Financial Markets Act, 2012 (Act No. 19 of 2012)RegulationsFinancial Markets Act RegulationsChapter VI : Central Counterparties39. Investment strategy and safeguarding of assets |
| (1) | A licensed central counterparty’s investment strategy must be— |
| (a) | consistent with its overall risk-management strategy; |
| (b) | disclosed to its clearing members; and |
| (c) | disclosed to the Authority. |
| (2) | A central counterparty must invest its financial resources only in cash or in highly liquid securities with minimal market and credit risk. |
| (3) | The amount of capital, including retained earnings and reserves of a central counterparty which are not invested in accordance with subregulation (2), may not be taken into account for the purposes of Regulation 21 or Regulation 37(1)(c). |
| (4) | A central counterparty may not acquire or invest in commercial paper of securitisation schemes, strategic long-term investments in any venture without prior written approval of the Authority. |
| (5) | Where the Authority has granted approval, the investments referred to in subregulation (4) may be deducted from qualifying capital, and or minority interest relating thereto in accordance with the method contemplated in Regulation 21(2). |
| (6) | Securities posted as margins or as default fund contributions must be deposited— |
| (a) | with (third party) custodians that will ensure the full protection of those securities; or |
| (b) | through other highly secure arrangements with regulated financial institutions. |
| (7) | Cash deposits posted as margin or as default fund contributions must be held through— |
| (a) | highly secure arrangements with regulated financial institutions; |
| (b) | the use of the standing deposit facilities of central banks; and |
| (c) | other comparable means provided for by central banks. |
| (8) | Where a central counterparty deposits assets referred to in subregulations (4) and (5) with a third party, it must ensure that the assets belonging to the clearing members are identifiable separately from the assets belonging to the central counterparty and from assets belonging to that third party by means of differently titled accounts on the books of the third party or any other equivalent measures that achieve the same level of protection. |
| (9) | A central counterparty must have prompt access to the securities when required. |
| (10) | A central counterparty must take into account its overall credit risk exposures to individual (debtors) obligors in making its investment decisions and must ensure that its overall risk exposure to any individual (debtors) obligor remains within acceptable concentration limits. |
| (11) | As a minimum, and without derogating from the relevant requirements specified in terms of International Financial Reporting Standards, a central counterparty that invests or trades in instruments, contracts or positions that are measured at fair value must implement robust governance structures and control processes as part of its risk-management framework for the prudent valuation of the instruments, contracts or positions, which structures, control processes and risk-management framework must include the key elements specified below— |
| (a) | the structures, processes, systems and controls in respect of instruments, contracts or positions measured at fair value, must— |
| (i) | explicitly provide for the role of the controlling body and the senior management of the central counterparty; |
| (ii) | ensure that the controlling body receives regular reports from senior management regarding matters related to the valuation oversight and valuation model performance that were brought to the attention of the senior management for resolution, and all significant changes to valuation policies; |
| (iii) | ensure the robust production, assignment and verification of all relevant valuations; |
| (iv) | be sufficiently robust to— |
| (aa) | ensure and promote the quality, integrity and reliability of all relevant input that affects the valuation of instruments, contracts or positions, in respect of which input the central counterparty must consider— |
| (AA) | the frequency and availability of the relevant prices or quotes; |
| (BB) | whether or not the relevant prices represent actual regularly occurring transactions on an arm's length basis; |
| (CC) | the breadth of the distribution of the data and whether it is generally available to all relevant participants in the market; |
| (DD) | the timeliness of the information relative to the frequency of valuations; |
| (EE) | the number of independent sources that produce the relevant quotes or prices; |
| (FF) | whether or not the relevant quotes or prices are supported by actual transactions; |
| (GG) | the maturity of the market; and |
| (HH) | the similarity between the instrument, contract or position sold in a transaction and the instrument, contract or position held by the central counterparty; |
| (bb) | appropriately consider and apply all relevant international standards or guidance that may affect the valuation of instruments, contracts or positions, including all relevant financial or accounting standards or statements; |
| (cc) | ultimately ensure that the central counterparty’s valuation estimates are prudent and reliable; |
| (v) | ensure that all relevant new product approval processes include all internal stakeholders relevant to risk measurement, risk control, and the assignment and verification of valuations; |
| (vi) | ensure that the central counterparty’s control processes for the measurement and reporting of valuations are consistently applied across— |
| (aa) | the central counterparty; |
| (bb) | similar instruments or risks; and |
| (cc) | all relevant business lines; |
| (vii) | be integrated with other risk management structures, policies, procedures, processes and systems, such as credit analysis, within the central counterparty; |
| (viii) | be based on documented policies and procedures for the process of valuation, which documented policies and procedures, among other things, must— |
| (aa) | ensure that all relevant approvals of valuation methodologies are duly documented; |
| (bb) | specify the range of acceptable practices for the initial pricing, marking-to-market or model, valuation adjustments and periodic independent revaluation; |
| (cc) | include defined responsibilities of the various areas involved in the determination of valuations; |
