The Securities and Exchange Commission (SEC) recently approved rules to regulate Central Counterparties alongside Derivatives trading rules. The new rules were approved on the 23rd of December, 2019. The rules define a Central Counterparty (CCP) as an entity registered by the Commission that interposes itself between counterparties to a securities’ transaction traded on one or more financial markets, becoming the buyer to every seller and seller to every buyer. CCPs play an essential role in derivatives trading. Hence, the need to have adequate rules to regulate their operations.
Highlights of the new rules are as follows;
Rule 3 lays down the registration requirements for a CCP. One of such registration requirements is evidence of minimum capitalisation of N5 billion, which shall be in the ratio of 90 percent cash and 10 percent fixed and other assets. The 90 percent cash is to be escrowed in an interest-yielding account with the CBN until approval is granted. Other requirements include fidelity bond representing 25 percent of minimum required capital as well as Bank Verification Number and Credit Bureau Report of the directors of the company.
Some other additional requirements were listed in rule 4 and the include: Sufficient assets and resources, which include financial, management and human resources with appropriate experience, to perform its functions as set out in these Rules; An effective and reliable infrastructure to facilitate its clearing operations or services; A comprehensive risk management process; Appropriate systems, controls and procedures that are reliable and secure and have adequate scalable capacity.
Rule 5 categorically states that a CCP shall not carry out any business, activity or function that is not related or incidental to clearing. Rule 6 lists the functions of a registered CCP as follows: Interpose itself between counterparties to contracts traded in one or more financial markets through the process of novation, legally binding agreement or open offer system; Facilitate post trade management functions; Implement a margin system that establishes margin levels commensurate with the risks and particular attributes of each product, portfolio and the market; Collect and manage collateral held for the due performance of the obligations of Clearing Members; Establish and maintain a Default Fund to mitigate the risk of default by a Clearing Member and to ensure, where possible, that the obligations of that Clearing Member continue to be fulfilled; Have a clearly defined default management system and waterfall where the obligations of the defaulting Clearing Member, other Clearing Members and the CCP are legally and clearly managed; Provide for portability in the case of default of a Clearing Member; Perform any other function as may be determined by the Commission from time to time.
A CCP is required to have rules and procedure that support financial stability, safety and efficiency of its clearing activities. – Rule 7(1) (a). It is essential for the Board and Management of a CCP to have the required mix of skills and competence to discharge their duties in line with the explanatory guidelines issued by the SEC from time to time. Rule 7(2). Appointment of members of the Board will be subject to SEC’s approval- Rule 8(2). SEC will also approve appointment of its Chief Executive Officer and Principal Officers-Rule 9(2)
CCP rules on derivatives trading
Rule 10 (1) provides that CCPs shall develop rules pursuant to the Investments and Securities, Act (ISA) and the CCP Rules to govern its operations and Clearing Members. The rules are to be clear, transparent, understandable and enforceable for all its operations; ensure that its activities are consistent with relevant laws and regulations, have a high level of certainty. – Rule 10(2) (a-e)
Rule 12 indicates that a CCP may outsource some of its functions. However, where a CCP outsources any of its functions, services or activities, it shall take full responsibility for the functions, services and activities outsourced. It shall also ensure that the outsourcing does not affect the discharge of its obligations to Clearing Members and Clients.
Efficiency and transparency
A CCP is to design its operations and processes to meet the need of the market. – Rule 13 (1) (a) the design shall include: Specific clearing and settlement arrangements; operating structure; Scope of products cleared; Use of technology
A CCP is also required to carry out a review of the efficiency of its operations and processes at least once in a year.
There are other noteworthy sections of the rules that will be highlighted in the concluding part of this article.