Never Settle for Anything Less

One of the most significant risks that has plagued markets since the beginning of time has been that a seller would deliver their securities (equities, bonds, money market instruments), but would not receive payment in return, or that the buyer would make payment and will not receive what they had paid for.

 

This is referred to as Principal Risk.

 

The Knock-on Effects of Principal Risk

Today, the financial markets are certainly not immune to Principal Risk. In many ways, developments have made things more complex – with buyers and sellers of securities located further apart. Trading practices have changed and the electronic systems that are used have become more sophisticated, as the markets have sought to address other risks or issues faced.

 

In many instances, one has no idea who the counterparty is or where they are situated, let alone whether they are even in a position to fulfil their obligations in terms of the transaction. As a result, onus has been placed on a variety of intermediaries to manage these risks and provide others with assurance. The integration of systems across the intermediary chain means that the effective mitigation of Principal Risk (at an individual transaction level) is essential.

 

The consequences of hypothetically having a small percentage of transactions fail due to Principal Risk could have profound implications on the financial system. Should one financial institution be unable to meet its obligations, it will impact another institution’s ability to meet its own obligations as well…creating greater financial market contagion or systemic risk.

 

Delivery versus Payment (DvP): Designed to mitigate Principal Risk

Those challenges have resulted in the introduction of the concept of Delivery versus Payment (DvP), which is specifically designed to mitigate Principal Risk and protect against widespread contagion. DvP can be achieved in a number of ways, but even in this area, markets have evolved to allow for the efficient delivery of securities in exchange for cash.

 

For as long as we can remember, banks have provided us with a trusted service in respect of our money – and it is only when we physically require actual bank notes that we draw them out. If not, we rely on our ability to instruct our bank to transfer money safely and efficiently through the banking system to an appointed recipient.

 

Similarly, the first Central Securities Depository (CSD) was created just over 40 years ago and was designed to provide a trusted service in respect of securities, using its independent, secure environment in which the ownership (and transfer of ownership) of securities is recorded and maintained. The creation of a CSD to perform this function has become a critical component of the financial markets around the world, and South Africa is no different.

 

The Golden Triangle

The challenge for markets, however, is just how do the banks and the CSD interface with each other to ensure an effective DvP process. Regulators and practitioners around the world have long recognised that the ultimate DvP process also embodies the legal certainty that the final settlement of one obligation (say the cash movement) is contingent upon the final settlement of the other (the securities) and that these are both irrevocable at a point in time.

 

This process (often referred to as the Golden Triangle) is essentially:

  • For the CSD to reserve (or block) the securities that have been sold in its system;
  • For the CSD to then instruct the bank (appointed by the buyer) to transfer the funds to the sellers’
  • account; and finally
  • For the reservation on the securities to be lifted and the securities moved from the transferring party to the recipient party, thereby transferring ownership of the securities to the recipient.

Additional protection for investors – SFIDvP

One of South Africa’s Financial Market Infrastructures is the Central Securities Depository, Strate. In conjunction with the other financial market stakeholders, Strate chose at the outset to develop the most secure method of DvP possible – simultaneous, final and irrevocable Delivery versus Payment (SFIDvP) using the Central Bank, i.e. the South African Reserve Bank (SARB).

 

Why the Central Bank?

Commercial banks perform multiple roles in the market (such as taking deposits and granting credit to their clients) and this exposes them to credit and liquidity risks. The Central Bank, on the other hand, has the lowest possible credit risk exposure in any given market.

 

By Strate interfacing directly with the South African Multiple Options System (SAMOS) operated by the SARB, SFIDvP has become one of the cornerstones of our market.Both credit and liquidity risks are significantly reduced because of the risk profile of both the SARB and Strate as the CSD. Not only does the SARB have the lowest possible credit risk exposure in any given market, every transaction that is processed through its South African Multiple Options System (SAMOS) is collateralised, adding additional layers of security.

 

In addition, Strate only deals with operational risk and is not exposed to counterparty credit risk. This provides both local and foreign investors with a measure of comfort in the settlement process that has been rated at one of the best in the world. With the value of securities settlements exceeding R2 trillion on a monthly basis, a large portion of which can be attributed to the bond / debt market where liquidity is essential, it clearly highlights the important role that Strate plays in the mitigation of Principal Risk and the promotion of financial market stability.

