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BONDS HANDBOOK
Version 10
Date: June 2014
1
Document Information
Copyright Notice
Contents of this document are protected under South African copyright law. No part of this
document may be copied, completely or partly, either electronically or manually, without the
written consent of Strate Ltd.
This document remains the sole property of Strate Ltd.
Disclaimer
Although this document is the result of extensive analysis and research, it is subject to changes
which may emanate from the audience or any supporting or endorsing party. The revisions and
editions will be recorded and indicated per the Version Numbers that are released.
2
Document Information 1
1 MESSAGE FROM THE CEO 7
2 STRATE’S VISION, PURPOSE AND OBJECTIVES 8
2.1 Vision 8
2.2 Purpose 8
2.3 Objectives 8
3 ACKNOWLEDGMENTS 10
4 INTRODUCTION 11
4.1 History of electronic settlement in South Africa and the run up to Strate 11
4.2 Start of the Strate Project 13
4.3 The Merger of Strate and UNEXcor 17
4.4 Strate at present 18
5 THE BASICS OF STRATE 25
5.1 The Benefits of Strate 25
5.2 Participants 32
5.3 Types of Clients 33
5.4 Users of the system 34
6 AN INTRODUCTION TO CAPITAL MARKETS 36
6.1 Background 36
6.2 The Capital Markets 40
3
6.3 What is a bond? 42
7 CHARACTERISTICS OF BONDS 43
7.1 Coupons 43
7.2 Maturity Date 46
7.3 Principal/Nominal Amount/ Face Value/Par Value 46
7.4 Secured versus Unsecured Debt 47
7.5 Subordination 47
7.6 Bond Indenture 48
7.7 Derivatives 49
7.8 Sinking Fund Provision 53
7.9 Yield to Maturity (YTM) 54
7.10 The Yield Curve 55
8 TYPES OF BONDS 57
8.1 Government Bonds 57
8.2 Corporate Bonds 58
8.3 Municipal Bonds 59
8.4 International Bonds 59
8.5 Floating Rate Notes 60
8.6 Reverse floaters 61
8.7 Amortising Bonds 61
8.8 Securitisation 61
8.9 STRIPS 63
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8.10 Inflation Linked Bonds 64
9 THE BOND MARKET 65
9.1 The International Bond Market 65
9.2 Background of the South African Bond Market 70
9.3 Development of the Clearing System for Electronic Nett Settlement 73
9.4 Key stakeholders 74
10 LEGAL FRAMEWORK 82
10.1 Legislation 82
10.2 Pledge in the Strate Environment 87
11 ACCOUNT STRUCTURES 91
11.1 Central Securities Accounts 91
11.2 Securities Account 91
11.3 Dematerialisation and Immobilisation 92
11.4 Rematerialisation 92
11.5 Nominees and Beneficial Ownership Disclosure 93
11.6 Segregated Depository Accounts 95
12 SETTLEMENT 100
12.1 From trade through to settlement 100
12.2 On-market and Off-market transactions 103
12.3 Off-market Settlement Process Flow 105
12.4 Settlement Principles 106
12.5 Strate Settlement Directives 110
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12.6 Other types of transactions 111
13 CORPORATE ACTIONS 118
13.1 Definitions 118
13.2 Types of Corporate Actions 119
13.3 Conversions 122
13.4 Proxy Voting 123
13.5 Splitting 123
13.6 Top-Ups and Buy-Back 124
13.7 Strate Bonds Corporate Action Directives 125
14 REGULATION AND SUPERVISION 126
14.1 Strate as a Self-Regulatory Organisation (SRO) 126
14.2 Regulation and Supervision 128
14.3 Regulatory and Supervisory Pyramid 129
14.4 Supervisory approach and strategy 139
14.5 Chinese walls 139
15 COMPLIANCE AND REPORTING REQUIREMENTS 145
15.1 The Compliance Function 145
15.2 Conflicts of interest for Compliance Officers 147
15.3 The Roles and Responsibilities of the Strate Compliance Officer 149
15.4 Whistleblowing 153
15.5 Strate Circular 157
16 RISK 162
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16.1 Risk and the Role of the Compliance Officer 162
16.2 Regulatory and Supervisory Risks 164
16.3 Aspects of the Rules and Directives which require monitoring 167
16.4 Risks Associated with Investing in Bonds 167
16.5 Systemic Risk 172
17 THE BASICS OF THE SYSTEMS 175
17.1 The need for Straight Through Processing (STP) 175
17.2 SWIFT and interfacing with the Securities market 176
17.3 Bond System Participant Interface 177
18 GLOSSARY OF TERMS – BONDS` 179
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1 MESSAGE FROM THE CEO
Strate reaches another milestone during 2014 by publishing the 10th version of the Strate Bonds
Handbook. This Handbook has been purchased by, and is circulated around, the four corners of
the South African Securities market and even international stakeholders. The Handbook provides
an explanation of Strate‘s core functionality and procedures, and forms the basis of the learning
material for candidates wishing to participate in the Strate examinations.
It has been encouraging to see how the number of candidates who have registered for the Strate
compliance examinations has risen over the years. Success is a continuous process and can only
be achieved through commitment and dedication.
Our audience may have various needs in terms of the levels of training required, and as such,
Strate continues to adopt a modular approach to the Handbooks and E-learning packages.
The lecture type learning environment continues to be supported by Strate. Seminars can be
arranged through liaison with our Strate Training Division. For more information please contact
We are sure you will enjoy reading this material as much as we have enjoyed creating it. If in the
process you come across ideas that you feel we could use to improve what we do, please do not
hesitate to contact the training division. We value your input and we are committed to meeting
stakeholders‘ needs in an ongoing process of improvement.
I hope these words will inspire you in your work and your personal life
“It takes a lot of courage to release the familiar and seemingly secure, to embrace the new.
But there is not real security in what is no longer meaningful. There is more security in the
adventurous and exciting, for in movement there is life, and in change there is power.”
Monica Singer
Strate Chief Executive Officer
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2 STRATE’S VISION, PURPOSE AND OBJECTIVES
2.1 Vision
We are the leading independent South African provider of innovative post-trade products and
services. We facilitate risk management, enabling transparency and efficiencies for the financial
markets.
2.2 Purpose
Strate‘s purpose is to provide post-trade services for the securities market, enabling end-to-end
pragmatic, reliable, innovative solutions that facilitate the management of risk and the realisation
of value for all stakeholders.
2.3 Objectives
Strategic objective # 1: To ensure operational excellence and the effective management of
enterprise risk while driving innovation and market best practice.
Strategic intent:
Continuously enhance and maintain Strate‘s operational capabilities and governance
to enable corporate strategy.
Provide thought leadership on national and international forums to drive innovation.
Retain the CSD and Clearing House licenses.
Drive market best practice.
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Strategic objective # 2: To be stakeholder Centric
Strategic intent:
To expand the Client base and service offerings.
To build the Strate brand globally.
To manage stakeholder relationships with excellence
Strategic objective # 3: To be profitable
Strategic intent:
Increase revenue from new income streams
Provide superior products and services at a commensurate price.
Ensure Strate‘s financial self sustainability.
Meet shareholder‘s financial expectations on returns.
Ensure operational costs are effectively contained.
Strategic objective # 4: To be a learning organization, enabling Corporate and Personal
growth.
Strategic intent:
To strive for personal growth and the development of skills amongst Strate staff.
Maintain an appropriately skilled, competent employee base within Strate.
Meet Transformation targets.
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3 ACKNOWLEDGMENTS
Strate takes this opportunity to thank the JSE Limited (JSE) including the BESA Market,
(specifically Mr Brett Kotze) and Mark Raffaelli from Geometric Progression for their valuable
contribution, both in information and time, to the writing of this Bonds Handbook. Without their
involvement and willingness to assist, this Handbook would not have been as comprehensive.
11
4 INTRODUCTION
4.1 History of electronic settlement in South Africa and the run up to Strate
Advances in telecommunication technology have brought far-reaching changes in the
characteristics and supply of financial products and services, and in trading and settlement
systems. Changes have also fuelled cross-border activities. The South African industry has not
escaped this dramatic paradigm shift and continually initiates strategic projects, all with the
objective of positioning South Africa in the forefront of the world‘s financial markets.
In the early 1990s, the JSE Limited (JSE) appointed a sub-committee to investigate all aspects of
the operations of the JSE. This Committee was often referred to as the ―Katz Committee‖, named
after its Chairman, Michael Katz. Working groups were established in January 1995. One of the
working groups was involved in researching the requirements for electronic settlement and
custody.
On 03 April 1995, the JSE and the Council of South African Bankers (COSAB) signed an
agreement where the parties agreed to assist each other and co-operate to achieve several
targets. The JSE endeavoured to investigate:-
restructuring the South African Securities market to ensure it could be placed in
an internationally competitive position in the shortest possible practical time;
how Securities transactions could be conducted at internationally competitive
costs yet at a level which would not prejudice the security and integrity of the
market; and
the legislative amendments required and regulations or drafting of Rules or
Directives to cater for the implementation of electronic settlement and custody.
In 1992, an electronic settlement system for bonds was introduced. This system was operated by
Bankserv, an entity which is majority owned by the 4 major banks. It was later housed in a
separate legal entity, named Universal Exchange Corporation (UNEXcor), the company with
which Strate merged in 2003.
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COSAB, Bankserv and the JSE agreed to use their best endeavours to move towards the
implementation of electronic settlement and custody. In June 1995 a delegation of representatives
from the JSE and the banks visited several countries to investigate and assess whether their
electronic settlement systems would be suitable for the South African market.
On 2 May 1996, the JSE and Bankserv signed an agreement to work together in designing and
implementing a modern electronic clearing and settlement system that would meet the G30
recommendations. One of the objectives was to “contain costs by using and developing the
existing clearing and settlement systems available to both parties, as far as is practicable”.
The agreement also provided for the establishment of a steering committee, named the Electronic
Settlement Committee (EESC). The committee was constituted with:-
each party having equal representation; and
two chairpersons (at all times), one appointed by each party (the JSE and
Bankserv) with chairmanship of meetings rotating every three months.
The EESC had its first meeting on 16 May 1996. Numerous meetings followed between the
various stakeholders to resolve all the issues at hand in order to progress the project. The
methodology of changing Chairman each 3 months proved not to be ideal and from mid 1997 the
JSE took over the running and financing of the project but with the substantial input of all the
market players.
The JSE was, at the time busy investigating both electronic equities trading and electronic
settlement systems, with the main focus being on electronic trading. As a result of the progress
made with electronic trading, the JSE implemented an electronic trading system in June 1996.
Trading volumes quickly surged to a daily average of over 10,000 trades, from approximately
3,000 trades a day in December 1995. Back offices of the brokers and banks were in chaos with
failed trades reported to be 40% to 45% of trades concluded.
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4.2 Start of the Strate Project
Based on the agreement signed between the JSE and Bankserv on 2 May 1996, Bankserv was
given ownership of the Strate project and Monica Singer was appointed as the project manager.
As from 26 July 1997 the JSE took over the ownership of the project and it was noted that the
EESC would no longer be necessary as presently constituted.
It was also during this period 1998/1999 when South Africa was rated the worst in terms of
settlement and operational risk by GSCS Benchmarks (an international rating agency), with
ratings of (1,28) and (0.14) out of a potential 100. Further, the successful introduction of the
Johannesburg Equity Trading (JET) system (replaced in 2002 by the SETS system) highlighted
the deficiencies of a paper-based system. The growing use of the Internet, declining mortality
rates, the liberalisation of Pension Funds and the relaxation of Exchange Controls were
encouraging investors to invest more. With the number of Securities transactions growing rapidly,
a need arose to introduce a settlement infrastructure which could support this growth and mainly
remove the inefficiencies inherent in the traditional paper based environment.
In August 1997 a very intense meeting took place between the JSE and the banks where it was
agreed that neither the JSEs system nor the UNEXcor system would be used as the electronic
settlement system for equities.
In September 1997, a team of banks and JSE representatives visited Switzerland to assess the
appropriateness of the Swiss Central Securities Depository (CSD) system, SECOM. A decision
was taken to purchase a license to use the Swiss CSD system at a cost of ZAR 10,575,004. The
Licence Agreement stipulated that an Indian company, Tata Consulting Services (TCS), had to be
contracted to do the customisation as they developed the system for the Swiss in the first place.
The customisation cost an additional ZAR 60,209,607.
It can be argued that a less expensive and complex system could have met the market‘s needs,
but the JSE and the banks had to be convinced of the system‘s comprehensive functionality.
Over and above the central system cost, the JSE and banks also incurred costs to develop their
systems. Part of the cost incurred by the JSE and banks related to the development of the
―Subregister functionality‖, which was one of the decisions that were taken by the market at the
time.
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In September 1998, all the legislation supporting and enabling the dematerialisation of Securities
was in place. The amendments to the Companies Act and Custody and Administration of
Securities Act, as well as a new Act, the Uncertificated Securities Tax Act, were all approved by
Parliament.
4.2.1 Strate Limited incorporated
On 9 November 1998, Strate Limited (initially registered as Share TRAnsactions Totally Electronic
Limited) was incorporated as a Public Company, with 7 JSE representatives holding 100% of the
shares in issue.
By the end of 1998, the JSE had already invested ZAR 5,313,569 in the Strate project.
4.2.2 The Dematerialisation process and the Dispossessed Members Fund
In December 1998 the various stakeholders agreed for Strate to go live with the pilot phase by 30
July 1999. The customisation of the system started and by June 1999, integration testing with the
market was completed.
On 28 May 1999, a document titled ―Establishing a common understanding of key unresolved
issues regarding the transition to electronic Securities settlement in South Africa‖ was issued by
the four major custodian banks in South Africa. The document listed the four banks‘ conditions to
commence with the phase 1 implementation of Strate on 30 July 1999. The conditions stipulated
that:-
mutually acceptable resolutions to the identified issues be found; and
the resolution of the identified issues were placing constraints on the four banks,
in developing appropriate internal operating procedures in time.
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This document included the establishment of the Issue Resolutions Committee (IRC) with
representatives from the four banks and Strate making up the membership. Strate was required
to meet the representatives of the IRC on a weekly basis to reach agreement on and resolution of
the outstanding issues in order to go live by the end of July 1999.
A timetable, based on the latest dates upon which the banks would have sufficient time to
complete internal systems/process developments and conduct a level of testing adequate to go
live by 30 July 1999, was prepared.
With the system ready and all the issues viewed to be satisfactorily resolved, the go live date of
the pilot phase got delayed on the 11th hour. The delay was motivated by the risk of tainted scrip.
The banks imposed a condition that the project would not proceed unless the market could be
sufficiently protected from the perceived risk of tainted scrip.
Tainted scrip occurs when share certificates are lost or stolen and subsequently negotiated using
a forged document leading to the removal of the legitimate shareholder, referred to as the
Dispossessed Member, from the company‘s share register.
The implementation schedule for 30 July 1999 was eventually delayed until the end of September
1999, with the tainted scrip concern and Y2K being the major drivers of this decision.
To get the project back on track, a solution for the perceived problem was urgently required. The
banks employed the consulting firm McKinseys, who produced a report estimating the value of
tainted scrip at ZAR130 million. Insurance companies were approached with this problem and
asked to provide quotes for insurance against this risk.
Insurance quotations were received. On the advice of the underwriters, Lloyds of London, the IRC
decided that it would be more efficient to self insure the first ZAR 50 million and put in place
catastrophe insurance of ZAR 2 billion. This insurance cost Strate ZAR 18,500,000.
The Dispossessed Members‘ Fund Trust (DMF) was consequently established in September
1999, registered as a trust on 9 May 2000 with the Master of the High Court. The purpose of the
DMF was to compensate any Dispossessed Member who was entitled to compensation in terms
of the Rules of the Fund.
The risk of tainted scrip turned out to be nothing like that estimated as the DMF paid out claims
approximating only ZAR 925, 000.
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4.2.3 The Shareholders Agreement
On 10 September 1999, the shareholders agreement between Strate, the JSE, Standard Bank,
Absa, First National Bank, Nedbank, Mercantile Bank and Citibank was signed.
The shareholders‘ objectives for Strate were to:-
reduce settlement risk in transactions in Securities;
increase efficiency in clearing and settlement of transactions in Securities;
contribute to the reduction of costs in transactions in Securities;
comply with the G30 Recommendations;
maintain a system of settlement in accordance with the requirements of the
markets;
provide simultaneous, final and irrevocable delivery versus payment, which
ensures the secure transfer of ownership with simultaneous, secure transfer of
value; and
provide for the dematerialisation of Securities in order to facilitate electronic
settlement of such Securities.
Strate is appointed as a Central Securities Depository (CSD) in terms of the Financial Markets Act
(FMA) and provides custody, clearing and settlement services as set out in that Act..
4.2.4 The first electronic settlement on 9 November 1999 and the continuation of the
dematerialisation process
Strate eventually went live in November 1999 with a gross trade by trade settlement model in
Central Bank funds. Shareholders of Harmony Gold Mining Company Limited were the first to
dematerialise their shares (dematerialisation is the elimination of a paper share certificate and the
creation of an electronic record of ownership of Securities). The first electronic settlement of
trades in Harmony Gold Limited occurred on 9 November 1999. The market soon expressed its
concern with the costs and complexity of the gross trade by trade model and decided not to
dematerialise any additional counters until these problems had been resolved. Consequently the
dematerialisation project was put on hold and a new model, which catered for both gross and nett
settlement, was developed.
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In June 2000, Strate was allowed to move an additional 11 counters into the dematerialised
environment.
Strate was allowed to continue with the dematerialisation process from 5 March 2001 and by 22
January 2002 all the remaining counters had been migrated into the Strate environment.
4.2.5 The Netting model for settlement
As stated above, investigation into the netting model for settlement commenced shortly after the
first electronic settlement in November 1999. Extensive consultation followed and it was decided
to develop additional functionality to enable netting. Strate incurred development cost totalling
ZAR 8,750,452 to develop this functionality.
4.2.6 Additional functionality implemented by Strate
On 6 August 2001 Strate implemented additional functionality for Securities lending and borrowing
(SLB) and Corporate Actions at a cost of ZAR 5,851,383 and ZAR 11,976,762.
The Corporate Action functionality offered several market benefits which included electronic
payment of dividends on due date and the elimination of market claims.
4.3 The Merger of Strate and UNEXcor
The four major banks that were 100% owners of UNEXcor and 50% owners of Strate, the two
CSDs in South Africa, started exploring a merger of the two entities.
The bank shareholders and the JSE, with a shareholding of 50% in Strate at the time, came to an
agreement to merge the two entities and made a voluntary submission to the Competitions
Commission.
At the same time, the Ludin Report was published. This Report dealt with various aspects of
settlement and ownership of settlement entities. In July 2003 the Competitions Commission
18
approved the merger unconditionally and the merger of Strate, UNEXcor and Central Depository
Limited (the Clearing House for UNEXcor) became effective on 1 August 2003.
The shareholding in Strate before and after the merger is shown in the table below:-
Shareholders % Shareholding –
before transaction
% Shareholding –
after transaction
JSE Limited 50% 41,001%
ABSA Bank Limited 9,975% 12,679%
FirstRand Bank Limited 9,975% 12,679%
Nedbank Limited 14,9625% 16,769%
Standard Bank of South
Africa Limited
14,9625% 16,769%
Citibank N.A 0,125% 0,1103%
4.4 Strate at present
The shareholding in Strate as at December 2011 is shown in the table below
Shareholders % Shareholding –
JSE Limited 44,547%
ABSA Bank Limited 12,679%
FirstRand Bank Limited 12,679%
Nedbank Limited 14,996%
Standard Bank of South
Africa Limited
14,996%
Citibank N.A 0,103%
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Strate was borne out of a need to make the settling of equity transactions simpler, safer and more
efficient. The JSE was languishing at the bottom of the ratings of settlement risk amongst
emerging markets and carried the burden of this image at an international level. The GSCS
Benchmarks, which measured the international Securities industry, consistently placed South
Africa last out of the 20 emerging markets under review. Improvements had to be made.
The table below shows how badly South Africa was rated in terms of settlement risk. The rating
improved from 2002 following the successful implementation of Strate and electronic settlement.
BEST
2001
2002
2003
2004
2004
Ranking
Korea
China
Taiwan
Indonesia
Turkey
Malaysia
South Africa
98.13
95.62
77.32
98.27
95.34
58.48
98.74
96.75
99.24
96.95
98.86
95.95
98.13
99.69
98.35
99.70
99.41
99.14
98.34
97.62
99.81
99.79
99.59
99.44
98.97
98.68
98.27
(1/22)
(2/22)
(3/22)
(4/22)
(5/22)
(6/22)
(7/22)
GSCS Benchmarks figures for 2002 highlighted that South Africa made considerable progress up
the settlement rankings, and has subsequently maintained a highly impressive rate of 97.62%
during 2003. This continuous improved performance shot South Africa up from worst position of
20th
(in 2000) to 7th in the emerging market rankings by the end of 2004.
Global Investment Services, March 2002 are quoted as saying ―South Africa’s Securities
Exchange infrastructure is among the most sophisticated in any emerging market, and the
migration of all JSE listed Securities onto the market's CSD, Strate, confirms its position at the
cutting edge of financial technology.”
Unfortunately GSCS no longer publish global rankings, but Strate continues to make progress in
its settlement ratings. The following chapters of this Handbook and Learning Material explain the
current functionality and procedures supporting Strate and electronic clearing, settlement and
custody services.
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4.4.1 Africa and Middle East Depositories Assosiation (ACSDA)
It was announced in May 2002 that Strate was invited to become a member of the Americas‘
Central Securities Depositories Association (ACSDA). This was the first time that a CSD operating
in a country outside of the Americas had been invited to join the association.
The invitation followed a visit in 2001 to Panama by Monica Singer where she addressed the 2001
ACSDA annual meeting.
"We are obviously honoured to have been asked to join the ACSDA," says Singer. "Strate has
accepted the invitation rather than applying for membership of the equivalent European
association, largely because we have more in common with the emerging markets of the
Americas than with Europe’s CSD’s realities."
The Americas‘ Central Securities Depositories Association is a non-profit organisation comprised
of CSDs and Clearing Houses of the Americas and South Africa. ACSDA‘s main purpose is to be
a forum for the exchange of information and experiences among its members in a spirit of mutual
co-operation and to promote the best practice recommendations in services such as Securities
depository, clearing, settlement and risk management.
The benefits for Strate to be part of this association are:-
the attendance of yearly conferences regarding the latest issues, trends and
developments in the industry;
contact with other CSDs for advice and recommendations;
forum to discuss issues affecting emerging markets;
as the USA and Canada are leading the way forward to T+1 and other industry
initiatives, this will allow Strate to learn from their experiences without the need to
reinvent what already exists in this industry; and
representation at an international forum.
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ACSDA Members
There are currently 25 CSDs from 30 different countries. These members include:
Argentina
Caja de Valores S.A. (CVSA)
Argentina Mercado de Valores de Buenos Aires, S.A.(MERVAL)
Barbados
Barbados Central Securities Depository Inc. (BCSD)
Bermuda Bermuda Stock Exchange/ Bermuda Securities Depository (BSD)
Bolivia
Entidad de Depósito de Valores de Bolivia S.A. (EDV)
Brazil Companhia Brasileira de Liquidacao e Custódia (CBLC) and Brazil Central de
Custódia e de Liquidacao Financeira de Títulos (CETIP)
Canada
The Canadian Depository for Securities Limited (CDS)
Chile
Depósito Central de Valores, S.A., Depósito de Valores (DCV)
Colombia
Depósito Centralizado de Valores de Colombia S.A. (DECEVAL)
Dominican Republic Depósito Centralizado de Valores S.A. (CEVALDOM)
Eastern Caribbean
Eastern Caribbean Central Securities Depository (ECCSD)
Ecuador
Depósito Centralizado de Compensación y Liquidación de Valores S.A.
El Salvador
Central de Depósito de Valores, S.A. (CEDEVAL)
Guatemala Bolsa de Valores Nacional S.A. (BVN)
Jamaica
Jamaica Central Securities Depository Limited
Mexico
S.D. Indeval, S.A. de C.V. (S.D. Indeval)
Nicaragua Central Nicaragüense de Valores, S.A. (CENIVAL)
Panama Central Latinoamericana de Valores, S.A. (LatinClear)
Peru Cavali S.A. I.C.L.V. (CAVALI)
South Africa Strate Ltd. (Strate)
Trinidad & Tobago Trinidad & Tobago Central Depository Limited (TTCD)
USA The Depository Trust & Clearing Corporation (DTCC)
Uruguay Bolsa de Valores de Montevideo (BVM)
Venezuela Caja Venezolana de Valores (CVV)
22
ACSDA Structure
Legal
Committee
CSD Links
Committee
Communi-
cations
Committee
Risk Auditing
Working
Committee
Executive
Secretary
Corporate
Actions Working
Committee
ACSDA
Leadership and
Development
Committee
Executive
Committee
23
4.4.2 Africa and Middle East Depositories Association (AMEDA)
Strate officially became a member of AMEDA in November 2007.
AMEDA was established in April 2005. AMEDA is a non-profit organization comprised of CSDs
and Clearing Houses in Africa and the Middle East.
AMEDA's main purpose is to be a forum for the exchange of information and experiences among
its members in a spirit of mutual co-operation and to promote best practice recommendations in
services such as Securities depository, clearance, settlement, and risk management.
AMEDA's goal is also to support local markets in their efforts to adopt Securities market
regulations, while considering their specific circumstances and to serve as a dialogue channel
with other organizations worldwide.
24
AMEDA Members
Below is a list of AMEDA‘s current members.
Abu Dhabi Securities Market
Bahrain
Bahrain Stock Exchange
Egypt
Misr for Central Clearing, Depository & Registry - MCDR
Israel
Tel Aviv Stock Exchange and Clearing House
Jordan
Securities Depository Center
Kuwait
Kuwait Clearing Company S. A. K.
Lebanon
MIDCLEAR S. A. L.
Libya
Libyan Stock Market
Mauritius
Central Depository & Settlement Co Ltd (CDS)
Morocco
MAROCLEAR
Nigeria
Central Securities Clearing System Ltd
Oman
Muscat Depository & Securities Registration Co. (S.A.O.C)
Palestine
Palestine Securities Exchange
Saudi Arabia
Tadawul (Saudi Financial Market)
South Africa
Strate Ltd
Tunisia
STICODEVAM Tunisian Central Depository
UAE-Duba-DIFX
Dubai International Financial Exchange - DIFX
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5 THE BASICS OF STRATE
5.1 The Benefits of Strate
The benefits of Strate emerge from the variety of advanced technological platforms and systems,
as well as the underlying business, clearing, settlement and custody principles and processes.
Each element provides a very significant, risk-reducing benefit to the market as a whole.
5.1.1 Electronic custody of Securities
Shareholding is recorded electronically by each of the Central Securities Depository Participants
(Participants) i.e. Clients open Securities Accounts with Participants who maintain details of the
Securities deposited. The Securities holdings are aggregated and collated and recorded within the
Central Securities Accounts opened at Strate by each Participant. A Participant may open one or
more Central Securities Accounts at Strate.
These electronic records take the place of the register of shareholders kept by Transfer
Secretaries on behalf of companies. The records of the Participants i.e. each Client Securities
Account, are balanced and reconciled every day with the records of Central Securities Accounts
kept at Strate, where the total balance of dematerialised Securities is kept. Investors, or Clients,
receive regular statements from their appointed Participant detailing their electronic holdings.
These statements are not negotiable instruments and as such, investors need not fear the loss or
duplication of such statements. These statements take the place of share certificates. This is in
direct contrast to the paper settlement environment where the risk of lost, forged or stolen
documents abound.
26
5.1.2 Security of the system
The electronic records of shareholding maintained by Strate are subject to extensive system
controls. Thanks to sophisticated encryption and authentication devices in the coding in the CSD
systems the security of the electronic records has never been compromised.
Furthermore, in certain bond functionality, Strate utilises the renowned Society for Worldwide
Interbank Financial Telecommunications (SWIFT) network for the relay of electronic messages.
SWIFT is a network used by all the banks in the world and therefore the provider of choice for all
major financial institutions, globally.
5.1.3 Electronic settlement of transactions
At the point of settlement, the electronic records are updated via book-entry. Settlement via book
entry is both secure and efficient. It is no longer necessary for the seller to submit his share
certificate to his broker for further submission to the Transfer Secretary who issues a new
certificate in the name of the buyer. This manual process was risky, administratively burdensome
and time consuming.
5.1.4 Rolling settlement
Rolling settlement refers to a settlement environment in which transactions (Securities and funds)
become due for settlement a set number of Business Days after trade. In South Africa, rolling
settlement has been introduced on a T+5 basis for equities and T+3 for bonds (where T = Trade
Date). Rolling settlement represents a significant departure from the ‗account period‘ methodology
employed in the past whereby trades of any given week were settled from Tuesday of the
following week.
Investors know that the trade settles a number of Business Days later and they can plan/budget
accordingly. The ‗account period‘ methodology of the paper-based settlement environment
operated on an indefinite basis - some transactions remained unsettled for months. As every day
is a trading day, every day is also a settlement day.
