- South Africa plans to introduce final rules governing parts of its $9.3 trillion over-the-counter derivatives market by 2028.
- Rand-linked derivatives traded locally and overseas have a notional value exceeding R150 trillion.
- Interest-rate swaps and forward-rate agreements are expected to be the first products required to pass through central clearing.
- The reforms are designed to improve transparency and reduce the risk that the failure of one market participant spreads through the financial system.
The South African Reserve Bank said the Prudential Authority and the Financial Sector Conduct Authority plan to publish a proposed joint standard for consultation between April 2027 and March 2028
The final rules are expected to take effect in 2028, the central bank said in an emailed response to Bloomberg
Rand-linked over-the-counter derivatives traded within and outside South Africa have a notional value exceeding $9.3 trillion, according to the Reserve Bank
That figure represents the total value used to calculate payments under the contracts. It should not be interpreted as the amount of money changing hands or the market’s exposure to losses
The size is nevertheless significant. It is many times larger than South Africa’s annual economic output and shows the importance of derivatives to its banks, investors and companies
Interest-rate contracts targeted first
The proposed framework would require certain derivatives to be cleared through a central counterparty rather than settled directly between the two sides of a transaction
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South African regulators have proposed that rand-denominated interest-rate swaps and forward-rate agreements become the first products covered by mandatory central clearing
Other products could be added gradually, following consultations with financial institutions and further examination of market data
Interest-rate swaps allow companies and investors to exchange different types of interest payments, usually fixed and floating rates. Forward-rate agreements allow two parties to lock in an interest rate for a future period
Banks, pension funds, asset managers and large companies use such contracts to manage movements in interest rates and currencies or to take positions on future market conditions
Unlike exchange-traded derivatives, over-the-counter contracts are negotiated privately between counterparties. This allows the contracts to be customised but can also make risks more difficult for regulators and other market participants to track
Reducing risks between financial institutions
Central clearing introduces an institution known as a central counterparty between the buyer and seller
Instead of the two parties depending directly on each other to meet their obligations, the clearing house becomes the buyer to every seller and the seller to every buyer
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This structure can reduce the damage caused when a large participant fails to meet its obligations. It can also give regulators a clearer view of transactions and the concentration of risk across the market
South Africa has licensed JSE Clear, a subsidiary of the Johannesburg Stock Exchange, as a central counterparty for derivatives transactions. Financial infrastructure company Strate has also been designated as a trade repository for recording transactions
The proposed rules would set the conditions that an over-the-counter derivative must meet before it becomes eligible for mandatory central clearing
Regulators said centralising and standardising the clearing of selected contracts would make the financial system more transparent and better able to withstand shocks
Public comments on a discussion document released by the Prudential Authority and the Financial Sector Conduct Authority closed on 5 June
Reform process stretches back years
South Africa’s derivatives reforms form part of a global effort launched after the 2008 financial crisis exposed the risks created by privately negotiated contracts connecting major banks and financial institutions
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The collapse of one heavily exposed institution could leave several counterparties with unpaid obligations, potentially spreading losses through the financial system
Members of the Group of 20 committed to requiring standardised over-the-counter derivatives to be centrally cleared and reported to trade repositories
South Africa adopted a phased road map for mandatory central clearing in 2022, but implementation has taken longer than in several major markets
The latest timetable indicates that the country is moving closer to completing an important part of that commitment
South African regulators have already introduced reporting and margin requirements for some non-centrally cleared derivatives. The proposed clearing rules would add another layer to that framework
Possible costs for banks and investors
The changes are expected to reduce systemic risk, but they could also increase operating costs for banks, asset managers and other derivatives users
Market participants may have to provide more collateral, connect their systems to clearing infrastructure and make changes to existing trading and risk-management processes
Companies that use customised contracts may also find that some transactions cannot easily be standardised for central clearing
Regulators are therefore taking a phased approach and consulting the industry before deciding which products will be covered
The reforms could be particularly important for South Africa because it has Africa’s most developed financial market and a large pool of banks, insurers, pension funds and asset managers
Financial institutions elsewhere in Africa that enter rand-linked transactions or trade with South African counterparties may also be affected once the final requirements take effect