Regulatory and Supervisory Report - Strate · Internet: First Edition 2006 Regulatory and Supervisory Report . Contents Introduction 1 Chairman’s address 2 ... Monitor the workings

1st Floor, 9 Fricker Road, Illovo Boulevard Illovo, Sandton, 2196, South Africa

PO Box 78608, Sandton, 2146

Tel: +27 11 759 5300 Fax: +27 11 759 5500E-mail: [email protected]

Internet: www.strate.co.za

First Edition 2006

Regulatory and Supervisory Report

ContentsIntroduction 1

Chairman’s address 2

Preface 4

The STRATE Regulatory and Supervisory Committee 6

SRO milestones 8

Regulatory activities 14

Supervision 19

Enforcement 26

Training and education 27

Appendices 30

Introduction

1Regulatory and Supervisory Report

Legal framework under which STRATE operatesSTRATE is licensed as South Africa’s only Central Securities Depository (CSD) in terms ofthe Securities Services Act, 2004 (SSA). STRATE is also licensed as a Clearing House underthis legislation.

A major development in the South African securities legislation took place with theenactment of the SSA. The SSA provides the legal framework to support electronic securitiesservices performed by STRATE as the CSD. This legal framework rests on certainfundamental points and basic principles, but the SSA also adds a number of new provisionsto the repealed Custody and Administration of Securities Act, 1992 (CASA), the StockExchanges Control Act, 1985 (SECA), the Financial Markets Control Act, 1989 (FMCA) andthe Insider Trading Act, 1998.

Although the SSA sets out a framework for market regulation, it leaves much of the detailedsubstantive provisions to secondary legislation. STRATE is required to issue and amendRules within the framework of the SSA where the basic principles are set out. The objectivesof the SSA that are expressly stated protect the public interest and provide the principles forthe supervisory approach adopted by the Registrar of Securities Services (the Registrar). TheSSA provides a framework for STRATE when issuing Rules and Directives. The ExecutiveOfficer of the Financial Services Board (FSB) fulfils the function of the Registrar and theCapital Markets Department of the FSB is the responsible department within the FSB forensuring that the objectives of the SSA are met by STRATE in its function as a self-regulatoryorganisation (SRO) and Clearing House. In terms of section 33(o) of the SSA, STRATE mustact with due regard to the rights of Participants, clients and Issuers.

Thus, the legislation establishes a co-regulatory regime in terms of which STRATE’s self-regulatory responsibilities arise. STRATE must regulate its activities and those of itsParticipants by making and enforcing Rules that comply with the requirements prescribed bythe SSA. The FSB is required to supervise compliance with the SSA by every regulated person.

Regulatory and Supervisory Report 2

Chairman’s address

There have been significant developments in the regulatory environment over the past fouryears since the establishment of STRATE’s Supervision division and the STRATE Regulatoryand Supervisory Committee (Committee) to which it reports. The principal legislativedevelopment during this period was the promulgation of the SSA in February 2005.Alongside this, there were significant increases in the scope of STRATE’s self-regulatory rolewith the addition of Bonds to the existing Equity activities.

STRATE’s regulatory role, as provided for in legislation, has likewise evolved, as has the workof the Supervision division.

The Committee initially focused on clarifying its and the division’s role and functions as wellas the process for developing and approving Directives for the Participants which is one ofSTRATE’s regulatory roles. This understanding was achieved mainly by means of thedevelopment by the division of a “Regulatory Pyramid” which is a chart depicting the rolesthat the various stakeholders play in the securities custodial industry and the responsibilityfor their regulation and supervision. The understanding set out in the pyramid was agreedwith the FSB. This was followed by clarifying the approach to supervision using Risk Mapsand developing tools such as the Performance Monitoring Model for Participants developedby the division. The approach to on-site visits to Participants was also developed and theprogramme has now been implemented successfully. Entry criteria for new Participants arestill being developed, as is a manual for action to be taken in the event of the failure of aParticipant. A lot of work has gone into preparing for the regulation and supervision of MoneyMarket securities during 2006.

3

Memoranda of understanding (MOUs) have been signed with the JSE Limited (JSE), theBond Exchange of South Africa (BESA) and the South African Reserve Bank (SARB) whichalso have regulatory responsibilities in the areas in which STRATE is involved.

The creation of a “Chinese Wall” to protect confidential information obtained as a result ofSTRATE Supervision’s supervisory role from becoming available to STRATE’s operational staffhas also been developed. The Committee will monitor the processes in place to ensure theongoing effectiveness of the Chinese Wall.

There is a high level of compliance with the SSA, Rules and Directives by Participants. Someenforcement issues have arisen but all these have been satisfactorily resolved, in some casesby escalating issues to appropriate management levels of the Participants.

This has been an interesting and challenging period and I am pleased with the progressmade. The progress was made possible by the:

• competence, skill and experience of the members of the Committee; and• initiative, hard work and open mindedness of the head of the division and members of her

staff.

I would like to take the opportunity to thank all involved for their contributions and support.Regulation and supervision are far more effective if carried out in a collaborative rather thana confrontational environment. I therefore thank the Participants for their co-operation andcontribution during this evolutionary process.

Finally, I would like to thank the FSB, the Bank Supervision Department of SARB, the JSE,BESA and other self-regulatory organisations for their co-operation and assistance.

Rick Cottrell ChairmanMay 2006


consistency is key


STRATE’s licence as a CSD is subject to STRATE performing a regulatory and supervisory role.

A co-regulatory regime exists within the South African financial markets. The SSA sets abroad range of principles under which STRATE must operate. However, it gives STRATE thepower to set detailed Rules and issue Directives which stipulate the specific businessstandards under which the Participants must operate. The term SRO under the SSA meansthe power to set and enforce STRATE’s own set of Rules and Directives. STRATE’s Rule andDirective setting process is overseen by Dr Maria Vermaas, Head of STRATE Legal. TheSTRATE Rules were rewritten during 2005 to comply with the SSA. In 2006, a similarexercise will be undertaken in respect of the STRATE Directives. I take this opportunity tothank Maria and her team for their legal assistance and support in our supervisory andenforcement initiatives.

The regulatory role of STRATE is split into two distinct areas namely Rule writing andDirective setting function and the supervision of Participants. It is the supervision functionwhich required the Chinese Walls to be established between STRATE the regulator andSTRATE the CSD.

To this end, STRATE Supervision reports to the STRATE Regulatory and SupervisoryCommittee and not to STRATE management. The Committee was established by and reportsdirectly to the Controlling Body of STRATE Limited.

Preface

5

STRATE Supervision is pleased to release the first regulatory and supervisory report whichdetails the strategy adopted and implemented to enforce and supervise compliance with theSSA, Rules and Directives. The report explains our approach to monitoring Participants’compliance and the tools we use to ensure that the supervisory decisions we take are reachedin a sound, fair and consistent manner. The Committee continually monitors the effectivenessand adequacy of our regulatory and supervisory responses. I thank the Committee for itscontinuous guidance and leadership in developing STRATE’s supervisory arm.

Bev BrazierHead: STRATE SupervisionMay 2006


consistency is key


This section of the report details the structure, functions and activities of the Committee.

Corporate Governance The common law fiduciary duties of directors towards their company (in terms of companylaw) are similarly imposed on the Controlling Body of a SRO in the SSA. Each member ofthe Controlling Body of STRATE owes a fiduciary duty and a duty of care and skill to the SRO(section 55 of the SSA). The fiduciary duty entails that the Controlling Body must remainwithin the scope of the powers which have been conferred upon it; that they must act in goodfaith in what they believe to be the best interests of the SRO; and that they must not putthemselves in a position in which their personal interests or duties to others conflict withtheir duty to the SRO.

The Committee’s overall objective is to assist the Controlling Body in discharging itsregulatory and supervisory obligations in terms of the SSA and the Rules.