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5.1.5 Contractual settlement
With specific reference to the JSE‘s Yield X market, contractual settlement is a market convention
embodied in the Rules of the JSE which states that a Client has a contractual obligation to cause
a JSE trade to settle on settlement day. The JSE, in its capacity as Settlement Authority, ensures
that all Yield X trades entered into by two JSE brokers settle 3 days after the trades are entered
into.
Investors obtain the assurance that their transactions will settle on the specified settlement day.
The appropriate cash and Securities Accounts will be debited / credited on settlement day and the
risk of delayed settlement and loss of earnings is vastly reduced.
Rolling – contractual-guaranteed settlement
S
M
T
W
T
F
S
X
X
X
3
10
17
T+0
T+3
4
11
18
T+1
5
12
19
T+2
6
13
20
T+3
7
14
21
X
X
X
5.1.6 Simultaneous Final Irrevocable Delivery versus Payment (SFIDvP)
Strate is proud to be amongst the CSDs to have achieved true Simultaneous, Final, Irrevocable
Delivery versus Payment (SFIDvP) in Central Bank funds. This has been achieved with the use of
the Concurrent Batch Processing Line (CBPL) functionality of the National Payment System at the
Central Bank. With the new CBPL functionality, settlement instructions are settled as a group.
This means that all paying custodians must have funded their South African Multiple Options
System (SAMOS) accounts before the settlement run can be completed.
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With the implementation of the netting model, settlement within Strate has been maximised
through netting of Securities at Central Securities Account (or Safe Custody Account (SCA)) level
and funds at Participant level.
On settlement day, Strate reserves the Securities for the nett positions. As part of the Strate
Rules, a delivery instruction will be generated in parallel with the payment instruction. The delivery
instruction will ensure that the required Securities are available and reserved. The payment
instructions are submitted to the Central Bank on an individual basis, however upon receipt, each
instruction is left on ‗hold‘ status until the final instruction is received. The principle applied is
similar to netting i.e. settlement cannot progress until all instructions are received. Once all
payment instructions are received, a settlement confirmation is sent out by the Central Bank.
Upon receipt of the settlement confirmation, Strate will unreserve the Securities for the reserved
positions and complete the Securities movements. The funds will be simultaneously transferred,
thereby completing settlement in one step. The settlement cannot be reversed. The general rule
is that irrevocable finality of payment follows settlement finality.
Once transfer of Securities within the Strate system has been completed, an instruction is sent to
the Participants and the applicable Exchange on behalf of the brokers so that the entry is reflected
in the custodial systems. In terms of the Strate Rules this entry must take place by no later than
end of day of settlement of the trade. A reconciliation process of all records within the Participant
and Strate is performed daily to ensure that the records are in balance.
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The below diagram is a very high-level description of the settlement process.
5.1.7 Connectivity through SAMOS
The main benefit that SAMOS brings to the South African financial markets is that it provides for
final and irrevocable payment.
By synchronising Securities transfer through Strate with cash payment through SAMOS, the
South African market is able to provide local and international investors with SFIDvP, as explained
above. SAMOS provides for final and irrevocable payment settlement, while Strate provides the
investor with settlement and finality of ownership transfer.
By making the SAMOS settlement infrastructure available for the settlement of financial market
transactions, the South African Reserve Bank (SARB) has greatly boosted the capability and
competitiveness of the South African financial markets.
SARB
SAMOS
STRATE
SFIDv
Securities position ?
Reservation
Funds position
Prematched Instructions
Queue
(automatic
retry)
Final Irrevocable
Debit/Credit
Payment message
Queue
(automatic
retry)
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5.1.8 Accuracy of the Register of Shareholders
The electronic register is updated on T+5 for equities and T+3 for bonds when the simultaneous
transfer of Securities and cash takes place.
This means that all trades are reflected on the register of shareholders for dematerialised
Securities in the Strate environment as there are no outstanding Securities transactions except for
trades affected during the last 3 days. This is in stark contrast to the paper-based environment
which allows up to six months for the register of shareholders to be updated. Listed companies
wishing to obtain an accurate idea of their shareholders find themselves in a far more efficient
position in the Strate environment.
5.1.9 Compliance with G30 Recommendations
The Group of 30 (G30), a private group of prominent, international financial industry Participants,
in 1989 proposed nine standards (currently 20 recommendations) for improving the world
Securities industry's efficiency and reducing settlement risks. Strate complies with all but one of
these recommendations (the exception being not settling on a T+3 basis for the equities
environment) and even surpasses certain of the guidelines to ensure that the risks in the
settlement process are further minimised.
Foreign fund managers operate within the parameters of local regulations which invariably
demand a balance between risk and return. Strate‘s adherence to internationally accepted
settlement standards results in the enhanced global status of the South African market, increased
foreign investment and exchange and, consequently, an improved economy.
5.1.10 Ability to settle all financial instruments
The Strate system would be able to, and in some cases does already, settle all kinds of financial
instruments, bonds, money market Securities, derivatives and unit trusts.
If Strate were to settle all financial instruments, investors would benefit from an efficient system in
the settlement of all their investment transactions. The utilisation of Strate for the settlement of all
31
financial instruments would lead to significant economies of scale. Indeed, settling all financial
instruments in the same environment would create consolidation, streamlining, cost savings and
marketing opportunities for all affected industries. It would also increase market liquidity, eliminate
operational risk and enhance market efficiency.
5.1.11 Combination of gross and nett settlement
Strate is in a position to offer both gross and nett settlement. The ability to offer both methods of
settlement is an advantage to all market players, who invariably offer multiple investment
products.
5.1.12 Electronic execution of Corporate Actions
Strate executes Corporate Actions electronically e.g. the electronic payment of interest and
redemption payments. The electronic execution of Corporate Actions is quick and secure.
Payments are transferred electronically with same-day value. Investors therefore benefit from a
dramatically increased level of efficiency and cost effectiveness and the elimination of market
claims.
5.1.13 Increased market regulation
Strate supervises compliance by Participants with the Financial Markets Act (FMA), the Strate
Rules and Directives. Similarly, the Exchange regulates and supervises the brokers. The
regulation and supervision of the market players is significant as Participants and brokers act as
agents for investors and have a statutory and contractual duty to protect the records of the
investor in the electronic environment.
Investors gain the peace of mind that all business processes associated with electronic settlement
are regulated and supervised by Strate and the Exchange under the authority of the Financial
Services Board (FSB).
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The key features of electronic settlement contribute to a massive reduction of risk in the South
African market. This increases South Africa‘s standing as an investment destination for
international investors which undoubtedly provides a significant boost to both trading and liquidity.
5.2 Participants
In terms of the Financial Markets Act (FMA) a Participant is defined as:-
“a person authorised by a licensed central securities depository to perform custody and
administration services or settlement services or both in terms of the central securities depository
rules, and includes an external participant, where appropriate”
The following entities have met the entry criteria and have qualified as Participants in the
electronic bonds environment:-
ABSA Bank Limited
FirstRand Bank Limited
Nedbank Limited
The Standard Bank of South Africa Limited
Citibank
Link Investor Services
Standard Chartered Bank
The South African Reserve Bank
Detailed below are some of the roles performed by a Participant:-
to act as a recipient of Securities on behalf of its Clients who buy;
to act as a deliverer of Securities on behalf of its Clients who sell;
to inform Strate of its intention to settle a transaction;
to provide or facilitate Securities lending and borrowing facilities to its Clients;
to maintain accurate records so that they can report quickly and accurately to
their Clients;
issue statements of Securities balances to its Clients;
act as agents to Clients for Corporate Actions; and
to identify errors in the information received from/sent to Strate.
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5.2.1 Entry Criteria
The Strate Rules stipulate the criteria which must be met to be accepted as, or to remain, a
Participant.
Proposed Participants have to meet standards regarding, inter alia, financial resources and
minimum capital, as well as operational and human capabilities. All Participants are required to
meet the entry criteria as set out in the CSD Rules. These stringent entry criteria are in place
primarily to ensure systemic stability and the protection of investors. They involve stipulating ―fit
and proper‖ standards.
In addition to the Rules, there are two Strate Directives directly relating to entry criteria, namely
Directive SAA and Directive SAB. The reader of this Handbook / Learning Material must refer to
the Strate website www.strate.co.za for the most current version of these Directives.
Directive SA.1 is the Application Form to Become a CSD Participant.
Directive SA.2 details the minimum requirements of financial soundness which a
Participant must meet and maintain, to be accepted as, or to remain, a Participant.
5.3 Types of Clients
An investor can not deal directly with Strate.
An investor, seen as a Client of a Participant, can be termed either a controlled or a non-
controlled Client. A broker is a Client of a Participant.
A controlled Client is one whose Securities and cash are under the custody of his broker and the
broker‘s Participant, while a non-controlled Client is one who has appointed his own Participant to
act on his behalf.
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NOTE: A Broker is defined in the Financial Markets Act as an “Authorised User” – the
specific definition in the FMA reading:
“`authorised user’ means a person authorised by a licensed exchange to perform one or
more securities services in terms of the exchange rules, and includes an external
authorised user, where appropriate”
Brokers are often also referred to as Members – being a Member of an Exchange.
Throughout this Learning Material the terms Broker, Member or Authorised User is used
interchangeably.
5.3.1 Controlled Clients / Member-settled Clients
In a controlled environment, the Client has an account with a broker, keeps his Securities with his
broker and utilises the Participant of the brokers choice i.e. all contact is with the broker. The
Client‘s Securities statement comes from his broker. In the bonds environment such Clients are
also termed ―Member-settled‖ Clients.
5.3.2 Non-Controlled Clients / Ordinary Clients
In a non-controlled environment, the Client nominates a Participant, opens a Securities and cash
account with his Participant, submits his Securities and keeps his cash with the Participant and
deals with a broker only when he wants to trade. Such a Client receives Securities statements
directly from the Participant. In the bonds environment such Clients are also termed ―Ordinary
Clients‖.
5.4 Users of the system
A variety of entities have connectivity to or interact with Strate either directly or indirectly. There is
a difference between those who are licensed to participate and those who, by virtue of the
services they provide, or may require, have a need to interact with Strate.
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Participants are only one group of users of the Strate systems.
Other entities rely on some level of interaction with Strate (to a greater or lesser degree
dependant upon their own functionality and the specific market that they are involved in). Such
―users‖ of the system are referred to as Business Partners and would include, inter alia:-
Transfer Secretaries;
Securities Lending and Borrowing Desks; and
Issuers (including Company Secretaries).
Other players/stakeholders in the market who would interact with Strate and the Participants
include:-
Investors – local and foreign;
Fund Managers;
the JSE;
the JSE acting as the Settlement Authority;
JSE Equities Members;
the South African Reserve Bank;
JSE BESA Members.
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6 AN INTRODUCTION TO CAPITAL MARKETS
The financial markets are often regarded as a mystery to many people. What makes it
complicated is that many Participants use jargon which has different meanings when used in
different contexts. Once you have learnt this jargon you will find that understanding the financial
markets is quite easy.
6.1 Background
The definition of finance is the management of money, therefore to explain the origin of the
financial markets one has to go back in time to the origin of money.
Money did not have a single source of origin but developed independently in many different parts
of the world. Many factors contributed to the development of money namely:-
Barter: This is the most primitive exchange of goods and services e.g. 2 cows
for 10 tons of grain. The inconvenience of barter provided an impetus for the
development of a standard unit of Exchange;
―Blood Money‖: Many societies had compensation for crimes of violence. In
fact the word ―pay‖ is derived from the Latin word ―pacare‖ meaning ―to pacify,
appease or make peace with‖. Therefore, compensation for a crime was
made through an appropriate unit of value acceptable to both parties;
―Bride Money‖: The bridegroom had to compensate the bride‘s family for the
loss of their daughter‘s services. A practice that still exists in many cultures
today;
Ceremonial rites: The exchange of gifts e.g. the North American Red Indian
―potlatch‖;
Religious rituals: Sacrifice was a payment or tribute; and
Jewellery\Ornamentation: Jewellery demonstrated a level of status and
wealth.
Commodities became the first unit of currency. (Commodities are traditionally defined as raw
materials or primary agricultural products - the definition has however been extended to mean
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something usable or valuable). Therefore, one of the oldest unit‘s of money was the cow. The
cow is still used as a unit of wealth \ currency in many countries and is still common in South
Africa (Lobola). Some other primitive forms of money were Cowrie shells (they were still used in
Nigeria up until the 1940‘s.), whale teeth (in Fiji), beads, ivory, eggs, feathers, jade, leather, vodka
etc.
6.1.1 Coinage
Precious metals in weighed quantities were a common form of money even in ancient times. It is
no coincidence that the word pound is a unit of weight as well as the name of the British currency
(and others). In fact, the words ―spend‖, ―expenditure‖ and ―pound‖ all come from the Latin word
―expendere‖ meaning ―to weigh‖. The Greek currency is Drachma meaning ―handful‖ of grain. The
talent referred to in the Old Testament is a monetary unit and a Greek unit of weight.
Although coinage developed independently in different parts of the world, it is well documented in
Asia Minor where the Lydians used to stamp (mint) small round pieces of precious metals as a
guarantee of their purity and use these pieces of metal as a unit of Exchange. The first coins were
minted in around 640-630 BC and spread from Lydia to Ionia, Greece and Persia.
Gold and silver were the most popular of the precious metals used for minting. Coins spread
rapidly as a unit of money due to their convenience and that they did not need weighing. Despite
the challenge of counterfeiters, monarchs and governments controlled coin production and hence
money supply (the amount of money in the economy).
The introduction of paper money came from the Chinese in around 960AD. Although paper money
had no intrinsic value, its acceptability depended on it being backed by some commodity, normally
precious metals. For centuries, silver was the precious metal used. Co-incidentally, the Pound
was originally an amount of silver weighing a pound. Although a bi-metallic standard (gold and
silver) was adopted in many countries including USA and France, it was in 1871 that Germany
adopted only gold as there base metal. The rest of the world followed suite shortly afterwards.
This link between gold and currency remained in place until 1973.
The evidence of the old gold standard used to be printed on banknotes whereby it used to say ―I
promise to pay the bearer on demand the amount of…‖ (signed by the governor of the Reserve
38
Bank) – this is still found in many countries even though we have moved off the gold standard e.g.
the UK.
The break from precious metals helped to make money a more elusive entity. The paper itself
holds no metallic ―backing‖, but forms a unit of currency in itself. In today‘s world, even paper
money is inconvenient, especially for large purchases – hence the move to electronic money
whereby large amounts of money are transferred between banks and other institutions not by
delivering ―truckloads of cash‖ but transmitting electronic messages between each other.
6.1.2 Trading
A trade is defined as the process of buying and selling. In today‘s modern society, the process of
buying and selling has been made very easy for us through supermarkets and shopping centres
etc. However we often forget what is implied with every purchase we make in that the commodity
we buy must be well standardised, with grades of quality and units of trade being widely accepted
by commercial parties, and independent entities able to evaluate grades e.g. fruit, grain, sugar.
When we buy sugar we simply go to the shopping centre where all of the ―buyers‖ and ―sellers‖
converge.
What if we wanted to buy 500 tons of sugar? Is it any different?
Answer: No, we simply go to the place where buyers and sellers converge in those size quantities.
This marketplace could be a physical place e.g. an Exchange, electronic platform (e.g. the
internet), or spread out globally where each person works from their own offices and contacts
each other via the telephone.
An Exchange is simply a formalised, organised and managed marketplace. Many Exchanges
started off their life informally e.g. in coffee houses\taverns e.g. London Stock Exchange.
However many products do not trade on an Exchange. Any product\instrument that trades ―off
Exchange‖ is referred to as an OTC trade (i.e. over the counter trade). This market is therefore
known as the OTC market. The OTC market is substantially larger than that of the Exchange
traded market. Instruments such as foreign Exchange and many derivatives trade in the OTC
market rather than On Exchange. Some products trade both on and Off Exchange e.g. bonds,
equities, etc.
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Whenever we purchase a bag of sugar at a supermarket, we are used to paying for the sugar and
taking delivery (personally) of the bag of sugar at the same time. There are occasions however
whereby we don‘t take delivery of the good or service immediately. For example if we purchase a
house, we will purchase the house (agree a price and sign the documentation) on one day and
only move in (take delivery of the house) some months later. The day we agree to buy the house
and sign documentation is known as the Trade Date and the day we hand over the cash in return
for moving in is known as the Settlement Date or value date. (Please note that if after the Trade
Date (but before the Settlement Date), the value of the house increases or decreases, we still only
pay what we agreed on Trade Date). It is therefore quite clear that a transaction can be broken
up into 3 distinct components namely: Trading, clearing and settlement. (From an operational
point of view, a transaction can be broken down into many more process which we will pick up
later).
Trading can take place in 3 ways, namely:-
Physically: One-on-one negotiation:-
- This could be anywhere from a golf course to an Exchange.
- Auction: Auctions still take place globally for all types of commodities as well
as other financial instruments. Just like a car auction, the highest bidder
(person who is willingly to pay the most) will ―win‖ the auction i.e. receive the
goods. (There is an auction called a ―Dutch Auction‖ whereby the auctioneer
begins with a high asking price which is lowered until some Participant is
willing to accept the auctioneer's price, or a predetermined minimum price is
reached.
Screen and telephone:-
- Traders advertise bids and offers (i.e. where they are prepared to buy and
sell) from their own premises (i.e. anywhere in the world) on electronic media
such as Reuters and Bloomberg which is displayed to all people who own
such systems instantly and globally. Traders contact each other electronically
or over the telephone to transact, or trade through and Inter Dealer broker
(IDB).
Electronic trading:-
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- This is the ―newest‖ method of how to trade and became popular in the early
nineties. Although it is expected that all types of trading (physical, screen and
telephone etc) will continue, it is expected that electronic trading will
dominate.
Clearing is the process, in conjunction with settlement, of determining accountability for the
exchange of money and Securities between counter parties to a transaction. Clearing creates
binding statements of obligation for Securities and/or cash due.
Settlement is the completion of a transaction, where the seller transfers the goods\Securities to
the buyer and the buyer transfers money to the seller. As mentioned earlier, as consumers we
are used to settlement almost instantaneously when we go to a supermarket. But what if you
bought 5000 cattle? To delivery the cattle is quite a logistical nightmare. In addition, to deliver
say ZAR 950 million can‘t be done with notes and coins, it must be done electronically. Therefore
we specify a convention for settlement. This is called the ―SPOT‖ convention whereby if we trade
today (T) we would settle a certain number of Business Days following the transaction. For
example, bonds generally settle based on T+3. This means that the convention is to settle 3
Business Days following the Trade Date (equities in South Africa have a spot convention of T+5);
(coincidentally, the delivery of cattle in ―Commodity‖ markets can be 3 months!).
Although trading ―spot‖ is the most common, it is possible to settle for any day so long as it is
agreed up front by the buyer and seller. If nothing is said about Settlement Date, it is customary
to assume the spot convention.
6.2 The Capital Markets
So far we have concentrated on commodities or on what companies\business entities produce.
For example, Anglo American produces gold (amongst other things). The question has to be
asked as to how did companies like Anglo America originally get the money to sink a mine shaft,
or build a factory to produce their outputs? Answer: They had to source some money (known as
raising finance or raising capital).
There are only two ways to raise finance:-
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either by borrowing money from friends, from the bank or from the public, with the
promise to pay the money back over time - usually with interest (known as debt);
or
by receiving cash from friends, family or the public in return for giving them a
proportionate share in the future profits of the business for as long as the
business exists (known as equity).
Therefore, when these companies originally looked to start their businesses, or expand their
businesses they would have either borrowed money or issued shares. When a company initially
goes to the market to raise capital, we say that they are raising capital through an initial public
offering (IPO). We also classify this trade as a ―primary market‖ trade i.e. a trade where the Issuer
(the company) receives their cash in return for either giving up a share in the business (equity) or
the obligation to pay the cash back at a future date with interest (debt). We also refer to the
person who pays cash in return for the shares or the right to receive money back in the future with
interest (debt) as an investor. The primary market can be equated to buying a brand new car
whereby the car manufacturer is the entity that receives the cash for the car. Both equity and debt
are generically called Securities or Security instruments.
We refer to the mix of debt and equity of a company as its capital structure. The process of
raising capital through equity is almost identical to that of raising finance through debt (although
there are minor differences, the outcome is the same). Firstly the company will employ the
services of an Investment Bank. After all, the company probably operates in an industry other
than the financial markets and therefore will not possess the expertise to raise finance on a large
scale, which typically requires specialised skills.
The generic name given to these Investment Banks, which advise, underwrite and distribute the
equity and debt is lead manager. If the Issuer has a large amount to sell, the lead manager may
appoint additional investment managers to form a consortium known as a syndicate who work
together to underwrite and distribute, to spread some of the risk and help with the sales. It is not
uncommon for an Issuer to issue directly to an investor or group of investors; this is known as a
private placement (in reality, Investment Banks also arrange private placements). Historically, the
Issuer used to (any in many countries still do) provide acknowledgement\proof of debt or equities
by giving an investor a certificate indicating the amount of shareholding or the debt outstanding.
Although certificates still exist, they are becoming a thing of the past.
Once the initial sale of shares or debt has taken place, an investor may choose to sell their shares
or debt to someone else; they would do this in the ―secondary market‖. Please note that it is
unlikely that you would sell your shares or debt back to the original Issuer, although it is of course
42
possible. Again this is no different to selling your brand new car through the ―second‖ hand
market either through a dealer or advertising directly through the media.
Many people get confused when we refer to buying and selling of debt versus lending and
borrowing money. Although we refer to borrowing and lending versus purchasing and selling
interchangeably for debt instruments, it is worth noting that lawyers deliberately distinguish
between buying and selling and lending and borrowing. In the primary market, the words lending
and borrowing make sense, simply because at the initial auction the investor is essentially lending
money to the Issuer with the agreement to receive the cash back in the future with interest. In the
secondary markets, it is not as clear cut because if you buy a debt from a respective investor, you
are not going to receive the interest payments and principal from the investor; you will receive
these payments from the original Issuer. Strictly speaking, the purchaser of the debt will be
purchasing the contract from the investor entitling the purchaser to all of the rights of the contract
namely, the interest and principal from the Issuer.
6.3 What is a bond?
A bond is simply a long term loan. If you borrow money from a bank to buy a house, you would
essentially be issuing a mortgage bond to the bank. This mortgage bond is a contract between
you and the bank whereby you typically borrow a sum of money and promise to repay the money
over a period of time at a specific interest rate. This contract (also known as an indenture) is
usually non-negotiable, i.e. the bank cannot on-sell this mortgage bond to someone else as the
contract is between yourself and the bank. However, this does not have to be the case. In fact,
the majority of bonds issued by Governments, Corporates, Parastatals, Municipals etc are
negotiable in the market; i.e. the owner of the bond can on sell the bond to someone else.
Each bond-holder is entitled to receive:-
interest on that loan (also known as the coupon – refer below).
the nominal value of the loan at the maturity date (or as payments through-
out the term of the loan (refer below)).
In this way an Issuer can raise money/funds from numerous entities (including individuals) needed
to finance new business ventures, purchases, expansions etc – this can be a mere alternative to
obtaining a loan from a bank.
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7 CHARACTERISTICS OF BONDS
7.1 Coupons
A coupon is the amount of interest an Issuer has agreed to pay through the life of the bond to the
investor. Coupons are traditionally paid semi-annually, however annual, quarterly and monthly
paying coupons are also common. The word coupon comes from the fact that the certificates
issued used to have perforated markings on the side of the certificate which represented an
individual interest payment for a specific period. The bond holder would simply tear off the coupon
and claim the cash amount.
Coupons can be:-
Fixed
The Issuer pays interest based on a fixed percentage per year over the entire life of
the bond, irrespective of the change in interest rates in the economy. Most bonds in
South Africa pay a fixed coupon every six months.
Floating \ Indexed
The Issuer pays interest based on an index or specific interest rate; e.g. home
loans are related to the prime interest rate - if the prime rate increases, then the
payments will reciprocally increase. Most Floating Rate Notes in South Africa (refer
to types of bonds) are linked to a floating interest rate called JIBAR and pay interest
quarterly.
Step up
The Issuer pays increasing interest through the life of a bond (step down is the
opposite). These coupons are usually associated with callable bonds (refer to
callable options).
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Zero
The Issuer pays no interest – you simply receive the nominal at maturity. The
concept of zero coupon bonds usually confuses a lot of people, because why would
you want to buy a bond that does not pay you interest? Answer – it works the same
as discount paper i.e. what if I told you that if I lend you R80 now, I want R100 back
at the end of the year. Essentially I would have earned R20 in cash.
7.1.1 Setting the Coupon
Naturally, when an Issuer seeks to borrow money, they want to pay the lowest possible interest.
Similarly, the investor wants to receive the highest possible interest rate (return), given the relative
risk of the Issuer. It is important to stress the relative risk of an Issuer, because when we lend
money to someone, our key concern is whether we are going to get our money back! Therefore,
we categorise Issuers based on what we believe is their relative capacity to repay the debt.
Although there are numerous criteria, some of the more important ones are:
The relative risk of the Issuer. You would rather lend to the South African
Government than you would to a South African bank (the reason is that the
Government could (worst case scenario) print money to pay off the debt,
unfortunately this would result in rampant inflation, therefore Governments typically
adopt a more sensible approach and increase taxes for instance.) Corporates do
not have the luxury of being able to simply increase their prices in the event they
cannot repay their debt as their customers would probably go somewhere else. In
the same breadth, you would rather lend money to a South African bank than you
would a student, as it is highly likely than you will get your money back from the
bank compared to that of a student. This is why student loans have such large
interest rates i.e. the bank is compensated for the extra risk by charging a higher
interest rate.
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The opportunity cost of the investor i.e. what are the prevailing interest rates
charged by a similar Issuer in the economy with a similar maturity?
Liquidity of the issue. Liquidity in the financial markets refers to the ability of an
investor to be able to sell the issue without incurring a substantial discount from the
market value because there is a lack of buyers and vice versa.
Therefore, the demand of a higher return required by the investor versus the low interest
preference of the Issuer, coupled with the prevailing interest rates and opportunity cost of the
investor will lead to the coupon rate. Generally, Issuers set the coupon to where the investors
would be prepared to lend money (buy the bond) such that the Issuer would have to pay the same
amount back on the maturity date (not forgetting the interest payments). Although coupons are
usually set on issuance date or very close thereto, they don‘t necessarily have to be. For example
a zero coupon bond is usually decided upon well before the issuance date.
One has to ask the question: If the prevailing rates in the economy are at 10% for a specific
maturity (taking into account the relative risk of an Issuer), and the Issuer issues the bond with a
coupon of 6%, will anyone buy the bond? Naturally one would normally answer no, because you
can get 10% return from a similar Issuer at a similar maturity in the market. However, the actual
answer to the question in practice is a qualified yes! Since the investor can receive a higher
interest rate in the market, instead of lending ZAR 100.00 (buying the bond for ZAR 100.00) and
receiving ZAR 100.00 back at maturity with coupon payments of ZAR 6.00 (6% of ZAR 100.00),
the investor can instead only lend the Issuer say ZAR 90.00, still receive the fixed coupons of ZAR
6.00, but receive ZAR 100.00 back at maturity. The shortfall of ZAR 10.00 paid by the investor to
the Issuer makes up for the low coupon. In fact, the bond pricing formula determines how much
an investor must pay/lend given a specific coupon and maturity, as well the interest rate/return
required. We say that a bond is trading at a discount if the required rate of return is higher than
the coupon rate.
Quite clearly, the opposite can also happen, where the same Issuer issues a bond at a rate of
15% when the prevailing rates in the economy are at 10% for a specific maturity (taking into
account the relative risk of an Issuer). In this case the investor/market would be willing to pay
more (lend more) for the bond now e.g. ZAR 109.00, receive coupons of 15% (ZAR 15.00) and
only receive ZAR 100.00 back on maturity date. We say that a bond is trading at a premium if the
required rate of return is lower than the coupon rate.
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Although one would usually associate higher coupons with riskier companies this is not
necessarily the case because, interest rates, relative risk and opportunity cost change over time.
For example if you wanted to borrow money to buy a house (―Mortgage bond‖) when the prime
rate was 25% versus borrowing money while the prime rate is 10.5%.
7.2 Maturity Date
Maturity Date (also known as Redemption Date) is the closing date at which the contract ends on
the last payment. This is when the Issuer has promised to meet the conditions of the debt and the
principal amount is paid back. The amount of time remaining to the maturity date at any one time
is referred to as the ―term to maturity‖. Please note that it is possible to have multiple redemptions.
For example some South African Government bonds have three maturity dates, whereby the
investor receives one third of the principal (refer below) back in the first year, one third in the
second year and the final third in the third year.
7.3 Principal/Nominal Amount/ Face Value/Par Value
This is the amount that will be paid at maturity. It is occasionally the original amount of the loan
e.g. the Issuer would initially borrow ZAR 1 000.00 which they would pay back at maturity along
with the agreed coupon payments; however, this does not necessarily have to be the case as the
investor may have purchased the bond at a discount or premium.