 

Alignment to International Standards

The settlement model implemented by Strate has been affirmed time and again, as international standards (such as the CPSS-IOSCO Principles for Financial Market Infrastructures) clearly favour the use of central bank money in securities settlement models. Principle 9 of the Principles for Financial Market Infrastructures states that a “Financial Market Infrastructure should conduct its money settlements in central bank money where practical and available.”

 

Many markets around the world have not yet achieved this particular standard and are now having to earnestly re-assess their settlement models to establish just how they can achieve something that is fast becoming a ‘not negotiable’ requirement designed to protect the investor.

 

Conclusion

South Africa’s markets have provided SFIDvP through Strate and the SARB for over 17 years. Both parties provide integral elements in the processes that seek to ensure the stability of our financial markets. Given the efficiencies created and the mitigation of risk achieved, one shouldn’t even need to ask of the importance of settlement using SFIDvP in central bank funds.

 

 

 

Strate’s Commitment to Stakeholder Engagement

Strate is committed to its stakeholders and continues to effectively engage with them across various mediums.

 

This includes stakeholder satisfaction surveys, which are conducted across stakeholder groups to measure Strate’s service levels where these results form part of measuring the corporate performance. A formal Stakeholder Engagement Report is tabled with Strate’s Board on a biannual basis. It provides the Board with an overview of key issues facing each stakeholder group and the necessary steps that Strate management is taking to address these issues.

 

Prioritisation and execution of strategic projects is very much guided by this engagement.

 

Strate continues to value its relationships with its stakeholders and encourages regular two-way communication. It has a dedicated division that is responsible for engaging with stakeholders on a continuous basis.

 

Should you wish to share the experience you have had while engaging with Strate, please contact Leigh Bevis, Strate’s Head of Stakeholder Relations, on Leighb@strate.co.za or on +27(0)11 759 5466.

 

 

Strate to Reduce Fees on Tax Free Savings and Investment Accounts

National Treasury is reforming non-retirement savings in South Africa via tax-free savings accounts.

 

Tax-free savings and investment accounts are savings products on which no income tax, capital gains tax or dividend withholdings tax will be charged. The idea, which was first introduced in the 2012 Budget Review, aims to encourage household savings and to increase the overall level of savings in the economy.

 

However, these accounts were launched at the beginning of March 2015. To support this initiative, Strate is lowering its Contract Note Fee for these tax-free savings accounts and investments by 67%. You can access Strate’s latest fees schedule online by clicking here.

 

 

Strate’s Collateral Management Services Update

Interest in Strate’s Collateral Management Services continues to grow, as nine local banks have successfully performed scripted testing on the system.

 

The banks participated in scripted market testing of the service to secure the interbank lending market. There was a particular focus on the lending in the ‘the South African Multiple Option Settlement (SAMOS) system position/square-off window’. Over 90 people were trained by Strate.

 

Strate has also submitted motivations to National Treasury and the South African Revenue Service to consider certain tax exemptions to remove the impediments relating to the use of specific securities for collateral. A Working Group has been put in place as a result. The Finance Minister Nhlanhla Nene noted in the 2015 South African Budget Speech that “government proposes to review the tax treatment of the transfer in beneficial ownership of collateral to reduce any negative effects on acceptable business practices and limit the use of collateral in possible tax avoidance arrangements”.

 

Strate has continued its engagements to confirm the next steps to having the dispensations included in the Tax Laws Amendment Bill. Should the amendments be accepted, they are expected to be effective from the beginning of 2016.

 

Looking at the second quarter, Strate and the Association of Corporate Treasurers of South Africa (ACTSA) hosted a conference on collateralisation benefits for Corporates during April. Strate and Clearstream also participated in the Securities Finance Masterclass Conference.

 

To find out more about Strate’s Collateral Management Services, email collateral@strate.co.za.

 

 

BaNCS Market Infrastructure for Money Markets is Underway

In September last year, Strate had announced that it had selected the TCS BaNCS Market Infrastructure (BaNCS MI) solution to replace its money market, bond and equity depository operations.

 

Development and testing for money markets is underway, with the implementation scheduled for the third quarter of 2015. Strate will then turn to the replacement of its current bonds and equities applications onto the new infrastructure. The new BaNCS infrastructure offers the market a streamlined service across all asset classes, as the three systems are consolidated into one. The benefit thereof is that fewer systems will need to be  supported and CSD Participants will have fewer interfaces to maintain.

