• Friday, March 29, 2024
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Highlights of the new securities and exchange commission’s rules on the regulation of derivatives trading

Securities and Exchange Commission

Investopedia defines a derivative as a contract between two or more parties whose value is based on an agreed-upon underlying financial asset (like a security) or set of assets (like an index). Common underlying instruments include bonds, commodities, currencies, interest rates, market indexes, and stocks. Futures contracts, forward contracts, optionsswaps, and warrants are commonly used derivatives. There are Exchange trade Derivatives and Over the counter (OTC) Derivatives. Over the Counter Derivatives are contracts agreed between parties directly without going through an Exchange.

The Securities and Exchange Commission (SEC) recently approved rules to regulate derivatives trading in the country. The new rules were approved on the 23rd of December, 2019. The New rules will apply to both Exchange traded Derivatives and OTC Derivatives where specifically mentioned.

Highlights of the new rules are as follows;

Registration of contracts

Rule 3 (1) provides that SEC ’s approval shall be sought and obtained prior to the introduction of any contract. Such an application for the registration of a contract shall be filed with SEC by or on behalf of an Exchange. An application for the registration of a contract shall be accompanied with an Information memorandum that will state the specification of the contract. Where an Exchange intends to amend the contract specifications, it has an obligation to notify the Commission within 24 hours of such amendments

Registration of derivatives clearing members

Rule 4 lays down the registration requirements for Derivatives Clearing Members. It also specifically provides that only merchant banks licensed by Central Bank of Nigeria are eligible to register as derivatives clearing members.

One of the documents required for registration as a Clearing member is a Copy of Memorandum and Articles of Association certified by the Corporate Affairs Commission which among others shall include the power to act as a derivative clearing member. Rule 4(2) states that clearing members’ sponsored individuals shall pass a special examination on derivatives trading to be conducted by SEC. Where a bank, registered as a capital market operator intends to take up derivatives clearing as an additional function, an application shall be filed to SEC for registration of that function- Rule 4(4)

Exchange rules on derivatives trading

Rule 5 (1) provides that Exchanges shall develop rules for the derivatives market. The Exchange rules are to include the following: General Requirements, Membership Requirements, Reporting Requirements, Risk Management Requirements.

Where an underlying is suspended from trading or delisted, contracts on such underlying shall cease to trade on an Exchange-Rule 5(2)

Rule 5(3) provides that Exchange Traded Derivatives can only be traded on Exchanges recognized by SEC.

Permitted participants

Rule 7 (1) provides that no person(s) shall trade on Exchange-traded Derivatives either for proprietary accounts or on behalf of clients except entities registered with a recognized Exchange and/or Central Counterparty as Dealing Members and/or Derivatives Clearing Members. This implies that anyone who doesn’t fall under the listed categories cannot trade on Exchange-traded Derivatives.

Rule 7 (2) indicates that no person(s) shall clear Exchange Traded Derivatives or OTC Derivatives except entities registered as Derivatives Clearing Members.

Rule 7 (3) provides for the prompt provision of complete and accurate information by Participants on their trading and clearing activities to the Commission as the need arises in accordance with the Act and SEC Rules and Regulations. Participants are also to comply with all relevant provisions of the Act and SEC Rules and Regulations, whether or not expressly stated in these regulations.

Market surveillance

The Exchange (Any Securities, Commodities or Futures Exchange where derivatives are listed and/or traded) shall have the responsibility for market surveillance to ensure derivatives contract prices reflect demand and supply in order to deter market manipulations. – Rule 8(1)

Disclosure

Rule 11 (1) deals with the obligations of Participants to disclose their outstanding derivatives exposures to SEC on a quarterly basis. The disclosure shall include but not be limited to the following information: List and description of proprietary and clients’ outstanding positions; Outstanding derivatives exposure from proprietary and clients’ positions; Profit or loss resulting from proprietary positions; Proprietary and clients outstanding positions as a percentage of net liquid capital, where applicable; Estimated maximum loss that could be incurred from proprietary outstanding positions and its effect on the financial position.

Risk management

Clause 12 (1) provides for a robust risk management framework for Participants as follows shall: Risk management units within their organizations; Comprehensive risk management frameworks and investment policies for managing derivatives related risks. The framework shall include but not limited to the following: The officer responsible for coordinating risk function, Reporting line, Risk appetite and risk tolerance for all classes of risks, Risk register, Roles and responsibilities of every staff including board members on risk management, Include risk management report in their annual financial statements.

Any person who violates any provision of these rules and regulations shall be liable to a penalty of not less than N1,000,000 and a further sum of not more than N25,000 for every day of default.

 

Uloaku Ekwegh