Traditionally the principal is paid back as a lump sum on maturity (otherwise known as a bullet or
balloon payment). However this is not always the case (remember our multiple redemption
bonds.)
As consumers we are more used to paying back the nominal in the form of monthly fixed
payments (tied to the prime rate) as well as the interest on a monthly basis until the balance is
reduced to zero. This process is called amortisation e.g. house finance or car finance.
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7.4 Secured versus Unsecured Debt
Secured debt is backed by a legal claim on some specified property/collateral. The debt holders
(lenders) will have a senior claim on the assets in the event of default (refer to subordination
below for a further explanation). For example the mortgage bond you have on your house is
backed by the actual house itself. If you should miss a payment the bank has the right to sell your
house to recover the cash. Unsecured debt is backed by the simple promise of the Issuer to pay
interest and principal (otherwise known as general obligation bonds). The most common general
obligation bonds are that of Government bonds, Parastatals and Municipals bonds.
7.5 Subordination
In order to explain subordination, we have to examine what happens if an Issuer defaults on the
interest or principal payments (Default is used in two contexts in the financial markets. Default in
terms of settlement is failure to complete a funds or Securities transfer according to its terms for
reasons that are not technical or temporary, usually as a result of bankruptcy. Default in terms of
an Issuer would be where an Issuer does not have enough cash to honour the debt payments;
typically, before the debt holders look to liquidate the company they will try to restructure the debt
payments).
In the event of liquidation, all assets of the company/Issuer are frozen by the court and are
converted to cash usually through an auction. The liabilities (what the company owes) are then
ranked based on a schedule set out by law. For example:-
1. Creditor A (Preferred creditor – Taxman and the liquidator fees)
2. Creditor B (Secured creditor- e.g. mortgage bond)
3. Bond 14% 2010
4. Bond 18% 2008
5. Employees
6. Shareholders
After the assets are sold, the liabilities are settled in progressive order i.e. liability 1 is settled in its
entirety before liability 2 is paid etc. In the event there is only sufficient cash to settle say liabilities
1-3 but there is some cash to settle liability 4 but not enough, then this liability will be paid off
proportionately. The rest receive nothing!
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If after selling the assets, there is sufficient cash to settle all liabilities, then the balance of the
cash will be distributed to the shareholders. Since the shareholders always rank the lowest in the
event of liquidation, we say that shareholders carry a residual right to the assets of the company
once the liabilities have been settled. This is also the reason why bonds/debt of a company is
considered safer than equity, because debt holders can put a company in liquidation if the
company should default on payment (shareholders cannot do this if say the company decided not
to pay a dividend), and debt will always rank higher than equity in a liquidation.
In the above example bond 14% 2010 is said to be senior to bond 18% 2008 because in the event
of liquidation it will be paid off first. We could also say that bond 18% 2008 is subordinated to
bond 14% 2010. Therefore subordinated bonds only posses a claim on the assets after the senior
debt has been paid in the event of a default. The ranking of a bond is set out in the indenture of a
bond (refer below).
7.6 Bond Indenture
This is the contract between the bondholder and the Issuer. It sets out the terms and conditions of
the bond e.g. maturity, coupon etc. It may also include a set of restrictions on the firm issuing the
bond which serves as protection of the bondholder‘s rights e.g. covenants.
Covenants are a key element of the risk/reward analysis of Corporate debt. Their role is to
maintain a desirable risk profile of the investment throughout its life. They also establish the
procedures for orderly liquidation and preserve the debt holder‘s seniority in case of default.
Types of covenants are:-
Negative Pledge Clause
A negative pledge clause is a covenant that limits the amount of new debt with a
higher priority (protects against subordination).
Limitation on additional debt
Limitation on additional debt protects against dilution. We all know that the more
debt you get into the harder it is to get out of (after a certain point). This is not
different for Corporates and Governments.
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Limitation on asset sales
Debt holders will want to prevent certain income generating assets from being
sold by a company as these assets generate cash that pays off the bonds.
Limitation on restricted payments
This is a check on the potentially poor judgement of the Issuers when weighing
the debt holders rights against those of other stakeholders such as the
shareholders. It has not been unheard of where a Corporate borrows money and
then uses the money to pay the shareholders a dividend. Surely a dividend
should be paid out of the profitable operations of a company!
7.7 Derivatives
So far we have taken a look at the commodities markets and the capital markets. There is also a
market known as the derivatives market. The formal definition of a derivative is: ―A derivative is an
instrument whose value is derived from something else.” Unfortunately the definition does not
really tell us much about what a derivative is; so I am going to describe what derivatives are by
describing some of the instruments to help elucidate what a derivative is.
Derivatives have been around for hundreds of years, and many of us use derivatives in our lives
on a daily basis. Strictly speaking there is only 2 derivative instruments namely an option and a
forward (all other derivative can be replicated by combining these instruments or modifying some
of the features of these instruments). Professionals from farmers, energy firms and portfolio
managers use futures and options to reduce the risk to their business associated with volatile
prices.
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7.7.1 Forwards
A forward contract is a contract made today for future delivery of an asset at a pre-specified price.
No money or assets change hands prior to maturity. Forwards are traded in the OTC market. The
buyer of a forward contract is obligated to take delivery of the asset on the maturity date and pay
the agreed-upon price on the maturity date. The seller of a forward contract is obligated to deliver
the asset on the maturity date and accept the agreed-upon price on the maturity date. Most of us
have in fact traded a forward.
For example, have you ever bought a new car where delivery is only in three months? The price
you pay for the car you agree up front, in the event after three months the price goes up 50%, you
still pay the amount you originally agreed. Forward markets have their roots in agriculture, but
today forwards are traded on a wide range of products from wheat, natural gas, stock indexes,
precious metals and currencies etc. A futures contract is exactly the same as a forward except
that futures are more formalised in that they traded on Exchanges, have standardised quantity
and Settlement Dates.
7.7.2 Options
Options can be thought of like insurance. An option buyer (the insured) pays a premium to an
option seller (the insurance company) for the right to be able to receive a sum of money in the
future if a pre-specified event occurs. However, just like with insurance, the option buyer may or
may not exercise their right (use his insurance). With options, one pays money to have a choice
in the future. There are only two types of options namely calls and puts.
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7.7.2.1 A Call Option
A call option gives the person who bought the option the right (but not the obligation) to purchase
an instrument at a specific price at a specific time in the future.
A European call option, this option buyer can only exercise the call option on a
specific date (or pre-specified set of dates).
An American call option allows the buyer of the option the right to exercise the
call option at any point before or on the pre-specified date (known as the expiry
date).
Call options have many benefits, especially to Corporates. For example if a mine budgets to buy
machinery in a year‘s time to mine gold, they could simply wait for a year and see what the price
is of the machinery a year down the line – the problem is a lot can happen in a year, and the
prices could escalate for any unknown reason. The mine could also buy an option now to buy the
machinery in one year‘s time for a pre-specified price. If after the year, the cost of the machinery
is higher than the pre-specified agreed price, the mine would exercise the option and buy at the
cheaper rate. If on the other hand, the option pre-specified price was higher than the market price
for the machinery in a year‘s time, then the mine would simply let the option lapse and would
instead buy the machinery in the market at the cheaper price.
7.7.2.2 A Put Option
A put option on the other hand, gives the person who bought the option the right (but not the
obligation) to sell an instrument at a specific price at a specific time in the future.
A European put option, this option buyer can only exercise the option on a
specific date (or pre-specified set of dates).
An American put option allows the buyer of the option the right to exercise the
put option at any point before or on the pre-specified date.
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Put options also have many benefits. For example, a farmer could buy a put option which gives
him\her the right to be able to sell their crop at a pre-specified date in a year‘s time. If after a year,
the market price is less than the pre-specified option price then the farmer would exercise the
option and sell the crop at the pre-specified option price. If on the other hand the market price a
year down the line is higher, then the farmer will let the option lapse and sell their crop at the
higher price.
Please note that it is the buyer of the option (call or put) who has the right and not the obligation to
exercise the option (in return for paying a premium). The person who sells the option (known as
the option writer) and receives a premium up front for selling the option is obligated to sell at the
pre-specified price (seller of a call option) or buy at the pre-specified price (seller of a put option)
in the event the option is exercised against them.
7.7.3 Options attached to bonds
Since the fundamental reason why organisations use futures and options to reduce the risk to
their business associated with volatile prices, it comes as no surprise that options and futures can
be attached to bonds (and other instruments) to either increase their value or modify some of the
characteristics in the favour of either the buyer or seller. Both call and put options can be attached
to bonds and are often called call and put provisions.
Call provisions
This is a bond with a call option attached to it. A call option gives the Issuer the right (but
not the obligation) to buy back their bonds (redeem) at a specific price (the call price) at
a specific time in the future (European Option). Please note that the call option is in
favour of the Issuer, therefore when an investor buys one of these bonds, they are also
selling an option to the Issuer to be able to repurchase the bond at a specified price on a
certain date (or a number of dates) before maturity. These provisions are common with
Corporate bonds and banks issuing in accordance Tier II capital requirements (more on
this later).
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Put provisions
This is a bond with a put option attached to it. A put option gives the investor of the bond
the right (but not the obligation) to sell the bond at a specific price (put price) at a
specific time in the future (European Option) back to the Issuer. Please note that put
options are in the favour of the bondholder i.e. the investor, therefore when the investor
purchases a bond they are also purchasing a put option giving them the right to
―put‖/give the bonds back to the Issuer at a specified price (usually par) before maturity.
7.8 Sinking Fund Provision
A sinking fund provision specifies that a bond must be paid off systematically over its life rather
than only at maturity as a bullet payment. Retirement of the bond generally takes place in one of
three ways namely:-
the Issuer may repurchase the bonds in the open market;
the Issuer makes payments to a group of trustees who are empowered to monitor the
indenture and will ―call‖ a certain number of bonds by lottery. Since each certificate has a
unique reference number, essentially, all the numbers get placed in a ―hat‖ and the
certificate numbers drawn are bought back by the Issuer; and
a waterfall effect. This is where every bondholder will receive a proportionate amount on
principal on a specific date. This is the existing practice in South Africa.
It is common not to retire the full issue over the life of the bond but rather leave a bullet payment
of 20% - 30%; this balance can almost be equated to car finance where you leave a residual
balance at maturity which you settle with one payment.
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7.9 Yield to Maturity (YTM)
The ―Yield to Maturity‖ (YTM) of a bond can be equated to the required return an investor requires
from the bond given the risk profile of the Issuer. The required rate of return (interest rate) has to
compensate the investor for things such as inflation, risk, the length of the loan, convenience,
liquidity etc. Don‘t forget that with the majority of bonds issued, the coupon is fixed throughout the
life of the bond. However, when the coupon is originally set at issuance, criteria such as the
relative risk of the Issuer, opportunity cost and liquidity etc are used to determine the appropriate
coupon rate. However the day after issuance date, the interest rates could increase by 20% or the
Issuer could have numerous misfortunes (or vice versa) that lead you to realise that you could get
a better return (or worse) for an equivalent investment in the market. This return that you require
at any instant for a specific bond is known as the Yield to Maturity (YTM) and is very likely to
change through the life of the bond.
Since the YTM has to compensate an investor for inflation amongst other things, this means that
every time an investor purchases a bond, they are implicitly making an assumption as to what
they believe inflation is going to be through the life of the bond. Since inflation is a common
variable to all bonds, unexpected changes in inflation will therefore affect the YTM of all bonds.
We use the term ―Risk free bonds‖ in the market which refer to bonds issued by the Government
of a country. Therefore if a Government has issued a bond, the return on this bond for the specific
maturity is known as the risk free rate. Since some countries have a better reputation and history
from repaying debt, quite clearly this concept is relative between countries, hence the risk free
return between countries will depend on the relative risk of a country.
Since the debt of a country has a better chance of been paid back than the Corporate debt within
a specific country, (because the Government can raise taxes to pay off debt), whereas
Corporates‘ have to compete with each other and don‘t have such a luxury.
Corporates trade at a ―spread‖ to the equivalent Government bond for a given maturity. (The word
spread is used in numerous contexts in the market; the spread in this case means that the
Corporate issue will trade at a certain percentage higher than the equivalent Government bond for
a given maturity). It is important to stress equivalent (closest Government bond) to Corporate
bonds. This is because Term to Maturity is also a determinant of real Yield in itself. Simplistically
put, investors usually require a higher return for bonds with longer maturities due to uncertainty.
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Bonds trade in South Africa trade on Yield to Maturity. Therefore you would buy a bond at say
7.59%. This means that your required return is 7.59% (please note in order for an Investor to
receive an actual return of 7.59% for the bond they would have to hold the bond to maturity and
invest the coupons at 7.59% otherwise the actual YTM return will not materialise.) Also, we refer
to the term basis points, which is the 59 portion of 7.59. Therefore if the bond interest rate
reduced by 1 basis point, then the new level is 7.58%, half a basis point would be say 7.595%.
We do not trade in any unit less than half a basis point.
7.10 The Yield Curve
A term that one will often come across in the bond market is the Yield curve. If one goes to the
bank and enquires about the fixed deposit rates the bank offers for cash on deposit, one would
receive a schedule something like:-
• 1 month 4%
• 3 months 4.2%
• 6 months 5%
• 1 year 6%
• 2 years 7%
If we plotted all of these rates on a graph against time, we would have the banks fixed deposit
Yield curve! Therefore a Yield curve is a plot of bond Yields against time to maturity.
As shown below, we use money market rates for the ―short‖ end of the curve. (After all, every
bond eventually becomes a money market instrument!) Yield curves are often referred to as the
term structure of interest rates. (Strictly speaking, this term should be reserved for zero coupon
bonds only but this topic is beyond the scope of the course).
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A Yield curve provides us with numerous benefits namely:-
it provides a description of the Yields in the bond market at any point in time;
it indicates the cost of funds to an Issuer associated with different maturities;.
Reciprocally, it shows the required rates of return by investors for different
maturities. The fact that the curve is very rarely flat shows that different rates of
return are required for different maturities;
the Yield also shows the relationship between interest rates e.g. the relationship
between the long end of the curve (30 years) and the short end of the curve
(money market rates). By comparing curves from different dates, we can see how
these relationships change;
the Yield curve is used to set the interest rate levels for new bond issuances (a
specific type of curve is used to do this called a par curve);
the Yield curve inherently displays what the current expectations are of future
interest rates. This can be derived from a specific type of Yield curve called the
zero coupon curve. The curve that displays these future expectations at any
instant is called a forward curve;
it shows the relative value between bonds of similar maturity i.e. whether they are
expensive or cheap in relation to each other; and
the Yield curve is a good indication of market sentiment i.e. whether interest rates
are going to go up, down or remain the same in the future.
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8 TYPES OF BONDS
8.1 Government Bonds
When the Government needs to borrow money, they can‘t just go to a bank nor can they issue
equities (essentially the citizens of a country are already the equity holders). Instead they issue
Government bonds or Treasury Bills (T Bills is how a Government raises short term finance). The
bond market is an excellent place for Governments to raise long term finance and the
Government is usually the largest Issuer of bonds in any specific country (there are a few
exceptions). Governments need to raise money to pay for education, welfare, health, roads etc.
As previously mentioned, Government bonds are deemed to be very secure as Governments
have the ability to increase taxes to repay interest and principal. Government bonds, also known
as Treasury bonds, are mostly issued in the domestic currency of that country.
One can think of Governments as no different to individuals or Corporates. Think of the
Government as directors of one very large company. The company (country) gets the majority of
its revenues from taxation and sets a budget as to how they will spend (allocate) the money. For
things like hospitals, roads etc (for which they have the benefit over many years), they will borrow
cash and pay it off over many years, just like we do with our houses. In addition, there are times
when they need an overdraft, in this case they will issue short term instruments such as T Bills.
When a Government issues bonds, they need to consider inter alia:-
what they need the money for and how much i.e. borrowing requirements;
the required return and needs of the investors; and
the type of bond that is to be issued.
Bonds generally get issued by Governments via an auction managed by the country‘s Reserve
Bank. Every time a Government looks to raise finance through bonds, they don‘t necessarily have
to issue a new bond, instead they can ―tap‖ an existing issue. (“Tapping” an issue simply means
that the Issuer issues more of an existing bond. For example, although the R153 bond was
issued years ago, the South African Government still issues more of this bond almost every
month).
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8.2 Corporate Bonds
Corporate bonds are issued by private companies as a means of raising funds for a variety of
reasons including purchases (stock or machinery), new acquisitions etc. Issuing bonds is an
alternative to approaching a bank for a cash loan or overdraft.
The bonds issued by Corporates that have failed to pay either the coupon payment or principal
when due, or low grade Corporates (distressed companies) who look like they could default are
known as ―Junk bonds‖. The bond-holders, as creditors, have legal claim over the shareholders to
the company assets and income in respect of any interest or principal due to them. These rights
are embodied into a written contract called the bond indenture.
From 1999 the Corporate bond market has grown considerably in the SA market. Reasons for this
growth appear to be:-
interest rates are at historic lows, therefore funding is ―cheap‖;
institutions who were previously underweight in bonds (to some extent they still are)
compared to offshore funds. This is quite strange since bonds have for many years
outperformed equities (year on year) in South Africa and had considerably less
volatility. This trend has reversed over the last few years;
influence of international banks who prefer to earn fees from managing a listing of a
Corporate to lending cash directly. Capital adequacy has had a strong influence (refer
to the section on capital adequacy); and
Corporates have looked to the bond market as an alternative financing vehicle versus
equities. The reason for this is because bonds are often regarded as a cheaper
financing vehicle due to less Corporate Events and issuing bonds does not result in
dilution as is in the case of equities (dilution simply means that if more shares are
issued by a company, the existing shareholders will own a lower percentage of shares
(but of a bigger company).
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8.3 Municipal Bonds
Municipal bonds are very similar to Government bonds and Corporate bonds. They are issued by
municipalities in order to finance the building of roads, installation of water systems etc. For
example the City of Johannesburg is listed on the JSE.
In the USA, municipal bonds have certain beneficial characteristics. For instance in the USA,
investors pay both Federal taxes and individual state taxes. Certain municipal bonds exempt the
bondholders from incurring State taxes on the interest earned, making them very attractive.
8.4 International Bonds
International bonds are divided into 3 categories: Domestic, Foreign and Euro. The classification
depends on the domicile of the Issuer, nature of the underwriting syndicate, domicile of the
primary buyers and currency denomination. Domestic bonds are issued, underwritten and traded
under the currency and regulations of a country‘s bond market located in the country e.g. R153.
In South Africa, domestic bonds can be purchased by foreign parties, however in some countries
only citizens of the country could own the bonds issued by that Government. Historically, this used
to be the case in Italy.
8.4.1 Foreign Bonds
Foreign bonds are issued under the regulations of a domestic market and are intended primarily
for that country‘s domestic investors by a foreign domiciled borrower. Foreign bonds are
denominated in the currency of the country in which it is marketed e.g. if a German company sells
a dollar-denominated bond in the US, it is considered to be a foreign bond and would be termed a
Yankee bond.
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These bonds have nicknames:-
Bonds issued into the UK by non-domestic companies are known as Bulldog bonds;
Bonds issued into the USA by non-domestic companies are known as Yankee bonds;
Bonds issued into Japan by non-domestic companies are known as Samurai bonds;
Bonds issued into Spain by non-domestic companies are known as Matador bonds; and
Bonds issued into the Netherlands by non-domestic companies are known as
Rembrandt bonds.
8.4.2 EuroBonds
Eurobonds are underwritten by an international syndicate and traded outside any one domestic
market. They came about because many Issuers who issued foreign bonds wanted to raise
dollars without having to register with the USA regulator who required the Issuer to comply with
certain regulations. In addition, there was a significant market for Dollar denominated instruments
traded of the shores of the USA. The Eurobond market is the second biggest market to that of the
Government bond Market.
Example, the Eurobond issued in the Japanese Yen is known as the Euroyen bond. It is now
market practice for foreign countries to issue Eurodollar bonds with London being the largest
market for Eurodollar bonds.
When Eurobonds are issued, it is done simultaneously across a number of countries in
unregistered form. The Issuers of these bonds are mostly Governments, Government institutions
and large national corporations.
8.5 Floating Rate Notes
There are many different Floating Rate Securities or simply floaters, which all have a common
feature namely: the coupon interest will vary over the instruments life. Although a floaters coupon
can depends on a wide array of economic variables (FOREX rates, commodities etc), a floaters
coupon payments usually depend on the level of money market interest rates (short term interest
rates) e.g. JIBAR, T-Bills, Prime etc. Reset of the coupon rate is usually quarterly in South Africa,
however semi- annually and monthly also exist.
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The fundamental benefit of a Floating Rate Note is that the Security will pay coupons based on
the prevailing interest rates. These instruments are typically trade on price rather than YTM.
8.6 Reverse floaters
These bonds are similar to Floating Rate Notes except that the interest rate (coupon) on these
bonds falls when the interest rate rises.
8.7 Amortising Bonds
Amortising bonds pay Interest and Principal at the same time. In other words, the Issuer pays off
a bit of the principal every time they make a payment to the investor. Mortgage bonds are the
most common type of amortising bonds – the person who borrows (Issuer) pays back the bank in
equal monthly payments over 20 years, that after 20 years a zero balance is obtained.
8.8 Securitisation
―Securitisation may be broadly defined as the process whereby loans, receivables and other
financial assets are pooled together, with their cash flows or economic values redirected to
support payment on related Securities. These Securities, which are generally referred to as ‗Asset
Backed Securities‘ or ‗ABS‘, are issued and sold to investors.
Not withstanding the above paragraph as a formal definition of securitisation, it is much easier to
understand what a securitisation is by working through an example. Let‘s have a look at the most
common form of securitisation namely: Mortgage Backed Securities (MBS).
A mortgage is a secured loan, with the Security being a real property i.e. your house. Traditionally,
the borrower, or mortgagee, agrees to make monthly \ periodic payments to a lender (bank), or
some other lender. The mortgage itself is not a financial Security as we know it because it cannot
be traded in a secondary market and is non-negotiable. To become a Security, individual
mortgages must be ―securitised‖. Essentially, the bank will take all of the mortgages they own and
pool them together. The bank will then issue marketable bonds into the market backed by the pool
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of mortgages. Thus, an illiquid group of assets (mortgages) are transformed into a marketable
liquid asset that can be traded in the secondary market. Payments made by the homeowners are
made to the bank (or a mortgage servicer, which collects the payments) and are then forwarded to
the investors of the securitised bonds. This way, the bank essentially sits in the ―middle‖ and takes
a cut e.g. the coupon on the securitisation is ―Prime-1‖ and the individual mortgage loans are
required to pay interest of ―Prime‖. Therefore the bank netts 1%. In addition, when a bank
securitises an existing pool of mortgages, they will receive a lump sum from the issuance of the
securitised bond up front, which the bank can then use as they see fit.
Since homeowners often sell their homes, refinance or pay off the mortgage sooner, the cash
payments can become uncertain. If a person pays off their mortgage quickly the payment simply
passes through to the investor. As a result, these Securities can be packaged such that they
receive more constant cash payments. These packages are generally referred to as Collaterised
Mortgage Obligations (CMOs) - a detailed discussion of CMOs is beyond the scope of this course.
Bank
Pool of Mortgage
Obligations
Mortgage
Loans
investors
Mark
Bob
Frank
Securitised bond
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Essentially any asset can be securitised. Some South African examples of securitisations are:-
Eagle bonds – Securitisation against Aircraft;
Auto (BMW), CAR (ABSA), Procul (FNB) bonds – Securitisation against Cars;
On the Cards (Edgars), Account on Us (BAG bonds, Woolworths) - Securitisation against
credit card payments;
ERS, Fintech - Securitisation against Equipment Rentals;
FRESCO – Securitisation against FNB loan book; and
Kagiso – Securitisation against Black Empowerment Projects, which excludes Alcohol,
Cigarettes and armaments projects.
8.9 STRIPS
Coupon stripping is the process of separating the coupons of a bond from the principal as well as
separating each coupon payment from each other. After stripping, each Security can trade by
itself and will receive an individual unique code, entitling the holder to the respective specific
coupon payment (or the principal payment) on the Payment Date. Therefore a 30 year treasury
bond can be split into 60 individual coupon payments called coupon strips and one principal
payment (principal strip). Since the components of the stripped Securities consist of single
payments (with no intermediary payments), they are referred to as zero coupon bonds or simply
zeros.
This process all started in the 1980‘s because the US treasury did not issue zero coupon debt
with a maturity of greater than 1 year (and still doesn‘t). Instead, zero coupon Securities were
created by Government Securities dealers who stripped treasury bonds into their respective
coupons and principal. Merrill Lynch was the first to do this with its creation of Treasury
Investment Growth Receipts (TIGRs) in August 1982.
These became so popular that the US Treasury eventually introduced ―Separate Trading of
Registered Interest and Principal Securities ―(STRIPS) in 1985 to improve liquidity of the zero
coupon market. The programme allows the individual components (coupons and principal) of
eligible bonds to be held separately in the Federal Reserve (Fed) book entry system. Investors
can request that a bond be stripped into its separate components by sending instructions to the
Fed. Each strip receives its own unique bond code and can then be traded separately. The Fed
also allowed for the components of a stripped treasury bond to be reassembled into their fully
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constituted form. This is done by sending instructions to the Fed to re-constitute the strips and
principal and is known as re-constitution.
The South African National Treasury introduced STRIPS on 21 January 2002. Initially, the bonds
that could be stripped were the R150, R153, R157, R194, R186. The coupon STRIPS are called
―C STRIPS‖ and the principal STRIP is called a ―P STRIP‖ and each has a unique code. (Since
all of these bonds each had 3 redemption dates, there are 3 P strips per bond). The minimum
strippable amount is ZAR 2 400.00 and multiples thereof. (This was to ensure rounding to the
nearest ZAR 1.00). Stripping and reconstitution can only be done through selected Primary
Dealers and the process is managed through the Participants.
8.10 Inflation Linked Bonds
We know that inflation is a key driver of bond performance and a fundamental component of
nominal Yield. In order to measure true performance of an investment, the ―real return‖ is
calculated. Many Issuers recognised this and devised a bond based on ―Real Yield‖ rather than
―Nominal Yield‖ with the promise to protect purchasing power. These Securities are called Inflation
linked bonds. Internationally, these instruments are also called ―TIPS‖ (Treasury Inflation
Protection Securities). Another popular acronym is CIB i.e. Capital-Indexed bonds.
Inflation linked bonds were first issued by the South African Government on 20 March 2000.
These bonds have been issued in such a way that both their coupons and principal are linked to
the South African Consumer Price Index (CPI) as distributed by Statistics South Africa (―Stats
SA‖). Please note that it is the headline CPI that is used (i.e. the Consumer Price Index for the
historical metropolitan areas –all items) and not CPIX (Consumer Price Index excluding interest
rates on mortgage bonds). The historical CPI (and CPIX) information can be found at
www.statssa.gov.za.
Strategically, institutions are attracted to TIPS due to the low correlation to traditional financial
assets, and muted volatility. Tips help funds achieve long term investment goals and reduce risk
in the process. In emerging markets such as South Africa, the issuance of TIPS by the National
Treasury demonstrates the commitment of the Government to control inflation! TIPS have been
around for some time e.g. in the USA they date back to 1742! In the UK, more than 20% of their
treasury issuance is in TIPS.
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9 THE BOND MARKET
9.1 The International Bond Market
Debt certificates have traded internationally for many centuries amongst traders. In addition it is
well documented that Kings and Emperors borrowed heavily to finance their wars. ―In the 14th
Century, for example, Edward I financed his wars through bond issues launched in Italy by the
then big banking families. Centuries later, the great coalition against Louis XIV led by William of
Orange was financed by a group of Dutch families operating from The Hague. Later, the
Rothschilds became famous for supporting the British war effort against Napoleon I through their
European Family network.‖1 The bond markets have been around for years and are here to stay!
If one looks at the figures provided by the Bank of International Settlements (BIS), it is quite
evident how large the bond markets are globally.
