The US Subprime lending crisis and aftermath of 2008 were a watershed moment for financial regulators worldwide. The collapse of big financial institutions in the US and its impact on the global financial system was attributed mainly to unregulated trading in OTC derivatives.
The global financial system needed a revamp and cooperation of all the major economies to create a robust regulatory regime.
Being a member of the G20, South Africa has also recently implemented changes on the trading of OTC derivatives to improve the financial market governance and oversight over over-the-counter derivatives like CFDs. These include central clearing; higher operational requirements, changes in margin requirements for non-centrally cleared derivatives & reporting of all transactions to trade repository.
This increased scrutiny on all existing and new FSCA licensed CFD & forex brokers would bring transparency in OTC market dealings.
This would impact all forex & CFD brokers in the South African market; with guidelines on how they must operate as their operations will now be closely monitored by the financial regulator, with increased regulatory requirements for clients & brokers.
What are OTC Derivatives and CFDs?
Derivatives are contracts between two parties, that derive their value from the price of underlying asset, but you don’t own the actual asset.
An example is Online Forex trading or CFDs, which are contracts between the trader & the brokerage for buying or selling or currencies, stock CFDs etc. OTC Derivatives are over-the-counter financial contracts or agreement between two parties at an agreed price.
The issuer of the OTC derivative contracts is called an ODP or OTC Derivatives provider.
CFD is a form of OTC derivative where price difference is cash settled between opening and closing balance of trade between 2 parties i.e.: ODP and client.
CFDs are popular way to trade forex, indices and commodities online in South Africa.
Who is required to apply for FSCA’s ODP license?
It was made mandatory for all OTC derivative brokers to obtain a license under new ODP regime starting 8th August of 2018. This deadline has since been extended.
Any provider that offers OTC derivative products to South Africans is required to apply for FSCA’s ODP licensing scheme & get approval before they can offer such contracts legally.
The FSCA’s new licensing regime mainly affects CFD & forex brokers, banks & other non-banking financial institutions that offer OTC derivatives to their customers.
Forex brokers offer CFD (Contract for Differences) products to their customers, which is a margin based financial derivative, allowing customers to speculate on the price of an instrument.
According to Forex Brokers South Africa, many forex brokers have applied under FSCA’s ODP licensing to be able to offer their CFD products legally in SA. But currently there are only 6 approved ODPs as per FSCA’s ODP search page. These are the large banks & wealth management companies in SA; Standard Bank, Nedbank, RMB, ABSA, Goldman Sachs International Bank & Investec.
62 other institutions have applied for the FSCA’s ODP license. These are mostly large global CFD brokers that operate in South Africa & offer forex, CFD instruments to traders.
It was reported that the application of one of the largest global CFD brokerage IG Group to act as an ODP in South Africa was denied by FSCA, as CFD products offered by IG are undertaken on principal-to-principal basis, without any middle man.
IG Group has appealed the decision, and this could define how the brokers can offer their CFD products to retail traders in South Africa in the future.
Understanding the ODP Regulations in South Africa
Following the reform, the country reorganized the existing financial administration. The result was the creation of a Prudent Authority under the South African Reserve Bank (SARB) and the FSCA following the famous Twin Peaks model.
One of the most important pillars of new financial regulatory framework in SA is the implementation of "twin-peaks" model that calls for two independent regulators with two different goals – financial stability and code of conduct for market participants & investor protection. This model is already implemented successfully in many developed countries like Australia, UK, USA, Canada, France.
FSCA is the market conduct regulator under Twin Peaks that oversees practices of all financial market entities, and it also acts as primary regulator of the OTC derivatives market.
Since 2018, OTC derivative providers (ODP) regulation fall under the Financial Sector Conduct Authority or FSCA. The 2018 FSCA's ODP regulation requires all existing OTC derivative providers to apply for a license to continue their services in South Africa. They also need to report all transactions to the FSCA's trade depository.
After comprehensive consultation with the financial industry and stakeholders and best trading practices and regulations from major countries, these new OTC regulations have been put in place.
The ODP licensing under FSCA has following requirements:
• Due Diligence: The broker or OTC providers need to conduct due diligence on potential customers. It means a broker needs to ensure that the customer fits the criteria of trading in highly risky derivative instruments.
• Capital Adequacy Ratio: To provide services in South Africa, the broker must apply for a license to the FSCA, and the broker should meet the capital adequacy ratio (CAD). The CAD is meant to ensure that the service provider maintains enough funds to meet any insolvency scenario and fulfill the customer obligations.
• Reporting Requirements: The service provider must report all the transactions to an authorized trade repository.
These regulations are meant to provide transparency and create a robust regulatory framework for OTC forex and CFD instruments.
Since its adoption, many brokers have applied under this regime while licenses of few non complaint brokers were also revoked. This has benefited South African investors and brokers as it has organized the largely unregulated OTC derivatives sector with more transparency and strengthened trust among investors on FSCA regulated brokers for the safety of their funds.
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