JSE Post-Trade Services
Winds of change - a decade of risk
August 2012
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Copyright© JSE Limited 2009
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Discussion points
• What is Post-Trade services?
• What is the role of the clearing house during a default?
• Have clearing houses ever defaulted?
• How have the regulators reacted? G20 mandate
• Regulatory changes
• What will our world look like in 5 years?
• How is the JSE responding?
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Context: the crisis changed our approach
The markets before the crisis were like a bowl of spaghetti:
. . . disorganised, but they served a purpose . . .
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Context: the crisis changed our approach
. . . the problem . . .
. . . people ate too much spaghetti . . .
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What is Post-Trade Services?
Trade
- Post-Trade Services Providing settlement assurance
and
credible information
PostTrade
• Reduce systemic risk
• Ensure efficient, fair markets
• Protect investors
• Ensure orderly markets
• Promote transparency
• Provide credible information
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Macro factors affecting Post-Trade Services
Political:
• Politically motivated
regulation of risk mgt
• trend to on-exchange
• standardisation,
transparency
• capital sensitive trading
• Separation of duties
(Volcker Rule)
Economic:
•Losses from 2008 caused sovereign debt
burdens, increased flows to emerging
markets and low risk debt products
JSE
Post-Trade
Services
Social:
• Recent losses have educated man in
the street - Main Street v Wall Street
Laymen now understand the negative
impact of risk
• High demand for credible information
Legal/Regulatory:
• Increased regulation
puts PTS in the spotlight
Technology:
• High-speed trading
increasing settlement risk
• IT improvements enable
integrated clearing, margin
offset, cross-collateralisation
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G-20
Basle III
Dodd-Frank
EU Draft Reg, ISDAwww.jse.co.za
Clearing house defaults
Notable clearing house defaults:
• France (Caisse de Liquidation) – 1974
• Malaysia (KL Commodity Clearing House) – 1983
• Hong Kong (Hong Kong Futures Exchange) – 1987
• Brazil (BM&F) – 1999
• Hong Kong (Hong Kong Futures Exchange) - 2012
Defaults by clearing houses are typically characterised by sharp
intraday moves, a lack of coordination between traders, clearing house
and the regulator, concentration and inadequate margin
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The role of the clearing house
• Market protection: monitor
and manage open
positions to ensure orderly
markets
• Settlement Assurance
• Comprehensive risk
management standards
• Margin management to
protect against intra day
losses
• Default management
Source: Oliver Wyman 2012
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OTC Derivatives Clearing: Context, current situation
The scale and growth rate of the dominant OTC trading market and costly defaults
led to regulatory investigations into the safety of the OTC market
Unprecedented defaults led to losses
and destabilised the global economy:
Concerns raised:
• Lack of transparency
• Lehman
• Fragmented, uneven risk
management
• Bear Stearns
• Inadequate risk governance
• AIG
• Inadequate management practices
and infrastructure
• MF Global
• Insufficient use of collateral
. . . this led to global political and
regulatory investigations . . .
• Vulnerable market infrastructure
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Source: Joint Forum
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G20 mandate
Nov 2008 Washington G20 meeting mandate to finance ministers:
‘Strengthening the resilience and transparency of credit derivatives
markets and reducing their systemic risks, including by improving the
infrastructure of the over-the-counter markets’
Sept 2009 Pittsburg G20 mandated reform measures in order to:
‘improve transparency in the derivatives markets, mitigate systemic risk,
and protect against market abuse’
Rationale:
Bear Sterns, AIG, Lehman
• Lack of transparency
• Interconnections in counterparty risk
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OTC Derivatives Clearing: Regulatory response
The G20 reform was a catalyst for a coordinated global regulatory response
US Dodd-Frank Act
(Q4 2012)
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EU Draft regulation
(Q4 2012)
• Central reporting
• Central clearing of standardised derivatives
• Regulation of CCPs as ‘systemically important’
Basle III (Q1 2013)
• Lower capital for centrally cleared derivatives and structured products
• Penalties for uncollateralised trades
• Clearing members to hold capital for default fund exposures
CPSS-IOSCO
• Global standard that CCPs must comply with
• B3 capital relief for IOSCO compliant CCPs
ISDA and G14
• Improvements to enable T+0; electronic processing; standardisation; OTC
clearing on exchange
SWAP dealers and participants must register
Central clearing of standardised OTC derivatives
Mandatory margin for cleared trades
Central trading of standardised derivatives
Restriction of activities
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OTC Derivatives Clearing: Regulatory response
In September 2009, G-20 Leaders mandated reform measures to ‘improve
transparency in the derivatives markets, mitigate systemic risk, and
protect against market abuse’
• All standardised OTC derivatives contracts
• should be traded on exchange / electronic platforms where appropriate; and
• should be cleared through a CCP by end-2012 at the latest
• Higher capital requirements for non-centrally cleared OTC contracts
• OTC derivatives contracts reported to trade repositories
As a member of the G-20, SA is obliged to implement
the OTC derivatives clearing reforms
Source: G-20 Pittsburgh Summit,
Sept 2009
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OTC Derivatives Clearing : Market size
According to BIS, 85% of all derivative transactions are traded OTC
• In June 2008, the global OTC derivatives
market gross notional outstanding peak
trading volumes were more than $680 trillion
• OTC trading increased by 535% over 7 years to
2008
• OTC market subsequently contracted to $615
trillion to date
• June 2010: ZAR OTC derivatives ZAR24 trillion,
ZAR800 billion traded on exchange
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Source: BIS, ISDA, SARB
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What will our world will look like in 5 years
Post-Trade services will affect trading patterns and is no longer a hygiene
factor. Result: increased competition, risk becomes front-of-mind
• Capital costs will be more granular and better reflect inherent risk of trades, hurdle
ROE rates will drive flows
• Traders will choose trading venues based on clearing costs and credibility
• OTC trading will be cleared on-exchange
• Global clearing flows will increase (driven by OTC flows)
• Exotic OTC trading volumes will reduce in favour of standardised, transparent
markets
• A more integrated clearing environment will evolve
• Information (eg Statistics and Indices) will be centralised
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How have we responded?
Post-Trade Services is improving risk mitigation to respond to dynamically
changing market needs
1. Integrate clearing
• Integrated organisation structure, separation of duties, increased risk focus
• Enhance the collateral accepted (non-cash)
• Margin (cross-product)
2. Regulatory credibility
• CPSS-IOSCO compliance (focus on liquidity, stress testing market conditions,
enhancing risk management and reporting)
3. Reduce the time it takes to settle from 5 days to 3 days (T+3)
4. Enable on-exchange clearing OTC Derivatives
5. Implement risk models
• SAFCOM Default Fund
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Thank you
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References
1. Dodd, R. (2004). Derivatives Markets: Sources of Vulnerability in U.S.
Financial Markets. The ICFAI Journal of Derivatives Markets and Edward
Elgar Publishers.
2. European Commission. 2010. Regulation of the European Parliament and of
the Council on OTC derivatives, central counterparties and trade repositories.
Brussels: European Commission.
3. G20 Working Group1. (2009). Enhancing Sound Regulation and
Strengthening Transparency. Final Report.
4. International Organisation of Securities Commissions (IOSCO) technical
Committee. (2009). Unregulated Financial Markets and Products.
5. Skerrit, P. (2012). An examination of the South African OTC Markets to
recommend measures for strengthening their regulatory oversight.
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