NOTICE FINANCIAL SERVICES BOARD. No. 2012

Transcription

1 NOTICE FINANCIAL SERVICES BOARD No PENSION FUNDS ACT, 1956: REGULATION 28 OF THE REGULATIONS MADE UNDER SECTION 36 OF THE ACT: CONDITIONS FOR THE USE OF DERIVATIVE INSTRUMENTS I, Dube Phineas Tshidi, Registrar of Pension Funds, hereby prescribe the conditions for investment in derivative instruments for pension funds as per Regulation 28(7) of the Regulations made under the Pension Funds Act, 1956 (No. 24 of 1956) as set out in the Schedule below. This Notice takes effect on 1 January DP TSHIDI Registrar of Pension Funds 1

2 Schedule Conditions for the use of derivative instruments In this Schedule, Act means the Pension Funds Act, 1956 (Act No. 24 of 1956). Any word or expression to which a meaning has been assigned in the Act has that meaning and, unless the context otherwise indicates Definitions authorised user means an authorised user as defined in section 1 of the Securities Services Act, 2004 (Act No. 36 of 2004); clearing house means a clearing house as defined in terms of section 1 of the Securities Services Act 2004, (Act No. 36 of 2004), or an entity that is domiciled, registered and supervised as a clearing house outside of South Africa; counterparty exposure means any credit risk exposure or credit risk residual exposure in relation to an entity or issuer of an instrument; delta means the ratio measuring the change in the price of the derivative instrument relative to the corresponding change in the price of the reference asset; derivative instrument means any (a) listed financial instrument; or (b) unlisted financial instrument, that creates rights and obligations and that derives its value from the price or value, or the value of which may vary depending on a change in the price or value, of some other particular product or thing; effective economic exposure means the exposure of a pension fund to a reference asset taking into account the delta of the derivative instrument, provided that the effective economic exposure calculation must allow for exposure to embedded derivatives subject to the look-through principle; Jibar means the Johannesburg Interbank Agreed Rate as published daily at 11:00 by the JSE Limited; 2

3 listed financial instruments means - (i) a futures contract; (ii) an option contract; (iii) a warrant; (iv) an index tracking certificate; (v) an instrument based on any underlying asset or basket of underlying assets, other than an Islamic Bond or and Islamic Compliant Instrument; net exposure means the effective economic exposure taking into account the offsetting of long and short positions; reference asset means the underlying asset or category of assets of the derivative instrument, which price or prices are used as an input in the valuation of that instrument, including but not limited to a security, basket of securities, index, interest rate, repurchase rate, swap rate, inflation rate, exchange rate or commodity; repurchase rate means the rate at which a South African bank borrows from the South African Reserve Bank as determined by the South African Reserve Bank from time to time; securities means securities as defined in the Securities Services Act, 2004, (Act No. 36 of 2004); underlying asset in relation to a listed or unlisted financial instrument means (i) any security; (ii) an index as determined by an exchange; (iii) a group of securities which is the subject matter of the financial instrument, whether such group of securities is represented by an index or not; (iv) a currency rate; or (v) an interest rate; unlisted financial instruments means - (i) forward currency swap; (ii) interest rate swap; (iii) exchange rate swap; and (iv) index swap. 3

4 1. Uses of derivative instruments A pension fund may use a derivative instrument to obtain effective economic exposure to reference assets per Table 1 of regulation 28 for purposes of reducing risk, reducing cost, generating capital or income for the fund and effective portfolio management. 4

5 2. Principles A board of a pension fund must as all times adhere to the following principles when derivative instruments are included in its investment portfolio: 2.1 Investments in derivative instruments must not be used to circumvent any principle, regulation or limit as set out in regulation 28 on an effective economic exposure basis; be used in a manner consistent with a fund s investment objectives, as contained in its investment policy statement; the sum of the effective exposures to derivative instruments, together with the market value of all the physical underlying assets of the investments of the fund, may not exceed the relevant asset limits as set out in Table 1 to Regulation 28; be covered by sufficient liquid assets to meet the fund s forthcoming obligations, taking into consideration the fund s liability position; not involve the use of leverage, gearing or result in net short positions at a fund level, other than those allowed for the purposes of interest rate hedging and the netting rules set out in paragraph 4 below; be subject to reliable, independent and verifiable valuation on a regular basis; and at the fund s initiative, be able to be sold, liquidated or closed out by an offsetting transaction at any time; 2.2 The board of a fund must ensure that it is aware of all the risks inherent in derivative instruments and that such risks are disclosed to it in an understandable manner, taking into consideration that more exposure in respect of an asset or asset class could be obtained through the use of a derivative instrument than would be obtained by investing directly in the asset or asset class i.e. the cash value of the derivative is often more sensitive to a change in the price of the asset than if the investment had been made directly in the asset. 5

6 2.3 In addressing the risks relating to a specific instrument or counterparties in derivative transactions, or both, the fund must perform the appropriate due diligence investigation taking into account all risks relating to a derivative instrument. Such risks include but are not limited to market-, credit-, valuation- and liquidity risks, as well as operational risk in respect of instruments not listed on an exchange. In performing the due diligence investigation a fund may take credit ratings of the derivatives counterparty into account, but such credit ratings should not be relied on in isolation for risk assessment or analysis of an asset. 2.4 A board of a pension fund must ensure that risk management processes and procedures are implemented to identify, manage and measure, at any time, the exposure to and risks of all derivative instruments and the contribution of these to the overall risk profile of an investment portfolio of the fund. 2.5 A fund must have an appropriate risk management policy or framework in place to determine amongst others with the processes and procedures in selecting a counterparty, managing counterparty exposure, monitoring counterparties, managing counterparty risks and close out in the event of a counterparty default. 2.6 The de minimus exception as referred to in regulation 28(4)(b) must not be used in the case of the fund s direct use of derivative instruments. 3. Counterparties A fund may only invest in derivative instruments where the counterparties are: 3.1 the South African Government; 3.2 South African banks; 3.3 long-term insurers; 3.4 short-term insurers; 3.5 foreign banks; 3.6 authorised users; or 6