Country (Sept 08) Total Government Financial Institution Corporate Issuers
Argentina 74.8 63.1 4.3 7.5
Australia 630.7 114.2 479.5 36.9
Austria 317.2 111.1 176.6 29.4
Belgium 570.0 386.9 146.4 36.7
Brazil 1,017.8 657.3 352.8 7.7
Canada 1082.5 708.4 243.6 130.6
China 2121.3 1.405.6 570.5 145.2
Czech Republic 105.2 83.4 16.4 5.4
Denmark 505. 71.9 431.8 2.1
Finland 131.7 62.1 56.4 13.3
France 2,899.6 1,441.9 1,144.1 313.7
Germany 2,660. 1,377.5 1,037.5 245.0
Greece 350.3 312.1 13.7 24.5
Hong Kong SAR 49.5 19.3 20.2 9.9
India 433.4 384.9 37.4 11.1
Indonesia 77.0 68.6 3.9 4.5
Ireland 116.2 56.0 - 60.2
Italy 3,218.7 1,807.4 1,049.4 361.9
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Japan 9,606.2 7,890.4 1,037.2 678.6
Malaysia 183.9 72.8 30.0 81.2
Mexico 382.8 209.9 140.8 32.0
Netherlands 883.4 301.6 505.7 76.2
Norway 141.4 48.0 67.2 26.2
Poland 176.8 176.8 - -
Portugal 245.3 129.8 66.5 49.0
Singapore 100.3 71.0 25.1 5.3
South Africa 105.5 62.6 28.3 14.6
South Korea 885.7 352.2 329.2 204.4
Spain 1,736.3 514.1 603.0 619.2
Sweden 391.6 131.9 218.9 40.8
Switzerland 243.0 114.2 115.0 13.9
Thailand 146.3 103.6 0.3 42.4
Turkey 216.3 215.8 - 0.5
United Kingdom 1,286.9 843.4 423.0 20.5
United States 25,800.3 7,322.8 15,512.4 2.965.0
Source: BIS IFS, Stock of Domestic Debt Securities by Residence and Sector of Issuer
9.1.1 United States
The United States has the largest and most active bond market. The U.S. Government has never
defaulted on a loan. As a result, US Government bonds are among the safest in the world. US
Government bonds are also known as Treasury bonds or even T-bonds.
The US Treasury issues bonds in the primary market which is open to all investors. However, the
majority of the auctions are taken up by the primary dealers who are organisations who interact
with the Federal Reserve Bank of New York and are required to bid actively at the auctions and
make a market (provide a bid and offer) in selected Government bonds. Secondary market trading
takes place in the OTC market. The majority of the liquidity is concentrated around the on-the-run
issues which are the most recently issued Securities.
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Trading takes place on a price basis rather than Yield in the secondary market. However bidding
at the auctions in the primary markets takes place on a Yield basis for Government bonds. The
spot settlement convention for Government bonds is T+1.
9.1.2 Japan
Japan has the second-largest Government bond market in the world. Japanese Government
bonds are otherwise known as ―JGBs‖. The JGBs can be classified into 6 categories:-
Short term – issued with 1 year or less to maturity;
Medium term – issued with 2 & 5 years to maturity;
Long term – 10 year bonds;
Super Long term – 15,20 and 30 year bonds;
Inflation Indexed bonds; and
JGBs for individual investors
Coupon bonds pay semi-annual coupons. While certain Government bonds are listed on the
Tokyo, Osaka and Ngaya Stock Exchanges, Exchange-trading volumes are low and the majority
of trade takes place OTC. JGBs clear and settle through the Bank of Japan Financial Network
System known as BOJ-NET. Settlement takes place on a T+3 basis.
9.1.3 Italy
Italy currently has the third largest bond market in the world. The Ministry of the Economy and
Finance sets out the issue, on the domestic market, of five categories of Government bonds
available for both private and institutional investors:-
Treasury bills (bots);
Zero coupon bonds (ctzs);
Treasury bonds (BTPs)
Treasury bonds indexed to eurozone inflation (btp€i)
Treasury certificates (ccts)
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The BTPs are denominated in Euro‘s and pay semi-annual coupons. Only Authorised Dealers,
who meet the terms and conditions set out in the Italian legislation can bid at the primary auction.
Settlement is T+2 in the primary market and T+3 in the secondary market.
9.1.4 Germany
The German bond market is the fourth largest in the world. The issuance of German Government
bonds is the responsibility of the German Finance Agency, known as Bundesrepublik Deutschland
Finanzagentur, on behalf of the German Government. bond maturities of two, five, ten and thirty
years are issued. Interest payment for these bonds is annual and maturities are fixed.
The two year German issues are known as Federal Treasury notes (Bundesschatzanweisungen
or ―Schätze‖). The five year Federal notes are known as Bundesobligationen or ―Bobls‖ and the
ten and thirty year Federal bonds are known as Bundesanleihen or ―Bunds‖. German bonds and
notes are listed and traded on all eight of the German Stock Exchanges (Frankfurt being the
primary one). Substantial over-the-counter (OTC) trading also takes place.
Bonds and notes are cleared via the Kassenverein – the central depository for Securities. All are
eligible for clearing through Euroclear or Clearstream. Since the introduction of the euro in
January 1999, all new Government debt is denominated in euro.
9.1.5 United Kingdom
UK Government bonds are known as gilts or gilt edged Securities. The name ―Gilts‖ comes from
the fact that the certificate issued by the UK Government used to have a gold lining around the
edge. The market is centred around a group of firms known as ―Gilt Edged Market Makers‖
(GEMMS) who actively bid at the primary auction and make a market in gilts. Trades are
conducted on a price basis and the settlement convention is T+1.
Settlement of the bonds takes place through Crest Co and the scrip is held in dematerialised form.
Crest is part of the Euroclear group.
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9.1.6 Malaysia
The types of debt Securities issued and traded in the Malaysian bond market include:
Government Securities, Treasury bills, Cagamas Berhad (National Mortgage Corporation) papers,
unlisted private debt Securities (PDS), Bank Negara Malaysia (BNM) certificates and bills, listed
Corporate bonds.
Secondary market trading takes place OTC between banks and Securities companies and their
customers. Bonds may be listed on the Kuala Lumpur Stock Exchange (now Bursa Malaysia) and
the Labuan International Financial Exchange.
The settlement system (called RENTAS) is a DvP gross trade-for- trade settlement system. The
settlement convention is T+3.
9.1.7 Korea
The Republic of Korea has a very large domestic bond market. It was the largest in Asia after
Japan until 2002 when preliminary figures indicated that the People‘s Republic of China may have
become the largest market in the region.
The Korea Stock Exchange (KRX) accounts for only 5% of the trades, with the balance taking
place in the OTC market. The OTC market is a wholesale market in which one-to-one trading of
bonds between various types of institutional investors is conducted. The value of each trade is
large, with the minimum traded amount being W 10 billion (about US$ 9.6 million) per transaction.
Bond transactions are settled on a rolling basis. The settlement cycle has been changed from T+0
to T+1 to facilitate the use of the DvP settlement system. Participants‘ settlement obligations are
calculated on a gross trade-by-trade basis without netting, for both Securities and cash.
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9.2 Background of the South African Bond Market
The market consisted of a large number of stakeholders with diverse interests ranging from
Issuers and investors, of various sizes; jobbers and speculators, to brokers acting as Agents and
principals. These stakeholders, irrespective of their sizes, ability and strength, followed the market
practice developed over many years of settling their deals, purchases or sales, on a simultaneous
physical transfer of cash and Securities every Thursday. Deals were usually struck from
settlement two Thursdays hence. Same day settlement did occur but was not the norm.
Bookkeeping processes and the production of Securities were all manual. With the number of
Securities transactions growing rapidly, a need arose to introduce an infrastructure which could
support this growth and mainly remove the inefficiencies and risks inherent in the traditional paper
based environment.
9.2.1 Licensing of an Exchange
In the mid 1980s Dr Stals and Dr Jacobs, both of the South African Reserve Bank (SARB),
undertook an extensive review of the financial markets culminating in their well-known ―Stals/
Jacobs Report‖, which recommended inter alia, tight control via regulation in the financial markets
under the umbrella of a Financial Markets Control Act (FMCA).
Note: the FMCA has since been repealed and replaced first by the Securities Services Act, 2004
(SSA), and then by the Financial Markets Act, 2012 (FMA).
The authorities recognized that self-regulation by market players was and still is more desirable
and acceptable than imposed regulation. To this end, the majority of the bond market players
formed a voluntary association in 1989 under the auspices of the FMCA, with the intention of
formalising i.e. licensing, an Exchange. The Bond Market Association (BMA) was the vehicle
through which the bond market Exchange was developed.
BESA was formally licensed in May 1996 by the FSB as a licensed financial Exchange on which
bonds and related products were to be traded.
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9.2.2 Bond History
As recently as 1988, the Government‘s debt policy was not designed to enhance marketability so
if they had a funding requirement, they would issue a new bond with its own terms and conditions.
Once the bond was issued it would never be changed, which led to the existence of a large
number of bonds with small nominal amounts. This approach resulted in a lack of liquidity.
In 1989 the Department of Finance held discussions with the local merchant banks and investors
and it was subsequently decided to consolidate its issued stock and to replace them with four new
issues which had been created for this purpose.
The objective of the consolidation was three-pronged:-
to increase the marketability of Government stock;
to increase the competitiveness of the Government as a borrower in the
capital markets; and
to create benchmark bonds across the Yield curve.
9.2.3 Consolidation of Bonds into Categories
13 bonds with maturity dates between 1994 and 1996 were consolidated into
the R144.
16 bonds with maturity dates between 1996 and 2000 were consolidated into
the R147.
12 bonds with maturity dates between 2001 and 2005 were consolidated into
the R150.
Bonds with maturity dates between 2006 and 2008 were consolidated into the
R153.
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9.2.4 Establishment of the Three-Legged Bonds in 1989
In order to develop liquid instruments, the project managers at the time thought it prudent for the
four new bonds to have three maturity dates. The aim was to increase the nominal outstanding
amount of the bonds without increasing refinancing risks. From 1990, the liquidity of Government
bonds improved.
The unintended side effect of the so called ―three-legged bonds‖ was that the majority of bullet
bonds (i.e. bonds having a single maturity date) became grossly illiquid after 1989. This created a
chain-reaction in which only the three-legged bonds could be liquid bonds and therefore
Government had to continue issuing these bonds.
As recently as 1 April 2001 there were new issued bonds: R157, R186 & the R194. Bullet bonds
such as R184, R179 & R177 remained illiquid, whilst having large nominal amounts.
The three-legged bonds are priced on the middle or second maturity date which means that three
different maturities in the Government Yield curve have the same price. This is technically
incorrect, as the different legs of the bonds should generally have different price levels.
9.2.5 Government Developments 2000/2001
Government however realized that they needed to keep abreast of time and adopt strategies that
would allow them to compete with the best in global markets. An in depth study of global markets
was done by National Treasury and investors indicated that three-legged bonds should be split
into bullet instruments. Global trends indicated a shift to bullet bonds due to their price efficiency.
9.2.6 Splitting R150 Bond
The R150 bond with the maturity date of 2004/2006 could be split into the following new
instruments:-
R006 maturing 28 February 2004;
R151 maturing 28 February 2005; and
R152 maturing 28 February 2006
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If a holding of the R150 is not divisible by one third, then the R006 & R152 will be rounded to the
nearest one thousand Rand and the balance added to the middle tranche.
Despite reminders to investors in 2002 and 2003, very small amounts of bonds were split, as they
feared lack of liquidity as well as pricing differences and losses when trading. However, to cater
for the repayment of the first tranche of the R150 bond on 28 February 2004, investors were
obliged to split their holdings at the end of January 2004.
9.2.7 Three-Legged Bonds
Since the issue of the last three-legged bond in 2001, all new bond issues have been single bullet
issues. There has been no further announcement regarding the splitting of the current three-
legged bonds. The three-legged bonds are still the highest traded bonds on JSE BESA, and for
the year 2004 accounted for 68.1% of total market turnover as follows:
R194 maturing Feb 2007/2009 22,7% of turnover;
R153 maturing Aug 2009/2011 32,9% of turnover; and
R157 maturing Sept 2014/2016 12,5% of turnover.
9.3 Development of the Clearing System for Electronic Nett Settlement
The market needed to be automated with electronic nett settlement of cash and listed Securities
using a Securities depository.
The major clearing banks and the South African Reserve Bank formed a company called
Universal Exchange Corporation (Pty) Ltd, (UNEXcor), with the express purpose of developing a
system for electronic nett settlement using a central securities depository. The objective was to
develop an electronic system, which would eliminate manual intervention and the associated
risks, and provide on-line, real-time trade reporting and matching and electronic nett settlement of
Securities against cash. The joint initiative to introduce electronic settlement was spearheaded by
BESA (then the BMA) and the major clearing banks (ABSA, FirstRand, Nedbank and Standard
Bank).
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The BMA Members, at a general meeting in May 1994, adopted the ―BMA Secure Settlement
Proposal‖ and formally appointed UNEXcor as the clearing-house.
9.4 Key stakeholders
The key stakeholders in the bond market include:-
JSE BESA Members;
Participants;
South African Reserve Bank – SARB;
Issuers;
JSE;
JSE Equities Members; and
Clients – (Ordinary Client and Member-Settled Client).
9.4.1 Bond Exchange of South Africa (BESA)
The Bond Market Association (BMA) was a voluntary association formed in 1989 under the
auspices of the Financial Markets Control Act (FMCA) of 1989. It was formed with the intention of
developing a formal bond Exchange. The BMA became the Bond Market Exchange when the
Financial Services Board licensed the Exchange.
The principal objectives of the newly licensed Exchange included:-
addressing the key systemic risks inherent in the market;
implementing a robust, electronic delivery versus payment system;
establishing a guarantee fund to underpin the performance of transactions; and
developing a rulebook to reflect international best practice.
An Exchange‘s responsibility is to ensure compliance of brokers to Rules of the Exchange through
surveillance of their transactions.
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9.4.2 Merger of JSE and BESA
9.4.2.1 One Securities Exchange for South Africa
On Monday, 27 October 2008, the JSE Ltd (JSE) announced its intention to make an offer to
acquire all the issued ordinary shares of the Bond Exchange of South Africa Ltd (BESA).
The JSE and BESA decided that the most effective way to implement the transaction was by way
of a Scheme of Arrangement between the JSE and BESA shareholders in terms of section 311 of
the Companies Act, 61 of 1973. The Bond Exchange of South Africa (BESA) became a wholly-
owned subsidiary of the Johannesburg Stock Exchange (JSE) on 22 June 2009, the operative
date of the Scheme of Arrangement in terms of which the JSE acquired the entire issued share
capital of BESA.
The JSE‘s ultimate objective was to integrate the business of BESA into the business of the JSE,
i.e. the take-over of the business and winding –up of BESA, with the latter ceasing to exist as a
separate legal entity and to harness the respective areas of expertise of the two Exchanges to
deliver increased liquidity, increased functionality and a broader range of products and services to
market participants, bond issuers and investors, such as retirement funds, insurance companies
and their members.
9.4.2.2 Application by the JSE
Section 57 of the Securities Services Act, 2004, required that the Registrar of Securities Services
approve the acquisition of more than 15% of the issued shares of an Exchange. Furthermore, in
terms of section 54 of the SSA, the Registrar had to approve any merger of two or more
Exchanges or the transfer of assets and liabilities by one Exchange to another. As a result of the
interconnectedness of the two applications, the Registrar decided to deal with the two issues as
part of a single process.
9.4.2.3 Approvals required
The implementation of the Scheme of Arrangement was subject to the fulfilment of the conditions
of the Scheme document. After extensive consultation with all stakeholders, the Financial Markets
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Advisory Board, and the National Treasury, the FSB approved the transaction on 11 May 2009,
subject to the following:
that the conditions in the Scheme of Arrangement are met;
that the Registrar has approved the integration plan and the fixed income growth strategy;
that the JSE trading costs will not be increased for the first two years following the
approval of the fixed income growth strategy.
that the National Treasury shall be guaranteed two seats on the JSE Interest Rate
Advisory Committee;
that a technology plan for the interest rate market be submitted to the National Treasury
and the FSB to ensure system reliability;
that the Bond Market in South Africa will not be negatively affected; and
that any further requirements or conditions that the Registrar may impose are met.
9.4.2.4 Benefits of the transaction
In processing the applications, due regard was given to the regulatory implications on the South
African capital markets and of the furtherance of the objectives of the SSA.
The FSB viewed the following as benefits:
Improved risk-management processes will enhance efficiency in the South African capital
markets;
An enhanced trading model funded from the existing capital; a strong balance sheet;
A variety of products allowing greater flexibility to meet customer needs;
Increased liquidity;
A reduction in costs through economies of scale, including lower regulatory costs;
More effective supervision by the FSB;
The elimination of risk of regulatory arbitrage;
Defragmentation of the South African capital markets; and
Enhanced global competitiveness of the South African markets.
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9.4.2.5 BESA Guarantee Fund
The BESA Rules and the FMCA required the establishment of a Guarantee Fund. In accordance
with these regulatory requirements, the Executive Committee of the Bond Market Association
(forerunner to BESA) established a Guarantee Fund on 28 September 1995 to provide an initial
ZAR 30 million in cover to bond market stakeholders.
The purpose of such a fund is to protect both Members and Clients against re-transaction price
losses, arising between Trade Date and Settlement Date, which result from the default of a
Member. This fund may not be less than ZAR 30 million for the discharge of a claim in respect of
the outstanding bond trading liabilities of a Member. Although not registered as a trust, the Fund is
constituted as an independent entity under the FMCA (now FMA) and is accounted for and
audited separately from the affairs of the Exchange. This separation of the Exchange and the
Fund is designed to ensure that a claimant may look only to the Fund itself for satisfaction of a
claim.
In the event of the insolvency on liquidation of the Exchange, the JSE‘S trade creditors may
proceed only against the assets of the Exchange and have no enforceable rights against the
Fund. The Guarantee Fund is also subject to a set of Rules approved by the FSB. These Rules
prescribe various matters, including the management and control of the Fund, the manner in
which contributions may be levied and the procedure for admitting a claim on the Fund.
As mentioned above, the sole purpose of the Fund is to afford protection to Members and Clients
against re-transaction price losses. In other words, the Guarantee Fund covers losses incurred in
replacing (or re-transacting) bond trades which were originally executed with a defaulting Member.
This market movement, being the difference between the price of the original trade and the price
of the replacement trade, can be claimed from the Fund. It should be noted that such claims can
be triggered only by a Member default.
The existence of the Fund does not prevent the need for Members to assess the counterparty risk
of Clients or of other Members prior to trading, nor does the Fund cover against settlement risk,
that is, the risk of the capital amount of the transaction being impaired through settlement failure
or fraud.
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The Bond Exchange Guarantee Fund is also not a fidelity fund, and does not cover fraud or
misappropriation on the part of the officers or employees of a Member. These latter risks are
addressed by each Member individually through self-insurance or an appropriate fidelity insurance
policy.
9.4.3 JSE BESA Members
Membership is available only to corporate entities who need to be registered as either trading or
broking Members. (NOTE: A Member is also known as broker or an Authorised User.)
The Members are required to abide by the Financial Markets Act and the Rules of the Exchange.
Requirements of a Member include inter alia:-
registration and incorporation as a Company under the South African Companies
Act, 2008;
minimum capital adequacy;
need to be of good repute;
need to appoint a service provider and Strate Participant;
system requirements for trade execution, reporting and settlement; and
need to comply with the Rules relating to the Guarantee Fund contributions, fidelity
insurance cover, trading and settlement.
9.4.3.1 JSE BESA Membership
BESA Membership is open to Corporate entities only and comprises, inter alia:-
Primary Dealer Banks;
Banks;
Matched Principal Traders;
Securities Trading Houses (Non-Aligned);
Bond Issuers;
Asset Managers;
Name Give-Up brokers; and
South African Reserve Bank.
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NOTE: For an updated list of BESA Members please contact JSE (011) 520-7000 or
visit www.jse.co.za or [email protected]
9.4.4 Participants
In the definition section of the Financial Markets Act a Participant is defined as:-
“a person authorised by a licensed central securities depository to perform custody and
administration services or settlement services or both in terms of the central securities depository
rules, and includes an external participant, where appropriate”
The Participants perform electronic nett settlement of funds. The Participants have clearing
accounts with the South African Reserve Bank. The current approved bonds Participants in the
Strate environment are:-
ABSA Bank Limited;
FirstRand Bank Limited;
Nedbank Limited;
Standard Bank of South Africa Limited; and
South African Reserve Bank
9.4.5 South African Reserve Bank (SARB)
The SARB provides an inter-bank settlement service via the real-time electronic settlement
system, the South African Multiple Option Settlement (SAMOS) system.
The SARB is also a Participant in the bonds market.
National Treasury is an Issuer in the bond market of predominantly Treasury Bills (TB‘s).
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9.4.6 Issuers
The major Issuers of bonds, National Treasury aside, are active players in the market in their own
right. These Issuers are primarily the parastatals in the form of Eskom, Transnet, and Telkom.
Other Issuers playing smaller roles are the Development Bank and the Landbank – both
Government controlled entities.
In contrast to other bond markets elsewhere in the world, these Issuers are market makers in their
own debt and thus some are very active in writing options on that debt.
9.4.7 JSE Limited (JSE)
The JSE expanded its existing interest rate product range to include the listing, trading, clearing
and settlement of spot bonds in the secondary market as well as interest rate products on existing
derivatives.
The Yield-X system went live on the 21st February 2005 which allowed for the loading of master
file information with the Yield-X market going live on the 28th February 2005.
The Yield-X market was achieved by the creation of a separate environment and alternative
platform within the JSE for trading and clearing, with settlement taking place through existing
structures of Strate and the Participants.
9.4.8 Clients
Clients in the bonds environment can be classified into two groups namely:-
9.4.8.1 Ordinary Clients / Non-Controlled Clients
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Clients may elect to appoint their own Participant. Having a direct relationship with the Participant
means that the Client deposits both his cash and Securities with the Participants and only deals
with a broker when they wish to trade. Statements are received from the Participant.
9.4.8.2 Member-Settled Clients / Controlled Clients
Clients may elect to appoint a broker as their service provider and as such has an indirect
relationship with the Participant appointed by that broker. The Client deposits both his cash and
Securities with the broker.
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10 LEGAL FRAMEWORK
10.1 Legislation
Legislation provides for the legal framework of Strate and its Participants and the functions it may
perform (i.e. the electronic clearing, settlement and custody of Securities) and makes provision for
uncertificated Securities and delivery versus payment by electronic book-entries.
10.1.1 The Financial Markets Act (No 19 of 2012)
Strate is licensed as South Africa‘s only CSD in terms of the Financial Markets Act (FMA). Strate
is also licensed as a Clearing House under the legislation.
The FMA provides the legal framework to support electronic Securities services performed by
Strate as the CSD. The legal framework rests on certain fundamental points and basic principles,
but the FMA also adds a number of new provisions to the repealed Acts (Custody and
Administration of Securities Act, the Stock Exchange Control Act, the Financial Markets Control
Act, the Insider Trading Act and the Securities Services Act).
Although the FMA sets out a framework for market regulation, it leaves much of the detailed
substantive provisions to secondary legislation. Strate is bound to issue and amend Rules within
the framework of the FMA where the basic principles are set out.
The objectives of the FMA are expressly stated as being to:
(a) ensure that the South African financial markets are fair, efficient and transparent;
(b) increase confidence in the South African financial markets by—
(i) requiring that securities services be provided in a fair, efficient and
transparent manner; and
(ii) contributing to the maintenance of a stable financial market environment;
(c) promote the protection of regulated persons, clients and investors;
(d) reduce systemic risk; and
(e) promote the international and domestic competitiveness of the South African financial
markets and of securities services in the Republic.
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The objectives of the FMA also give Strate a yardstick to follow when issuing Rules and
Directives.
The Executive Officer of the FSB fulfils the function of the Registrar and the Capital Markets
Department of the FSB is the responsible department within the FSB for ensuring that the objects
of the FMA are met by Strate in its functions as Self-Regulatory Organisation (SRO) and Clearing
House.
The FMA applies to ‗regulated persons‘ and the securities services provided by them. Strate is a
regulated person and is by definition a SRO. In terms of section 30(1) of the FMA, Strate must act
with due regard to the rights of Participants, Clients and Issuers.
In addition, the FMA sets out requirements which Strate must comply with in conducting its
business as a CSD, and in its role as a SRO. To further ensure adequate disclosure and
accessibility, the FMA states that Strate must disclose its fees and charges to its Participants and
Issuers and provide in its Rules for equitable criteria for acceptance and expulsion of a
Participant.
This legislation established a ―co-regulatory regime‖ in terms of which Strate‘s self-regulatory
responsibilities arise. Strate must regulate its activities and those of its Participants by making and
enforcing Rules that comply with the requirements prescribed by the FMA. The FSB must
supervise compliance with the FMA by every regulated person.
CSD Rules
A comprehensive set of CSD Rules have been enforced to:-
ensure that the CSD is managed and controlled by a highly competent body
which has the necessary powers to effectively manage the CSD;
ensure that participation in the CSD is limited to suitable entities which are
required to comply with stringent entry criteria;
ensure that the business of the CSD and the Participants is carried out
according to a strict ethical code with a disciplinary procedure to deal with any
contraventions of the code or the Rules;
prescribe the various types of accounts that may be opened and maintained
by a Client with a Participant and by a Participant with the CSD; and
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prescribe the security measures and internal and external controls required to
be implemented by Participants.
Strate Directives
Please refer to the Strate Website – www.strate.co.za for a complete list of all Strate Bonds
Directives.
Rule and Directive Setting Process in Strate
Regulation in Strate is very important. The Rules must be consistent with the FMA (section 35(1)
of the FMA). The Rules must also contain, as a minimum, the requirements determined by the
FMA (section 35(2)). The CSD may also, with the approval of the Registrar, make Rules on
additional matters that are not covered in the FMA.
Whereas the Rules are made by the CSD in accordance with the FMA, a ―Directive‖ is defined as
a Directive issued by the SOR in accordance with its Rules. The Directives normally prescribe the
detail or technical requirements for electronic settlement and other matters. Strate endeavours to
deal with ‗principle matters‘ in the Rules and ‗detail‘ in the Directives.
It should be noted that all Rules are binding on the CSD, a Participant, an Issuer of Securities
deposited with the CSD and their officers and employees, and Clients (section 35(6) of the FMA).
The FMA prescribes the manner and process for making Rules in section 71. This must be read
together with the summary of the steps set out below.
For purposes of the FMA, licensing of a CSD means that the CSD must provide Securities
services in terms of a pre-determined set of CSD Rules (section 35). The responsibilities of care
and skill and fiduciary duties of members of the Controlling Body include the two distinct
responsibilities namely the Rule/Directive making process and secondly, enforcement and
monitoring of compliance by Participants to the FMA, Rules and Directives. In the case of
Strate,the second duty has been delegated to the Strate Regulatory and Supervisory Committee
of the Controlling Body.
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The Rules are published in a Government Gazette as prescribed for public comment and
approved by the Registrar and therefore constitute subordinate legislation.
On the supervisory role of Strate, the CSD must supervise compliance by Participants with the
FMA and Rules.
The Rule and Directive setting process is explained below:-
Sequence
Step 1
Step 2
Step 3
Step 4
Step 5
Step 6
Step 7
Owner
Head of Legal
Head of Legal
Head of Legal
Head of Legal
Head of Legal
Head of Legal
Head of Risk, Head of
Activity
Draft Rule or Directive in conjunction
with the relevant Head of Division
based on market requirement, best
practice or legislation
Strate review internally
Head of Division releases to
appropriate market forum (e.g.
Corporate Actions Forum, Bonds
Settlement Workgroup, Systems
Working Committee, Money Market
Advisory Committee) for comments.
Review and consider comments made
in conjunction with relevant Head of
Division. Amend where necessary.
Relevant Head of Division to re-
circulate to market and set date for final
comments.
Complete ―Approval Form‖ that details
all steps above. Implications (financial,
risk, legal, etc) spelled out.
Sign-off on Approval Form
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Step 8
Step 8A
Step 9
Legal, Head of
Supervision, Head of
Internal Audit
Head Legal
Head of Supervision
Head of Supervision
Submit ―Approval Form‖ together with
Directive/Rule to Supervision Division
Authority is delegated to the Head of
Supervision to approve Directives in
certain limited defined circumstances
(e.g. fee schedule where Board of
Strate has already approved it).
Submit Directive/Rule with Approval
Form to Strate Regulatory and
Supervisory Committee to approve/
reject/amend. The Committee‘s Terms
of Reference allow for a Round Robin
Resolution for the approval of urgent
amendments to existing Directives.
Step 10
Step 11
Step 12
Chairperson of Strate
Regulatory and
Supervisory Committee
Head of Legal
Head of Legal
Formally approve/reject/amend at
meeting (Financial Services Board is
observer at this meeting). The
Chairman must give prior permission to
approve Directives by means of a
Round Robin Resolution.
In the case of a Directive, send
Directive with Special Gazette to all
Participants, Financial Services Board,
Board members and Strate
Management, all interested and
affected parties indicating effective date
of implementation.
In the case of a Rule, send to Financial
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Step 13
Step 14
Financial Services Board
Financial Services Board
Services Board for publishing in
Government Gazette.
14 days for objections on Rule from
date of publication of notice
If no objections received, or Financial
Services Board decides to approve
Rule, the amendment or new Rule
comes into operation on date
determined by Financial Services Board
by notice in Gazette.
10.2 Pledge in the Strate Environment
Securities can be ceded or pledged in securitatem debiti to secure a loan or debt. Traditionally,
people refer to the ―pledging‖ of ―securities‖, although it is actually the share certificate that is
pledged and the rights in the securities (a share is an ―incorporeal right‖) that are ceded in
securitatem debiti.