 

In addition, workforce productivity is expected to improve, as there is less need for users to learn and work in as many different applications as they currently do. This was in line with its strategy of acquiring technology that will introduce further operational efficiencies to South Africa’s financial market.

 

 

iValue Entrepreneurship Programme Bears Fruit

The shortlist of the learners participating in the final phase of the iValue Entrepreneurship Programme has been announced.

 

Nineteen grade 11 learners from Kwena Molapo High School near Lanseria addressed a panel of four judges on 17 April 2015, using their newly acquired knowledge of business management and entrepreneurship to develop their feasible ideas. Over recent months, they had formed groups to work hard on their ideas and present them to the panel with the hopes of being selected to receive start-up capital for their business plans. Two of these groups – Matrix Play and iHealth – were announced as the winners. Matrix Play will be an internet service provider to learners at their school, while iHealth aims to accelerate living a healthy life style for schoolchildren.The iValue Entrepreneurship Programme, initially launched in 2014 as a pilot project, was targeted at a group of grade 10 learners with the aim to have at least five of the learners become entrepreneurs within the next five years.

 

With the help of second year students completing their Diplomas on Small Business Management at the University of Johannesburg, the learners have spent the past year developing their skills. Learners have been empowered to understand and apply entrepreneurial knowledge, skills and principles in their entrepreneurship projects, as well as identify viable entrepreneurial opportunities within their communities.

 

According to Carole Podetti Ngono, the Founder and Managing Director for the Valued Citizens Initiative, “The learners now have the entrepreneurial spirit and skillset to implement their business ideas successfully. Over the coming months, they’ll be afforded the opportunity of gaining real-world experience of running a business and forming relationships with stakeholders.”

 

As one of the Programme’s sponsors, South African Central Securities Depository Strate strongly believes the iValue initiative is aligned to government’s important objectives of addressing youth unemployment to foster sustainable economic growth. “Not only is South Africa confronted with high levels of unemployment, there is also an increasing number of discouraged work seekers among young people. Only some 7% of successful grade 12 learners in South Africa find employment in the formal sector. There is an urgent need for the promotion of entrepreneurship as a potential solution to youth unemployment, which is why initiatives such as the iValue Entrepreneurship Programme are vital. It enables young people to empower themselves, so that they can successfully contribute to the economy and inspire the people around them to follow in their steps and nurture their own entrepreneurial spirit,” explains Tanya Knowles, the Head of Strate’s Project Innovation and Business Services Division.

 

To ensure that the Programme continues to be sustainable, the learners will be tracked over a five-year period to ensure the successful implementation of their business ideas. Key Performance Indicators will be developed and measured on an annual basis. These measures will include operational areas, such as profits margins, growth of the business, job opportunities created, contracts with vendors, marketing exposure and sustainability.

 

Following the success of the pilot programme, the Valued Citizens Initiative will continue to search for learners to enrol in future iValue Entrepreneurship Programmes. The University of Johannesburg, Faculty of Management has also identified the need to tailor make a new programme and curricula to entrepreneurship. If successful it will be among the first tertiary institutions in South Africa to launch Bachelor in Entrepreneurship at undergraduate level.

 

“Learners who partake in the iValue programme will be afforded the opportunity to get a bursary to these new entrepreneurship programmes at UJ. In addition, the rest of South Africa or any prospective entrepreneurs will also be able to empower themselves and nurture their skills to become vital contributors to their own success, and in turn South Africa’s socio-economic development,” says Joyce Sibeko, Faculty Advisor for Enactus at the University of Johannesburg.

 

 

What Does Strate Do?

We’ve put together an infographic to show you exactly what Strate does as a South African Central Securities Depository…

 

Video Tribute to Nelson Mandela

Strate has created an online version of a book that is in dedication to the loving memory of a nation’s hero – Nelson Mandela. You will be missed Tata, but are in our hearts forever.

 

Click on Mandela Tribute to view the video on YouTube.

 

 

Strate e-Tutor Training App Launched

To improve access to education for the financial markets, which includes both the local and the international community, Strate launched an online training portal, called Strate e-Tutor, on 29 October 2014.

“Education is one of the most important investments that can be made to secure a brighter future for a country  and its people. Similarly, an investment in people who want to learn about the financial markets provides numerous benefits for the economy, as it transfers knowledge and critical skills which contribute positively towards society,” says Leigh Bevis, Strate’s Head of Stakeholder Relations.