7 3.7 clearing houses. 4. Calculating exposure 4.1 The calculation of assets and categories of assets referred to in regulation 28 must include the net exposure of a derivative instrument subject to paragraph 4 of this Schedule; 4.2 In calculating the counterparty exposure, the following must be taken into account all transactions relevant to such counterparty including any counterparty exposure obtained through derivative instruments; and counterparty exposure may be reduced where the counterparty has provided appropriate collateral as set out in paragraph Notwithstanding paragraph 4.2, where a derivative instrument is traded on an exchange, such counterparty exposure will not form part of the calculation in determining the counterparty exposure, if cleared through a clearing house, on condition that: the due performance of the derivative instrument is underwritten from the time of trade to the time of settlement; initial margin is lodged in respect of overnight positions in such derivative instruments; and profits and losses are realised daily through a mark-to-market process. 5. Netting 5.1 Netting of long and short derivative and securities positions is allowed in calculating the limits set out in regulation 28 where: 7

8 5.1.1 the derivative instrument is aimed at reducing or eliminating the risks associated with an asset or category of assets obtained through the use of derivative instruments or securities; the reference asset(s) of the derivative instrument is identical or similar to the assets underlying the position of which the risks are being reduced or eliminated, where similar in this context means that the reference assets - (i) are of an index form and listed on an exchange, or are highly correlated to the assets underlying the position, leaving no material residual risk; (ii) are sufficiently diversified so that price movements of one of the assets do not unduly affect the performance of the underlying reference assets as a whole, whether such underlying reference assets are in an index form or other as allowed in sub-paragraph (i); and (iii) represent an adequate benchmark or reference asset for the market or portfolio to which it refers, including regular measurement, rebalancing and liquidity appropriate to replicability; and further with regard to the netting of debt instruments- (iv) the effective economic exposure to debt instruments as defined in Table 1 of regulation 28 may be hedged and netted with a derivative instrument whose underlying reference asset is a government bond, JIBAR or the repurchase rate; however, any consequential or residual spread exposure as a result of the netting must be disclosed; and (v) the effective economic exposure to debt instruments may be netted off with an opposite exposure where the issuer is the same but the term may differ; however, any residual exposure as a result of the difference in term must be disclosed; and 8

9 5.1.3 exposure to a counterparty may be netted off with the opposite exposure to the same counterparty only where an appropriate master agreement is in place which give legal effect to netting as contemplated in section 35B of the Insolvency Act, 1936 (Act No. 24 of 1936) to create a single legal obligation, covering the relevant transactions included in the calculation of the counterparty exposure. Such master agreement must provide that, where such counterparty fails to perform, or in cases of bankruptcy, liquidation or any similar circumstance, the fund would have a preference claim to receive or an obligation to pay only the net sum of the positive and negative mark-to-market values of the underlying transactions. 6. Collateral Collateral may be used to reduce counterparty exposure, subject to the following conditions: 6.1 The assets that are backing the collateral must be capable of being liquidated within seven days based on 5% of the previous 30 days total available liquidity in the market for the assets being liquidated; transparent; and priced daily. 6.2 There must be legal separation between the counterparty and the collateral received. 6.3 The collateral received must be held by the fund or an approved nominee or an independent custodian on behalf of the fund; where held by an independent custodian such collateral must not form part of the assets of the independent custodian and such collateral in a segregated account with an independent will not be regarded as counterparty exposure. 6.4 Non-cash collateral posted to a counterparty may not be sold, hypothecated, re-invested or pledged unless it is agreed to by the fund and immediately replaced with other eligible collateral. 9

10 6.5 Collateral held in the form of cash must be in the form of bank deposits or bank issued money market instruments. 6.6 Counterparties must manage the risk associated with the cash reinvestment and the credit quality of the reinvestment institution. 7. Reporting A fund s investment mandates with its relevant investment managers must ensure that the fund receives appropriate and timely information to enable proper management and monitoring of derivative positions and compliance with the relevant limits set out in regulation 28. Amongst others, a fund must receive the following information at least quarterly: 7.1 a full listing of the fund s assets including detailed information for the full identification and disclosure of all derivative instruments in the fund s portfolio(s); 7.2 a summary of the fund s effective economic exposure for each derivative and net exposure for each asset and category of assets as per regulation 28; 7.3 a report showing the counterparty exposure to each counterparty before and after netting subject to the provisions in paragraph 4; 7.4 certificates issued by collective investment schemes and long-term insurers, as contemplated in regulation 28(8), which must provide the information referred to in sub-paragraphs 1 to 3, except for policies contemplated in regulation 28(8)(b)(iii); and 7.5 an investment statement showing that the derivative instruments are valued and disclosed in compliance with international financial reporting standards. 8. Investment policy statement The fund s investment policy statement must include the following: 10

11 8.1 a summary of how and when derivative instruments are allowed to be used and whether both listed and unlisted derivative instruments will be allowed; 8.2 a requirement that any investment mandate allowing the use of derivatives will require compliance with this notice and require the manager to employ appropriate risk management and reporting; and 8.3 a requirement that compliance to investment mandates must be monitored and reported at least monthly and that the board of the fund must apply its mind to understanding all risks related to the use of derivative instruments. 11