The usual way of pledging Securities in the paper environment was by handing the pledgee the
securities, together with a transfer form (signed in blank by the pledgor), but without registering
the pledgee (creditor) as a member in the Register of Members.
There are no legislative or formal requirements for the pledging of certificated Securities: the
common law applies. To protect the rights of shareholders in the CSD environment, section 39 of
the FMA makes provision for pledge (out-and-out cession, which in essence is a transfer of
ownership, is also allowed under the FMA).
.
The commonly asked question is: ―How is pledging facilitated in the Strate environment without
the possession of a share certificate?‖
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In terms of the FMA, a pledge or cession is affected in terms of the CSD Rules by an applicable
entry in the Securities Account (or Central Securities Account, depending on the account structure
used) of the relevant shareholder.
The entry in the Securities Account of the pledgor or cedent must contain:-
the name of the pledgee or cessionary;
detail of the actual Securities pledged or ceded; and
the relevant date thereof.
It is submitted that because the entry is made on a Securities Account in the Subregister, which
forms part of the Register of Members, it therefore fulfils the ―publicity requirement‖ of the
common law. It is a requirement that the Participant makes this information available to a
company on request, and in turn the company is obliged to disclose the information to any third
party, on request.
The FMA determines that once the securities have been flagged (or blocked) by the Participant as
being pledged or ceded, the securities cannot be transferred without the written consent of the
pledgee or cessionary. The pledgee or cessionary of such securities will be entitled to all rights of
a pledgee or cessionary of moveable property. In other words, shareholders in the Strate
environment have not lost any of their common law rights. The security interest in the pledged
securities will be enforceable and can be transferred to the pledgee if the pledgor does not fulfil
his obligations in terms of the Security agreement.
As such, the introduction of uncertificated securities affects the taking of securities over securities
in a physical sense, but not in a legal sense. In addition, the rights of the respective pledgor and
pledgee remain protected through the obligations detailed in FMA.
CSD Rules that relate to Pledge
The below Strate Rules apply to pledge.
Administration and Maintenance of Information:-
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5.1 Participant’s Records must, in addition to the requirements of relevant legislation
applicable to that security, contain at least the following details of all deposits and
withdrawals of Securities in Securities Accounts;
5.1.5 details of any pledge or cession of the Securities to secure a debt, as the case may be;
Operation of Securities Accounts:-
6.7.3 A Participant must make a deposit, withdrawal, transfer, record a pledge or cession
to secure a debt on behalf of a Client in a Securities Account in accordance with the
provisions of the Client Mandate, the Act, Rules and Directives;.
6.7.4 Where a Participant records a pledge or cession to secure a debt on behalf of a
Client in a Securities Account;
6.7.4.1 the requirements of the Act, Rules and Directives shall also be applicable to
any Securities Account in which the Client’s Securities are held;
6.7.4.2 it must, in accordance with the Act, prevent the Securities from being
transferred from the Securities Account or the underlying account in which the
Client’s Securities are held, except with the written consent of the pledgee or
cessionary;
6.7.4.3 it must, in its statements to its Clients, indicate which Securities have been
pledged or ceded and specify the nominal amount or number of such
Securities; and
6.7.4.4 it must, when it sends out statements in accordance with rule 6.7.4.3, send to
the person to whom the Securities are pledged or ceded, a statement
evidencing the existence of the pledge or cession to secure a debt.
Pledge Practice Note
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Strate has released a ―Pledge Practice Note‖ to clearly explain the practical implications of the
pledge Rules and how the Participants are to implement procedures (manual and/or automated)
to adhere to such requirements.
Please refer to the Strate website www.strate.co.za for the Strate Pledge Practice Note.
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11 ACCOUNT STRUCTURES
The following section of the Handbook explains the Securities Account structures that form the
basis of the records of all holders of bond securities.
11.1 Central Securities Accounts
The first level of Securities Accounts which would be opened within the Strate bonds environment
would be the Participants‘ Securities Account at Strate and would record the total electronic
Securities administered by the Participant on behalf of its Clients. This account is known as the
―Central Securities Account‖ and is defined in the Strate Rules as:
“an account kept by the CSD for a Participant reflecting the number and/or nominal value of
Securities of each kind and all entries made in respect of such account.”
In terms of the Rules, a Participant may have one or many Central Securities Accounts at Strate.
11.2 Securities Account
The second level of Securities Accounts which would be opened within the Strate bonds
environment would be the Client‘s Securities Account at a Participant and would record the total
Securities placed under custody with their Participant. This account is known as the ―Securities
Account‖ and is defined in the Strate Rules as:
“an account kept by or on behalf of a Participant for a Client and reflecting the number or nominal
value of Securities of each kind deposited and all entries made in respect of such Securities.”
A Client may elect to have one or many Securities Accounts with a Participant.
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11.3 Dematerialisation and Immobilisation
Dematerialisation is the exchange of Securities (physical certificates) for an electronic record of
ownership of Securities.
In short, to dematerialise physical bond certificates, an investor approaches either a Participant
directly, or via a broker, to affect the process. The Participant communicates with Strate and
would submit the certificate to Strate (before the merger with UNEXcor this was known as ―Central
Depository Limited‖).The certificate is immobilised or dematerialised. The CSD credits the
Participants account in the CSD (i.e. the Central Securities Account) and the Participant credits
the Clients account (i.e. the Securities Account). Once the Securities are dematerialised and
reflected as an electronic entry, they may be sold or transferred.
11.3.1 Duty of Care
It is accepted that the process of dematerialisation is vital in the control and detection of tainted
Securities. As stated above, in order to dematerialise Securities, the investor will hand his share
certificates to his chosen Participant or via his broker to the Participant of the broker‘ choice. The
investor warrants the genuineness of the share certificate. At this point, both the broker and the
Participant carry out a level of verification before certificates are lodged with Strate who
undertakes the immobilisation or dematerialisation thereof. Both the broker and the Participant
have a duty to physically validate the certificate and are entitled to reject any certificate which, to
an ordinary person, appears to have been tampered with.
11.4 Rematerialisation
Shareholders are permitted to ―rematerialise‖ their Securities and obtain share certificates. Once
approached by the investor or his Agent, the Participant will advise the CSD of the investors
requirements for a share certificate. The Participant will flag the shareholding entry in its electronic
records and ask the Issuer to issue a share certificate. The CSD, on advice of the Participant and
subsequent confirmation by the Issuer, will debit the Participants account in the CSD and the
Issuer will release the paper certificate to the Participant.
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This process has several drawbacks:-
fees are charged for the reissue of a certificate in order to discourage
investors from reverting to a paper environment;
the reissue of paper can take up to 10 days to process;
the share certificate is not ―good for delivery‖ i.e. it can not be used to trade
on an Exchange; and
rematerialisation reintroduces the risk of tainted Securities into the market.
11.5 Nominees and Beneficial Ownership Disclosure
In the Strate environment the investor is empowered to make his/her own decisions and to choose
a service provider most suitable to his/her needs. Depending on the level of services required, the
investor can choose from a number of brokers and several Participants offering such services.
The bonds environment is historically a ―wholesale‖ market and very few private investors hold
bond Securities. Most bonds Securities are held by large Corporate and institutional investors
whose Securities are held under the Nominee of their broker or Participant. These investors will
not be treated as registered owners, but as Beneficial Owners.
11.5.1 Disclosure in terms of the Financial Markets Act
In terms of Section 35(2)(l) of the FMA:
The CSD must make Rules which provide for
(i) the duty of persons for whom securities accounts or central securities
accounts are kept to disclose to a participant or central securities
(ii) depository, as the case may be, and the duty of a participant to disclose
to a central securities depository, information about a beneficial, limited or
other interest in securities deposited with the participant or central
securities depository, as the case may be; and
(iii) the manner, form and frequency of such disclosure;
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In terms of section 1 of the FMA ―Securities‖ is defined as:-
(a) listed and unlisted—
(i) shares, depository receipts and other equivalent equities in public companies, other
than shares in a share block company as defined in the Share Blocks Control Act, 1980
(Act No. 59 of 1980);
(ii) debentures, and bonds issued by public companies, public state-owned enterprises,
the South African Reserve Bank and the Government of the Republic of South Africa;
(iii) derivative instruments;
(iv) notes;
(v) participatory interests in a collective investment scheme as defined in the Collective
Investment Schemes Control Act, 2002 (Act No. 45 of 2002), and units or any other form
of participation in a foreign collective investment scheme approved by the Registrar of
Collective Investment Schemes in terms of section 65 of that Act; and
(vi) instruments based on an index;
(b) units or any other form of participation in a collective investment scheme licensed or
registered in a country other than the Republic;
(c) the securities contemplated in paragraphs (a)(i) to (vi) and (b) that are listed on an external
exchange;
(d) an instrument similar to one or more of the securities contemplated in paragraphs (a) to (c)
prescribed by the registrar to be a security for the purposes of this Act;
(e) rights in the securities referred to in paragraphs (a) to (d), but excludes—
(i) money market securities, except for the purposes of Chapter IV; or if prescribed by the
registrar as contemplated in paragraph (d);
(ii) the share capital of the South African Reserve Bank referred to in section 21 of the
South African Reserve Bank Act, 1989 (Act No. 90 of 1989); and
(iii) any security contemplated in paragraph (a) prescribed by the registrar;
Strate is currently investigating the requirements for the electronic disclosure by Participants of
their underlying Client Securities Accounts. Unlike the equities environment, the Beneficial
Ownership disclosure for bonds has not been automated.
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11.5.2 Approved Nominees
Nominees limit transparency to the frustration of issuers, investors and regulators alike. It makes
detecting hostile take-overs and insider trading more difficult. An obligation on Nominees to
identify beneficial shareholders is essential in the maintenance of free, fair and acceptably
regulated Securities markets where transparency and accountability are of vital importance.
CSD Participant Nominees are approved by Strate in terms of section 76(1)(b) of the FMA, the
Rules and Directive SA.7.
Broker Nominees are approved by the JSE in terms of section 76(1)(a) of the FMA and the JSE
Rules.
In the case of a foreign Nominee, the Participant obtains assurance that such Nominees are
operating within its domestic legal framework with the appropriate regulatory approval required in
the home jurisdiction.
In terms of section 76 of the Financial Markets Act:-
76. (1) (a) A nominee of an authorised user must be approved as a nominee by the exchange in
terms of exchange rules and comply with the requirements set out in the rules.
(b)A nominee of a participant must be approved as a nominee by the central securities depository
in terms of depository rules and comply with the requirements set out in the rules.
(2) The criteria for the approval of a nominee of an authorised user or a participant must be
equivalent to that applied by the registrar when approving a nominee under subsection (3).
(3) (a) The registrar may prescribe requirements for—
(i) the approval of a nominee that is not approved as a nominee in terms of subsection
(1); and
(ii) approved nominees.
(b) The registrar must maintain a list of all nominees approved under this section.
11.6 Segregated Depository Accounts
11.6.1 Introduction
The inter-dependence of the world‘s financial markets took centre stage with the failure of
Lehman Brothers. As the significance of this event has rippled through the financial world, many
financial institutions and Investors are calling for higher levels of transparency, increased
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regulation and improved protection of their Securities. Increasingly the co-mingling of Securities
and legal certainty of title has come into question where Client‘s Securities are placed under the
management and custody of a Custodian.
In an effort to address these trends, the South African market, under the guidance of the Central
Securities Depository (CSD), Strate Ltd, and the local Custodians, has created the concept of
Segregated Depository Accounts (SDAs). The South African market operates nominee Securities
Account structures for equities and fixed income Securities. Currently Investors Securities are
held in Custodians nominee accounts at the CSD.
The SDA account allows Investors to open an account directly at the CSD level while maintaining
all their existing relationships and services with their Custodian. Not only are Investors Securities
held in a separate account but they also benefit from increased protection in the event of an
Insolvency Proceeding being instituted against one of the Custodians.
11.6.1.1 Legal Considerations
The Companies Act, 2008 (effective 1 May 2011) enables Strate to revise its CSD Rules to allow
legal record of ownership to be recorded at the CSD. By allowing Clients‘ SDAs to be opened
directly in the books of the CSD, Investors will be granted full legal ownership rights upon credit
of their accounts, providing legal certainty to Investors in the current intermediated Securities
environment. While Clients‘ Securities held in CSD Participants‘ nominee accounts will not fall in
the intermediary‘s estate in the event of an Insolvency Proceeding (see specifically section
36(2)(a) of the FMA), the proposed SDAs guarantee full legal ownership and direct access at
CSD level.
11.6.1.2 Benefits of a Segregated Depository Account
SDAs offer numerous benefits to Clients and Investors, including:
The option of opening a direct SDA at the CSD as opposed to remaining in a Sub-register
holding chain in the name of a CSD Participant Nominee;
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Clients/Investors who select the option, through their CSD Participant, to open an SDA
directly with the CSD, have the legal security and protection of their Securities in the case
of an Insolvency Proceeding against their CSD Participant, thereby reducing both
operational and systemic risks;
In the event of an Insolvency Proceeding, this product is designed to reduce market, price
and operational risk by avoiding a situation where the Securities may otherwise have
been trapped in the books of the failed Participant, while the Insolvency Administrator
endeavors to identify their ownership and return the Securities to the rightful owner;
The SDA functionality significantly enhances the portability of Clients holdings, allowing
them to engage with an alternate service provider at short notice thereby ensuring that if
there was an Insolvency Proceeding instigated against their Participant, their account
would not be frozen by the Insolvency Administrator and the Client could continue trading
in that account in a relatively seamless manner; and
The ability to appoint a Primary and Secondary Participant where, in the event of
Insolvency Proceedings being instituted against the Primary Participant, the custody and
administration of the Client‘s Securities can be switched to their appointed Secondary
Participant almost immediately. This has the effect of significantly reducing the risks
associated with time delays and other operational impacts while having to move a
portfolio from one Participant to another.
11.6.1.3 The following principles apply to all SDAs:
The SDA is opened in the records of the CSD by the Primary Participant;
The Client / Investor may pre-appoint a Secondary Participant and details of the
appointment are provided to the CSD via the Primary Participant as well as by the
Secondary Participant;
The Primary and Secondary Participants are responsible for entering into or amending a
Safe Custody Agreement / Client Mandate with the Client / Investor; and
Where applicable, the SDA account holder must ensure that all standing instructions in
place with their Primary Participant, are communicated and switched to the Secondary
Participant in the event of an Insolvency Proceeding being instituted against the Primary
Participant.
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11.6.1.4 How does the SDA structure differ from the current custody account structure?
The current account structure appears as follows:
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The SDA structure is as follows:
11.6.1.5 SDA Directive
A Strate Directive have been published by Strate. The reader of this Handbook must refer to the
Strate website www.strate.co.za and obtain a copy of the latest version of the Directive detailed
below. The content of any Directive is not repeated in the Handbook.
11.6.1.6 Directive SA.9 – Segregated Depositary Accounts: Opening, Administration and
other Procedures
This Directive caters for the opening, administration and other procedures in respect of
Segregated Depositary Accounts.
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12 SETTLEMENT
This section of the Handbook gives the reader an overview of the Strate Bonds settlement
procedure, timelines and process flows.
12.1 From trade through to settlement
The initial trade could involve numerous persons in a Securities institution, from the Trader who
transacts the deal with another counterparty, to the sales person on the trading desk who liaises
with the Client/Fund Manager, to the Repo Trader who would source funding or Securities.
Once the trade is concluded it would be captured on the bank‘s internal treasury system either by
the Trader directly or the Trader would complete a deal ticket which outlines the key information of
the trade e.g. date, time, rate, counterparty, financial instrument, buy\sell etc. This deal ticket
would then be collected by ―trade support‖ who are often referred to as middle office.
Following trade capture into the in-house treasury system, the system would append the trade
with ―static data‖ such as account details, counterparty address etc. The capture of this static data
into a system is very important because with the large number of transactions conducted, one
cannot afford to append incorrect trade details (the appending of this information is also known as
trade enrichment). This static data capture can be an entirely separate and independent
department in a large organisation.
The trade will then be fed into an Exchange trade capture system. (For entities which have
transacted in the OTC market there is generally a few extra stages before one gets to this point).
Subject to the counterparty having captured the correct trade details, the trade will then match i.e.
the trade would be agreed and validated by the counterparty. In the event the trade does not
match, the counterparties will contact each other to resolve the differences.
At this point, the bank will send settlement instructions to their custodian bank. A custodian is an
organisation that holds Securities and (usually) cash on its Clients‘ behalf. Custodians are often
referred to as depots/nostros/custodians/Participants. These instructions authorise the custodian
to deliver Securities in return for cash and vice versa on a specific value date (there are occasions
when only securities is delivered – this is called a free of payment settlement or a free of value
(FOV) settlement). The counterparty to the trade will also issue instructions to their Participant and
these instructions will need to match between Participants in order to effect settlement. A large
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bank or fund manager would typically employ the services of numerous Participants located in
various financial centres around the globe, each Participant being responsible for exchanging
Securities and cash as a result of buying and selling by the bank or fund manager, and for holding
the resultant Securities and cash in safekeeping on behalf of the bank or fund manager.
Although there are procedures and processes in place to ensure transactions do not fail to settle
in South Africa, this is not the norm for most countries globally.
―The act of settlement should be viewed as no different from buying or selling goods in one‘s
personal life. For instance, most people are reluctant to pay the purchase cost of a car without
taking delivery of the car at the same time. Conversely, most people would not feel happy about
handing over a car that they were selling without receiving the buyer‘s cash at the same time. The
risk, applicable to both buyer and seller, is that at one point in time they may be in possession of
neither asset, whether goods or cash. The most efficient and risk-free method of settlement is
known as Delivery versus Payment (DvP), whereby simultaneous exchange of Securities and
cash is effected between buyer and seller (through their custodians), the seller not being required
to deliver Securities until the buyer pays the cash and the buyer not being required to pay cash
until the seller delivers the Securities, thereby ensuring that both parties are protected.‖2
2 ―Securities Operations – A Guide to Trade and Position Management‖, Michael Simmons, John
Wiley & sons, Ltd, 2002
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Below is a list of depositories globally.
Country Depository
abbreviation
Depository full name
Argentina Caja Caja da Valores
Australia CHESS Clearing House Electronic Subregister System
Brazil CBLC Brazilian Clearing & Depository Corporation
Canada CDS Canadian Depository for Securities
Denmark VP Vaerdipapircentralen
Finland APK Finnish Central Securities Depository
France Euroclear France Euroclear France (formerly Socovam)
Germany CLEARSTREAM
BANKING
Clearstream Banking AG (formerly Deutsche Borse
Clearing AG)
Hong Kong CCASS Central Clearing and Settlement System
India NSDL National Securities Depository Limited
Italy MT Monte Titoli
Japan JASDEC Japan Securities Depository Centre
Korea KSD Korea Securities Depository
Malaysia MCD Malaysian Central Depository Sdn.Bhd
Mexico INDEVAL Instituto para el Deposito de Valores
Netherlands NECIGEF Nederlands Centraal Instituut voor Giraal Effectenverkeer
New Zealand NZCSD New Zealand Central Securities Depository
Pakistan CDC Central Depository Company
Phillipines PCD Phillipine Central Depository
Poland KDPW National Depository of Securities
Portugal Central Central de Valores Mobiliarios
Singapore CDP Central Depository Pte. Ltd
Spain SCLV Servicio de Compensacion y Liquidacion de Valores
South Africa Strate Strate Ltd
Sweden VPC Vardepapperscentralen
Switzerland SIS SegaIntersettle AG
Taiwan TSCD Taiwan Securities Central Depository
Thailand TSD Thailand Securities Depository
UK & Ireland CREST Crest
USA DTC Depository Trust Company
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12.2 On-market and Off-market transactions
On-market Transactions
On –market transactions are also known as on-exchange transactions. All Ordinary and member-
Settled client transactions in bond securities are reported to the JSE trade reporting system
Nutron, are referred to as on-market transactions and settle on a nett basis for the 1st Settlement
Run and gross bais for the 2nd
Settlement Run. All such transactions must be reported to the
Nutron system. The JSE regulates all on-market transactions.
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12.2.1 On-market Settlement Process Flow
1. Broker\ Member can either trade electronically, over the phone or face-to-face.
2. Broker \ Member send a settlement instruction to their selected Participant instructing
them to settle.
3. Transactions are reported between Brokers \ Members on Nutron system.
4. Transactions are matched on Nutron system. The Nutron system then sends the
individual trade legs through to Strate where they are validated against the Strate Bonds
system matching criteria. The Strate Bonds System sets up Settlement Positions and
Valid Trade Advices.
5. Participant obtains the nett settlement schedule and commits to the nett position although
they do verify ability to commit on each individual gross trade. Participant commits as long
as the Client has Securities or cash. 1st Settlement Run is Netted – 2
nd Settlement Run is
Gross Transactions / Netted Funds
6. Strate will send out a SWIFT message instructing the Participant to pay or receive
cash/Securities. At the same time Strate sends a payment obligation to SAMOS advising
of the Participant funding requirements
Sends a payment
Confirmation MT298
Reserves
Securities
Sends
out
MT202
Sends out MT598
payment
instruction
Sends out MT598
payment
instruction
Send a
Settlement
Instruction to
their
Participant
S-1 10h00
Send a
Settlement
Instruction to
their
Participant
S-1 10h00
Commits to the Trade Commits to the Trade
Broker /
Member:
1
Broker /
Member:
2
Participant
A Participant
B
Strate
Clearing &
Settlement
CSD
Settlement of
Securities
SARB
Settlement of
Cash
Trade with each other 1
2
Captures the Trade on Nutron system
3
5 5
Matches the Trade
3
1
4 4
6 6
6
7
7
JSE (Nutron)
2
105
7. Only once SAMOS has confirmed funding, will SFIDvP occur, funds settle at SARB and
Securities settle at CSD.
Off-market Transactions (OTS)
Off-market transactions (also known as Off-Exchange transactions) are also referred to as OTS
transactions (off-shore trade settlement). An Off-market trade means an OTC (over-the-counter)
trade concluded between Clients resident off-shore and which is reported via Participants into the
Strate Bonds System for settlement. Off-market bond settlements are regulated by Strate.
12.3 Off-market Settlement Process Flow
1. Clients can either trade electronically, over the phone or face-to-face.
2. Clients send a settlement instruction to their selected Participant instructing them to settle.
3. Participant reports transactions to Strate.
4. Transactions are matched in the Strate bonds System. The Strate Bonds System sets up
Settlement Positions and Valid Trade Advices.
5. Participant obtains the nett settlement schedule and commits to the nett position although
they do verify ability to commit on each individual gross trade. Participant commits as long
Sends a payment Confirmation Reserves Securities
Sends out
payment
instruction
Sends out
payment
instruction
Send a Settlement
Instruction to their
Participant
Send a Settlement
Instruction to their
Participant
PasssPartParticipant
Report
CLIENT 2
Participant
A
Participant
B
Strate
Matching,
Clearing &
Settlement
CSD
Settlement of
Securities
SARB
Settlement of
Cash
Trade with each other
2 2
3 3
5 5
6
7
7
1
4
6 6
Report
7
CLIENT 1
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as the Client has Securities or cash. 1st Settlement Run is Netted – 2
nd Settlement Run is
Gross Transactions / Netted Funds
6. Strate will send out a SWIFT message instructing the Participant to pay or receive
cash/Securities and notifies SAMOS.
7. Only once SAMOS has confirmed funding, will SFIDvP occur, funds settle at SARB and
Securities settle at CSD.
12.4 Settlement Principles
12.4.1 T+3
In order to align South African settlement practices with international best practice, the G30
Recommendations on clearing and settlement systems were adopted. In November 1997 T+3
continuous, rolling of settlement was introduced.
A standard trade means a trade that is to be settled on the third Business Day after Trade Date.
This is also referred to as a ―Spot‖ trade.
A non-standard trade means a trade which is to be settled less than three Business Days after
Trade Date. Same day settlement (T+0) is permitted in the bonds environment.
A forward-dated trade means a trade that is to be settled at a future date more than three
Business Days after Trade Date.
12.4.2 SFIDvP
In 2001 the Market achieved full Simultaneous Final Irrevocable Delivery versus Payment
(SFIDvP).
A delivery instruction is generated in parallel with the payment instruction. The delivery instruction
will ensure that the required Securities are available and reserved in the CSD. The payment
instructions are submitted to the Central Bank on an individual Participant basis. Once all payment
instructions are received, a settlement confirmation is sent out by the Central Bank. Upon receipt
by Strate of the settlement confirmation, transfer of ownership (Securities) will be affected in the
CSD. The funds will be simultaneously transferred, thereby completing settlement in one step.
The settlement cannot be reversed.
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12.4.3 Netting
In 1990 the G30 standard of trade netting for the settlement of most types of transactions
concluded on the Exchange was adopted. This netting procedure, which was implemented in
1995, dramatically reduces settlement risk and simplifies the settlement process.
For each Broker \ Member registered with the Exchange, the Strate Bonds system determines the
netted funds and Securities movements for a particular settlement day by summing individual
transactions to be settled on the same day. This nett position, rather than the individual
transactions, is settled via the appointed Participants.
In the netting process, the Strate Bondssystem calculates the amount of Securities to be delivered
or received by each buyer and seller as well as the amount of money to be exchanged across: -
Settlement Date ;
Security;
Broker / Member who reported trade;
Principal;
Participants; and
Settlement Account
12.4.3.1 Nett Settlement Schedule
The nett settlement schedule can be downloaded by Participants from the Strate Bonds System at
any time during a trading day for both Broker/Member and Client transactions. The schedule
shows all the settlement positions, for every future settlement day. Given that these schedules
can be requested daily, a Participant has from the morning following a trade being reported until
the settlement day to prepare for the actual settlement. In other words, in a T+3 environment, the
position at the end of a trading day will be the position to be settled three Business Days later, on
the assumption that there are no further transactions concluded on the intervening days and
which will be settled, by agreement, on that settlement day.
As the settlement day approaches, the settlement positions reflected on the settlement schedule
may change: settlement instructions may be changed or new transactions may be struck. The
settlement schedule contains not only the settlement positions, but also all of the settlement
instructions from which the position is derived.
108
Having reference to the settlement schedule and depending on the arrangements with the Client,
the Participant may wish to confirm the settlement position, or he may simply ensure that the
Client is holding sufficient cash or Securities to cover the position. The Participant may request
some special arrangements prior to settlement day so that the Participant can commit (for
example: the immobilisation of Securities in the CSD dematerialisation of Securities or the
depositing of cash with the Participant).
At the end of the last trading day before settlement day, all settlement positions are frozen
(except for those special circumstances, which apply in respect of the rectifying of settlement
shortages). The settlement schedule drawn at the close of business then represents the
settlements that are expected for each Broker \ Member or Client.
12.4.4 Settlement obligations
12.4.4.1 Obligations of Participants
Counterparty risk exists in the bond market for all transactions between Brokers \ Members and
between Brokers \ Members and Clients up and until such time as the Participant commits to
settle the relevant trade.
Counterparty risk is defined as the risk that the counterparty involved in the transaction will default
on its obligations.
A commitment is the irrevocable obligation of the Participant to ensure that settlement takes place
on settlement day.
As mentioned above, Participants review the nett settlement schedule. These schedules reflect
the nett settlement obligation of the Participants per settlement day. The schedule also reflects the
gross transactions making up the nett obligations. Whilst Participants ultimately commit to the nett
obligation, they do review the individual gross transactions to determine, at Client level, whether
they are in a position to settle all transactions making up the nett. In other words, whilst the nett
position settles within the Strate Bonds System, gross transactions must settle within the internal
systems of the Participant.
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12.4.4.2 Obligations of Brokers \ Members and Clients
It is the responsibility of the Broker \ Member and/or Client to ensure that:-
there is sufficient dematerialised or immobilised Securities and cash in his own settlement
account held with the Participant; and,
for Member-settled Clients, the Broker \ Member has funded in full the settlement
accounts to be used for settling the Client transactions.
Where the settlement accounts have not been fully funded, the JSE Rules stipulate that a
Member/Broker must conclude buy/sell backs, equal and opposite or same day transactions, or
enter a Securities lending transaction to rectify the position. Members/Brokers bear the
responsibility to see to it that they and their Clients deliver Securities and settlement instructions
timeously to the Participant.
It is important to note that for Member-settled Clients, any Securities shortages experienced by
the Broker‘s \ Member Clients must be resolved by the Broker \ Member prior to settlement day.
12.4.5 Settlement Instructions
Every Broker \Member and Client must have a settlement account at a Participant through which
the buyer or seller is required to settle.
For On-market transactions, a reference to the settlement account is recorded in the Nutron
settlement system, so that the system is able to notify the Participant through which account the
Member/ Broker or Client wishes to settle any given trade. The onus is on the Broker to ensure
that the references to the settlement accounts for his firm and his Clients are correct. If these
details are incorrect, it may result in the Participant excluding the trade from settlement.
Settlement instructions are also given for Off-market transactions to the Participant about the
accounts through which an Off-market settlement is to take place.