Terms of ReferenceIn order to assist the Controlling Body, the Committee is required to: 1. Review the process of identifying the risks and exposures that arise within the ambit of

the STRATE Rules and Directives;2. Review the overall regulatory scope of the STRATE Rules and Directives and consider,

on an ongoing basis, whether they provide an adequate infrastructure to mitigate againstrisks that have been identified;

3. Approve new STRATE Rules and Directives and the subsequent amendments for issuanceto Participants and other parties. In the case of amendments to Directives pertainingspecifically to operational issues, the approval process will be sub-delegated to the Headof Supervision in accordance with the specific delegation by the Controlling Body;

4. Approve a programme of regulatory surveillance and enforcement to determine whetherParticipants and other parties that fall within the ambit of the STRATE Rules andDirectives comply with the SSA, STRATE Rules and Directives;

5. Review the findings of the surveillance or enforcement programme and the penaltieslevied for such transgressions and/or other actions taken;

6. On request, provide guidance in terms of a course of action arising from the findingsreferred to in 5. above;

7. Review proposed Memoranda of understanding between STRATE and any otherregulatory body and recommend their approval by the Controlling Body;

8. Review the nature and extent of the liaison with other regulators of Participants andother external parties on matters of mutual concern and the effectiveness of theoperation of the MOUs that have been entered into;

The STRATE Regulatory andSupervisory Committee

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9. Review any matters arising from the liaison with the FSB on STRATE’s regulatoryfunctions and the enforcement thereof;

10. Recommend to the Controlling Body the acceptance and/or expulsion of a person as aParticipant in terms of the governing rules and procedures to enable the Controlling Bodyto make a final decision in this regard that is equitable and in the public interest;

11. Ensure compliance with licensing conditions of STRATE for new or existing Participants;12. Recommend to the Controlling Body the approval of Nominees to open accounts with

Participants and to review such approval annually;13. Recommend to the Controlling Body to withdraw approval in terms of 12 above, in cases

where the Nominee no longer meets the requirements imposed on Nominees to operatein the STRATE environment;

14. Monitor the activities of the Supervision division of STRATE;15. Monitor the workings of the Chinese Walls between STRATE’s roles as CSD and SRO and

obtain annual external assurance that independent structures, policies and proceduresremain in place.

Activities of the Committee Throughout the last four years, many milestones have been achieved by the Committee. Thesehave been accomplished through active participation and dedication by all Committee members.

Please refer to Appendix A for details of members’ attendance at meetings.


consistency is key


SRO milestones

Date Activity

November 1999 STRATE goes live with the first electronic settlement on 9 November 1999.

Decision taken by the Controlling Body of STRATE to create a sub-committee named the STRATE Regulatory and Supervisory Committee (the Committee) to be chaired by Mr Rick Cottrell.

February 2002 First meeting of the Committee.• Agreement was reached on the business plan for the establishment of a

Supervision division. Distinction was made between a Regulation divisionwhich provides the legal framework for STRATE Limited – and aSupervision division tasked with the daily monitoring and supervision ofParticipants.

• First discussions held to define STRATE’s regulatory scope, ie regulationextended over Participants only and not brokers.

• First drafting of the STRATE Equities Handbook and Compliance OfficersExamination Curriculum.

• First drafting of the STRATE SAICA external audit guidelines.• Work commences on the creation of a Participant Performance

Monitoring Model.

April 2002 FSB was represented for the first time on the Committee.

Initial discussions held on the introduction of a regulatory levy. Agreementreached that regulatory costs would be passed down to the investor as asingle charge within the STRATE fee.Bank Participants raised concern over the scope of STRATE’s regulationand the ambit of regulation of SARB.

First Directives approved by the Committee – previously approved by theControlling Body in board meetings.The Committee designed a “Directive Approval Form” and set proceduresfor the approval of Directives.

July 2002 First STRATE Equities compliance examination held. STRATE accredits thefirst four STRATE Compliance Officers.

Drafting of the STRATE/SARB regulatory MOU commences.

Committee introduced a self-assessment guide.

September 2002 Meeting held between representatives of the Committee and the FSB.The FSB confirms “STRATE must regulate any entity that introduces risk to the CSD and where entities regulation overlaps, the co-regulators must work in tandem”.

October 2002 The Committee’s Terms of Reference approved.Committee defines the regulatory risks.

The JSE joins the Committee in an observer capacity.

Committee agrees that Directives may, in exceptional cases, be approved via a Round Robin Resolution.

January 2003 The first bi-annual STRATE Compliance Officer Reports are received.

February 2003 Directive SAJ approved mandating the appointment of alternative Compliance Officers.

Drafting of the STRATE/JSE regulatory MOU commences.


Date Activity

April 2003 The Participant Performance Monitoring Model is presented to theCommittee for the first time.

Work continues on defining the regulatory risks and setting Regulatory Risk Maps.

August 2003 STRATE/SAICA external audit guidelines approved by the Committee andratified by the Controlling Body on 21 August 2003.STRATE merged with UNEXcor and Central Depository Limited.

October 2003 Regulatory MOU signed between STRATE and the JSE.

November 2003 Completion of the STRATE Equities Pyramid – endorsed by the FSB in January 2004.

STRATE reviews any possible regulatory responsibilities as a result of the merger between STRATE, UNEXcor and CD Limited.Committee completes the first self-assessment for the 2003 year.

February 2004 First draft of the Participant Failure Procedure Manual is released.STRATE’s regulatory responsibility does not extend to Bonds in terms ofthe FMCA. STRATE commences discussions with BESA in this regard.

Definition of STRATE’s 34 supervision tools.

May 2004 Drafting of the STRATE/BESA regulatory MOU commences.Completion of the STRATE Bonds Pyramid – scope of STRATE’s Bondsregulation is accepted by the FSB.

The regulatory risks are integrated into the Participant Performance Monitoring Model.

July 2004 Regulatory MOU signed between STRATE and the SARB.

July 2004 BESA and STRATE agree that BESA would, under the FMCA, delegate theregulation of Settlement Agents to STRATE.

Market drafts the first STRATE Bonds Directives.

STRATE defines its Participant on-site review programme.The first results of the Participant Performance Monitoring Model are submitted to the STRATE Regulatory and Supervisory Committee.

October 2004 Regulatory MOU signed between STRATE and BESA.

November 2004 Committee completes the self-assessment for the year.Second version of the Participant Failure Procedure Manual circulated to the market.

Committee approves the introduction of the first STRATE Bonds settlementDirective and associated penalty schedule.


2005 year under review

Date Activity

January 2005 Committee agrees to a project plan to resolve the securities imbalanceswithin Participants and agrees certain monthly milestones.

January 2005 Chairman conducts one-on-one discussions with members of the STRATERegulatory and Supervisory Committee. Discussions surround theperformance and functions of the Committee.

Yield X Directive approved.Amendments to Directives SCP (1) and (2). Amendments to Directives SFA and SFB.Amendments to Directive SAJ.STRATE Supervision introduces a programme of Continuous ProfessionalEducation (CPE).

February 2005 Promulgation of the SSA.

Progress commences on the re-write of the CSD Rules.

Drafting of various Money Market Directives commences.

March 2005 Concern raised over the number of client mandates outstanding atParticipants. Project plans agreed to.

STRATE Supervision meets with the head of compliance at each Participantto determine the extent to which a compliance culture exists and theindependence of the compliance reporting lines within Participants.

Receive legal opinion from Deneys Reitz Attorneys on the impact of variouslegislation on Participant Failures, including the Banks Act, 1990,Protection of Funds Act, 2001, and Insolvency Act, 1936.

STRATE Supervision meets with the SARB in their capacity as a Participantand defines the regulatory scope.

April 2005 – November 2005 STRATE Supervision conducted six Participant on-site reviews.

These on-site visits revealed the following areas of concern:• Client mandates are not always maintained in a complete and accurate

manner and in some instances are not in place with clients.• Understanding of Nominee requirements, specifically as this pertains to

securities account opening procedures, is weak.• In some instances, management oversight and implementation of internal

controls relating to corporate actions processing required attention.

The following positive items were identified:• High levels of staff experience, skill and STRATE knowledge.• Commitment to client service.• Robust internal controls and procedures specifically in the

settlements arena.

March 2005 Participant Performance Monitoring Model for Bonds is created.

Committee’s Terms of Reference and Regulatory Pyramids are amended torefer to the Securities Services Act.

BESA joins the Committee in an observer capacity.

The “Requirements for Nominees to operate in the STRATE environment”in terms of section 36(1)(b) of the SSA is drafted. Amendments to Directive SEA.


Date Activity

May 2005 Added the approval of Nominees to the Committee’s Terms of Reference.

Money Market training presentation given to the Committee.

MM Application Form Directive approved.

MM Data Standard Directive – agreed to be approved via Round Robin Resolution.

Money Market Operational Windows Directive approved.

MM Fee Schedule Directive approved.

June 2005 First STRATE Bonds compliance examination held.

July 2005 New Rules aligned to the SSA approved by the Registrar. Several specialpurpose Committee meetings held to review the proposed Rules.

Money Market legal sub-committee meetings commence. Six workshops heldwith the market to define the Rules for Money Markets.