| (dd) | include the sources of market information to be used and the review of their appropriateness; |
| (ee) | include appropriate guidelines for the use of unobservable inputs, reflecting the central counterparty’s assumptions of what market participants may use when pricing the relevant position; |
| (ff) | include the frequency of independent valuation; |
| (gg) | include the timing of closing prices; |
| (hh) | include all relevant matters related to verification. |
| (ix) | ensure that the performance of the central counterparty’s relevant models is subject to robust testing and review, particularly under stressed conditions, in order to ensure that the controlling body and senior management of the central counterparty understand any potential limitations of the models; |
| (x) | ensure that the central counterparty has in place— |
| (aa) | adequate capacity to determine or establish and verify all relevant valuations, particularly during periods of stress; |
| (bb) | a controlling body-approved external reporting or disclosure policy that— |
| (AA) | ensures that the central counterparty provides timely, relevant, reliable and meaningful information relating to its respective modelling techniques and the instruments to which they apply, sensitivity of fair values to modelling inputs and assumptions, and impact of stress scenarios on valuations; |
| (BB) | promotes transparency; |
| (CC) | is subject to regular review to ensure that the information disclosed continues to be relevant and current; |
| (xi) | be subject to clear and independent reporting lines, that is, independent from the front office, which reporting line ultimately must be to an executive member of the controlling body of the central counterparty; |
| (xii) | be subject to internal audit. |
| (b) | Based on readily available close out prices, which close out prices must be sourced independently, a central counterparty must mark-to-market all positions accounted for at fair value as often as possible, but not less frequently than at the close of business of every day or when the closing price of a particular position or market is published, provided that— |
| (i) | the central counterparty must use the more prudent side of bid/offer prices; |
| (ii) | when estimating fair value the central counterparty must maximise the use of relevant observable inputs and minimise the use of unobservable inputs; |
| (iii) | when observable inputs or transactions are deemed by the central counterparty not to be relevant, such as in a forced liquidation or distressed sale situation, or transactions not being observable, such as when markets are inactive, the central counterparty must duly consider any observable data in accordance with its controlling body approved policies, in order to determine the extent to which such inputs should be regarded as determinative. |
| (c) | Only when a central counterparty is unable to mark-to-market positions accounted for at fair value, may it use a mark-to-model approach, that is, valuations that are benchmarked, extrapolated or otherwise calculated from a market input, provided that— |
| (i) | the senior management of the central counterparty must be aware of the instruments, contracts or positions that are accounted for at fair value and that are subject to mark-to-model valuations, and must understand the uncertainty that may exist in the reporting of the risk or performance of the central counterparty; |
| (ii) | the central counterparty must— |
| (aa) | demonstrate to the satisfaction of the Authority that its mark-to-model approach is prudent; |
| (bb) | source market input as frequently as possible; |
| (cc) | use generally accepted valuation methodologies relating to particular products as frequently as possible; |
| (dd) | have in place formal change control procedures and a secure copy of the model, which copy of the model must be maintained and periodically used to check all relevant valuations; |
| (iii) | when the model is developed internally by the central counterparty, the model must be— |
| (aa) | based on appropriate assumptions, which assumptions must be assessed by appropriately qualified persons who must be independent from the development process; |
| (bb) | approved independently from the front office; and |
| (cc) | independently tested; |
| (iv) | the model must be subject to periodic review to determine the accuracy of its performance, including an analysis of profit and loss against the risk factors and a comparison of actual close out values to model outputs. |
| (d) | By way of independent price verification, a central counterparty must regularly, but not less frequently than once a month, verify market prices and model inputs for accuracy, which independent price verification in respect of market prices or model inputs must be— |
| (i) | performed by a unit independent from the investment function; |
| (ii) | used to— |
| (aa) | identify any errors or biases in pricing; |
| (bb) | eliminate any inaccurate adjustments to valuations. |
| (e) | Due to the uncertainty associated with liquidity in markets, instruments or products accounted for at fair value, that may result in a central counterparty being unable to sell or hedge the instruments, products or positions in a desired short period of time, as part of a central counterparty’s risk management framework and mark-to-market or mark-to-model procedure, a central counterparty must establish and maintain procedures for considering relevant valuation adjustments, provided that, as a minimum, the central counterparty must consider— |
| (i) | valuation adjustments to instruments, products or positions that may be subject to reduced liquidity; |
| (ii) | relevant close-out prices for concentrated positions and/or stale positions; |
| (iii) | the relevant factors when determining the appropriateness of valuation adjustments or reserves for less liquid positions, including, for example the— |
| (aa) | time required to hedge out the position or risks associated with the position; |
| (bb) | average volatility of bid or offer spreads; |
| (cc) | availability of independent market quotes; |
| (dd) | number and identity of market makers; |
| (ee) | average and volatility of trading volumes, including trading volumes during periods of market stress; |
| (ff) | market concentrations; |
| (gg) | aging of positions; and |
| (hh) | extent to which valuation relies on marking-to-model, and the impact of model risk. |