When a trade is captured, details about the Participant or the accounts to be used for settlement
may be specified. If settlement instructions are not specified, the Strate Bonds System
automatically creates the instructions from the static data held in the system. For each buyer and
seller the system creates a settlement instruction using the ‗first choice‘ settlement account. Each
settlement instruction is given a unique Settlement Instruction Number.
Both Brokers \Members and Clients can elect to have standing settlement instructions with their
Participant.
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12.4.6 Timelines for On-market transactions
The JSE regulates trading on the Interest Rate Market and has stipulated via Directives the
timelines for On-market transactions. The Rules and Directives of the Interest Rate Market can be
obtained from the website www.jse.co.za
12.5 Strate Settlement Directives
The reader of this Handbook must refer to the Strate website, www.strate.co.za and obtain copies
of the latest versions of the Directives listed below. The content of any Directive is not repeated in
the Handbook.
12.5.1 Directive SD.2 – Operational Market Windows Off-Market Bonds
Directive SD.2 details the time parameters to be adhered to as well as the process to be
undertaken by a Participant in the settlement of all Off-market transactions. The Directive caters
for the settlement of bond transactions concluded Off-market, not concluded through an
Exchange, and which are reported by the sellers and purchasers to the relevant Participant for
settlement through the CSD.
12.5.2 Directive SD.1 – Operational Market Windows On-Market Bonds
Directive SD.1 details the time parameters to be adhered to as well as the process to be
undertaken by a Participant in the settlement of all On-market transactions. The Directive caters
for the settlement of bond transactions concluded On-market (i.e. through an Exchange).
12.5.3 Directive SF.4 – Fines Schedule On-Market and Off-market Bonds
Directive SF.4 caters for the imposition of fines by the CSD for the contravention of Directives
SD.1 and SD.2.
12.5.4 Directive SG.2 – Fees - Bonds
Directive SG.2 provides for the disclosure and record of the fees payable to Strate by Participants
and service providers relating to the custody, settlement and connectivity in the bond market.
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12.6 Other types of transactions
12.6.1 Repo’s
Have you ever wondered why the interest rate you are charged by your bank is significantly lower
when you borrow money from a bank to buy a house versus borrowing money to go on a holiday.
The reason why banks are very happy to lend you money to buy a house at a lower interest rate is
because the bank will make it a condition of your loan that the house becomes collateral for the
loan. What this means is that if you don‘t make your regular monthly payments to the bank, the
bank can ―seize‖ the house, or sell the house to recover the outstanding payments. The house
therefore provides the bank with ―security‖, such that in the event of a liquidation or default of
payment, the bank can recover its loan by selling the house. Quite clearly a bank will not receive
any security if you borrow money to go on holiday; therefore, they will price a higher interest rate
into the transaction to compensate them for this risk.
Just as individuals get cheaper access to borrowing cash by offering some form of collateral; it is
exactly the same for banks, Corporates and even Governments. In the financial markets, if you
borrow cash and promise to return it at a pre-specified date in the future with interest, and put up
bonds (or even another form of security) as collateral, you would have transacted in the Repo
market. Therefore a Repo (short for ―sale and repurchase agreement‖) is simply a collateralised
loan. Please note that the word collateral is used very loosely in the financial markets and is used
in certain contexts to mean that something is temporarily given as a guarantee without the change
in ownership. This is not the case with Repo transactions. In a Repo transaction, the ownership of
the Securities does pass from one party to the other.
The Repo is essentially a transaction whereby the two parties involved agree to do two deals as a
package. The first is a purchase or sale of a Security – often a Government bond – for delivery
straight away. The second deal is a reversal of the first deal, for settlement on some future date.
Because it is understood from the outset that the first deal will be reversed, it is clear that both
parties intend the transfer of Securities (in one direction) and the transfer of cash (in the other
direction) to be temporary rather than permanent.
The party providing the money is often referred to as the ―investor‖ while the party providing the
Securities is referred to as the seller. The terms ―Securities‖ and ―collateral‖ are generally
interchangeable. To further confuse things it is customary to say that the party looking to borrow
112
money is transacting a Repo, whereas the party looking to obtain Securities is executing a
Reverse Repo i.e. for every transaction one party‘s Repo is another party‘s Reverse Repo; (both
are the same transaction viewed from two different perspectives).
The Repo is structured so that the economic benefit of owning the Securities – income and capital
gains/loss – remains with the original owner. The price on the first leg of a classic Repo is the
market price. The price on the second leg is the first price plus the Repo interest. The Interest rate
negotiated is often called the carry rate or Repo rate. The prices for both the original sale and the
subsequent repurchase are agreed at the outset.
The difference between these two prices is calculated to be equivalent to the cost of borrowing
secured money, as shown below.
12.6.1.1 Benefits of Repos
For lenders of cash, a Repo has the advantage of double security - if a counterparty defaults, they
can rely on the collateral. They can therefore look to the creditworthiness of both the counterparty
and the Issuer of the collateral. For borrowers of cash, the advantage is that they can make use of
an investment in their portfolio to borrow funds either more cheaply, or which they might not
otherwise be able to borrow at all. In addition, Portfolio Managers can enhance return on their
portfolios via Repos. The way they do this is to conduct a Repo transaction whereby they give out
the Securities they have in their portfolio in return for cash. They then either lend the same cash
out at a higher rate to their Clients or undertake investments which Yield higher returns.
Party A Party B
Bond
Cash
Party A Party B
Same nominal amount of bond
Same amount of cash plus
interest
Flows on the start date
Flows on the end date
113
Repos are also used to facilitate short selling or for taking a forward position in bonds. For
example, if you expect interest rates to decrease, over a period of a week, you would buy bonds
now for settlement (T+3). You could then also undertake a one week Repo whereby the first leg
coincides with the spot settlement. Therefore, on the first Settlement Date you are required to
deliver cash in return for bonds in the spot transaction and are required to receive cash in return
for bonds in the first leg of the Repo transaction, therefore your nett position for the spot
Settlement Date is zero and you have an obligation to deliver cash plus interest in one week‘s
time in return for bonds for the second leg of the Repo. This is the same as undertaking a forward
settlement bond transaction.
The words REPO, classical REPO, ISMA REPO (now ICMA REPO), carry and Buy/Sell-back are
used interchangeably in the market, however they mean different things legally. A classical REPO
and an ICMA REPO are essentially the same thing; the Buy/Sell-back is different to the above (we
pick these up in detail below) and the term carry is a generic term referring to either of the terms
above (its roots come from the forward market e.g. the cost of carrying gold – storage cost,
transport etc.)
The majority of the Repo or even Buy\Sell-back transactions are now conducted under a legal
agreement called the TBMA\ISMA Global Master Repurchase Agreement (GMRA) (TBMA stands
for ―The Bond Market Association‖, ISMA stands for ―International Securities Market Association -
they merged with the International Primary market Association to become the International Capital
Markets Association). The agreement used to be called the PSA/ISMA GMRA (PSA stands for
Public Securities Association, which became TBMA). This agreement is a global norm and caters
for both Repo‘s and Buy/Sell-backs. If counterparties have not signed any legal documentation
such as the (TBMA/ISMA agreement) the transaction will fall under common law and be treated
as a Buy/Sell-back.
12.6.2 Coupon Payment in a Classical Repo
Legal title (ownership) to the collateral passes to the buyer/borrower for the period of the Repo.
The effect of this is that if the seller defaults on the cash repayment, the buyer does not need to
establish his or her right to the collateral. Since the legal rights relating to the collateral pass to the
buyer, the buyer receives coupons or partial redemptions due. If a coupon is payable on the
Security during the term of the Repo, the buyer, who is holding the Security, will receive the
coupon. However, although the buyer has legal title, from an economic point of view he or she is
holding the Security only as collateral. The financial reward from the transaction comes from
interest on the cash loan, which the buyer is effectively receiving through the difference in prices
114
between the first and second legs of the Repo. The coupon is thus passed back to the seller in a
classical Repo or ISMA Repo. The payment back to the seller, due on the same date as the buyer
receives the coupon, is known as a ―manufactured dividend‖.
12.6.3 Buy/Sell-back
A Buy/Sell-back is similar to a Classic Repo but the two legs of the deal, although dealt
simultaneously, are treated as two separate transactions rather than one from a legal perspective.
The economics of the deal are the same, except when it involves a coupon payment. The
consequences of a coupon payment are included as part of the price of the second leg of the
transaction and agreed up-front rather than passed on separately to the counterparty when the
Issuer pays the coupon. In other words the buyer would return the bonds on the second buy/sell-
back date in return for their cash plus interest due minus any coupons or interest earned on the
coupons.
12.6.4 Equal and Opposite Transactions
Means a trade equivalent in all respects to the original transaction and which is concluded in order
to reverse the effect of the original transaction.
Please note On-market transactions are excluded on S-1 by brokers \ Members and Off-markets
on S by Participants.
12.6.5 Buy/Sell Back Transactions
Means an agreement between two parties in terms of which one party agrees to buy underlying
assets from the other party and simultaneously agrees to sell the underlying assets back on an
agreed future date at an agreed price.
12.6.6 Exclusions
All transactions in the 1st Settlement Run settle on a nett basis and therefore any individual trade
that is unable to settle will hold up the entire settlement run and prevent settlement from
completing. For that reason the potential problem transaction\s requires to be removed (excluded)
from the 1st Settlement Run and placed into the 2
nd Settlement Run later in the day (settled on a
gross trade by trade basis). The exclusion process allows all transactions that can settle to settle,
removes the systemic risk and allows the parties to the transactions more time to resolve their
position problem before the 2nd
Settlement Run occurs.
115
Participants are able to systematically exclude any transaction that is unable to settle for any of
the following reasons:-
Securities or cash shortages; or
no or incorrect settlement instructions.
Participants are obliged to inform all Brokers \ Members/s and Clients of any T+3 or T+2
transactions unable to settle on the day before settlement (S-1). Brokers \Members and Clients
then have the opportunity to resolve their settlement position in order to avoid the transactions
being excluded on settlement day.
On-market settlement problems that remains unresolved after 09:00 on S will be automatically
excluded by the Participant from the 1st nett settlement run and moved into the 2
nd gross
settlement run. On-market transactions that are excluded in this manner will incur severe
penalties on the part of the Broker. Participants will also be subject to monetary fines (penalty) if
due process is not properly followed by them in the exclusion process applicable to Off-market
transactions.
The exclusion of one transaction may impact the settlement positions of other transactions
(knock-on effect), which in turn means these transactions also have to be excluded by the
applicable Participants and settled in the gross run – also termed ―on-exclusions‖. It is not always
possible for Participants to identify affected transactions until the exclusion process takes place. In
order to minimise the knock on impact, Participants will notify each other beforehand of any
transactions that are likely to be excluded and this allows the affected Participant to identify the
possible knock on effect and to inform their respective Broker \ Member and/or Clients.
Participants are obliged to exclude On-market transactions and unresolved Off-market
transactions in order to commit to 1st Settlement Run and Broker \Member or Clients may not
refuse a Participant the right or select which transactions should or should not be excluded.
The following are important steps in the exclusion process:-
Participants must inform the Broker \ Member and/or Client and any other affected
counterparty Participants, giving them adequate advance notice before a transaction is to be
excluded;
116
Brokers \ Members and/ or Clients must be given the opportunity to correct their settlement
position before a trade exclusion takes place;
Participants may exclude On-market \ Off-market transaction from the 1st Settlement Run up
to 10h00 on the morning of settlement;
Participants must pursue resolution of the knock-on effect with their Clients and reconstitute
the settlement position by 10h30 on S. If the settlement positions are not resolved by 10h30
on S, Participants must request extension of the Trade Exclusion window. Please refer to
Directive SD.1 and SD.2 for settlement parameters and timelines.
Participants have the right to exclude any further trade or transactions impacted by the
exclusion of a prior trade and Brokers and/or Clients may not refuse them this right or
determine which other transactions should be excluded in their place.
Below is a diagram of the Exclusion Model.
Directive SC.2 (OTS)
TL1
TL2
TL3
TL4
TL5
TL6
TL7
TL8
TL9
TL10
TL11
TL12
TL13
TL14
TL15
TL16
TL17
TL18
TL3
TL4
TL9
TL10
TL11
TL12
TL15
TL16
TL17
TL18
Primary Exclusion
Knock-On Effect
Settlement Run 1 (Nett) 11h00 Settlement Run 2 (Gross) 14h30
Settlement Position 1
Settlement Position 2
Settlement Position 3
Exclusion Model
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Failed Transactions Management for On-Market transactions
Where transactions are not committed to by 11h00 on S, they shall be regarded as failed
transactions and the JSE Settlement Authority will implement their failed transaction
management procedures. Give-up Transactions shall be submitted to the CSD by the JSE
Settlement Authority who shall advise Strate Custody and Settlement Services of any action
to be taken by a Participant. Where the JSE Settlement Authority at any stage becomes
aware of a potential failed transaction, they may initiate failed transaction management
procedures, as they deem fit.
Participants must commit to Give-up Transactions within 30 (thirty) minutes of receipt of
written notification from Strate Custody and Settlement Services or inform Strate Custody
and Settlement Services as to why they cannot commit to these transactions. Strate
Custody and Settlement Services shall inform affected Participants of the Trade leg
numbers of these Give-up Transactions upon notification by the JSE Settlement Authority.
Failed Transactions for Off-market transactions3 Only legitimate failed transactions will be allowed to fail in the CSD.
Legitimate failed transactions are:
Transactions that are booked against a counterparty who does not match the transaction;
Transactions that are booked but are short of Securities; and
Funding of settlement which is not done during the specified settlement window.
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13 CORPORATE ACTIONS
A ―Corporate Action‖ or ―Corporate Event‖ means an action taken by an Issuer or any other entity
or third party, which affects the owners of Securities in terms of entitlement or notifications.
This chapter of the Handbook explains the key types of events, the Corporate Action processes
and procedures adopted in the Strate environment.
13.1 Definitions
Certain common Corporate Action definitions are listed below.
Announcement ‗Announcement‘ means notices regarding rights accruing to owners of
Securities, which are published by Issuers by means of the Securities
Exchange News Service (SENS) of the JSE, the newspaper3, and, where
provided to the CSD, company reports and circulars. In respect of
Unlisted Securities, Announcements means all notices regarding rights
and other benefits accruing to owners of Securities, which are provided
by Issuers to the CSD;
Cum: Including or qualifying for an entitlement arising from a Corporate Action.
CDN: Central Depository Nominees (Pty) Ltd, a wholly owned subsidiary of
Strate.
Declaration Date: (DD) The date on which the Corporate Action and the declaration data
(including any conditions precedent to which the Corporate Action is
subject) are announced.
Declaration data: The minimum information to be announced on the Declaration Date (e.g.
Security name, ISIN, event type, LD etc).
Election: The exercise of any or all of the elective, voting, conversion, redemption
or other rights attached to Securities.
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Ex: Excluding or non-qualifying for an entitlement arising from a Corporate
Action.
Interest Payments: Income payments due to the registered holder of the bond as stipulated
on the Listing Information or as stipulated by the Issuer.
ISIN: International Security Identification Number which is a unique
internationally recognised Securities identification number that identifies
the specific Security.
Last Day to Register: (LDR) Being close of business on the last day an investor may send a
certificate to the Issuer Agent for transfer into the investor‘s name and the
day on which all current registered holders will be eligible for an
entitlement as stipulated on the Listing Information.
Listing Information: The essential terms of the Security including but not limited to the LDR
and Payment Date or such other related information as stipulated by the
Issuer.
Payment Date: (PD) This is the date on which entitlements will be paid by the CSD to the
Participants.
13.2 Types of Corporate Actions
13.2.1 Interest Payments
Interest payments are based on the nominal value of a Financial Instrument (FI) / Security. Within
the electronic Strate Bonds System one interest rate for each interest Payment Date is stored for
each Security. The CSD is responsible for maintaining this information.
On Interest Payment Date the system calculates the interest payable per depository account.
Interest is calculated on the Participant‘s Securities balance as at LDR (last day to register) for the
Security.
120
The Issuer and Transfer Secretary are responsible for reconciling interest payments on LDR for
Securities holdings bearing interest on LDR. Interest payment amounts are credited to the CDN
on interest due date (Payment Date). Strate in turn will credit the various Participants‘ funds
accounts with the interest payment amounts. Participants are responsible for paying the interest
payment monies to the relevant Securities holders/Clients in their books.
13.2.1.1 Interest Calculation
The interest calculated for a Security may be based on several types of coupon rates namely: -
Fixed Coupon Rates. The coupon rate does not change throughout the
life of the Security;
Variable Coupon Rates. Quarterly on the day after interest date, the
coupon rate will be changed according to a formula declared when the
Security was issued. The new coupon rate is declared by the Issuer; and
Zero Coupon Rates. This Security is sold at discounted rates and no
interest is paid during the life of the Security.
13.2.2 Redemptions
Securities redemptions are processed on Redemption Date as allocated in the Strate Bonds
System. The percentage recorded on the Security for the Redemption Date is paid to the relevant
Securities holders.
The Issuer and Transfer Secretary are responsible for reconciling redemption payments on PD-1
EOD for the total holding of Securities that are redeemed. Redemption payment amounts are
credited to CDN on Payment Date. Strate in turn will credit the various Participants‘ funds
accounts with the redemption payment amounts. Participants are responsible for paying the
redemption monies to the relevant Securities holders / Clients.
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13.2.2.1 Redemption Types
The redemption of a Security may be governed by different criteria. The redemption type indicates
these, which is one of the following:-
Fixed Redemption date, which falls on an interest date.
100% of the nominal value will be redeemed on the redemption date. Interest will
be paid on the redemption date.
Fixed Redemption date, which does not fall on an interest date.
100% of the nominal value will be redeemed on the redemption date. Pro rata
interest may or may not be paid on the redemption date.
Variable Redemption - Holder on interest date.
100% of the nominal will be redeemed on the final redemption date. The holders
of the Security may opt to redeem their holdings on one of several redemption
dates, which are declared when the Security is issued.
Notice must be given to the Issuers, by the holders of the Security, of their intent
to redeem. The required notice period is declared when the Security is issued.
If the holders of the Security wish to exercise this option on redemption date prior
to final redemption, the Participant, on behalf of the holder of the Security, will
withdraw their holdings from the depository and the redemption will be conducted
outside the CSD system. Interest will be paid on the redemption date.
Variable Redemption – Holder not on interest date.
As above, but pro rata interest may or may not be paid on the redemption date.
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13.2.3 Capital Repayments
Capital repayments are performed on amortised Securities that are in a dematerialised or
immobilised form in the CSD. Amortised Securities have no fixed time schedule of capital
repayments. This is dependant on the capital amount repaid on the underlying assets and the
Issuer is only in a position to confirm the capital repayment amounts, if any, closer to the interest
repayment dates.
It is quite possible that the first few interest payments will be paid without any capital being repaid
at the same time. Although most interest rates linked to these Securities are variable, the interest
rate is known in advance.
Repayment of Securities can be done on a quarterly, half-yearly or yearly basis. During Books
Closed Period (BCP):-
for immobilised Securities the Issuer notifies the CSD of the capital
repayment and the CSD in turn, calculates the repayment per Participant
account and the Issuer‘s amount will be reduced when books re-open; and
for dematerialised Securities, the Strate Bonds System will reduce the
individual Participant‘s Securities balances by the payment amount and
reduce the Issuer‘s account by the total equivalent amount on Payment Date.
13.3 Conversions
CSD conversion is the process whereby the CSD and Issuer convert immobilised Securities
certificates and Transfer Secretary receipts into an electronic Securities register format i.e.
dematerialisation. Although the CSD initiates the conversion process it is the Issuer‘s confirmation
that updates the electronic record known as the Issuer‘s Account. The conversion process is not
bound by any restrictions, and conversion can take place at any time during Books Closed Period.
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13.4 Proxy Voting
There are certain categories of bondholders that are eligible to complete proxy forms in respect of
their own Securities, or in the case of Nominees, on behalf of the Beneficial Owners. In addition,
there are categories of persons who can, if applicable, issue a ―Letter of Representation‖
authorising someone to represent them in person.
These categories include:-
certificated shareholders; and
dematerialised shareholders who open Securities Accounts with
Participants. These are made up of the following categories:-
a. Beneficial Owners; and
b. Nominees.
If a Beneficial Owner has lent out Securities and wishes to be eligible to vote these Securities, he
will need to recall them from the borrower. This must be done before the published cut-off time for
the receipt of proxy votes.
13.5 Splitting
Only dematerialised Securities may be marked as split-able. These are bonds that are actually
made up of three separate bonds but grouped together on issue date. They were all issued on the
same date and have the same attributes but redeemed one year apart. The CSD has the
functionality to split the Standard Coupon Bearing Bond (SCBB) into its three principal Securities.
This function will automatically create the three new Securities within the system according to the
principle data of the SCBB. The Issuers will, at their discretion, perform buy-backs on the SCBB
and top ups to the Principal Securities as required and authorised.
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13.6 Top-Ups and Buy-Back
13.6.1 Top-Ups
The top-up function allows the Issuer to place, electronically, new or additional Securities into the
market via the CSD system. The process involves the Issuer capturing an electronic top-up list
and the Issuer‘s Participant ‗confirming‘ the individual items on the top-up list.
The CSD system automatically sends a ―notifying‖ message, to the relevant Participant advising
them that items are pending ‗confirmation‘, once the Issuer ‗stores‘ his electronic deposit list.
When the individual items have been ‗confirmed‘ by the Participant, the Participant‘s free balance
in their Securities Account and their current LDR balances are updated immediately. The Issuer‘s
account balance is also updated at the same time by the same amount. The confirm process will
automatically update the amount on issue balance held on the CSD system.
Where the Issuer does not have direct connectivity to Strate‘s Systems, Strate will, on behalf of
the Issuer, under signed instructions, perform the top up process of the Issuer.
13.6.2 Buy-Back
The ‗buy-back‘ function allows the Issuer to reduce, electronically, the amount of Securities on
issue to the market via the CSD system. The process involves the Issuer capturing an electronic
buy-back list and the Issuer‘s Participant ‗confirming‘ the individual items on the buy-back list.
The CSD system will verify that the Issuer‘s buy-back amount does not exceed the amount held
by the Participant in their free balance in their Securities Account.
The CSD system automatically sends a notifying message to the relevant Participant advising
them that items are pending ―confirmation‖, once the Issuer ―stores‖ his buy-back list. When the
individual items have been confirmed by the Participant, the Participant‘s free Securities Account
and their current LDR balances are reduced immediately. The Issuer‘s account balance is also
reduced at the same time by the same amount. The confirm process automatically reduces the
‗amount on issue‘ balance held by the CSD system.
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Where the Issuer does not have direct connectivity to Strate‘s Systems, Strate will, on behalf of
the Issuer, under signed instructions, perform the buy back process of the Issuer.
13.7 Strate Bonds Corporate Action Directives
The reader of this Handbook must refer to the Strate website www.strate.co.za and obtain copies
of the latest versions of the Directives listed below. The content of any Directive is not repeated in
the Handbook.
13.7.1 Directive SB.2 – Procedures for Conversion of Certificated Bonds to Uncertificated
Bonds and vice versa.
Directive SB.2 caters for the process that Participants and Issuers who have no direct link to the
CSD system must follow for an orderly and regulated deposit and withdrawal process so that
there is no duplication of Securities on the register, the Securities holder is not dispossessed and
to limit the risk faced by the CSD and Issuer in this process.
13.7.2 Directive SD.3 – Processing of Capital Events – Bonds
Directive SD.3 sets out the processes and procedures to be followed to facilitate the payment and
or distribution by Participants to Clients of interest, capital payments, notices, reports, circulars
and other information or payments received by the CSD from the Issuers or their agents.
13.7.3 Directive SD.4 - Proxy Voting Procedure – Bonds
Directive SD.4 caters for the issuing of Letters of Representation and proxy voting by holders of
bonds within Central Depository Nominees and to facilitate the attendance or voting by such
holders at meetings of the Issuer of such bonds.
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14 REGULATION AND SUPERVISION
One of the main challenges of regulators is to keep up with and adapt to continuous changes –
some of which are international in nature. Regulation must be flexible. The regulatory structure in
South Africa is dynamic and since the 1980‘s major changes have taken place.
As lead regulator in the Securities environment, the Financial Services Board (FSB) has actively
utilised the concept of self-regulation through the appointment of certain appropriate SROs.
14.1 Strate as a Self-Regulatory Organisation (SRO)
Strate has been appointed as a Self-Regulatory Organisation by the FSB in accordance with the
Financial Markets Act Act. It is through, inter alia, Section 2 and 3 of the CSD Rules that the
powers to regulate are vested on Strate.
In terms of the Strate Rules:-
2.4 The authority to enforce the Rules and Directives vests in the Controlling Body, which authority
has been delegated to the Regulatory and Supervisory Committee.
2.5 the Regulatory and Supervisory Committee may impose a penalty or take disciplinary
action against any person or entity referred to in section 35(6) of the Act, which fails to
execute an instruction given or take any action required by, the Controlling Body; and
2.7 the Regulatory and Supervisory Committee must make, and may amend, Rules that
comply witsection 35 (6) of the Act and must supervise compliance with the Rules by
Participants.
It should be noted that, in terms of section 35(6) of the FMA, all Rules and Directives are binding
on the CSD, a Participant, an Issuer of Securities deposited with the CSD and their officers and
employees, and Clients.
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The advantages of self-regulating organisations include:-
regulation is carried out by acknowledged experts in the market;
the regulators‘ standing in the market is likely to enhance the consent and compliance
of the regulated;
the SRO is fully aware of innovations and industry changes and their implications, and
can adapt accordingly;
the SRO is likely to be less legalistic and dogmatic in its decisions;
it is in the self-interest of the SRO to maintain standards and retain the public‘s
confidence in the market;
the SRO is better positioned to detect abuses of the regulatory system;
the SRO can operate with greater flexibility, speed and effectiveness than direct
regulation; and
self regulation is more effective as the regulated activity becomes more specialised.
(Source : Financial Regulation in South Africa Bamber, Falkena, Llewellyn and Store)
STRATE AS REGULATOR
REGULATORY
Setting of Rules and
issuing of Directives
Monitoring of
Participants
compliance.
SUPERVISORY
Regulatory
and
Supervisory
Committee
Boar
d
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14.2 Regulation and Supervision
The FMA identified the main objectives of securities regulation and supervision namely:-
increasing the confidence in South African financial markets by:-
o requiring that securities services be provided in a fair, efficient and
transparent manner; and
o contributing to the maintenance of a stable financial market environment.
the protection of regulated persons and Clients;
the reduction of systemic risk; and
promoting the international competitiveness of securities services in South Africa.
Regulation, supervision and enforcement include the following:-
legislation framework and specific regulation governing the activities of Participants
Rules and Directives set by Strate;
entry criteria;
monitoring and supervision by the regulator;
disincentive structures;
disciplinary procedures;
on-site visits and audits; and
the role of market discipline, monitoring and reputation.
The Strate regulatory and supervisory strategy is about optimising the combination of these
components. The key is to optimise the effectiveness of this mix. All components are necessary
but none alone is sufficient. The mix will change over time and depending on transgressions,
heavier reliance will be made on particular components than others.
As an SRO and the regulator of the Strate system, it is necessary for Strate to establish a
structure that achieves the following:-
performance of the regulator role defined in the Financial Markets Act;
Participant compliance with the Rules and Directives;
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effective risk management for Strate and the Strate system;
effective management of operational and financial risks;
co-ordination and direction of the appointed Strate Compliance Officers;
monitoring of licensee performance and investigation of breaches of Rules/Directives
and the application of appropriate and effective discipline;
maintenance of system integrity and monitoring of performance and activities in the
Strate system; and
the provision of education and training courses for stakeholders.
This structure will ensure that the objectives of maintaining market confidence, reducing risk,
protecting investors, and providing a secure environment to encourage investment are achieved.
Regulatory intensity refers to the degree of detail and prescription and the extent to which the
behaviour of the regulated person has to be modified by the regulatory agency. The supervision of
Participants normally entails medium to high intensity regulation – high in some instances e.g.
acceptance procedure for Participants, with low intensity supervision that escalates whenever
needed. This combination proves suitable for the South African market.
14.3 Regulatory and Supervisory Pyramid
The scope of Strate‘s regulatory and supervisory responsibilities has been depicted
diagrammatically in the below pyramid. The pyramid and below notes, explain the roles and
responsibilities of those institutions and organisations involved in various securities services.
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FSB responsibilities.
The FSB (which is at the apex of the pyramid) is, inter alia, responsible for supervising
and regulating the financial markets other than the function of accepting deposits from the
general public. This is achieved by, inter alia, the use of SRO‘s, which currently include
the JSE and Strate.
Exchange
SROs
*SARB - Regulates
cash only.