August 2005 First Participant Failure workshop held with market representatives.

Presentations are given by Deneys Reitz Attorneys and the SARB.

Committee’s Terms of Reference are amended so that the CEO of STRATEonly serves in an observer capacity.

FSB reviews the proposed STRATE Nominee Directives.

STRATE Supervision tables the first “Chinese Walls” report detailing theindependent procedures adopted and the separation of STRATE’s role asCSD versus SRO.

October 2005 STRATE Supervision undertakes an investigation into Participant adherenceto Rule 8.1.9, ie bi-annual DR/BCP testing of Participant’s core systemsand infrastructure.

STRATE’s proposed Nominee Directives circulated to the market for comment.

The first MM application forms are received. Review of applicationscommences.

November 2005 STRATE SAICA guidelines aligned to the SSA are presented to SAICA.Second Participant Failure workshop held. Client migration concerns arediscussed.

Further papers presented to the Committee on the “role of STRATE as aSRO and Chinese Walls”.

Money Market Rules and consequential changes to Rules presented to theCommittee for approval.

Controlling Body approves appointment of two additional non-executivedirectors to the STRATE Regulatory and Supervisory Committee fromJanuary 2006.

December 2005 Money Market Rules tabled with the FSB for approval.Committee completes self-assessment for the year.


Profiles

Rick Cottrell – ChairmanRick is a former chairman andmanaging partner of Coopers &Lybrand, South Africa, a predecessorfirm of PricewaterhouseCoopers. Heis a past president of the Institute ofChartered Accountants, chairman ofthe Accounting Practices Committeeand one of the two South Africanrepresentatives on the then formerInternational Accounting StandardsCommittee.

After retiring from practice, hebecame Executive Officer of theFinancial Services Board, whichposition he held from 1996 to 2000.

He is now a director of companies,including, Glenrand MIB Limited,Imperial Bank Limited, NedbankLimited, and Munich ReinsuranceCompany of Africa Limited. He isalso chairman of the AccountingStandards Board which sets publicsector accounting standards for SouthAfrican Public entities.

Malcolm (Bobby) JohnstonBobby obtained a Bachelor ofCommerce degree from the Universityof the Witwatersrand in 1970 andqualified as a Chartered Accountant(SA) in 1974. He became a memberof the Johannesburg Stock Exchangein 1978 and an honorary life memberof the SA Institute of Stockbrokers in1997.

He was elected to the JSE Committeein 1993 and served as its chairmanfrom August 1995 to October 1997during which time the JSE wasderegulated and the automatedtrading system, JET, was successfullyintroduced. He remains on the boardof JSE Limited.

He served as chairman of STRATEfrom inception to end-1999 when theproject was incorporated andelectronic settlement of equitiesbegan. He remains a non-executivedirector of STRATE Limited.

He serves on the Licensing Committeeof the Financial Services Board aswell as the Financial MarketsAdvisory Board.

Stuart YatesStuart entered the financial marketsin 1979 initially as a systemsdeveloper but later as a trader. He hasbeen with Rand Merchant Bank forthe past 14 years and before that,spent seven years with Finansbank.

During his career he has been and isa member of various boards andcommittees including:• SAFEX Development Committee

and Risk ManagementCommittee

• Bond Market Association• JSE Clearing and Settlement

Advisory Committee• Board of the Institute of

Financial Markets• SAFCOM (Pty) Limited• STRATE Money Market Advisory

Committee

Committee members


Nigel PayneNigel is an independent CorporateGovernance and risk managementconsultant. He is a member of theKing Committee on CorporateGovernance and was responsible fortwo chapters in the King II Report.

Nigel currently holds various non-executive directorships, these include:• JSE Limited (JSE) – director,

chairman of Risk Committee,member of Audit Committee

• STRATE Limited – director,chairman of Audit and RiskCommittee, member of theRemuneration and NominationCommittee

• Gobodo Forensic & InvestigativeAccountants (Pty) Limited –director

• Legal Aid Board – member ofAudit Committee

• Development Bank ofSouthern Africa – member ofAudit Committee

Nigel has a BCom (Hons) (Rhodes),Higher Diploma in Accounting(Rhodes), CA(SA), a masters inBusiness Leadership (MBL) (Unisa)and is a Certified Internal Auditor(CIA).

Heather Sonn – joined the Committee in2006Heather is the deputy CEO ofWipcapital, the operating company ofWIPHOLD. She was appointed as thechief executive officer of LegaeSecurities of which Wipcapital owns49% in January 2002 and to theexecutive committee of Wipcapital.

Heather has over nine years’ experiencein the financial services. She worked forMerrill Lynch in New York as aninvestment banker in global brandedconsumer goods and leveraged buy-outsfrom 1997 to 1999. When she returnedto South Africa she was employed bySanlam Investment Management (SIM),then known as Gensec AssetManagement in operations of theinvestment process. She was laterappointed as managing director to workon overall company strategy where shedeveloped the empowerment strategy,was integrally involved in transformationactivities in the holding company aswell and oversaw implementation atSIM.

She serves on the board of STRATE,the Nelson Mandela Investment andEndowment Committee, the FSBCollective Investment SchemesCommittee, the Old Mutual BlackDistributors’ Trust, is the president ofSouth African Association of Investors,an NGO focused on investment andfinancial market education, and is apatron of the Women’s Hope andEducation Training Trust.

In December 2005 she was voted bythe Mail & Guardian as one of the topbusiness people to watch in thecoming decade.

Sindi Zilwa – joined the Committee in2006Sindi obtained a BCompt (Hons), CTAand Advanced Taxation Certificatethrough correspondence with Unisa.In 1990, she wrote the final qualifyingexamination and passed at firstattempt and became the second blackwoman Chartered Accountant in SouthAfrica. She passed the AdvancedDiploma in Banking at RAU inNovember 2003.

She is the chief executive officer ofNkonki and a member of the SouthAfrican Institute of CharteredAccountants’ education committee, amember of the SAICA Banking ProjectGroup, a member of the PAABeducation committee and a non-executive director of WoolworthsLimited, Primedia Limited, DiscoveryLimited, Ethos Private Equity andSTRATE Limited. She is also thechairman of the BUSA standingcommittee on transformation.

In 1998 she was nominated as SouthAfrica’s Businesswoman of the Year bythe Executive Women’s Club. In 1999,she was nominated as one of the Top20 Business People in South Africa.In 2001 she was nominated as one ofthe Top 10 Business Personalities inSouth Africa by the Black Manage-ment Forum and Impumelelo Top 300companies. In 2004 she received theTop Emerging Female OwnedCompany of the Year Award on behalfof Nkonki.

In this section of the report, the regulatory activities undertaken by STRATE are explained.

Rule and Directive-making process Regulation in STRATE is very important and Parliament has delegated, through the SSA, therule-making authority to the CSD. Furthermore, the Rules must be consistent with the SSA(section 39(1) of the SSA). The Rules must contain, as a minimum, the requirementsdetermined by the SSA (section 39(2) of the SSA). The CSD may also, with the approval ofthe Registrar, make Rules on additional matters. A practical example would be where STRATEobtained approval from the Registrar to issue Rules on the settlement of unlisted securities.

Directive is defined as a Directive issued by the SRO in accordance with its Rules. TheDirectives normally prescribe the detail or technical requirements for electronic settlementand other matters. STRATE endeavours to deal with ‘principle matters’ in the Rules and‘detail’ in the Directives.

The Rules are published in a Government Gazette as prescribed for public comment andapproved by the Registrar and therefore constitute subordinate legislation.

It should be noted that all Rules and Directives are binding on the CSD, a Participant, an Issuerof securities deposited with the CSD and their officers and employees, and clients (section39(4) of the SSA). The SSA prescribes the manner and process for making Rules in section 61of the SSA. This must be read together with the summary of the steps set out below.


Regulatory activities


Rule-making process Below is the sequence of events which allow for STRATE to make, amend or suspend Ruleswith the approval of the FSB.

Sequence Owner Activity SSA

Step 1 Head of Legal Following a consultative process, draft Rule in s30, 33, 36, 39conjunction with the relevant head of divisionbased on market requirement, best practiceor legislation.

Step 2 Head of Legal STRATE review internally.

Step 3 Head of Legal Head of Legal releases to appropriate market forum (eg Corporate Actions Forum, Bonds Settlement Workgroup, Systems Working Committee, Money Market Advisory Committee) for comments.

Step 4 Head of Legal Review and consider comments made. Amend where necessary.

Step 5 Head of Legal Re-circulate to market and set date for final comments.

