South Africa has supported the G20’s efforts to reduce the risk posed by over-the-counter (OTC) derivatives, and has put in place a regulatory framework for the licensing of OTC providers that originate, issue, sell or make a market in OTC derivatives. The Financial Markets Act 2002 prescribes criteria for the authorisation of OTC derivative providers. We set out below 10 of the lesser known requirements:

  1. The business plan of an applicant must be approved by its board and must deal with the corporate governance principles that will be implemented by the applicant. Conduct Standard 1 in effect requires the applicant’s board to comply with Principle 7 of the King IV Report on Corporate Governance for South Africa (King IV). This includes the board comprising a majority of non-executive members, most of whom should be independent.
  2. The board of the applicant should establish an audit and risk committee in line with Principle 8 of King IV. This includes the appointment of an independent, non-executive board member to chair the committee.
  3. The applicant should have sufficient operational capital and liquid net assets to operate for at least 6 months in order to wind up operations in an orderly manner. Liquid assets for these purposes are assets that can be recovered or liquidated within 5 business days.
  4. An applicant must provide a viable funding plan for raising additional equity in the event of its equity capital falling below the amount required to cover all its operating expenses. Such a plan can be in the form of a bank facility, subordinated debt from a holding entity or similar arrangements.
  5. An applicant must describe the specific services and asset classes for which those services will be rendered. This is required since providers are licensed to issue specific types of derivatives over specific asset classes. Applicants are required to demonstrate their capacity to underwrite, risk-manage and administer such selected derivatives and asset classes.
  6. Members of the applicant’s board must provide adequate proof of qualifications and experience to confirm the competency of members of the board to undertake the relevant duties and functions within an OTC derivative provider. Any foreign employees should provide relevant work permits entitling them to work in South Africa.
  7. The applicant must demonstrate availability of staff for the performance of key functions, including a chief operating officer, risk manager, compliance officer and valuation officer. These roles should operate independently and report either to the audit and risk committee (in respect of risk and compliance functions) or directly to the board.
  8. All key staff functions (including individuals responsible for risk, compliance, operations and valuation functions) should be employed by the applicant, or must act in accordance with disclosed service level agreements should they be employees of another organisation.
  9. The applicant will have to demonstrate the principles and processes it implements to ensure segregation of client assets from the assets of the applicant. This may require the placing of client margin or collateral with third party custodian banks.
  10. The applicant must provide a full description of all client take-on processes, including a description of appropriateness assessments, applicable margin requirements, credit checks, client profiling, credit limits and the like. The applicant will be required to provide an end-to-end process that represents a procedures manual of on-boarding clients.