FSB
Strate MOU
Board of
Directors and
Committees
Board of
Directors and
Committees
Compliance
Officers
Compliance
Officers
Nominees
(Local)
Transfer
Secretaries
Management/Staff Management/Staff
SLB
Lending Desks -
Business Partners
CUSTODY
SETTLEMENT
CLEARING
TRADING
CUSTODY
Issuers
Exchange
LISTINGS
Participant Broker
Registered Registered
Internal Audit Internal Audit
Auth
ority
& re
sponsib
ility fo
r regula
tion
A
ssura
nce
* SARB
FMA 76
(1)(b)
MOU STRATE relies on co-operation
with other SROs
The Regulated
Entities
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Section 6(2) of the FMA stipulates that ―the Registrar must perform functions assigned to
the Registrar by or under this Act and must supervise compliance with this Act.”.
The FSB is an independent institution established by statute (Financial Services Board
Act, No 97 of 1990) to oversee the South African financial services industry with the
exclusion of the function of accepting deposits from the general public. The FSB became
operational on 1 April 1991, and is financed by the financial services industry itself by
means of levies, with no contribution coming from government. The FSB aims to foster an
efficient regulatory framework, which reflects a sound balance between statutory control
and self-regulation.
Principle 7 of the IOSCO Principles states: ―SROs should be subject to the oversight of
the regulator and should observe standards of fairness and confidentiality when
exercising powers and delegated responsibilities.”
The IOSCO recommendation of oversight is enshrined in the FMA. The oversight by the
Registrar is applied to the SRO in a strict, fair and effective way. It is widely accepted that
the basic principle of self-regulation could be undermined by too much oversight. Where
a SRO is appointed and licensed, there is no direct supervision of its Authorised Users /
Participants by the FSB. However, the FSB does supervise overall compliance with the
FMA (s6(2)).
Powers of intervention and inspection
For practical reasons, the regulatory arrangements by the Registrar do not place strong
emphasis on formal supervision other than on SROs and Clearing Houses. Compliance
by the Authorised Users/Participants with the FMA, Rules and Directives of the relevant
SRO, is not directly supervised by the FSB and will be driven mainly by complaints by
investors and others as well as by the application of sanctions for non-compliance with
the Rules.
The FSB has powers to investigate or conduct an inspection on any matter where it
receives a complaint, charge or allegation, or if the FSB has reason to believe that a
person who provides securities services is contravening or is failing to comply with any
provision of the FMA (s 94(1)). This means that the CSD is not only bound by its own
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Rules, but must also enforce them. Drastic measures can be taken against the SRO
where it fails its duties as an SRO.
After an investigation or inspection, the Registrar is authorised to:-
apply to court for the winding-up or judicial management of the SRO;
apply to court for the appointment of a curator;
direct the SRO to take any steps to remedy the irregularity;
direct the SRO to prohibit or restrict specific activities of a director or other officers
if the Registrar believes that the person is not fit and proper to perform such
activities;
refer the matter to the Enforcement Committee;or
hand the matter over to the National Director of Public Prosecutions where the
contravention or failure is an offence in terms of the FMA (see s 96(e)).
The Registrar has the power to impose penalties in the case of any failure by a SRO to
submit to the Registrar any statement, report or other document as required in terms of
the FMA (s 97).
Enforcement powers
It is important to understand that the role of the CSD as a SRO is balanced by the fact
that it is a ―regulated person‖ in terms of the FMA. The FSB has comprehensive
enforcement powers over Strate.
The Registrar may cancel or suspend the CSD licence (s 60(1)). This sanction is very
powerful as Strate realises that the CSD business is its core business. On refusal of the
licence, the Registrar may take such steps as are necessary to achieve the objects of the
Act, which steps may include the transfer of the business to another similar SRO or the
winding-up of the SRO in terms of s 100 (s 60(4)). This sanction could also be very
powerful as a new CSD could be licensed and the existing CSD closed down.
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The Registrar can also refer a matter to the Enforcement Committee in terms of s 99 of
the FMA. This Committee acts independently of the Registrar and gives the Registrar
more effective enforcement powers.
SARB responsibilities
The SARB performs multiple roles, namely:-
The Bank Supervision Department of the SARB is responsible for the regulation and
supervision of Banks, especially the prudential supervision thereof. Five of the existing
Participants are Banks. As such a co-regulatory environment exists between Strate and
the SARB in so far as bank Participants are concerned. A MOU was signed between
Strate and the SARB in July 2004. This serves as the agreement by which regulatory/
compliance information on relevant prudential issues is shared between SARB and
Strate.
SARB is also responsible for the payment and settlement system (SAMOS) operated for
the banks in the clearing system.
Exchange responsibilities
The JSE
The JSE is responsible to the FSB for the supervision of Authorised Users, including the
accounting, trading and custody activities. In turn the Authorised Users use Participants
for their settlement activities. Strate has no regulatory or supervisory responsibility for
Authorised Users. The JSE and Strate in their roles as SROs, do however have a need to
exchange information relevant to their respective regulated entities. A MOU, which was
signed on 13 October 2003, recognises the co-regulatory relationship that exists between
the JSE and Strate.
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The JSE is also responsible to the FSB to generally govern, control, manage and regulate
the affairs of the Exchange and its Authorised Users and to maintain an orderly market
for trading in Securities.
To the extent that Authorised Users are Clients of a Participant and the Strate Rules are
binding on Clients, a co-regulatory environment exists between Strate and the JSE.
Strate responsibilities
Since all but one of the Participants are banks, the prudential regulation and supervision
of the Bank Participants is performed by SARB. For Bank Participants, Strate‘s regulatory
scope is confined to functional regulation, i.e. Participant related activities of an accepted
entity. The Strate / SARB MOU, mentioned above, serves as the agreement by which
information is shared on relevant prudential issues between SARB and Strate.
Accordingly, Strate will not duplicate the activities of SARB in this regard.
However, the prudential regulation of non-bank Participants (e.g. entities such as
Computershare Limited) requires increased involvement by Strate as these entities do not
fall within the SARB regulatory net.
In respect to the Bonds environment, Strate is the appointed Clearing House (previously
UNEXcor).
Strate is licensed as a CSD for the maintenance of immobilised and dematerialised
Securities holdings.
The Regulated Entity
The body of the pyramid depicts the flow of information to and from the various parties
with regard to Rules, Directives and legislation. The roles performed by various parties
vary with regard to the making and updating and implementation of Rules and Directives
and the supervision thereof. These are depicted in the downward direction. The upward
direction depicts the flow of information from regulated entities to those involved in the
supervision of such entities.
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Controlling Body and Committees of the Controlling Body
In respect of Strate, the Controlling Body is responsible for the following five activities:-
The legislative function.
This is the power to make, alter or rescind Rules and issue Directives which effect
not only Strate but its Participants and their Clients via mandates. This power
brings with it the duty to ensure the Rules and Directives issued by Strate are
relevant and provide an effective legislative scheme; the Rules are reasonable
and intra vires the delegated power and they are kept up to date.
The enforcement function.
The authority to enforce the Rules and Directives is covered in the Rules -
specifically the disciplinary procedures established in Rule 12. The responsibility
to ensure the Rules are implemented lies directly with the directors of Strate.
The gatekeeping function.
Strate must satisfy itself that Participants are admitted or removed in terms of the
criteria stipulated in Rule 3.2.The competency, honesty and efficiency of
Participants are key to the structure.
The policing function.
Strate must prescribe to Participants the type of accounts and records required
together with minimum standards pertaining to the safeguards of internal controls,
internal audit and risk management procedures. Compliance Officers must
monitor these and report to STRATE Supervision. The responsibility for
supervising these functions lies with STRATE Supervision.
Investigation function.
The Rules provide for a variety of investigative and quasi-judicial bodies to act
upon complaints and breaches of Rules or of the Act.
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The Controlling Body has delegated certain functions to the Strate Regulatory and
Supervisory Committee to which STRATE Supervision has a reporting function.
Generally, the Controlling Body is responsible for the performance of the entity. Good
corporate governance should be fostered for a number of reasons. A primary need is that
poor governance can harm economic performance and ultimately effect financial stability.
This is because poor corporate governance structures lead to poor decision making.
Weak processes and ineffective procedures and controls prevent early warning signs
appearing and hence highlighting deteriorating conditions within an organisation.
Transparency and accountability attracts new business – it gives financial incentive to the
investing community. In order to attract and retain large pools of capital from investors,
there needs to exist credible and recognisable corporate governance arrangements.
Weak Corporate Governance undermines confidence in a financial system and market as
a whole.
Compliance Officer
CSD Rule 8.3.1 and Directive SAJ requires the appointment of a qualified Compliance
Officer by each Participant accepted by Strate. The Strate Compliance Officer‘s duty is to
ensure compliance with the provisions of the legislation, Rules and Directives and to
report breaches to STRATE Supervision. They must have sufficient support and authority
from their organisation to discharge this duty.
Management and Staff
The staff of Strate must have the necessary skills and training strategies to ensure they
are able to discharge their responsibilities. Staff of the STRATE Supervision division also
require judgement to balance their supervisory responsibility without creating a
prescriptive regime. They must act with professionalism and empathy but with an
appropriate sense of urgency when needed.
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With regards to the management and staff of the Participant, adequate levels of training
and experience must exist to be able to discharge their responsibilities. In addition,
management should embrace values, ethics and relationships with their staff and
stakeholders, which promote good corporate governance. The Strate Rules stipulate the
eligibility criteria of Participants and include a requirement to have competent and
experienced management and staff.
On an annual basis the directors of a Participant, in their annual report to STRATE
Supervision, are required to confirm that their organisation has competent staff. Strate as
a SRO does not determine what constitutes ―adequate and skilled personnel‖ – this is a
responsibility of the Participant‘s management.
Internal and Registered Audit
Participants should have an effective internal audit function which has sufficient authority
and competence to justify reliance being placed on its work. The program of work should
cover the custody function of the Participant at least annually. Reports on their findings
should be made available to STRATE Supervision.
Strate in its role a SRO does not currently mandate the submission of internal audit
reports of a Participant. The Rules do however give STRATE Supervision the power to
call for these reports if required.
Registered audits compliment the work of internal audit. By agreement with the South
African Institute of Chartered Accountants (―SAICA‖) and Independent Regulatory Board
for Auditors (IRBA) specific audits are carried out which provide assurance to the
Supervision division. The scope of these audits and the nature of the reporting
requirements have been agreed with STRATE Supervision.
The Base of the Pyramid
The bottom line of the pyramid shows entities in the Securities industry, whether regulated
or not.
138
Participants.
The FMA defines a Participant as ―a person authorised by a licensed central securities
depository to perform custody and administration services or settlement services or both
in terms of the central securities depository rules, and includes an external participant,
where appropriate.”
In terms of the FMA, Strate must supervise compliance by Participants with the FMA and
Rules. Participants must comply with Strate‘s Rules and Directives and must ensure
compliance by their Clients. Participants in turn should advise their Clients of the latter‘s
obligations in terms of the Rules.
STRATE Supervision has developed a supervisory program for the Participants.
Enforcement and disciplinary strategies have also been developed if any Participant fails
to act in accordance with the Rules and Directives.
Securities Lending and Borrowing (SLB)
The SLB industry is unregulated. Accordingly the activities of SLB lending desks do not
fall within the ambit of Strate‘s regulatory responsibility.
However, SLB lending desks in the Equities environment have contractually bound
themselves as Business Partners to Strate with respect to the settlement of SLB trades.
Compliance with these contractual obligations will be monitored and corrective action
taken if necessary. Unlike equities, no formal lending desks (Business Partners) exist in
the bond environment.
Nominees
In terms of Section 76 (1)(b) of the FMA:
“A nominee of a participant must be approved as a nominee by the central securities
depository in terms of depository rules and comply with the requirements set out in the
rules.”
Strate is responsible for the approval of Nominees (who are Clients of Participants) and
for monitoring the Nominees continued adherence to Directive SA.7.
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Transfer Secretaries
The transfer secretarial industry is unregulated. Strate cannot therefore issue a Rule or
Directive that imposes duties on a transfer secretary. Transfer secretaries, in so far as
they are acting as agent of an Issuer, must also comply with the JSE listing requirements
and Strate Eligibility Requirements.
Issuers
Issuers are regulated by the Exchange to the extent that their listing requirements impose
responsibilities on Issuers. A section has been included in the JSE listing requirements
which refers to eligibility to operate in the Strate environment. Strate must ensure
compliance therewith before accepting the Issuer‘s Securities for dematerialisation.
The diagram further depicts the co-regulatory environment where MOU‘s form the basis of
mutual co-operation and sharing of information. It is essential to avoid duplicating or over
regulating the market.
14.4 Supervisory approach and strategy
STRATE Supervision strives to build fair and credible supervisory processes consistent with low
to medium intensity supervision referred to above. Strate aims to apply and enforce its
supervisory approach consistently.
14.5 Chinese walls
The Strate Regulatory and Supervisory Committee (the Committee), a sub-committee of the
Controlling Body of Strate, is tasked with the overall objective of assisting the Controlling Body in
discharging its regulatory and supervisory obligations in terms of the Financial Markets Act (FMA)
and the Rules.
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Strate‘s Clients are Participants who in some cases are also shareholders. Strate‘s business is to
provide Security Services to these Clients (referred to as the CSD function). Under the FMA,
Strate also operates as a regulatory organisation which involves supervising Participants including
enforcement (known as the Self-Regulatory Organisation [SRO] function). Chinese walls have
therefore been established between the two functions to avoid confidential information obtained
as a result of its statutory powers as a SRO being used, or being seen to be used, to provide
Strate‘s CSD activities with an unfair advantage. The Terms of Reference of the Committee
require the Committee to monitor the workings of the Chinese walls between these two functions
which operate independently of each other.
The SRO function of Strate is split into two distinct areas namely the Rule and Directive setting
function and the supervision of Participants. The latter function is undertaken by the STRATE
Supervision Division (the Division). It is confidential information obtained while performing the
SRO function by the Division which needs to be protected by Chinese walls from reaching staff
involved in the CSD function.
CONFIDENTIAL INFORMATION
Confidential information means all information of any nature whatsoever which the Supervision
Division may obtain from another Party (Disclosing Party) while performing the SRO function, or
which:
is marked ‗confidential‘, (or similar legend),
may be password protected,
the Disclosing Party identifies as confidential, or which;
by its nature is confidential, including without limitation, reports, records, databases and
statistics pertaining to the performance, operations and structures of a Participant,
regardless of where or how such information is disclosed to the Supervision Division.
Confidential information includes information received, without limitation, orally, visually or
by reason of inspection of documentation, electronic data or other material.
THE OPERATION OF CHINESE WALLS AT STRATE
The following structures, procedures and processes have been put in place to operate the
Chinese walls:
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1. Access to computer systems and Participant information
In terms of Strate‘s company policy, access to all personal computers (PCs) is subject to
password protection. Automated password software is installed on all PCs. An alpha/numeric
password is required in order to gain access to a PC. This password expires every 30 days and
must be replaced with a new password known only to the specific staff member. This password
protection procedure applies to staff working in the Supervision Division.
Separate folders and files have been created on the Strate shared network which can only be
accessed by members of staff working in the Supervision Division. All documents and records
containing confidential information, including Participant Performance Models, databases and
statistic summaries, are password protected.
As Strate only has one network, the Strate System Administrators have access to these folders
too. A specific ―Code of Conduct: Networks and System Administration‖ has been developed for
System Administrator staff who are required to sign and be bound by this code of conduct.
2. Human resources policies
In terms of Strate Rule 4.4, ―… the CSD (including its officers and employees) must keep
confidential all information disclosed to it by a Participant….”
All Strate staff (including the System Administrators) are required to sign a Code of Conduct [in
addition to the one mentioned in 1. above] which includes a confidentiality clause. Staff working
for the Division are further assessed and measured in their Balance Score Cards (BSC) on their
adherence to the confidentiality clause. STRATE Supervision staff is constantly reminded of their
duty to observe the highest professional standards and are given clear guidance on the avoidance
of conflicts of interest, the possible abuses of confidential information, the observance of
confidentiality and secrecy, and the observance of procedural fairness.
Performance appraisals of the Head of STRATE Supervision are conducted by the Chairman of
the Strate Regulatory and Supervisory Committee in conjunction with the CEO. The Head of
STRATE Supervision conducts the performance appraisals of STRATE Supervision staff.
3. Legal Advice
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The Supervision Division may need to consult members of the Strate Legal Division on issues
involving confidential information of Participants. Members of the Strate Legal Division are
required to sign a STRATE Supervision Confidentiality Agreement undertaking to keep
confidential any information pertaining to a Participant that may be disclosed to the Legal Division
by the Supervision Division.
4. Expurgation and circulation of documents
Confidential information on Participants is only sent to members of the Committee (other than the
member described in 6. below) and attendees referred to the Committee‘s specific Terms of
Reference.
Minutes and records of proceedings of meetings or hearings of the Committee and documents in
Committee meeting packs circulated to other attendees and to the Board are expurgated to
exclude any reference to confidential information about Participants that are discussed at the
meeting.
Separate expurgated and unexpurgated versions of the minutes of each meeting, hearing and
reports are maintained in the STRATE Supervision folder on the common drive.
5. Attendance at Committee meetings
The Committee‘s Terms of Reference states, ―…any member or observer must recuse
themselves from those parts of a meeting when matters of a confidential nature relating to a
Participant are discussed, in accordance with the Chinese wall Manual.‖
Accordingly, staff of the CSD function of Strate, including its CEO and Legal Division, do not
normally attend Committee meetings while confidential information relating to Participants is
discussed. An exception is made when legal advice is required by the Committee and the member
of Legal Division has signed the additional Code of Conduct referred to in 3.
Even if in attendance at a Committee meeting, Strate‘s CEO and management cannot overrule or
veto regulatory or supervisory decisions or alter the supervisory strategy.
6. Non disclosure of confidential information to a member of the Committee
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The expurgation of documents and attendance at meetings referred to at 4. and 5. above also
apply to any member of the Committee who is appointed for his/her expert knowledge of the
Securities industry, but who is also employed by one of the Participants.
7. Physical Location
The STRATE Supervision offices are physically separated from the offices of the CSD function.
Access to these offices is restricted to staff working in the Division who control access by others
during visits.
8. Interaction between staff of Supervision Division and Strate’s CSD function
The Head of STRATE Supervision is not a member of Strate‘s Manco. The Head of STRATE
Supervision attends the Manco meetings as an observer. Matters relating to the supervision of
Participants are not included on the Manco agenda or discussed at these meetings.
STRATE Supervision Division staff develop the supervisory strategies required for the effective
and appropriate supervision and monitoring of compliance by Participants with the Rules and
Directives. Accordingly, the Head of STRATE Supervision and members of the STRATE
Supervision Division attend Strate operational forums and meetings only in the capacity as
observers for the purposes of gaining an understanding of the workings of the different settlement
and operational models and their functionality.
Accordingly, supervisory matters and findings are not discussed with staff of the Strate CSD
function and are only reported on at the Strate Regulatory and Supervisory Committee or
discussed with the Committee Chairman and the Financial Services Board (FSB).
AUDIT ASSURANCE
The operation of the Chinese wall structures, procedures and processes are periodically
subjected to audit procedures carried out by Registered Auditors, to provide assurance to the
Committee on whether or not they are working effectively.
FINANCIAL CONSIDERATIONS
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Although the Division generates its own income through membership fees and training initiatives,
the Board ensures that the Division is adequately funded and has the necessary resources to fulfil
its supervisory functions.
Penalties i.e. monetary fines, form part of the revenue of the Division, but reliance is not placed on
this stream of income to finance its activities or those of Strate. Accordingly, the Division does not,
and is not seen to be, raising fines to finance its, or Strate‘s operations.
MONITORING
The Committee is responsible for monitoring the effectiveness of the Chinese walls established.
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15 COMPLIANCE AND REPORTING REQUIREMENTS
“Although management may appoint a chief risk officer or risk facilitator to assist in the execution
of the risk management process, the accountability to the board remains with management and
should be the responsibility of every employee.” (King II)
This chapter of the Handbook briefly explains the valuable role which the compliance function
fulfils within an organisation.
15.1 The Compliance Function
Compliance functions are relied on to assist organisations in complying with ever increasing
regulatory requirements and managing risk.
Sound corporate governance is essential for effective compliance! The Board of Directors is
ultimately accountable for compliance with the regulatory requirements that are imposed.
Directors have the duty to make the necessary enquiries to ensure that risks (including
compliance risks) are adequately managed. Each organisation‘s governance structures should
address the delegation of compliance and risk management responsibilities to management and
employees.
The compliance function itself is not responsible for compliance. The compliance functions‘ key
contribution within an organisation is to assist management in discharging their responsibility to
comply with regulatory requirements.
The King Report on Corporate Governance supports this view in that it indicates that the role of
the Compliance Officer encompasses:-
providing a service to management by assisting them in identifying and prioritising
all applicable regulatory requirements;
providing awareness training to enable management to manage applicable
compliance risks appropriately; and
conducting monitoring programs to identify and report aspects of non-compliance
to the CEO and Board.
Although the above is merely a high level overview, it cuts to the core of the contribution that is
made by Compliance Officers.
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The Compliance Officer is therefore not responsible for compliance, but rather to assist
management in ensuring compliance. In order to assist management and the Board with this
compliance responsibility, the Compliance Officer has to adequately inform them of the status of
compliance within the organisation.
How exactly is this achieved?
One of the key means of providing the support needed is through the use of compliance reports.
Compliance reports generally serve to:-
report on challenges being faced;
highlight control issues;
bring problems and/or breaches to the attention of management / regulators; and
detail action taken or to recommend changes / remedial action.
The reporting lines within each organisation will also vary. The below diagram indicates an ideal
compliance reporting line.
Ov
era
ll co
mp
lian
ce re
sp
on
sib
ility flo
ws
from
the
top
do
wn
Board of Directors
CEO Board Audit Committee
Management Compliance Officer
Staff
Indirect reporting lines Direct reporting lines
Ro
ll u
p o
f re
po
rtin
g
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The Compliance Officer must at all times maintain a high degree of professional independence.
Where he/she reports directly to management, a conflict between business objectives and the
applicable regulatory requirements could exist. The Compliance Officer could effectively be
reporting the ―failure‖ to the person responsible for such non-compliance, added to which the
report may be squashed and never reach the Board who is ultimately responsible for compliance.
Becoming too independent can also be detrimental. Compliance needs to ensure that it remains
part of the day to day business decisions in order to ensure that it can assist management in
being ―part of the solution‖ in complying with regulatory requirements.
Compliance is more than just manuals and procedures – it is most effective when integrated into
all business processes. It should not be seen in isolation and should be seen in the light of all the
related role players. It is imperative that organisations promote a culture of ―doing the right thing.‖
It is equally important that those who report on any wrong doing are not adversely affected
through their ―whistleblowing‖.
Compliance with regulatory requirements is not only the law, but it also makes good business
sense. Customer satisfaction and confidence, to a large extent, is directly related to the level of
compliance by the financial institution with applicable regulatory requirements.
Compliance is ―good business‖ and much of what regulatory requirements represent or aim to
achieve, is good practice.
15.2 Conflicts of interest for Compliance Officers
The effectiveness of any self-regulating body is dependent on the information it receives from its
Compliance Officers who work in that industry. The effectiveness of a Compliance Officer in turn
is dependant on the information that he obtains from within his organisation, as well as his ability
to communicate with the regulator.
An effective Compliance Officer needs to have access to information, as well as the ability to
disseminate and communicate it to those who matter. His ability to communicate is however
governed by his duty to his employer, as well as his duty to the regulator. A Compliance Officer
could therefore be placed in a position of conflict.
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Duty to employer
The Compliance Officers duty to his employer can be divided into 2 areas:-
expressed duties: usually detailed in the Compliance Officer‘s contract or job
description. This often requires the Compliance Officer to ensure that the
company adequately complies with the Rules and regulations set down by the
regulator. The Compliance Officer would therefore be expected to enforce any
Rules / restraints on others; and
implied Duties: usually includes the duty of confidentiality and obedience to his
employer.
Rules imposed by regulator
Regulatory authorities may require that all Compliance Officers be registered as such, and that
they agree to abide by its Rules through the acceptance of a ―code of conduct or ethics‖. The
Compliance Officer is therefore unable to conceal information from the regulator, which the
employer may not want him to disclose.
A direct conflict exists between their obligations to the regulator, as well as their duty of
confidentiality and obedience to their employer.
Other duties often imposed on Compliance Officers may include a duty to the customer or a duty
imposed by Statute.
To mitigate the conflicts of interest, the Compliance Officer should always deal with its regulator in
an open and co-operative manner and keep the regulator promptly and adequately informed of
any issues that may reasonably be expected to be disclosed. It is imperative that those who ―blow
the whistle‖ on any offence, malpractice or irregularity be protected and should not be disciplined
or victimised for their disclosures.
Certain requirements should be met in order for Compliance Officers to provide an effective value-
added function within their organisations.
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As stated previously, the functions of a Compliance Officer include, inter alia:-
identifying the risks that an organisation faces and advise on them –
identification;
designing and implement controls to protect and organisation from those risks –
prevention;
monitoring and reporting on the effectiveness of those controls in the
management of an organisations exposure to risk - monitoring and detection;
resolving compliance difficulties as they occur – resolution; and
advise the business on Rules and controls – advisory.
Companies often expect their Compliance Officers to know the answers to all the regulatory
questions. This may seem unrealistic to some, but frequent contact with the regulator and the
Compliance Officers ability to identify and understand a problem should reduce the employers
concerns about talking to the regulator. It often enables concerns to be addressed before it
becomes a problem.
There is a need to instil a compliance culture in the regulated entity whereby compliance is a
preventative tool, rather than it being viewed by some as a policing function. Regular dialogue
between the Compliance Officer and management, as well as staff being able to raise day to day
queries with the Compliance Officer will increase the quality of information the Compliance Officer
is able to obtain. Inevitably this leads to better information flowing to the regulator which in turn
improves the effectiveness of self regulation.
15.3 The Roles and Responsibilities of the Strate Compliance Officer
Compliance officers should:-
have clear and objective responsibilities;
exhibit the highest levels of professionalism;
operate independently within their business unit;
be accountable;
have adequate powers, resources and capacity; and
adopt clear and consistent processes.
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The compliance program within an organisation must add value. The benefits of an effective
compliance program and appropriate compliance monitoring include:-
the reduction of regulatory wrongdoing;
potential administrative and cost reduction;
providing the organisations leadership with a more accurate view of its employees
behaviour;
helping personnel make sound business decisions;
identifying criminal and unethical conduct;
providing a channel for effective dissemination of changes in regulatory and
legislative requirements; and
encouraging employees to report and address concerns internally rather than
externally, which may reduce reputational risk.
As already highlighted above, the Compliance Officer‘s primary responsibilities, from a regulatory
perspective, should include:-
oversight and monitoring;
reporting;
education and training;
review and investigation; and
informer / ―whistle blowing‖ procedures.
15.3.1 Section 8.3.1 of the Strate Rules
Section 8.3.1 of the Strate Rules details the roles and responsibilities to be performed by a Strate
Compliance Officer as follows:-
8.3.1 a Participant must appoint a compliance officer as stipulated by Directive to ensure
compliance with the provisions of the Act, Rules and Directives;
8.3.2 a compliance officer must;
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8.3.2.1 pass the compliance officer examination and fulfil any further requirements
stipulated by Directive;
8.3.2.2 immediately report to the senior management of the Participant any apparent
breach by the Participant, its officers and employees, of the provisions of the
Act, Rules and Directives;
8.3.2.3 immediately report to the senior management of the Participant any
discrepancy or irregularity detected in terms of the Rules and Directives and
any other issue considered by the compliance officer to be irregular;
8.3.2.4 if the Participant fails to rectify the breach, discrepancy or irregularity reported
to it in terms of Rules 8.3.2.2 and 8.3.2.3 within 24 (twenty four) hours, the
directors of the Participant or, failing the directors, the compliance officer, must
report the breach, discrepancy and or irregularity to the Controlling Body, which
report shall include a description of any action taken by the Participant to rectify
the breach, discrepancy or irregularity;
8.3.2.5 submit a bi-annual report signed by the chief executive officer or designated
officer of the Participant and the compliance officer, relating to the Business of
the Participant which indicates any material problems that the directors or
compliance officer have experienced during the preceding 6 (six) months and
how these have been or are to be addressed. The report must include a
disclosure and analysis of the impact on the solvency of the company of any
material problems or losses experienced, risk management, internal controls
and procedures implemented to mitigate the risks introduced, as well as any
material claims of which the directors or compliance officer are aware;
8.3.2.6 receive all notices issued in terms of Rule 13 and monitor that they are
complied with;
8.3.3 The primary functions of the compliance officer are to:-
8.3.3.1 review the daily monitoring, controlling and reconciling of the Securities
Accounts of the Participant;
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8.3.3.2 review on a daily basis, that the total of the balances of the Securities Accounts
held for all Clients for each class and type of Securities held by the Participant
agree with the aggregate amount for those Securities reflected in the Records
of the Participant;
8.3.3.3 review on a daily basis, that the Participant’s Records of the aggregate quantity
of the Securities of each class and type held by it are the same as those held
by the CSD on its behalf;
8.3.3.4 review the effectiveness of the internal controls and risk management
procedures;
8.3.3.5 monitor that the Client mandates, BEE Contracts and BEE Certificates, where
applicable referred to in Rule 5 are in place; and
8.3.3.6 monitor the compliance by the Participant of all Rules and Directives.