Step 6 Head of Legal Complete approval form that details all steps above. Implications (financial, risk, legal, etc) spelled out.

Step 7 Head of Risk, Sign off on approval form.Head of Legal, Head of Supervision, Head of Internal Audit

Step 8 Head of Legal Submit approval form together with proposed Rules to Supervision division.

Step 9 Head of Supervision Submit Rule with approval form to STRATE Regulatory and Supervisory Committee to approve/reject/amend. Rules are only reviewed by the Committee before they are submitted to the FSB. The FSB is responsible for Rule approvals.

Rules may not be round-robined.

Step 10 Head of Legal In the case of a Rule, send to Financial Services s61(5)Board for publishing in Government Gazette for public comment.

Step 11 Financial Services Board 14 days for objections to Rule from date of s61(5)publication of notice.

Step 12 Financial Services Board If no objections received, and the Registrar s61(6)approves, the amendment or new Rule comes into operation on the date determined by the Registrar by notice in the Government Gazette.

Regulatory activities continued


Directive-making process Below is the sequence of events which allow for STRATE to make, amend or suspendDirectives.

Sequence Owner Activity SSA

Step 1 Head of Legal Following a consultative process, draft s30, 33, 36, 39Directive in conjunction with the relevant head of division based on market requirement, best practice or legislation.

Step 2 Head of Legal STRATE review internally.

Step 3 Head of Legal Head of division releases to appropriate market forum (eg Corporate Actions Forum, Bonds Settlement Workgroup, Systems Working Committee, Money Market Advisory Committee)for comments.

Step 4 Head of Legal Review and consider comments made in conjunction with relevant head of division. Amend where necessary.

Step 5 Head of Legal Relevant head of division to re-circulate to market and set date for final comments.

Step 6 Head of Legal Complete approval form that details all steps above. Implications (financial, risk, legal, etc) spelled out.

Step 7 Head of Risk, Sign off on approval form.Head of Legal, Head of Supervision, Head of Internal Audit

Step 8 Head of Legal Submit approval form together with Directive to Supervision division.

Step 8A Head of Supervision Authority is delegated to the Head of Supervision to approve Directives in certain limited definedcircumstances (eg fee schedule where board of STRATE has already approved it).

Step 9 Head of Supervision Submit Directive with approval form to STRATE Regulatory and Supervisory Committee to approve/reject/amend. The Committee’s Terms of Reference allow for a Round Robin Resolution for the approval of urgent amendments to existing Directives.

Step 10 Chairman of STRATE Formally approve/reject/amend at meeting of the Regulatory and Committee (the FSB is observer at this meeting). Supervisory Committee The Chairman must give prior permission to

approve Directives by means of a Round Robin Resolution.

Step 11 Head of Legal Send Directive with “Special Gazette” to all Participants, Financial Services Board, board members and STRATE management, all interested and affected parties indicating effective date of implementation.

Please refer to Appendix B for a full list of Directives approved (and implemented) by the Committee to date.


Regulation and supervisionThe SSA identifies the main objectives of securities regulation and supervision namely:• Increasing the confidence in the South African financial markets by;

– requiring that securities services be provided in a fair, efficient and transparentmanner; and

– contributing to the maintenance of a stable financial market environment. • The protection of regulated persons and clients. • The reduction of systemic risk.• Promoting the international competitiveness of securities services in South Africa.

Regulation and supervision of the Equities and Bonds environments The scope of STRATE’s regulatory and supervisory responsibilities has been depicteddiagrammatically in the Regulatory Pyramid. The pyramids and explanatory notes depict andexplain the roles and responsibilities of those institutions and organisations involved inEquities and Bonds trading, clearing, settlement and custody functions including inter alia,transfer secretaries, Nominees and securities lending and borrowing Business Partners. Itsummarises the extent of STRATE’s regulatory and supervisory responsibilities in terms ofthese two environments.

Please refer to Appendix C for copies of the pyramids and their relevant explanatory notes.

Regulatory ControllingBodyvia

Chairman

Ombudsmanfor investors

Setting of detailedRules and issuing

of Directives

Supervisory

STRATE AS REGULATOR

Monitoring of ParticipantsCompliance

Internal processesEnsuring “level playing field”

Regulatory activities continued


Regulation and supervision of the Money Market environment The introduction of dematerialised custody and settlement of Money Market securities bySTRATE in 2006 will introduce a new category of Participant, namely the CorporateParticipant.

An entity which administers not only their own securities but also the securities of thirdparties, ie clients, is known as a “Full Participant”.

An entity which uses its participant status exclusively for the administration of their ownsecurities is known as a “Corporate Participant”.

In terms of the SSA, STRATE is responsible for supervising compliance by Participants – thisincludes Full and Corporate Participants. The Rules and Directives apply equally to theseentities.

Appendix C includes the Money Market Regulatory Pyramid and provides an explanation ofthe entities and structures which apply in this environment.

Other Money Market players which will interact with STRATE, but which are not regulated bySTRATE include:• Transfer Secretaries/Registrars• Securities lending and borrowing desks• Issuers• Issuer Agents• Traders

Regulatory and supervisory approach and componentsThe objective of the approach is maintaining market confidence, reducing risk, protectinginvestors, and providing a secure environment to encourage investment.

Regulation, supervision and enforcement include the following:• Legislation framework and specific regulation governing the activities of Participants• Rules and Directives set by STRATE• Entry criteria • Monitoring and supervision by the regulator• Disincentive structures• Disciplinary procedures• On-site visits and audits• The role of market discipline, monitoring and reputation

The STRATE regulatory and supervisory strategy is about optimising the combination of thesecomponents. The key is to optimise the effectiveness of this mix. All components arenecessary but none alone is sufficient. The mix will change over time and depending ontransgressions, heavier reliance will be placed on particular components than others.

STRATE has laid down fairly precise regulatory and legislative requirements that are applieduniformly to all Participants. In terms of this, STRATE has set down a clear set of objectives.Each Participant has to demonstrate to STRATE how these objectives are to be met by itsown internal procedures. The Participant has to meet agreed standards and procedures and,if not, STRATE can act in terms of the disciplinary procedures as detailed in the Rules.


Supervision

Regulatory intensity refers to the degree of detail and prescription and the extent to whichthe behaviour of the regulated person has to be modified by the regulatory agency. Theregulation of Participants normally entails medium to high intensity regulation – high insome instances, eg acceptance procedure of Participants, with low intensity supervision thatescalates whenever needed. This combination proves suitable for the South African market.

Co-operation in regulation and supervision / MOUs A co-regulatory environment exists within the securities industry. Authorised Users can belicensed with both exchanges and at the same time are effectively clients of Participantsaccepted by the CSD. Participants may be banks regulated by the Bank SupervisionDepartment of the SARB.

Inter SRO co-operation and consultation between the exchanges, SARB, FSB and STRATESupervision is being established. Memoranda of understanding have been signed betweenSTRATE Supervision and the JSE, BESA and SARB. These MOUs enable the exchange andsharing of information.

In this section of the report we set out the risk-based approach adopted by STRATESupervision and explain some of the tools utilised in performing our supervisory function.

Participants Participants are defined in the SSA as “a person that holds in custody and administerssecurities or an interest in securities and that has been accepted in terms of section 34 bya central securities depository as a participant in that central securities depository”.

STRATE has accepted and supervises seven Participants to hold Equities and Bondssecurities in the CSD.

The current Equities Participants are: The current Bonds Participants are:Absa Bank Limited Absa Bank LimitedComputershare Limited FirstRand Bank LimitedFirstRand Bank Limited Nedbank Limited Nedbank Limited The Standard Bank of South Africa LimitedSociété Générale Johannesburg Branch South African Reserve BankThe Standard Bank of South Africa Limited

Please refer to Appendix D for details regarding the value of assets under custody for each Participant as at31 December 2005.

Supervisory approach and strategy STRATE Supervision strives to build fair and credible supervisory processes consistent withlow to medium intensity supervision referred to above. STRATE aims to apply and enforce itssupervisory approach consistently.

Supervision continued

Risk-based supervision Extensive work was conducted during the past few years to identify and fully understand thescope of STRATE’s supervisory responsibilities and the ambit of regulatory risks. This hasresulted in the development of the Regulatory Pyramids mentioned above, a comprehensiveRegulatory Risk Summary and specifically the development of a variety of supervisory tools.These tools are defined as the sources of information used by the Supervision division toidentify, manage and mitigate the various regulatory risks.

