Over-the-counter derivatives stem from deals negotiated bilaterally and privately between two parties rather than traded on a formal securities exchange such as the Johannesburg Stock Exchange or the New York Stock Exchange. These derivatives offer companies more flexibility because, unlike the “standardised” exchange-traded products, they can be tailored to fit specific needs, such as the effects of a particular exchange rate or commodity price over a given period.
The Insolvency Act of South Africa was drafted in 1930 and can, at the best of times, be seen to not adequately cater for the size and extent of the current global market trading in financial instruments. Previously, a secured creditor (counterparty of the insolvent individual) who held collateral for its claim, was obliged to sell the collateral and provide the proceeds of the sale to the liquidator. After a lengthy period, the secured creditor would need to prove its claim and then wait for "repayment" (potentially after the liquidator's fees were deducted).
Considering the context in which the global derivatives market operates, by preventing a secured creditor from accessing the proceeds from the collateral it holds, the secured creditor is placed at risk of financial distress, which could result in a knock-on effect for financial institutions. The new laws provide for a joint draft regulatory standard (Joint Standard) from the new regulators, under the auspices of the Financial Markets Act, which require that:
- certain covered entities must pledge an initial margin as collateral for its obligations that arise from an un-cleared OTC transaction; and
- the initial margin must be available immediately to a secured party if the counterparty goes insolvent.
It is apparent that the Act seeks to amend the Insolvency Act to allow a secured creditor to realise the pledged asset it held as collateral, retain any proceeds from its sale and use the proceeds toward the debt owed by the insolvent (in terms of a master agreement used to document the OTC transaction).
By aligning our laws with those of the G20, South African banks can maintain trading derivatives with G20 banks. The new requirement for parties to either accept or pledge an initial margin will enhance the stability of the derivatives market as well as the banking regulatory system.
By Rui Lopes, Associate and Farah Sheik, Candidate Attorney, Johannesburg