JSE Post-Trade Services

1. JSE Post-Trade Services Winds of change - a decade of risk August 2012

2. 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?

3. Context: the crisis changed our approach • The markets before the crisis were like a bowl of spaghetti: . . . disorganised, but they served a purpose . . .

4. Context: the crisis changed our approach • . . . the problem . . . . . . people ate too much spaghetti . . .

5. What is Post-Trade Services? Trade - Post-Trade Services - Providing settlement assurance and credible information Post-Trade • Reduce systemic risk • Ensure efficient, fair markets • Protect investors • Ensure orderly markets • Promote transparency • Provide credible information

6. Macro factors affecting Post-Trade Services • Economic: • Losses from 2008 caused sovereign debt burdens, increased flows to emerging markets and low risk debt products • Political: • Politically motivated regulation of risk mgt • trend to on-exchange • standardisation, transparency • capital sensitive trading • Separation of duties (Volcker Rule) 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 • G-20 • Basle III • Dodd-Frank • EU Draft Reg, ISDA • Technology: • High-speed trading increasing settlement risk • IT improvements enable integrated clearing, margin offset, cross-collateralisation

7. 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 Notable clearing house defaults: 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

8. 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

9. 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: • Lehman • Bear Stearns • AIG • MF Global • . . . this led to global political and regulatory investigations . . . Concerns raised: • Lack of transparency • Fragmented, uneven risk management • Inadequate risk governance • Inadequate management practices and infrastructure • Insufficient use of collateral • Vulnerable market infrastructure Source: Joint Forum

10. 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

11. OTC Derivatives Clearing: Regulatory response The G20 reform was a catalyst for a coordinated global regulatory response

12. 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

13. 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 Source: BIS, ISDA, SARB

14. 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

15. How have we responded? Post-Trade Services is improving risk mitigation to respond to dynamically changing market needs • 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) • 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

16. Thank you

17. References • Dodd, R. (2004). Derivatives Markets: Sources of Vulnerability in U.S. Financial Markets. The ICFAI Journal of Derivatives Markets and Edward Elgar Publishers. • European Commission. 2010. Regulation of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories. Brussels: European Commission. • G20 Working Group1. (2009). Enhancing Sound Regulation and Strengthening Transparency. Final Report. • International Organisation of Securities Commissions (IOSCO) technical Committee. (2009). Unregulated Financial Markets and Products. • Skerrit, P. (2012). An examination of the South African OTC Markets to recommend measures for strengthening their regulatory oversight.