Participant Performance Monitoring ModelThe supervisory tools include, inter alia, information received by the appointed STRATECompliance Officers, external and internal auditors and most importantly, informationextracted from the STRATE settlement systems. The information is collated on a monthlybasis into what is known as the Participant Performance Monitoring Model (PPMM).

Obtaining a regular and consistent understanding of the risk profile of the Participant isimportant. The PPMM incorporates a broad spectrum of information gathered on theperformance of a Participant including for example the number and frequency of settlementtransgressions (ie penalties); outstanding client mandates and imbalances in their record-keeping. This information is risk weighted and scored in terms of pre-determined scales.Implementation of this model has enabled the Supervision division to monitor and trackParticipant performance using an objective, risk-based method. Low scores would indicateareas of concern or weakness which need to be addressed.

Compliance OfficersSTRATE Compliance Officers play a vital role and are a key supervisory tool. MonthlyCompliance Officer Forums are held to discuss, debate and share knowledge on new Rulesand Directives or amendments, changes to operational procedures or new market practices.The structure that is being supported is one which cultivates the independence of theCompliance Officer role and one which encourages their performance as STRATE’s “eyes andears” within their respective organisations. The roles and responsibilities of the ComplianceOfficer in terms of the Rules requires daily review, monitoring and investigation andimmediate notification to STRATE Supervision when errors or transgressions are evident.

On-site visitsThe on-site programme was developed as a proactive supervisory tool and was implementedduring 2005.

Generally the findings of the on-site visits have evidenced robust and strict controlenvironments within the Participants. Staff and management have shown high levels ofknowledge and skills. Such weaknesses as were disclosed related to the need for higherlevels of management oversight or the implementation of stricter systems controls.

SAICA guidelinesDiscussions with the South African Institute of Chartered Accountants (SAICA) commenced in2003 with a view of stipulating and standardising the audit reporting to STRATE by the externalauditors of Participants. A working committee was formed to draft the STRATE SAICAguidelines which were eventually approved by SAICA and the Controlling Body in August 2003.

The guidelines have been amended following the promulgation of the SSA.


21

ComplaintsInvestor complaints are received directly or via the FSB. The nature of such complaints coverissues surrounding service fees, statements and corporate action entitlements. A total ofseven complaints were received during 2005.

The only complaints that have been lodged to date have been from private investors.Notwithstanding this, STRATE Supervision can confirm that Participants have alwaysresponded timeously and resolved all complaints to the satisfaction of the investor concernedand STRATE Supervision.

Chinese Walls STRATE identified the need for Chinese Walls during the latter half of 2005. A concern hasbeen expressed about the independence of STRATE Supervision and the conflict of interestwhich could arise between STRATE the CSD and STRATE in its capacity as a SRO.

What are Chinese Walls?Chinese Walls are invisible walls between business units within a single company to preventconflicts of interest when two or more units serve or deal with the same client. It is thesystem of policies, procedures and physical arrangements used to manage confidentialinformation and prevent the inadvertent spread and/or misuse of such information to thedetriment of a business unit or such client.

The operation of Chinese Walls at STRATEIn the case of STRATE such business units are better described as the roles which STRATEis obliged to perform, firstly operating as South Africa’s CSD and secondly, acting as a SROand performing a regulatory function over registered Participants. The clients are registeredParticipants (and in some cases shareholders) who fear that STRATE could abuse theinformation received in the capacity of SRO. It is important that STRATE does not, and isseen not to, abuse its power as a SRO to achieve a competitive advantage over the parties itregulates. No evidence of such abuse has been identified to date.

STRATE’s role as a SRO and that of a CSD providing securities services are clearly ring-fenced from one another. STRATE uses Chinese Walls to segregate confidential and materialinformation obtained from or relating to the performance of Participants.


consistency is key


The following steps were taken to establish the Chinese Walls:

Corporate Governance The Terms of Reference of the STRATE Regulatory and Supervisory Committee have recentlybeen amended to place an obligation and duty on the members to monitor the workings ofthe Chinese Walls.

Paragraph 2.15 of the Terms of Reference states, “The Committee will . . . monitor theworkings of the Chinese Walls between STRATE’s roles as CSD and regulator and obtainannual external assurance that independent structures, policies and procedures remain inplace.”

Paragraph 3.6 of the Terms of Reference states, “. . . any member or observer must recusehimself/herself from a meeting when findings of a confidential nature relating to a CSDparticipant are discussed and he/she could be faced with a conflict of interest.”

The CEO of STRATE is no longer a member of this Committee, no longer has a vote and onlyattends meetings in an observer capacity. Likewise, members of the STRATE Manco can onlybe invited to meetings in an observer capacity. STRATE’s CEO and management cannotoverrule or veto regulatory or supervisory decisions or alter the supervisory strategy.

Where specific Participant-related matters are raised and discussed, any person having aconflict of interest (eg representing a specific Participant, being a market practitioner, theCEO or STRATE Manco member) is asked to recuse himself/herself from such meetings.Minutes of meetings circulated to such persons exclude confidential information, aresanitised and non-public and material information removed.

LocationChinese Walls are designed to stem the flow of information between different parties.A Chinese Wall can involve physical separation (eg occupancy of a different building),restrictions on physical access, separate files and records, and controls overcomputer access.

IT and access controlSanitisation takes the form of preventing the discovery and spread of non-public and materialinformation relating to the performance and activities of the Participants. Separate foldersand files have been created on the STRATE shared network, which can only be accessed bymembers of staff working in the Supervision division. Further, a variety of documents andrecords including Participant performance models, databases and statistic summaries, areall password protected.

Code of conduct and confidentiality Chinese Walls are designed as a set of rules, practices and business ethics that govern theobligations of confidentiality and loyalty to clients. To build such a wall effectively, the wallmust be based on rules that are both binding and enforceable.

In terms of STRATE Rule 4.4, “ . . . the CSD (including its officers and employees) mustkeep confidential all information disclosed to it by a Participant . . . ”


23

All STRATE staff are required to sign a code of conduct which includes a confidentialityclause. Staff working within the Supervision division are further assessed and measured intheir Balance Score Cards (BSC – internal performance measurement tool) on theiradherence to the confidentiality clause. The supervision staff are constantly reminded toobserve the highest professional standards and are given clear guidance on the avoidance ofconflict of interest, the possible uses of confidential information, the observance ofconfidentiality and secrecy, and the observance of procedural fairness.

Performance appraisals of the Head of Supervision is conducted jointly between the CEO ofSTRATE and the chairman of the STRATE Regulatory and Supervisory Committee. The Headof Supervision conducts the performance appraisals of supervision staff. The independentboard sub-committee, the Remunerations Committee, determines and sets compensationand bonus structures of supervision staff.

Financial considerations In terms of the SSA, STRATE’s licence as a CSD includes its SRO responsibilities.Notwithstanding this, a core initiative stated on the Supervision division Balance Score Cardis financial independence. The cost of performing STRATE’s supervisory function must becovered from the annual membership fees and fines levied on Participants.

STRATE Supervision has chosen to undertake numerous educational programmes andtraining initiatives within the market. Such training is provided by STRATE in its SROcapacity and the revenue derived from such examinations, lectures and seminars is alsoallocated to the Supervision division.

Reporting lines The Head of Supervision is not a member of the STRATE management team. The Head ofSupervision attends Manco meetings as an observer. Participant supervisory matters are notraised under the Manco agenda or discussed at these meetings. Supervisory matters andfindings are reported through to the STRATE Regulatory and Supervisory Committee ordiscussed with the Committee Chairman and the FSB. Similarly the Head of Supervision andmembers of the Supervision division attend STRATE operational forums and meetings in anobserver capacity.

Attendance at meetings is made for the purposes of gaining an understanding of theworkings of the different settlement and operational models and functionality. In this waySTRATE Supervision can, inter alia, determine the supervisory strategies required for theeffective and appropriate monitoring of compliance by Participants to such procedures, theRules and Directives.


consistency is key


Participant failureSecurities settlement systems (SSS) are a critical component of the infrastructure of thefinancial markets.

A financial or operation problem at any of the institutions that perform critical functions inthe settlement process could result in significant liquidity pressures or credit losses for otherParticipants and investors. Any disruption of securities settlements has the potential to spillover to the payment systems used by the SSS.

STRATE has therefore commenced with a project to define the procedures (both settlementsand client migration related) to be adopted in the event of a Participant failure. Numerousworkshops have been held with key stakeholders with a view to finalise a procedure manualcovering the procedures to be followed to ensure that:• settlement proceeds with minimal disruption; and• securities belonging to clients of a failed Participant are migrated to a new service

provider as soon as possible to reduce price risk.

