Continuation of highlights of the new securities and exchange commission’s rules on central counterparty

Other noteworthy sections of the new rules are as follows;

Investment policy

A CCP is to have an investment policy that is consistent with its overall risk management strategy which is to be fully disclosed to Clearing Members. – Rule 14 (1) (a). It should also invest its cash collateral in liquid assets with low credit, liquidity and market risks. – Rule 14 (1) (d).

A CCP investment shall:

1. a) Be fully secured to mitigate against credit risk;
2. b) Allow for quick liquidation with little, if any, adverse price effect. –Rule 14(2)

Comprehensive risk management framework

A CCP shall have a framework, policies and procedures for comprehensive management of risks which should cover:

1. Legal basis that is clear, transparent and enforceable for each material aspect of its operations;
2. Credit exposures to Clearing Members and those arising from its payments clearing, and settlement processes where applicable;

iii. Collateral and margin management requirements that are adequate and risk based;

1. Maintenance of adequate liquid resources to ensure timely fulfilment of payment obligations with a high degree of confidence;
2. Risk management tools to effectively manage systemic risks arising from its interconnectedness with other CCPs and FMIs;

A CCP is also required to have a Risk Committee that will continuously identify, measure, monitor, and manage the range of risks that may arise. Rule 16(1)

Liquidity risks

A CCP is mandated to have highly liquid resources and committed line of credit. It should also have a diversified portfolio of liquid resources and avoid undue concentration with respect to any relevant asset class and issuer. -Rule 17 (1).

The Rules also provide that no instruments borrowed in a securities lending transaction shall qualify as highly liquid securities.

Furthermore, all highly liquid securities held by a CCP shall not be pledged, either explicitly or implicitly, to secure, collateralise or credit-enhance any transaction and cannot otherwise be subject to any further commitment.

The rules states that Highly liquid resources shall include a. Risk-free assets such as Sovereign government securities e.g. FGN bonds/Sukuk and Treasury Bills or FGN-guaranteed securities, that are liquid; according to the CCP’s determination of a liquid asset

1. Central Bank of Nigeria Open Market Operations bills;
2. Placement with Banks.

Collateral requirements

The only form of collateral that a CCP can accept are highly liquid assets with low credit, and market risks. -Rule 21 (1) (a)

A CCP shall also ensure that it carries out mark to market valuation of collateral on a real-time basis as well as monitor credit, liquidity and market risks of all collateral regularly.

A CCP shall avoid concentrating its collateral in one class of asset with the exception of Federal Government Securities.

Where a CCP accepts cross-border collateral, it shall:

1. a) Take steps to mitigate risks associated with its use and ensure that the collateral can be used in a timely manner;
2. b) Assess the foreign exchange, political   and other country specific risks and set haircuts to adequately compensate for the additional risks.
3. c) Make provisions in its rules and regulations on eligibility criteria for acceptance of the cross-border collateral which should be subject to the Commission’s approval.

Margin requirements

A CCP shall have a:

1. a) System that stipulates margin requirements proportionate to the risks and attributes of the relevant products and the markets;
2. b) Reliable source of timely price data for:
3. i) Exchange traded products, contracts and derivatives to determine margin requirements;
4. ii) OTC derivatives contracts.

Default Fund

A CCP shall:

1. a) Establish and maintain a Default Fund to cover losses not covered by margin requirements. -Rule 23

Rule 24 provides that a CCP shall maintain additional financial resources which must amongst other things:

1. a) cover potential losses not covered by margin requirements and the Default Fund;
2. b) be freely available to the CCP;

Default management procedure- Rule 26

A CCP shall have rules and procedures that enable it to continue to meet its obligations to non-defaulting Clearing Members in the event of a Clearing Member’s default;

The rules and procedures shall:

1. a) clearly define what circumstances constitute default of a Clearing Member
2. b) allow the CCP to use any financial resources it maintains according to the Default Waterfall to cover losses and contain liquidity pressures arising from default of a Clearing Member

Stress testing

A CCP shall test the sufficiency of its total financial resources available in the event of a default in extreme but plausible market conditions on an annual basis-Rule 27.

Recovery and resolution

A CCP shall have processes and procedures to achieve adequate recovery when its going concern status is threatened so that its critical operations and services can be sustained.

CCPs are also required to make certain reports on a periodic basis to the SEC.

The CCP rules are quite robust and stringent. The stringent nature of the CCP rules is no doubt to ensure that all stakeholders in the Derivatives trading transaction are adequately protected and attendant risks are mitigated. It is hoped that these rules will enhance Derivatives trading transactions in the country.

ULOAKA EKWEGH