Strate Training is committed to educating individuals working in the capital markets and financial services industry by constantly keeping them up-to-date with legislative developments and market best practices. It is this commitment that has led to the introduction of Strate’s customised training programmes and the continuous development of its seminars. 

“Now with the launch of Strate e-Tutor, stakeholders have their training requirements at their fingertips, bringing up-to-date educational content straight to you via your computer, tablet or smartphone, 24/7,” explains Bevis.

The training tool will benefit people wanting to learn about the industry, providing them with information from the basic understanding of how it operates to more advanced content for those wanting to become compliance officers. To access the portal, visit https://www.training.strate.co.za/.

Should you wish to contact the team, email Strate-training@strate.co.za.

Collateral 101

Collateral Management is increasingly becoming a topic of interest. Not only has the volume of collateral exchanged rapidly grown over the past decade, but regulatory reforms and international recommendations are also expected to place additional pressure on the need for collateral in global financial markets.

 

Many financial institutions have only just begun to fully appreciate the high cost of inefficient Collateral Management and the importance of using systems to more effectively manage their collateral.

 

Here, Strate features Collateral Management 101. If you have any further questions, email: collateral@strate.co.za.

 

Some Questions Answered

 

1. What is collateral?
Collateral is typically an asset (such as cash or securities, the latter of which is made of equities, bonds and money market instruments) that is used by borrowers to offer lenders as security over a loan.

 

The collateral serves as protection for the lender against the borrower in the event that the borrower defaults. Should the borrower not be able to pay back the loan, then the lender has the right to sell the collateral (asset) to recoup potential losses that are owed to them.

 

2. So is collateral a type of financial insurance?
In some ways it is. Collateral acts as partial insurance to cover the credit exposure or credit risk, i.e. which is the loss to the lender, in the case of the borrower defaulting on his payment.

a. What is a bilateral transaction?
This is a transaction that takes place between two parties, which are called counterparties. The agreement between these two counterparties comes with its own criteria specific to the deal and have been negotiated beforehand, where both parties promise to carry out the terms of their agreement. Counterparties can include banks, broker-dealers, hedge funds and corporates.

 

3. Placed collateral versus received collateral 

When you are the counterparty that is lending cash/an asset to a counterparty, then you receive collateral from that party as your insurance against the credit risk of that transaction. However, if you are the borrower that lends from another counterparty, then you have to give/place/pledge collateral with that party to provide them with security over that transaction in the case that you default on the payment.

 

4. Collateral Management

Collateral management is the continuous process of providing, taking and evaluating collateral to cover against the credit risk you may be faced with relating to your counterparty credit exposures.

 

The allocation of collateral is a complex process that involves defining which collateral is eligible to be received or placed and valuation mechanisms, both pre-agreed by counterparties. Efficient collateral management assists counterparties to mitigate credit risk, by identifying and allocating a similar valued asset in return for the loan/assets/cash that were lent.

 

Based on the changes in the market value, the collateral value to be allocated is continually adjusted, and margin calls will be made. Margin calls are calls from the lender of funds to invoke the borrower to provide additional funds, when there is a decrease in market value of the collateral. These calls are made to minimise the credit risk, so that in case of a default by the borrower, there are sufficient assets as collateral.

 

Efficient collateral management should be able to rebalance the exposures by either requesting for more collateral from, or returning collateral to counterparties when market prices of the collateral change.

 

For example, if you need shares as collateral to cover an exposure of R1000, and those share prices move on a daily basis, there may be times that the share price drops and you are exposed to counterparty credit risk. Depending on certain criteria in your agreement, as well as various calculations that determine the credit risk, you can call on more collateral to cover this risk.

 

5. Re-use/Rehypothecation of Collateral

When hedge funds, pension funds and insurers place collateral with large financial institutions, these banks can potentially re-use the collateral that has been placed with them in the bank’s name, to generate a return for themselves. This means that a single source of collateral can be recycled by a number of parties in the financial market, helping to lubricate the financial system. Therefore, collateral has multiple uses.

 

6. Collateral optimisation
Collateral optimisation is the process that determines the most efficient manner to identify and allocate collateral, keeping all parameters set out by the lender and borrower in mind.