It is important to note that STRATE has no regulatory or supervisory responsibility for thecash settlement component of any transaction, nor is STRATE responsible for any cash heldby a Participant. With regard to the cash settlement component of any transaction, the bankParticipants (as well as third-party banks, in the case of a non-bank Participant) areregulated by the SARB under the Banks Act, 1990 and the National Payments Act, 1998.On the occurrence of a Participant failure, STRATE only facilitates the delivery of securities.Insofar as the cash settlement leg of any transaction is concerned, SARB would be therelevant regulator.



consistency is key

Beverley BrazierBev holds a BCom from the Universityof the Witwatersrand. After obtainingher degree and majoring in Finance,Insurance and Risk Management, Bevjoined Heritage Financial Services in1993 working in the short-terminsurance field. After holding theposition of national personal linesmanager she left Heritage and joinedFirst National Bank Custodial Servicesin 1999 as manager of theregistrations department. Within threemonths Bev was appointed as thebusiness project manager for STRATEresponsible for documenting anddeveloping the business requirementsspecifications for FNB CSDPsintegration into STRATE. Bev managedthe STRATE project team responsiblefor the testing and successfulimplementation of phase one ofelectronic settlement of securities atFNB.

Bev left FNB in April 2001 to have herfirst child and joined STRATE asmanager of compliance in October2001. Bev was appointed as Head ofSupervision in 2002 when theControlling Body decided to create aseparate regulatory arm and form theSupervision division.

Beverley MuirBev matriculated from Northcliff Highin 1992 and completed her tertiaryeducation at RAU (currently known asthe University of Johannesburg) in1998 where she obtained her BCom(Law) and BProc.

She joined First National BankCustodial Services in 1999 andbecame part of the STRATE projectteam. Bev then took on a trainingrole within the CSDP, ensuring thatall staff were familiar with thenew electronic settlement marketprocesses and procedures. Shethereafter joined Standard Bank(Financial Asset Services) in 2001 astraining manager.

She left Standard Bank at the end of2002 and joined STRATE Supervisionin January 2003. Bev passed the RPEexams in 2005 and is currentlycompleting an LLB through Unisa.

Caren MunzerCaren matriculated from The Hill HighSchool in 1996 and in 1997 startedworking in the banking industry. Shejoined UNEXcor as a business supportconsultant and studied IT web designpart time obtaining a CIW professionalcertification. She joined STRATE withthe UNEXcor/STRATE merger in 2003and joined the STRATE Helpdesk.Caren then wrote the STRATEcompliance examination and joinedSTRATE Supervision in July 2004.

Profiles of the STRATE Supervision divisionThe department comprises three staff members. A brief profile of each member is providedbelow.

Enforcement

TransgressionsTo date the transgressions by Participants have primarily related to:• non-adherence to settlement time parameters (and then very often as a result of the

underlying client not conforming);• outstanding client mandates or mandates which do not contain the provisions prescribed

in the Rules; • weaknesses in internal controls (eg lack of management oversight and segregation

of duty); and• imbalances between Participant dematerialised holdings and their STRATE holdings.

Whilst there have been areas of non-conformity, there has never been an instance where aParticipant has failed to resolve the discrepancy or implement corrective action. At timesmilestones were set for Participants to achieve the desired performance. All milestones havebeen achieved by the applicable Participants.

PenaltiesPenalties in general seek to punish undesirable behaviour and thereby promote desiredbehaviour. The form and level of penalty applied will depend on its purpose, as well as onthe area of activity, the type of wrongdoer, the nature of the wrongdoing and importantly, therisk introduced by such a transgression.

In terms of section 61(10)(a) of the SSA, the SRO may impose any one or more of thefollowing penalties:• a reprimand;• censure;• a fine not exceeding R5 million;• suspension or cancellation of the right to be a Participant;• a restriction on the manner in which a Participant may conduct business or may utilise an

officer, employee or agent; and• the payment of compensation to clients prejudiced by the contravention or failure.

STRATE has passed penalty schedule Directives which detail the settlement related actionsor activities on the part of Participants which constitute a transgression and the associatedmonetary fine imposed for such conduct. Transgressions would include, inter alia, failure toreport trades for settlement or fund the cash associated with settlement, within thesettlement operational windows and timelines.

Please refer to Appendix E for a summary of the nature and extent of Participant transgressions during the2005 year.


27

ExaminationsSTRATE is committed to educating individuals working in the custody and settlement areas ofthe securities industry. All training and education initiatives fall under the Supervision division.

In terms of the Rules, the Compliance Officer of a Participant is required to pass a complianceexamination prescribed by the Controlling Body. The Supervision division manages thiscompliance programme, schedules and conducts the prescribed examination. An Equities andBonds module has been implemented and a Money Market module is to be implementedduring 2006. To date 62 people have successfully passed the compliance examinations.

These examinations are not limited to members appointed as STRATE Compliance Officers,but are open to all candidates interested in obtaining STRATE accreditation.

STRATE supports the Continuous Professional Education (CPE) principle. During 2005STRATE launched a series of one-day seminars, the purpose of which is to provide up todate, continuous training on STRATE specific functionality, procedures and legislation. Allparties, whether they have written and passed the STRATE compliance examination or not,are encouraged to maintain a high level of theoretical STRATE knowledge by attending theseseminars.

STRATE has introduced the STRATE Compliance Officer (SCO) and Alternate ComplianceOfficer (ACO) accreditation programme. The objective of an “annual points system” is toacknowledge those SCOs and ACOs that maintain high levels of understanding, knowledgeof, and participation in, STRATE market developments.

Please refer to Appendix F for additional graphical representations of candidates who have written the Equitiesand Bonds STRATE compliance examinations.


consistency is key

Training and education

Training and education continued

Circulars STRATE Supervision also produces an ad hoc regulatory/compliance newsletter toParticipants. The STRATE INFORMA aims to provide STRATE Compliance Officers withinteresting articles and information about compliance related matters.

The following STRATE INFORMAs have been released:• Business continuity and disaster recovery planning – “a little risk management saves a lot

of fan cleaning” – June 2003• Conflicts of interest for compliance officers – March 2004• Interdependency – July 2004• The purpose and effectiveness of penalties – September 2004• The “training responsibility” of a compliance officer – January 2005• The compliance function – March 2005• Newspaper article: Failure to report criminal acts by staff is a crime – May 2005• The compliance officers’ checklist to UST and SLB – August 2005• Newspaper article: Whistle-blowers need protection and incentives – December 2005



consistency is key

Conclusion and outlook – Future challengesSTRATE Supervision has established a regulatory and supervisory regime that is workingeffectively.

It is pleasing to report that there is a high level of adherence by the Participants to the SSA,Rules and Directives.

In addition to its ongoing regulatory and supervisory functions, the Supervision division willbe addressing and concentrating its efforts on the following key areas:• Approve new Participants (mainly the implementation of an electronic Money Market).• Clarify STRATE’s role with respect to the approval of Nominees.• Ensure that Chinese Walls continue to operate effectively.• Continue with the project to define and set procedures for the scenario of a Participant

failure.• Assist with the re-writing of the Directives to comply with the requirements of the SSA.• Promote a better understanding of the regulatory and supervisory roles that STRATE

performs.• Implement a training programme and examination module for Money Markets.

