Safcom, South Africa's clearing house appointed by the Johannesburg Stock Exchange (JSE) to provide services to the local exchange-traded derivatives market, on Thursday became the first in the world to qualify for CPSS-IOSCO compliance.
CPSS-IOSCO is a global standard for risk management aimed at any organisation enabling the part of a trade that occurs once an investor gives the "buy" command, namely, clearing, settling and recording the transaction.
The risk is that a party to a derivatives contract may default and fail to perform its contractual obligations, causing losses to one or more parties or a third party.
Part of global financial stability drive
The standard was designed as part of an international drive towards financial stability in the wake of the 2008-09 global financial crisis.
"If clearing houses are ineffective, they could be a transmitter of contagion, financial shocks and default," the JSE said in a statement on Thursday. "CPSS-IOSCO compliance demands adherence to a comprehensive set of principles designed to enhance investor protection, promote transparency and reduce systemic risk."
Safcom's achievement is important to derivative traders because Basel III, the global regulatory standard on banking regulations including capital adequacy, imposes prohibitive capital penalties on banks which deal with clearing houses that aren't IOSCO-compliant.
"Failure to comply means banks will have to hold up to 10 times more capital as surety, which will result in the derivatives market becoming increasingly expensive to trade in, further resulting in a decrease in investments," the JSE explained.
Basel III was agreed in 2011, and is scheduled to be introduced from 2013.
'Boost for SA as investment destination'
According to the JSE, there is currently R320-billion traded on the derivatives market in South Africa at any time, with R14-billion in initial margins to guarantee settlements.
"The JSE believes that the achievement of IOSCO compliance is a major step forward for Safcom, and an important move to enhance the credibility of the South African market ecosystem as a foreign investment destination," said Leila Fourie, director of post trade services at the JSE.
"The appointment of a qualifying clearing house in South Africa enables growth in the derivatives market as we approach the implementation of Basel III."
The achievement was the result of collaboration between the JSE, the country's banks and Safcom's other market participants, as well as JSE regulator the Financial Services Board, which reviewed and assessed the compliance activities.
'Next up: IOSCO-compliant OTC offering'
Having achieved compliance for clearing in the on-exchange environment, the JSE believes that the next logical step is to work with the market to resolve the need to centrally clear the Over The Counter (OTC) derivatives market.
"Internationally, the move is towards OTC derivatives being cleared through a regulated clearing house," said Fourie. "Having Safcom certified as a qualifying clearing house for exchange-traded derivatives creates a great foundation for the future development of an IOSCO-compliant OTC offering."
Achieving compliance has been a strategic initiative for the JSE as it enhances risk standards, affecting the market credibility and liquidity of the exchange.
As part of the compliance, Safcom established an enhanced default fund which further increases protection of investors, while also creating a more equitable line of defence against any possible default event.
"In the event of a default or insolvency, Safcom will now absorb the first loss before non-defaulting clearing members. This allows the risk to be spread rather than being carried by the banks alone," Fourie said.