OTC derivatives – or over-the-counter derivatives – are somewhat of an enigma. Few people trade OTC derivatives and even fewer people understand them. Essentially, OTC derivatives are securities that are traded between parties directly, as opposed to trading via an exchange like the Johannesburg Stock Exchange (JSE). A simple example of an OTC transaction would be if two people buy and sell shares in Company X that are not listed on the JSE. This does not necessarily mean that Company X is a small fish in a big pond; it just offers a cheaper alternative to investors in the market for quick capital turnarounds.
When is an entity required to apply for an OTC derivative provider (ODP) licence?
One needs to start off by distinguishing between the ODP and the FAIS Act Legal Frameworks respectively. Certain financial services can be performed in respect of your FAIS authorisation, depending on the Category of FSP (Financial Service Providers) license you hold. It can, however, happen that the services that you intend to render in terms of international business arrangements, or the availability of advanced platform technologies may cross into the scope of being an ODP provider in terms of the ODP legal framework, in which case there are separate ODP licensing requirements that you must comply with.
ODP Legal Framework
In terms of Regulation 5 of the Financial Markets Act (FMA), an authorised “OTC derivative provider” has been prescribed as a regulated person. Furthermore, in terms of Regulation 1 of the FMA, an “OTC derivative provider” is defined as a person who as a regular feature of its business and transacting as principal – (a) originates, issues, or sells OTC derivatives; or (b) makes a market in OTC derivatives.
An “OTC derivative” is defined as an unlisted derivative instrument that is executed, whether confirmed or not confirmed, excluding – (a) foreign exchange spot contracts; and (b) physically settled commodity derivatives. Derivatives are financial instruments which derive their value from an underlying asset like gold, wheat, or shares[1].
In terms of the FMA, a person may not act as an ODP unless authorised by the Financial Sector Conduct Authority (FSCA) and no person may advertise or hold themselves out as an ODP unless authorised by the FSCA. Therefore, if you are intending to “act as a provider of derivate products” by issuing over-the-counter (OTC) derivatives, including contracts for difference (CFDs), as principal in South Africa, then you need to have an approved ODP license. A person who fails to be licensed as an ODP and who issues CFDs as principal as a regular feature of the business is liable on conviction to a fine not exceeding 10 million Rand or to imprisonment for up to five years, or both in terms of section 109 of the FMA.
FAIS Act Legal Framework
The FAIS Act regulates the provisions of “advice” and “intermediary services” in respect of “financial products”.[2]
Anyone who intends to market (provide advice and/or intermediary services) for foreign derivative products issued by foreign issuers in foreign jurisdictions, including OTC derivatives, will also need to be appropriately authorised for financial services in the “derivatives” product as a Category 1 FSP. Similarly, anyone who intends to market (provide advice and/or intermediary services) for local derivative products issued by a local (third party) ODP provider on whose behalf the FSP “markets”, will need to be appropriately authorised for financial services in the “derivatives” product as a Category 1 FSP.
The consequences of non-compliance for not being licensed correctly are significant. If found guilty, a person can be liable to a fine not exceeding 10 million Rand or to imprisonment for up to 10 years, or both.
Should you require any further assistance or clarification, contact Masthead. We can also assist you with the compilation of an ODP License Application.
[1] What Is an Over-the-Counter (OTC) Derivative https://www.investopedia.com/
[2] Section 1(1) of the FAIS Act.