The benefits of collateral optimisation for both the lender and the borrower show that an investment in technology can generate a greater Return On Investment through optimisation related cost-savings.
The benefits include:

  • The efficient management and allocation of collateral;
  • Avoiding over-collateralisation;
  • Easily identify idle surplus collateral;
  • Compliance with regulatory requirements; and
  • Freeing up liquidity, to name a few.

 

7. What is placing more pressure on collateral?
Since the financial crisis, investors want more protection – safer assets and less credit risk. So they want high quality collateral and they want counterparties that can be trusted.

 

Part of that crisis internationally was that banks in the US lent out money recklessly. As credit was given easily, foreign counterparties borrowed from US banks. A lending or credit bubble formed across the world, particularly across the US, Europe and some parts of Asia. When a large number of these counterparties defaulted and went insolvent, they couldn’t pay their debt and needed to get bailouts from the government, as they were not sufficiently collateralised.

 

In an attempt to stop the 2008 financial crisis from happening again, more stringent regulatory requirements are being implemented by Government. Regulators are calling on banks and other financial institutions to have more liquid assets, such as cash, on their balance sheets (with Basel III and Solvency Assessment and Management), which will have an impact on the availability of high-quality liquid assets in the market.

 

Also, the Group of 20 (G-20) Finance Ministers have recommended that all standardised OTC derivatives should be centrally cleared with central counterparties (CCPs), which will require counterparties to place collateral with CCPs, while non-cleared OTC derivatives have to also be collateralised. As a member of the G-20, South Africa also adopts their recommendations, which include the processing of collateral management transactions.

 

8. The curious case of collateral fragmentation and operational silos:
Collateral agreements are more often than not bilateral in nature. This therefore leads to fragmentation of collateral through silos, not only within an institution, but also within the greater market as agreements that exist between counterparts and are not visible to the market.

 

The nature of the current bilateral arrangements within the market bring with it limitations, such as:

  • Inefficient use of and ability to optimise collateral within an organisation operating in silos, as there is often an incomplete overview of available collateral as well as collateral placed and received across an organisation;
  • Inability to optimise market-wide collateral due to the fact that counterparties are unaware of common bilateral relationships that exist with their counterparts, as they can only ‘see’ their collateral as far as their direct counterparts;
  • The uncertainty relating to the location and size of the collateral that has been placed;
  • Lack of an audit trail of reused collateral movements; and
  • Movements of collateral on a T+1 basis or later, which exposes the collateral receiver to credit risk until the collateral is received. 

 

9. What is the solution for South Africa?
Strate has launched its centralised, market-wide integrated tri-party collateral management service to complement current collateral management functions within financial institutions. This service aims to improve the tracking and efficient use of collateral management in South Africa.

 

Strate’s Collateral Management Services can manage bonds, equities, money markets and other eligible asset classes in multi-currencies.

 

This service brings the following benefits to the South African financial markets:

  • Standardisation of collateral operations, message types and timelines across counterparts;
  • Near-time collateral movements of cash (through central bank payments) and securities (by leveraging Strate’s existing position as South Africa’s CSD);
  • The ability to automatically manage bilateral eligibility criteria of collateral regularly on an intra-day basis;
  • Automatically allocate the cheapest way to deliver securities against open exposures;
  • Automatic management of collateral top-ups, returns and cash margin calls;
  • Automatic substitutions within the bilaterally defined eligibility criteria;
  • Internal and market-wide optimisation of collateral;
  • Improved market liquidity;
  • Improved asset safety:
  • Mandatory use of Segregated Depository Accounts (SDAs);
  • Perfecting pledges; 
  • Tracking of all collateral movements – prevention of unauthorised reuse and controlled reuse; and
  • Reduction in operational and settlement risk and the concomitant administrative burden associated with using securities as collateral.

 

10. A global approach to collateral management: The Liquidity Alliance
Strate is one of the initial five members of the Liquidity Alliance, a group of CSDs that have joined forces to collaborate on a global solution for collateral management. The Alliance gives members an opportunity to exchange information, identify common needs and extend global collateral solutions while encouraging the development of informed research. All members of the Alliance operate off the Clearstream platform, which will also pave the way for cross-border collateralisation in the future.

 

  • The initial members of the Alliance are as follows:
  • ASX, Australian Stock Exchange;
  • Cetip, one of the Brazilian CSDs;
  • Clearstream,the German and Luxembourg-based international CSD;
  • Iberclear, the CSD in Spain; and 
  • Strate, South Africa’s CSD.