KSA Securities Central Counterparties Regulation and the Central Counterparty Clearing House (Muqassa)
The Securities Central Counterparties Regulation (the “Regulation”) was issued by the Board of the Capital Markets Authority (“CMA”) pursuant to resolution number 3-127-2019 dated 21/3/1441H (corresponding to 18/11/2019G) to regulate Securities Clearing activities in the Kingdom of Saudi Arabia (“Kingdom”) and specify the procedures and conditions for obtaining an authorisation to carry out such activities. The Regulation reinforces the theme of risk mitigation and transparency in the derivatives space in the Kingdom.
Following the issuance of the Regulation, the Board of the CMA also issued the Securities Clearing Centre Rules and Clearing Procedures of the Central Counterparty Clearing House (Muqassa) (Resolution 1-137-2019 dated 12/4/1441H corresponding to 9/12/2019G) as well as the Derivatives Exchange Trading and Membership Rules and Procedures of the Saudi Stock Exchange (Tadawwul) (Resolution 2-137-2019 dated 12/4/1441H corresponding to 9/12/2019G) which were based on the terms of the Regulation.
The following are highlights of this Regulation:
1. Authorisation of a Central Counterparty (“CCP”) – given the CCPs are the critical nodes that reduce risk and increases financial stability, the Regulation sets out the requirements for an entity to be authorized by the CMA as a CCP as well as the procedure. Accordingly, the requirements are stringent and require that a prospective CCP established in the Kingdom must be a joint stock company. The other authorisation requirements relate to the net assets of the CCP, its expertise, risk management and shareholders. While it is possible for an entity established outside the Kingdom to be authorized as a CCP, there are certain additional requirements given it is regulated by an external regulator.
2.Clearing – under the Regulation, there are two ways of clearing securities: (a) open offer which is a process whereby the CCP extends an open offer to act as a counterparty to market participants and is immediately interposed as counterparty in a transaction where the two parties agree on the terms when the pre-agreed conditions of the CCP are satisfied; and (b) novation which is a process whereby the original contract between one party and another party is discharged and replaced with two new contracts, one between the CCP and the first party and the other between the CCP and the second party.
3.Clearing Members – the Regulation requires that the CCP shall, at least, provide for two categories of members: (a) a Direct Clearing Member which is a Clearing Member who is authorised to clear Securities which it has traded in its capacity as a member of an Exchange, including Securities it has traded on its own account or on behalf of its Client(s) but not for Exchange members with no clearing memberships; and (b) a General Clearing Member which is a Clearing Member who is authorised to clear Securities on behalf of its Client(s), including Exchange members with no clearing memberships. The Regulation sets out the relevant requirements for the Clearing Membership which again reinforces the theme of risk mitigation seen across the Regulation.
4. Collateral – continuing with the theme of risk reduction and transparency, the Regulation places a requirement on the Clearing Members to post collateral with the CCPs and also sets out the boundaries of acceptable collateral, haircuts, concentration limits and reuse of collateral while rejecting collateral that presents a wrong way risk.
5. Margining – continuing with the concept of collateral, the Regulation requires the CCP to specify margin requirements including models and parameters. The margin rules establish margin levels to be proportional to the risks and attributes of the cleared product. The Regulation also clarifies that the models and parameters adopted by the CCP should provide for Initial Margin (which refers to margin that is collected to cover the potential future exposure resulting from potential changes in the value of the Clearing Member’s position over the appropriate close-out period in the event that Clearing Member defaults) as well as Variation Margin (which refers to margin that is collected to cover the current exposure resulting from actual changes in market prices which affects the value of the Clearing Member’s position).
6. Risk management – management of risk is an important task of managing a CCP and accordingly, the Regulation requires the CCPs to identify sources of as well as measure and monitor:
- credit risk which includes creating a default fund to limit such exposure to its Clearing Members;
- liquidity risk, which in particular, requires the CCP should ensure that it has access to liquidity and maintain sufficient liquid resources so that all payment obligations may be met seamlessly even during times of stress; and
- operational risk which requires the CCP to have an effective business continuity plan.
7.Settlement finality – the Regulation also asks the CCP to have rules surrounding at what point a settlement is final and irrevocable in respect of cash settlements as well as physical deliveries.
8. Account structures – the Regulation requires that the CCP employs an account structure that enables it to readily identify the positions of the Clearing Member’s Client and to segregate related collateral and minimally, should include these account structures: (a) House Accounts (for the Clearing Member’s own trades); (b) Omnibus Client Accounts (which is an omnibus account for the Clearing Member’s clients); and (c) Individual Client Accounts (which is a segregated client account for each client). These account structures are designed to promote segregation as well as to create a framework that assist in porting and transfer of trades, particularly from a defaulting Clearing Member to a non-Defaulting Clearing Member.
9. Clearing Member default – the main method of addressing risk mitigation in clearing is to provide for Clearing Member’s default and thus, the Regulation mandates that the CCP should clearly specify what constitutes a Clearing Member’s default and the default rules and procedures. Any loss that the CCP may incur as a result of following such processes are made even by applying the proprietary assets of the defaulting Clearing Member and then the default fund contributions of the Clearing Members.