JSE Post-Trade Services

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JSE Post-Trade Services Winds of change - a decade of risk August 2012

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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?

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Context: the crisis changed our approach

The markets before the crisis were like a bowl of spaghetti:

. . . disorganised, but they served a purpose . . .

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Context: the crisis changed our approach

. . . the problem . . .

. . . people ate too much spaghetti . . .

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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

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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)

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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:

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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

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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 . . .

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

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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

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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

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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

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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

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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

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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 Derivatives5. Implement risk models

• SAFCOM Default Fund

Post-Trade Services is improving risk mitigation to respond to dynamically changing market needs

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Thank you

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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.

Documents

JSE Post-Trade Services