A – STRATE Regulatory and Supervisory Committee – Summary of attendance

20 January 9 February 23 March2005 2005 2005 7 June 21 June

Special Special Special 2005 2005purpose purpose purpose Special Special

Participant Directive 14 March Participant 11 May purpose purpose 10 August 14 Octoberimbalances approvals 2005 imbalances 2005 CSD Rules CSD Rules 2005 2005

MembersR Cottrell Y Y Y Y Y Y Y Y YB Johnston Y Y Y Y Y Y Y YN Payne Y Y Y Y Y YS Yates Y Y Y Y Y Y YM Singer Y Y Y Y Y

ObserversFSB Y Y Y Y Y YS Davies– JSE Y YG Greubel– BESA Y Y (alt) Y YM Singer Y

InvitationS Zilwa Y

* Note: M Singer is no longer a member of the Committee – only an observer


Appendices


consistency is key

B – STRATE Directives

SAA Application Form for CSD Participation – Form S1SAF STRATE Membership and Transaction Fees SAJ STRATE Compliance Officer AppointmentsSBA Dematerialisation Business ModelSCB Special circumstances for the reversal of the commitmentsSCC Operational Market WindowsSCD Rule 6.9 – List of Depository and Clearance SystemsSCE Same Day SettlementSCL Tolerance LevelSCP Penalty Schedule 1SCP Penalty Schedule 2 SCV Best Practices for Off-Market TradesSDA Statement in terms of Rule 7.3.2.6SDB File Layout for disclosure of beneficiary

ownership (Beneficiary Download) SDC Client Acceptance Procedure in terms of Rule 6.3.2.6SDD “Own Name” Client

Annexure A – Own Name Client DirectiveSDJ Processing of Corporate ActionsSDK Proxy Voting Procedure in respect of Foreign Listed CompaniesSDV Proxy Voting Procedure

SAN Nominees

SEA Yield-X

SFA Best Practices for Bonds OTS TradesSFB Penalty Schedule 1 – Based on Directive SFA “Best Practices for

Bonds OTS Trades”SFC Bonds Fees

C – Regulatory Pyramids and Notes


Pyramids and notes

*MOUs between co-regulators

Equities

ABSA

SARB*

SBSA FNBM

SOC GEN

STRATE*

NEDC COMPTSHARE

BP

BP

JSE*

FSB*

* MOUs between co-regulators

Bonds

Custody

Settlement of securities

FSB*

STRATEBESA*

JSE*

33

Regulatory and Supervision Pyramid (Equities)


consistency is key

FSB

STRATE MOU

MOU

JSE

Controlling Bodyand Committees


Assu

ranc

e

ComplianceOfficers

Management/staff

ComplianceOfficers

Management/staff

Internal audit Internal audit

External auditors External auditors

Authority and responsibilityfor regulation

SROs^^STRATE relies on co-operation

with other SROs

The regulatedentity

SARB*

# for the purposeof settlementassurance

* SARBregulatescash only

Participants

Settlement

SLB LendingDesks Business

Partners

Nominees(local)

SSA 36(1)(b)

TransferSecretaries

IssuersAuthorised Users

Clearing#

Trading

CustodyCustodyJSE Listings

Pyramids and notes continued

Regulatory and Supervision Pyramid (Bonds)


FSB

STRATE MOU

MOU

BESA



Assu

ranc

e

ComplianceOfficers

Management/staff

ComplianceOfficers

Management/staff

Internal audit Internal audit

External auditors External auditors

Authority and responsibilityfor regulation

SROs^^STRATE relies on co-operation

with other SROs

The regulatedentity

SARB*

* SARB

regulates

cash only

Participants

Settlement and custody

SecuritiesLending andBorrowing

Nominees

SSA 36(1)(b)

TransferSecretaries

Issuers(Underwriting bank/

Lead manager)

Authorised Users

Trading

CustodyClearingBESA Listings

35

Regulatory and Supervision Pyramid (Money Market securities)


consistency is key

Full Participant = administer their own MM securities and securities of clients

Corporate Participant = administer their own MM securities only

Trader = no formal exchange

exits. Traders report trades

for clearing and settlement

SLB = facilitating the

lending and borrowing

of MM securities

Issuer Agent = Issue MM

securities on behalf of Issuer

who appoints them

Issuer = • Issue MM securities

• Must appoint, but can be their own Issuer Agent

• Responsible for coupon and maturity payments

Transfer Secretary =

Act as agent of Issuer

Money Marketplayers who will

interact withSTRATE, the CSD, but who will notbe regulated by

STRATESupervision

SettlementBank = fund

paymentstreams at theCentral Bank

SARB

STRATE Supervision

SARB BankingSupervision

FSB


FSB responsibilitiesThe FSB (which is at the apex of each pyramid) is, inter alia, responsible for supervising andregulating the financial markets other than the function of accepting deposits from thegeneral public. This is achieved by, inter alia, the use of SROs which currently include theJSE, BESA and STRATE.

An SRO in terms of the SSA means “an exchange or a central securities depository”.Section 5(2) of the SSA stipulates that “the Registrar must perform functions assigned tothe Registrar by or under this Act and must supervise compliance with this Act by everyregulated person”.

The FSB is an independent institution established by statute (Financial Services Board Act,1990) to oversee the South African financial services industry with the exclusion of thefunction of accepting deposits from the general public. The FSB became operational on1 April 1991, and is financed by the financial services industry itself by means of levies,with no contribution coming from government. The FSB aims to foster an efficient regulatoryframework, which reflects a sound balance between statutory control and self-regulation.

Principle 7 of the IOSCO principles states: “SROs should be subject to the oversight of theregulator and should observe standards of fairness and confidentiality when exercisingpowers and delegated responsibilities.”

The IOSCO recommendation of oversight is enshrined in the SSA. The oversight by theRegistrar is applied to the SRO in a strict, fair and effective way. It is widely accepted thatthe basic principle of self-regulation could be undermined by too much oversight. Where aSRO is appointed and licensed, there is no direct supervision of its AuthorisedUsers/Participants by the FSB. However, the FSB does supervise compliance with the SSAby every regulated person (s5(2)).

Powers of intervention and inspection For practical reasons, the regulatory arrangements by the Registrar do not place strongemphasis on formal supervision other than on SROs and Clearing Houses. Compliance by theAuthorised Users/Participants with the SSA, Rules and Directives of the relevant SRO, is notdirectly supervised by the FSB and will be driven mainly by complaints by investors andothers as well as by the application of sanctions for non-compliance with the Rules.

The FSB has powers to investigate or conduct an inspection on any matter where it receives acomplaint, charge or allegation, or if the FSB has reason to believe that a person who providessecurities services is contravening or is failing to comply with any provision of the SSA (s93(1)).This means that the CSD is not only bound by its own Rules, but must also enforce them.



consistency is key

Drastic measures can be taken against the SRO where it fails its duties as a SRO. After aninvestigation or inspection, the Registrar is authorised to:• apply to court for the winding-up or judicial management of the SRO;• apply to court for the appointment of a curator;• direct the SRO to take any steps to remedy the irregularity;• direct the SRO to prohibit or restrict specific activities of a director or other officers if the

Registrar believes that the person is not fit and proper to perform such activities;• refer the matter to the Enforcement Committee; and• hand the matter over to the National Director of Public Prosecutions where the

contravention or failure is an offence in terms of the SSA (see s94).

The Registrar has the power to impose penalties in the case of any failure by a SRO to submitto the Registrar any statement, report or other document as required in terms of the SSA (s95).

Enforcement powers It is important to understand that the role of the CSD as a SRO is balanced by the fact thatit is a “regulated person” in terms of the SSA. The FSB has comprehensive enforcementpowers over STRATE:• The Registrar may refuse to renew the CSD licence (s50(1)). This sanction is very powerful

as STRATE realises that the CSD business is its core business.• On refusal of the licence, the Registrar may take such steps as are necessary to achieve

the objects of the Act (s2), which steps may include the transfer of the business toanother similar SRO or the winding-up of the SRO in terms of s107 (s50(3)). Thissanction could also be very powerful as a new CSD could be licensed and the existing CSDclosed down.

• The Registrar can also refer a matter to the Enforcement Committee in terms of (s94(e))of the SSA. This Committee acts independently of the Registrar and gives the Registrarmore effective enforcement powers.

SARB responsibilitiesThe SARB performs multiple roles, namely:• The Bank Supervision Department of the SARB is responsible for the regulation and

supervision of banks, especially the prudential supervision thereof. Five of the existingParticipants are banks. As such a co-regulatory environment exists between STRATE andthe SARB in so far as bank Participants are concerned. A MOU was signed betweenSTRATE and the SARB in July 2004. This serves as the agreement by whichregulatory/compliance information on relevant prudential issues is shared between SARBand STRATE.

• SARB is also responsible for the payment and settlement system (SAMOS) operated forthe banks in the clearing system.


Exchange responsibilitiesThe JSEThe JSE is responsible to the FSB for the supervision of Authorised Users, including theaccounting, trading and custody activities. In turn the Authorised Users use Participants fortheir settlement activities. STRATE has no regulatory or supervisory responsibility forAuthorised Users. The JSE and STRATE in their roles as SROs do, however, have a need toexchange information relevant to their respective regulated entities. A MOU, which wassigned on 13 October 2003, recognises the co-regulatory relationship that exists betweenthe JSE and STRATE.

BESABESA is responsible to the FSB to generally govern, control, manage and regulate the affairsof the Bond Exchange and its Authorised Users and to maintain an orderly market for tradingin securities.

