global political and regulatory investigations... Unprecedented defaults led to losses and destabilised the global economy: Lehman Bear Stearns AIG MF Global... this led to global political and regulatory investigations... Concerns raised: Lack of transparency Fragmented, uneven risk management Inadequate risk governance Inadequate management practices and infrastructure Insufficient use of collateral Vulnerable market infrastructure Concerns raised: Lack of transparency Fragmented, uneven risk management Inadequate risk governance Inadequate management practices and infrastructure Insufficient use of collateral Vulnerable market infrastructure Source: Joint Forum The scale and growth rate of the dominant OTC trading market and costly defaults led to regulatory investigations into the safety of the OTC market
10 www.jse.co.za G20 mandate Nov 2008 Washington G20 meeting mandate to finance ministers: ‘Strengthening the resilience and transparency of credit derivatives markets and reducing their systemic risks, including by improving the infrastructure of the over-the-counter markets’ Sept 2009 Pittsburg G20 mandated reform measures in order to: ‘improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse’ Rationale: Bear Sterns, AIG, Lehman Lack of transparency Interconnections in counterparty risk
11 www.jse.co.za OTC Derivatives Clearing: Regulatory response The G20 reform was a catalyst for a coordinated global regulatory response US Dodd-Frank Act (Q4 2012) SWAP dealers and participants must register Central clearing of standardised OTC derivatives Mandatory margin for cleared trades Central trading of standardised derivatives Restriction of activities EU Draft regulation (Q4 2012) Central reporting Central clearing of standardised derivatives Regulation of CCPs as ‘systemically important’ Basle III (Q1 2013) Lower capital for centrally cleared derivatives and structured products Penalties for uncollateralised trades Clearing members to hold capital for default fund exposures CPSS-IOSCO Global standard that CCPs must comply with B3 capital relief for IOSCO compliant CCPs ISDA and G14 Improvements to enable T+0; electronic processing; standardisation; OTC clearing on exchange
12 www.jse.co.za OTC Derivatives Clearing: Regulatory response All standardised OTC derivatives contracts should be traded on exchange / electronic platforms where appropriate; and should be cleared through a CCP by end-2012 at the latest Higher capital requirements for non-centrally cleared OTC contracts OTC derivatives contracts reported to trade repositories In September 2009, G-20 Leaders mandated reform measures to ‘improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse’ As a member of the G-20, SA is obliged to implement the OTC derivatives clearing reforms Source: G-20 Pittsburgh Summit, Sept 2009
13 www.jse.co.za OTC Derivatives Clearing : Market size In June 2008, the global OTC derivatives market gross notional outstanding peak trading volumes were more than $680 trillion OTC trading increased by 535% over 7 years to 2008 OTC market subsequently contracted to $615 trillion to date June 2010: ZAR OTC derivatives ZAR24 trillion, ZAR800 billion traded on exchange Source: BIS, ISDA, SARB According to BIS, 85% of all derivative transactions are traded OTC
14 www.jse.co.za What will our world will look like in 5 years Capital costs will be more granular and better reflect inherent risk of trades, hurdle ROE rates will drive flows Traders will choose trading venues based on clearing costs and credibility OTC trading will be cleared on-exchange Global clearing flows will increase (driven by OTC flows) Exotic OTC trading volumes will reduce in favour of standardised, transparent markets A more integrated clearing environment will evolve Information (eg Statistics and Indices) will be centralised Post-Trade services will affect trading patterns and is no longer a hygiene factor. Result: increased competition, risk becomes front-of-mind
15 www.jse.co.za How have we responded? 1.Integrate clearing Integrated organisation structure, separation of duties, increased risk focus Enhance the collateral accepted (non-cash) Margin (cross-product) 2. Regulatory credibility CPSS-IOSCO compliance (focus on liquidity, stress testing market conditions, enhancing risk management and reporting) 3.Reduce the time it takes to settle from 5 days to 3 days (T+3) 4. Enable on-exchange clearing OTC Derivatives 5. Implement risk models SAFCOM Default Fund Post-Trade Services is improving risk mitigation to respond to dynamically changing market needs
17 www.jse.co.za References 1.Dodd, R. (2004). Derivatives Markets: Sources of Vulnerability in U.S. Financial Markets. The ICFAI Journal of Derivatives Markets and Edward Elgar Publishers. 2.European Commission. 2010. Regulation of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories. Brussels: European Commission. 3.G20 Working Group1. (2009). Enhancing Sound Regulation and Strengthening Transparency. Final Report. 4.International Organisation of Securities Commissions (IOSCO) technical Committee. (2009). Unregulated Financial Markets and Products. 5.Skerrit, P. (2012). An examination of the South African OTC Markets to recommend measures for strengthening their regulatory oversight.