THE REGULATION OF DERIVATIVES IN SOUTH AFRICA – EZRA DAVIDS AND LELE MODISE
The trading of derivative instruments in South Africa is regulated by the Securities Services Act 36 of 2004 ("the Securities Services Act") and the rules of South African Futures Exchange ("SAFEX"), a division of the JSE Securities Exchange ("JSE"). The Securities Services Act, which came into effect on 1 February 2005, repealed the whole of the Custody and Administration of Securities Act, 1992, the Financial Markets Control Act, 1989, the Insider Trading Act, 1998 and the Stock Exchanges Control Act, 1985, which previously regulated the trading of derivatives in South Africa. The Securities Services Act incorporates some of the provisions of the above repealed acts.
The Securities Services Act states that no person may carry on the business of buying and selling listed securities unless such person is an authorised user or effects such buying and selling through an authorised user. An "authorised user" is defined in the Securities Services Act as a person authorised by an exchange to provide such securities services as the rules of such an exchange may permit. An exchange in this instance means SAFEX.
The Securities Services Act’s definition of securities services includes any services provided in respect of the buying and selling of both listed and unlisted securities. The definition of securities, in Securities Services Act, includes derivative instruments. The Securities Services Act prescribes the manner in which securities may be listed or removed, the requirements with which the issuers of listed securities must comply, the standards of conduct of issuers of securities, standards of disclosure and corporate governance rules that issuers of listed securities must meet.
Listed derivatives are traded through SAFEX and are regulated by the SAFEX Derivatives Rules of January 2005 ("the SAFEX Rules"). The SAFEX Rules only apply to and are binding on members of SAFEX, who are mostly registered financial institutions or authorised users. Every transaction in a listed security must comply with the provisions of the Securities Services Act, the SAFEX Rules, the JSE Securities Exchange Rules and directives ("JSE rules") and the decisions of the board of directors of the JSE.
According to the SAFEX Rules, a derivatives member of the JSE ("a derivatives member"), meaning any entity admitted to membership of the JSE to trade financial instruments under the derivatives rules, must be registered in the financial derivatives market or the agricultural derivatives products market, or both, in order to provide securities services.
A derivatives member is required to hold at least one JSE right, by registering in one of two classes, namely, as a clearing or non-clearing member in each market (a clearing member is one who has entered into a clearing agreement with a clearing house whilst a non-clearing member is not party to such clearing agreement), and in one of two categories as a broking or non-broking member in such market. A broking member may trade in financial instruments for his own account and on behalf of clients, whereas a non-broking member is not entitled to trade on behalf of clients or to enter into agreements with them. A broking member may be a clearing member or a non-clearing member.
When a derivative member trades for or on behalf of any derivatives client, a client agreement must be entered into in order to regulate their relationship and to comply with the JSE rules. The JSE prescribes the basic terms and formal requirements of the agreements for dealing in listed financial instruments, including, but not limited to the clearing house agreement and the client agreement. The procedures for offer and acceptance, trading for and on behalf of clients, order priority, trading priority, trading times, pre-arranged trades and so forth are regulated by the SAFEX Rules.
Over the counter transactions
As regards unlisted securities, the Registrar of Securities Services ("the Registrar") may prohibit, impose and/or prescribe conditions for the buying and selling of unlisted securities. There is no over the counter ("OTC") trading market for derivatives in South Africa. Parties may, however, enter into OTC transactions and regulate their relationship through the International Swaps and Derivatives Association Master Agreement ("the Master Agreement"), which will govern each OTC transaction entered into with regard to derivatives. The Master Agreement and the Securities Services Act must, however, be read together, in order to ensure that the transactions take place within the South African regulatory bounds.
The approval of the Registrar is required for the publication or circulation of any written comments relating to the trading results of a public company or which may influence the value of the listed securities, except where the name of the person/s who compiled it or the source from which such information has been obtained is disclosed. The approval of the Registrar, in terms of the Securities Services Act, is also required if one directly or indirectly advertises or canvasses for any business relating to the buying and selling of securities listed on a foreign stock exchange, provided that the foreign stock exchange is recognised by the Registrar.
The Securities Services Act provides that no person, other than an authorised user, who is permitted in terms of rules of an exchange to trade in securities, may directly or indirectly, in any manner, advertise or canvass for the business of that authorised user. The making of a false, misleading or deceptive statements, promises and forecasts constitutes an offence in terms of the Securities Services Act, which is punishable, upon conviction, by a fine or imprisonment for a period not exceeding five years or both. The Registrar may, at his discretion, direct that, if certain documentation relating to the advertisement or canvass for business with regard to listed or unlisted securities is for any reason objectionable, such documentation be amended before being advertised or that it not be published.
Derivatives members are entitled to advertise their material subject to the SAFEX Rules. In the event that the JSE concludes that a derivatives member has failed to conform to any of the advertising requirements published in terms of the SAFEX Rules, the JSE may in its discretion require that no further advertising or promotional or marketing material be published by or on behalf such derivatives member unless it has been submitted to the JSE in advance and the JSE has notified such derivatives member of its acceptance of the advertising or promotional or marketing material as suitable for publication.
Codes of conduct
The Registrar is responsible for prescribing a code of conduct for authorised users. This code of conduct is binding on all authorised users, their officers, employees and clients. The SAFEX Rules list a number of practices, whether an act or omission, which constitute improper conduct. These practices include, committing (or attempting to commit) dishonest, fraudulent, dishonourable or disgraceful acts, negligently or recklessly conducting the business or affairs of the member, knowingly obstructing the business of the JSE or its members. Any contravention of the SAFEX Rules, the Securities Services Act and/or the JSE rules will result in a disciplinary investigation, conducted by the director of the JSE Surveillance Department.
A member who has been found guilty of improper conduct will face a penalty that is considered appropriate taking into account any previous convictions of the member in terms of the JSE or in a court of law, the harm or prejudice which was caused by the offence, aggravating or mitigating factors (if any). The SAFEX Rules provide for, termination of membership, suspension of membership, and appropriate costs orders.
Registration of a compliance officer
The SAFEX Rules require each derivatives member to register a compliance officer with the JSE. The compliance officer is essentially responsible for ensuring compliance with the provisions of the Securities Services Act, the SAFEX Rules, JSE directives and rules and any other legislation applicable to the business of the derivative member.
A member who uses the services of the JSE, thus SAFEX, shall pay to the JSE such fees and charges as may be prescribed by the JSE from time to time. Subscription fees are payable annually in advance during January and shall be in respect of each JSE financial year. The JSE may, in addition to subscriptions, fees and charges prescribed by the SAFEX Rules, from time to time impose upon every member a levy which shall be paid to the JSE or any of its funds on such conditions as the JSE may decide.
The provisions of the Securities Services Act, read with the SAFEX Rules, require persons wishing to trade in listed derivatives to be registered as an authorised user of to effect the trade through an authorised user and to be a member of SAFEX.
Bowman Gilfillan Inc. has experience in assisting international institutions with capital markets and securities transactions within the South African regulatory landscape.