To the extent that Authorised Users are clients of a Participant and the STRATE Rules arebinding on clients, a co-regulatory environment exists between STRATE and BESA. A MOUwas signed between STRATE and BESA in October 2004. This serves as the agreement bywhich regulatory/compliance information pertaining to relevant regulated entities is sharedbetween BESA and STRATE.

STRATE responsibilitiesSince all but one of the Participants are banks, the prudential regulation and supervision ofthe bank Participants is performed by SARB. For bank Participants, STRATE’s regulatoryscope is confined to functional regulation, ie Participant related activities of an acceptedentity. The STRATE/SARB MOU, mentioned above, serves as the agreement by whichinformation is shared on relevant prudential issues between SARB and STRATE. Accordingly,STRATE will not duplicate the activities of SARB in this regard.

However, the prudential regulation of non-bank Participants (eg entities such asComputershare Limited) requires increased involvement by STRATE as these entities do notfall within the SARB regulatory net.

In respect to the Bonds environment, STRATE is the appointed Clearing House (previouslyUNEXcor).

STRATE is licensed as a CSD for the maintenance of immobilised and dematerialisedsecurities holdings.

The Regulated EntityThe body of the pyramid depicts the flow of information to and from the various parties withregard to Rules, Directives and legislation. The roles performed by various parties vary withregard to the making and updating and implementation of Rules and Directives and thesupervision thereof. These are depicted in the downward direction. The upward directiondepicts the flow of information from regulated entities to those involved in the supervisionof such entities.


39

Controlling Body and its CommitteesIn respect of STRATE, the Controlling Body is responsible for the following five activities: • The legislative function. • The enforcement function. • The gatekeeping function.• The policing function. • The investigation function.

The Controlling Body has delegated certain functions to the STRATE Regulatory andSupervisory Committee to which STRATE Supervision has a reporting function.

Generally, the Controlling Body is responsible for the performance of the entity. GoodCorporate Governance should be fostered for a number of reasons. A primary need is thatpoor governance can harm economic performance and ultimately effect financial stability.This is because poor Corporate Governance structures lead to poor decision making. Weakprocesses and ineffective procedures and controls prevent early warning signs appearing andhence highlighting deteriorating conditions within an organisation. Transparency andaccountability attracts new business – it gives financial incentive to the investingcommunity. In order to attract and retain large pools of capital from investors, there needsto exist credible and recognisable Corporate Governance arrangements.

Weak Corporate Governance undermines confidence in a financial system and market as a whole.

Compliance OfficerCSD Rule 8.3.1 requires the appointment of a qualified Compliance Officer by eachParticipant accepted by STRATE. The STRATE Compliance Officers’ duty is to ensurecompliance with the provisions of the legislation, Rules and Directives and to report breachesto STRATE. They must have sufficient support and authority from their organisation todischarge this duty.

Management and staffThe staff of STRATE must have the necessary skills and training strategies to ensure they areable to discharge their responsibilities. Staff of the Supervision division also requirejudgement to balance their supervisory responsibility without creating a prescriptive regime.They must act with professionalism and empathy but with an appropriate sense of urgencywhen needed.


consistency is key


The Regulated Entity continuedManagement and staff continuedWith regards to the management and staff of the Participant, adequate levels of training andexperience must exist to be able to discharge their responsibilities. In addition, managementshould embrace values, ethics and relationships with their staff and stakeholders, whichpromote good corporate governance.

The STRATE Rules stipulate the eligibility criteria of Participants and include a requirementto have competent and experienced management and staff.

On an annual basis the directors of a Participant, in their annual report to STRATESupervision, are required to confirm that their organisation has competent staff. STRATE asa SRO does not determine what constitutes “adequate and skilled personnel” – this is aresponsibility of the Participant’s management.

Internal and external auditParticipants should have an effective internal audit function which has sufficient authorityand competence to justify reliance being placed on its work. The programme of work shouldcover the custody function of the Participant at least annually. Reports on their findingsshould be made available to STRATE Supervision.

STRATE in its role as a SRO does not currently require the submission of internal auditreports of a Participant. The Rules do, however, give STRATE Supervision the power to callfor these reports if required.

External audits complement the work of internal audit. By agreement with the South AfricanInstitute of Chartered Accountants (SAICA), specific audits are carried out which provideassurance to the Supervision division. The scope of these audits and the nature of thereporting requirements have been agreed with STRATE Supervision.

The Base of the PyramidThe bottom line of the pyramid shows entities in the securities industry, whether regulatedor not.

ParticipantsThe SSA defines a Participant as “a person that holds in custody and administers securitiesor an interest in securities and that has been accepted in terms of section 34 by a centralsecurities depository as a Participant in that central securities depository.”

In terms of the SSA, STRATE must supervise compliance with the SSA and Rules byParticipants. Participants must comply with STRATE’s Rules and Directives and must ensurecompliance by their clients. Participants in turn should advise their clients of the latter’sobligations in terms of the Rules.

STRATE Supervision has developed a supervisory programme for the Participants.Enforcement and disciplinary strategies have also been developed if any Participant fails toact in accordance with the Rules and Directives.


41

Securities lending and borrowing (SLB)The SLB industry is unregulated. Accordingly the activities of SLB lending desks do not fallwithin the ambit of STRATE’s regulatory or supervisory responsibility.

However, SLB lending desks in the Equities environment have contractually boundthemselves as Business Partners to STRATE with respect to the settlement of SLB trades.Compliance with these contractual obligations will be monitored and corrective action takenif necessary. Unlike Equities, no formal lending desks (Business Partners) exist in the Bondenvironment.

Nominees In terms of section 36 (1)(b) of the SSA:“A nominee of a Participant, or any other nominee who has an account with a Participant,must be approved by the central securities depository in terms of depository rules.”

STRATE is responsible for the approval of Nominees, not for the direct regulation of suchentities.

STRATE has issued Directive SAN which details the requirements imposed by STRATE forNominees to operate in the STRATE environment.

Transfer SecretariesThe transfer secretarial industry is unregulated. STRATE cannot therefore issue a Rule orDirective that imposes duties on a transfer secretary. Transfer secretaries, in so far as theyare acting as agent of an Issuer, must also comply with the JSE or BESA listing requirementsand STRATE eligibility requirements.

IssuersIssuers are regulated by the exchanges to the extent that their listing requirements imposeresponsibilities on Issuers. A section has been included in the JSE listing requirementswhich refers to eligibility to operate in the STRATE environment. STRATE must ensurecompliance therewith before accepting the Issuer’s securities for dematerialisation.

The diagrams further depict the co-regulatory environment where MOUs form the basis ofmutual co-operation and sharing of information. It is essential to avoid duplicating or over-regulating the market.


consistency is key


D – Assets under custody per Participant

The value of assets under custody administered by Participants is shown in the table below:

Equities holdings Bonds holdingsas at as at

31 December 2005 31 December 2005Participant R million R million

Absa Bank Limited 297 377 85 661Computershare Limited 210 628 –FirstRand Bank Limited 268 143 51 257Nedbank Limited 976 276 115 143Société Générale Johannesburg Branch 57 935 –The Standard Bank of South Africa Limited 1 090 364 283 329South African Reserve Bank – 57 157

E – Fines 2005


Category Equities transgressions

Late reported 65%

Same day 2%

Less than T+5 13%

Exceeding max settlement cycle 2%

Late committed 16%

Overdue 0%

ATF/PM versus payment 1%

ATF/PM “CBO” 0%

Late funding 0%

Improper conduct 0%

ATF/PM between LDT+1 and RD 1%

Gridlock 0%

Category Bonds transgressions

Late reported 98%

Extending SD window 2%

Unauthorised exclusions 0%

Late submission of settlement lists 0%

Late committed 0%

Late funding 0%

F – STRATE examinations

STRATE Compliance Officers

CSDP 44%

Audit 5%

STRATE staff 23%

Other 5%

Banking 16%

Legal 2%

IT 5%

Examination candidates

Bonds 21%

Equities 79%


consistency is key

Notes

Notes continued


G R A P H I C O R 3 4 0 1 1

consistency is key

1st Floor, 9 Fricker Road, Illovo Boulevard Illovo, Sandton, 2196, South Africa

PO Box 78608, Sandton, 2146

Tel: +27 11 759 5300 Fax: +27 11 759 5500E-mail: [email protected]

Internet: www.strate.co.za

First Edition 2006


Documents

Regulatory and Supervisory Report - Strate · Internet: First Edition 2006 Regulatory and Supervisory Report . Contents Introduction 1 Chairman’s address 2 ... Monitor the workings