8.3.4 except where the Controlling Body may otherwise determine, a Participant must
not carry on Business for more than 3 (three) months in any continuous period
of twelve months unless such Participant has appointed a compliance officer in
terms of the Rules.
8.3.5 In the absence of a duly appointed compliance officer or where a compliance
officer post has become vacant, a temporary compliance officer must be
appointed for a period no longer than 3 (three) months.
15.3.2 Directive SA.6 – Strate Compliance Officer Appointments
In terms of Directive SA.6:-
1. all Participants must appoint a Strate Compliance Officer (SCO) who has passed the
Compliance Officer examination prescribed by the controlling body;
2. all Participants must appoint at least one additional Compliance Officer, termed the
Alternate Compliance Officer (ACO), to act as an alternate to the SCO. If more that
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one ACO is accredited, STRATE Supervision Division must be advised of the
nominated ACO when the SCO is absent from their post; and
3. SCOs and ACOs must achieve the minimum compliance points per annum, as
prescribe by Strate Supervision and communicated to them during regular Compliance
forums.
In terms of the above Directive, the Compliance Officer is required to maintain a minimum number
of points per annum. The objective of this points system is to encourage ―Continuous Professional
Education.‖ The actions, tasks and qualifications of a Strate Compliance Officer for which points
are awarded, and the quantity of such points, are detailed in Strate‘s Training and Examination
Guideline.
Please refer to the Strate website www.strate.co.za, for the current version of Directive SA.6 and
the Training and Examination Guideline
15.4 Whistleblowing
Various definitions of whistleblowing are provided, namely:-
a) ―bringing an activity to a sharp conclusion as if by the blast of a whistle‖-(Oxford English
Dictionary);
b) ―raising a concern about malpractice within an organisation or through an independent structure
associated with it‖-(UK Committee on Standards in Public Life);
c) ―giving information (usually to the authorities) about illegal or underhand practices‖-(Chambers
Dictionary);
d) ―exposing to the press a malpractice or cover-up in a business or government office‖- (US,
Brewers Dictionary);
e) police officer summoning public help to apprehend a criminal; and
f) referee stopping play after a foul in football.
Compliance officers are often seen as ―blowing the whistle‖ on wrongdoers. The conflict of
interests explained above, often results in Compliance Officers being placed in a tough position
between reporting the fraud or irregularity and their own personal security. The protected
Disclosures Act provides some compensation and protection to whistleblowers.
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15.4.1 Protected Disclosures Act
The Protected Disclosures Act came into force in February 2001. It encourages people to raise
concerns about improprieties in the workplace and will help ensure that organisations respond
by:-
addressing the message rather than the messenger; and
resisting the temptation to cover up serious malpractice or ―improprieties‖.
Through protecting whistleblowers from being subjected to an occupational detriment in the
following circumstances, the Act promotes the public interest.
Impropriety
The Act applies to people at work raising genuine concerns about crime, civil offences (including
negligence, breach of contract, breach of administrative law), miscarriage of justice, danger to
health and safety or the environment and the cover up of any of these. It applies whether or not
the information is confidential and extends to malpractice occurring overseas.
Individuals covered
The Act covers every employee and applies to every employer.
Legal Advice
The Act confirms that employees may safely seek legal advice on any concerns they have about
improprieties.
Internal disclosures
A disclosure in good faith to a manager or the employer will be protected if the whistleblower has
a reasonable suspicion that the impropriety has occurred, is occurring or is likely to occur. Where
a third party is responsible for the matter this same test applies to disclosures made to it.
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15.4.1.1 Disclosures to member of Cabinet or Executive Council
Where the employer is:-
an individual appointed in terms of legislation by a member of Cabinet or of the
Executive Council of a province; or
a body the members of which are appointed in terms of legislation by a member
of Cabinet or of the Executive Council of a province; or
an organ of state.
A disclosure made in good faith, by an employee to the member of Cabinet or Executive Council
will be protected in the same way as an internal one.
Disclosures to prescribed bodies
The Act protects disclosures made in good faith to prescribed regulatory bodies such as the
Public Protector and the Auditor General where the whistleblower reasonably believes that the
information and any allegation in it are substantially true.
Wider disclosures
Wider disclosures (e.g. to the police, the media, MPs and non-prescribed regulators) are
protected if, in addition to the tests for disclosures to prescribed regulatory bodies, they are
reasonable in all the circumstances and they meet one of the four preconditions.
Provided they are not made for personal gain, these preconditions are that the whistleblower:-
reasonably believed s/he would be subjected to an occupational detriment;
if s/he raised the matter internally or with a prescribed regulator; or
reasonably believed a cover-up was likely and there was no prescribed regulator;
or
had already raised the matter internally or with a prescribed regulator; or
the impropriety in question is exceptionally serious.
Whether the disclosure was reasonable will depend on the identity of the person to whom it was
made, the seriousness of the concern, whether the risk or danger remains, and whether it
breached a duty of confidence the employer owed a third party. Where the concern had been
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raised with the employer or a prescribed regulator, the reasonableness of its response will be
particularly relevant. Finally, if the concern has first been raised with the employer, it is relevant
whether any whistleblowing policy in the organisation was or should have been used.
Occupational detriment
A whistleblower who is subjected to any disciplinary action - including dismissal, suspension,
demotion, harassment or intimidation; a transfer against his or her will; a disadvantageous
alteration in the terms and conditions of his or her employment will have been subjected to an
occupational detriment.
A refusal of a transfer or promotion; a refusal to provide a reference or providing an adverse
reference; a refusal of employment or appointment to office; or any other adverse impact on the
whistleblower‘s employment will also amount to an occupational detriment.
Threatening the whistleblower with any of the above is an occupational detriment.
Remedies
Where the whistleblower is subjected to an occupational detriment s/he can bring a claim in any
court having jurisdiction, including the Labour Court, or pursue any other process allowed or
prescribed by law (for example conciliation through the CCMA). In addition to providing for
financial compensation, the Act enables the whistleblower to request and obtain a transfer on
terms and conditions no less favourable than the conditions that applied immediately before the
transfer.
Confidentiality clauses
Confidentiality or ‗gagging‘ clauses in employment contracts and severance agreements are void
insofar as they conflict with the Act's protection.
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15.4.1.2 Companies Act – Protection of whistle-blowers
Section 159 of the Companies Act also deals with the protection of whistle-blowers. This
protection is in addition to and not substituting the protection of whistle-blowers contained in the
Protected Disclosures Act 26 of 2000.
In terms of this section, any Memorandum of Incorporation, the rules of the company or
agreement is void to the extent that it is inconsistent with this section (that is, restricting whistle-
blowing or disclosures). It further states that shareholders, directors, company secretary,
prescribed officers, employees, registered trade unions or other employee representatives,
suppliers, etc, have qualified privilege in respect of the disclosure, and are immune from any
criminal, civil or administrative liability in respect of that disclosure.
The section further states that public companies (Strate) and state-owned companies must
establish and maintain a system to receive disclosures, and routinely publicise the availability of
that system to the persons mentioned above (shareholders, directors, employees, etc).
15.5 Strate Circular
15.5.1 Background
Discussions with the South African Institute of Chartered Accountants (SAICA) commenced in
2003 with a view of mandating and standardising the audit reporting for Participants. Previous
audit reports submitted in terms of the Strate Rules were inadequate and did not focus on the key
operational areas. When discussions commenced there was significant debate over the wording
of the Strate Rules and the processes to be performed by the Registered Auditors. The Rules
stated that the auditor was to express an opinion, but following lengthy debate it was finally
agreed that Strate would accept a report on factual findings.
A working committee was formed who proceeded to draft the SAICA/Strate Circular which was
eventually approved by SAICA in July 2003 and the Strate Controlling Body in August of 2003.
SAICA – Circular 3/2003 – Guidance for Auditors reporting in terms of Central Securities
Depository (CSD) Rules was thus passed.
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15.5.2 Strate / Registered Audit Guidelines
The purpose of the guidelines (known as the Strate Circular) is to provide guidance for Registered
Auditors when reporting in terms of the CSD Rules and the FMA on the Participants‘ compliance
with the relevant sections of the FMA. This Circular contains the ‗agreed-upon procedures‘ to be
performed by the Registered Auditor of a Participant regarding the implementation and operating
effectiveness of key controls (identified by management of the Participant), that are designed to
meet the control objectives (specified by Strate), for transactions relating to the settlement,
custody and administration, of Strate eligible Securities.
The format for the Registered Auditor‘s factual findings report is set out in an appendix. The
Registered Auditors scope of review includes the following areas:
Client mandates
Dematerialisation, Rematerialisation and Immobilisation
Operation of Securities Accounts
Balancing
Settlement
Securities Transfer Tax Act (Equities)
Corporate Events (Equities and Bonds)
Capital Events (Money Market)
The guidelines have been amended over the years. The current Strate Circular is available on the
Strate website www.strate.co.za.
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15.5.3 Reports and Audits
As mentioned above, in terms of Rule 8.3.2.5 the Strate Compliance Officer is to submit a bi-
annual report. This report is submitted for the following periods:
1 January to 30 June – to be submitted to STRATE Supervision by 31 July; and
1 July to 31 December – to be submitted to STRATE Supervision by 31 January of the
following year.
In terms of the Strate Rules, there are certain other reports which must be submitted during the
year. Section 8 of the Strate Rules state:-
8.1.1 the Controlling Body may, in addition to the Accounting Records prescribed by the
Act, determine the nature and type of reports, Accounts and Records which a
Participant shall maintain for the purpose of the requirements of the Act and Rules;
8.1.2 a Participant must, to the satisfaction of the Controlling Body, introduce and
maintain internal controls and procedures to ensure that the Securities Accounts
held by it are audited on a regular basis according to SAAS. All audit reports
compiled in accordance with the provisions of this Rule and submitted to the CSD
shall only be disclosed to the Executive Officers of the CSD and the Head of
Supervision and on request, to the Registrar;
8.1.3 every Participant must annually report to the Controlling Body whether or not;
8.1.3.1 the Participants’ internal controls and procedures, in so far as they relate to the
Business of the Participant, provide reasonable assurance as to the integrity
and reliability of the accounts;
8.1.3.2 the audit procedures and internal controls and procedures are based on
established policies and procedures and are implemented by trained and skilled
personnel;
8.1.3.3 the adherence to the implemented internal controls and procedures is
continuously monitored by the Participant;
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8.1.3.4 the Participant is maintaining high ethical standards, thereby ensuring that the
business of the Participant is conducted in a manner which is above reproach;
8.1.4 the Participants must submit the report required in terms of Rule 8.1.3 within 90
(ninety) calendar days after the financial year-end of the Participant;
8.1.5 The Registered Auditor responsible for the audit of the SARB or a Participant
which is also a bank must submit the factual findings report within 6 (six) months
after the financial year-end of such bank Participant or the SARB.
8.1.6 the Registered Auditor of the Participant must annually report to the Controlling
Body whether or not;
8.1.6.1 the Participant complies with the requirements of the Act and the Rules
regarding the maintenance of Securities Accounts;
8.1.6.2 the Participant complies with the Rules relating to the reconciliation of
Securities Accounts to the Central Securities Accounts kept by the CSD ;
8.1.6.3 the Participant complies with Rule 5.1.1, and on the adequacy of the arrangement made and measures taken by such Participant on holding of sufficient Securities in terms of Rule 5.1.
8.1.7 a Participant must, within 90 (ninety) days from its financial year end, or within
6 (six) months in respect of a bank Participant or the SARB, ensure that its
Registered Auditor submits to the Controlling Body, any further reports as
required by the Act and Rules;
8.1.8 a Participant must report any material malfunction in the functioning of the
aforementioned controls, procedures and systems to the CSD as soon as
reasonably possible after it has come to the directors' or officers’ of the
Participant’s attention, and as prescribed by Directive.
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8.1.9 a Participant must conduct a full Disaster Recovery test bi-annually on its
relevant internal systems and related infrastructure and report to the CSD the
results of such test, and as prescribed by Directive.
8.1.10 a Participant must advise the Controlling Body in writing of any material change to
its shareholding or corporate structure that is likely to affect the risk profile of the
Participant.
7.5.3.1 Directive SA.10
Directive SA.10 provides for the management of risks in the Strate environment, including testing
and disaster recovery, applicable to Participants and Business Partners.
This Directive covers three main requirements, namely:
a) Disaster Recovery Tests. As mentioned in Rule 8.1.9, Participants must conduct the
disaster recovery test at least once every 6 (six) months, and report the results of such
test to STRATE Supervision within 30 (thirty) days from the date of the test. Where tests
are unsuccessful (i.e. the results are ―fail‖) the Participant must, within 10 (ten) business
days, advise STRATE Supervision of the circumstances leading to the failure as well as
its plans to conduct a subsequent test. Further, the Directive includes requirements for
both Participants and Business Partners to participate in Strate‘s own annual testing
programme.
b) Technical Difficulty and Business Continuity. Requirements are imposed on Participants
and Business Partners to notify Strate of all technical difficulties experienced.
c) Communication Networks. The Directive stipulates the minimum messaging systems /
communication network service providers to be in place between a Participant and Strate.
For more information regarding any Strate Directives, the reader of this Learning Material must
refer to the Strate website www.strate.co.za.to obtain the latest version of any Strate Directive.
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16 RISK
Emerging markets face the same issue that today‘s developed first world markets faced in their
earlier stages decades ago. How does one build a safe Securities market that will attract both
domestic and foreign investment into the market, thereby increasing local and international
monetary flows to ensure a healthy and thriving environment?
A common issue facing all countries in the development of its Securities markets is safety. The
cornerstone of a safe, stable Securities market is a safe and reliable clearing and settlement
system supported by market Participants who operate effectively, efficiently and accurately.
Strate, in conjunction with the Financial Services Board and Exchange, focuses on achieving
safety in the clearing and settlement system so as to ensure that domestic and foreign investors
remain comfortable that their trades will be brought to completion.
16.1 Risk and the Role of the Compliance Officer
The International Organisation of Securities Commissions (IOSCO) recognised that the reduction
of systemic risk is one of three main objectives of Securities regulation; the others being
- the protection of investors and
- ensuring that markets are fair, efficient and transparent.
The IOSCO states ―an efficient and accurate clearing and settlement system that is properly
supervised and utilises effective risk management tools is essential”.
Risk can be managed but never totally mitigated. Life involves risk and companies can not escape
risks. It is important for companies to empower their Compliance Officers with the information to
know these risks and the understanding that when risks are faced that these were fully anticipated
and known so that they can be controlled and managed.
The compliance role is to assess the operations of their business units and make
recommendations on which compliance risks may or may not be accepted. It would also be
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expected that compliance risk areas be pointed out and advice given on which controls appear to
be inadequate. This suggests a sufficiently high level of understanding of the industry.
Compliance Officers need to acquire the skills, knowledge and experience to assist them in
performing this duty.
“The Compliance Officer must facilitate the development of a culture which is conducive to
minimizing risk” (Source: Compliance: Making Ethics work in Financial Services – Andrew
Newton). It is the responsibility of the Compliance Officer to establish procedures and to monitor
activities to ensure that all levels of staff are aware of the relevant regulatory requirements and
operational fundamentals so as to minimize the compliance risk exposure of the organisation and
market as a whole. The nature of Strate means wider impact i.e. a single transaction may become
complex and inter dependant and could impact multiple parties and systems.
Whilst IOSCO principles have been established for effective regulation, the same principles can
be applied to the ambit of Compliance Officers. Certain requirements should be met in order for
Compliance Officers to provide a value-added function within their organisations.
Techniques used to control and manage risks include:-
AVOIDING RISK – processes and operations are redesigned in order to reduce the overall
risk exposure.
DIVERSIFYING RISK – risk is spread in order to minimize the impact or exposure.
CONTROLLING RISK – redesigning of processes and activities to prevent, detect or contain
the adverse events and to encourage positive outcomes.
SHARING / TRANSFERRING RISK – a reinsurance of risk whereby elements of the risk are
outsourced to third parties.
ACCEPTING RISK – depends on the organisations level of risk aversion. This occurs when
minor risks are assumed / tolerated because the cost of managing the risk is greater than the
potential exposure itself.
Some academics refer to the above as the Four T‘s of Risk:-
TOLERATE – risks that are accepted with low severity and low probability
TREAT – risks with low severity and high probability
TERMINATE – risks with high severity and high probability that could cripple the business
TRANSFER – risks with high severity but low probability.
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Either way it must be remembered that risk can not be eliminated – it can only be controlled,
contained and managed.
16.2 Regulatory and Supervisory Risks
Risks are derived from areas such as business, operations, market and credit. The most important
area from Strate‘s perspective is operational risk.
Trades fail as a consequence of an operational process failure induced by failure within an
organisations system or by its people. Operational failures are often seen as ―normal failures‖,
which inevitably leads to repeat failures – but could have a major impact on settlement risk.
Two broad categories of risk are monitored by Strate, namely operational risks and financial risks.
16.2.1 Operational Risks
Operational risk can be divided into several sub-risks which are defined below.
CUSTODY RISK
The risk of loss of Securities held in custody occasioned by the negligent or fraudulent action
of the Participant. The risk of incorrect record keeping by the Participant, and as a result the
investor suffers a loss or it undermines confidence in the efficiency and effectiveness of the
market.
TECHNOLOGY AND SYSTEMS RISK
This risk is the inability of the custody and payment systems/applications to manage and/or
control the business processes/information of the Participant. The risk of system failure or
technical difficulty experienced by a Participant which results in the entity being unable to
perform its CSD related activities.
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COMMUNICATION RISK
The risk that the Exchange of information between Participants and Strate, and Participants
and their Clients, is inadequate. The risk that the Participant (and as such its Clients) is not
aware of or misunderstands new/amendments to operational procedures, Rules and
Directives. This results in operational errors and the consequence is that the investor suffers a
loss or it undermines confidence in the efficiency and effectiveness of the market.
CONTRACTUAL / LEGAL RISK
The risk that the Participant acts without, or contrary to the provisions of, a Client mandate.
The risk that the Participant settles transactions over a Clients Securities Account without
there being a mandate in place, or alternatively, where a mandate is in place, acts contrary to
the binding terms and conditions. As a result the investor suffers a loss or it undermines
confidence in the efficiency and effectiveness of the market.
COMPLIANCE OFFICER RISK
The risk that the Strate Compliance Officer is not effective in monitoring the applicable
processes and procedures. The risk that the Strate Compliance Officer fails to perform the
roles/responsibilities prescribed in the Rules which could result in fraud and errors in the
custody and settlement records maintained by the Participant not being detected. This could
result in the investor suffering a loss or it undermines confidence in the efficiency and
effectiveness of the market.
PROJECT MANAGEMENT RISK
The risk that the implementation of new or amended Strate products and/or functionality fails
or can not be implemented timeously due to the lack of resources or poor project
management and this introduces risk to the Participant, CSD, Exchanges or other
stakeholders.
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HUMAN RESOURCES / PERSONNEL RISK
The risk that a Participant fails to recruit and/or retain qualified staff with appropriate skills and
competencies to perform each business function.
AUDIT RISK
The risk that the auditors (internal and external) lack the knowledge and experience of Strate
procedures and practices, the result of which is inadequate audit findings. The risk that the
auditors lack the knowledge and experience of Strate related activities which results in them
failing to detect errors, weaknesses and transgressions, leading to poor/unreliable audit
reports.
16.2.2 Prudential Risks
Prudential risk can be separated into two separate risks, namely:-
INSURANCE RISK
The risk that the Participant has inadequate insurance in place to operate as a risk mitigating
tool. The risk that in the event of a loss (either own or via claim from third party) the
Participant can not look to an Insurer and/or lacks sufficient reserves (in the event of self-
insurance) to cover the financial costs/damages arising from the event.
FINANCIAL RISK
The risk that the Participant can not continue to operate as a financially viable entity. The risk
that the Participant fails (insolvent, placed into curatorship) and the assets (both cash and
Securities) are trapped in the failed entity to the detriment of the Client.
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16.3 Aspects of the Rules and Directives which require monitoring
Having explained Strate‘s regulation strategy, the need for supervision and the risks which can
arise in the course of electronic settlements, it is vital to go back and look at those sections of the
Rules and Directives on which Strate will focus their compliance attention on.
Aspects which require stringent monitoring are those that deal with, inter alia:-
knowledge and skill of the employees of the Participant who have access to or input
data into the CSD systems or who provide information to those people who input data
into settlement systems;
continued adherence to the participation eligibility criteria;
system integrity;
record keeping and the maintenance of Securities Accounts;
Client interaction and mandates
adherence to the financial soundness provisions (capital adequacy);
adherence to the settlement parameters and timeframes;
Beneficial Ownership information and disclosure; and
approval of Nominees.
Strate as regulating authority will take or initiate the necessary corrective action whenever
deficiencies are detected. Postponing action could cause an accumulation of adverse effects –
could exacerbate the disruption and threaten the stability of the market.
16.4 Risks Associated with Investing in Bonds
Bonds may expose an investor to one or more of the following risks:-
interest-rate risk
reinvestment risk
call risk
default risk
inflation risk
Exchange-rate risk
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liquidity risk
16.4.1 Interest-Rate Risk
We know that the price of a bond is the present value of its cash flows. As the Yield increases, the
present value of the bond decreases i.e. the price decreases. For example, by altering the Yield of
a 9% coupon, 20 year bond:-
There is an inverse relationship between the Yield and the price of a bond. As the Yield goes up,
the price of the bond goes down. This leads to the rule with bonds when trading on Yield – Buy
high and Sell low!
Furthermore, the price/Yield relationship is not linear i.e. it is not a straight line. It has a convex
shape. The consequence of the ―convexity‖ is that as Yield increases, price decreases at a
decreasing rate and as Yield decreases, price increases at an increasing rate! As can be seen
from the table, for large changes in Yield the percentage price change is not the same for an
increase in Yield to Maturity (YTM) as it is for a decrease in YTM.
Therefore, if an investor has to sell a bond prior to the maturity date, an increase in interest rates
will mean the realization of a capital loss (i.e. selling the bond below the purchase price). This risk
is referred to as interest-rate risk or market risk. This risk is by far the major risk faced by an
investor in the bond market.
The actual degree of sensitivity of a bond‘s price to changes in Yield to maturity depends on
various characteristics of the issue, such as coupon and time to maturity and Yield to maturity
itself. It can also depend on any options embedded in the issue (e.g. call and put provisions).
Required Yield Price of Bond
5% 1,502.05R
6% 1,346.72R
7% 1,213.55R
8% 1,098.96R
9% 1,000.00R
10% 914.21R
11% 839.54R
12% 774.30R
13% 717.09R
14% 666.71R
Price / Yield Relationship
Required Yield
Pri
ce
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Historically people used to look to how long the maturity of the bond was, as to how risky a bond
was; i.e. they believed risk was measured by how long it would take to get your money back!
Therefore people viewed a 10 year bond as more risky than a 5 year bond. One can possibly
excuse their ignorance in that they had very little volatility in interest rates many years ago.
However, it does not take much reasoning to realise that this thinking is flawed. For example if I
issue a 5 year ZAR 100.00 bond with 100% coupon, I get my money back after 1 year not 5 years!
Although time to get your money back is an important component in measuring the risk of a bond,
it is by no means the only component.
16.4.2 Reinvestment Risk
You will only receive a return on a bond equal to the YTM if you hold it to maturity and invest the
coupons at the same rate as the YTM you bought the bond at.
As the above example shows, for a 8% coupon bond, 25 year maturity, trading at par, will have a
market price of ZAR 1 000.00:-
if you consume the coupons when they are paid you will receive ZAR 1 000.00 at
maturity.
if you don‘t reinvest the coupons, you get a return of about 4.5%
only if you re-invest the coupons at 8% do you get a total return on maturity of
8%.
The effect of re-investment on total return
0
1000
2000
3000
4000
5000
6000
7000
8000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
Years
Cash
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The risk that one cannot re-invest the coupons at the same rate (YTM) as to when you purchased
a bond is called re-investment risk.
Reinvestment risk is greater for longer holding periods, as well as for bonds with large, early, cash
flows, such as high-coupon bonds.
It should be noted that interest-rate risk and reinvestment risk have offsetting effects. That is,
interest-rate risk is the risk that interest rates will rise, thereby reducing a bond‘s price. In contrast,
reinvestment risk is the risk that interest rates will fall thereby lowering the return from the re-
investment of the coupons at a lower rate. Therefore if interest rates increase, although the price
of the bond immediately reduces, you stand to earn more from re-investing the coupons at a
higher rate.
16.4.3 Call Risk
Many bonds include a provision that allows the Issuer to retire or ―call‖ all or part of the issue
before the maturity date. When the investor purchases a callable bond, they are also selling a call
option to the Issuer, which gives the Issuer the right to buy back the bond in the future. The Issuer
would do this if the market interest rate drops below the coupon rate, because they could then
refinance the bond at a lower coupon rate.
From the investor‘s perspective there are three disadvantages to call provisions. Firstly, the
investor has uncertainty as to when the bond will mature i.e. the future coupons and principal is
not known with certainty as the Issuer could call the bond back. Secondly, the Issuer will only call
the bonds back when interest rates have dropped, therefore the investor is exposed to
reinvestment risk (i.e., the investor will have to reinvest the proceeds when the bond is called at
relatively lower interest rates). Finally, the benefit from an increasing bond price due to lower
interest rates is reduced, because the price of a callable bond may not rise much above the price
at which the Issuer will call the bond.
The value of the call option is significantly influenced by the volatility of the bond Yields. As a
result, for bonds which have options attached, volatility risk is a further consideration.
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16.4.4 Default Risk
Default risk is also referred to as credit risk, which refers to the risk that the Issuer of a bond will
be unable to make timely principal and interest payments on the issue. We also use the term
default when we refer to settlement, whereby a counterparty is unable to deliver the cash or
Securities on settlement date due to permanent causes such as insolvency.
Default risk is closely monitored in the financial markets and certain organisations, called ratings
agencies, make it their business to publish reports on the default risk of companies and their debt.
We traditionally account for this risk in the real return component of the YTM –the higher the risk,
the higher our required return.
16.4.5 Inflation Risk
We already know that the YTM (required return) of all bonds is made up of an inflationary
component and real return component. Therefore when an investor purchases a fixed coupon
bond, they are implicitly making an assumption as to what they believe inflation will be until the
bond matures. If inflation increases unexpectedly, this reduces the value of the bond.
Unfortunately the investor is still going to receive a fixed coupon (based on what was set at
issuance date).
If you bought a bond with a 10% coupon following which there was a period of rampant inflation,
e.g. Zimbabwe (greater than 500%), the value of the bond will be close to being worthless. For all
but floating-rate bonds and inflation linked bonds, an investor is exposed to inflation risk because
the interest rate the Issuer promised to make is fixed for the life of the issue. To the extent that
interest rates reflect the expected inflation rate, floating-rate bonds have a lower level of inflation
risk.
16.4.6 Liquidity Risk
Liquidity or marketability risk depends on the ease with which an issue can be sold at or near its
value. The primary measure of liquidity is the size of the spread between the bid Yield and the
offer Yield quoted by a dealer. The wider the dealer spread, the more the liquidity risk. In South
Africa, we cannot get a bid offer spread on many bonds except for the more liquid government
―primary dealer bonds‖ or some of the bonds in which there are market markets.
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For an investor who plans to hold the bond until the maturity date, liquidity risk is less important.
16.4.7 Exchange-Rate Risk
Many large portfolios will have exposures to international bonds denominated in foreign
currencies. For non-Rand-denominated bonds (i.e. a bond whose payments occur in a foreign
currency) the future Rand coupons and Rand principal will be unknown because we are not going
to know what the future Exchange rates are. This risk can be mitigated be entering into forward
Exchange rate contracts.
16.5 Systemic Risk
Financial institutions are fundamentally different from other corporations. When a non-financial
company goes insolvent, shareholders, bondholders, and other creditors suffer financial losses.
The overall effects of the failure, however, are limited to direct stakeholders.
In contrast, if a bank should become insolvent, it could be significantly more harmful in that
corporations who have deposits with the bank (i.e. Clients of the bank) would not be able to
access their own cash to run their businesses, which could in turn cause them to also become
insolvent.
Unlike other entities, banks, Participants, brokers and Securities houses play a special role in the
economy. They facilitate payment flows to and from their Clientele. This very role, however, can
also make bank failures much more disruptive for the economy than the failure of other entities.
This threat is called systemic risk.
Systemic risk may be defined as the risk of a sudden shock that would damage the financial
system to such an extent that economic activity in the wider economy would suffer.
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Systemic risk can come from two sources:-
panicky behaviour of depositors or investors. In a bank run, depositors become
worried about the stability of their bank and queue up at the door of the branches
of the bank to withdraw all of their cash e.g. Saambou.
interruptions in the payment system. This can arise from the failure of an
institution or a technological breakdown in the payment system.
A significant milestone in the regulation of banks and Securities institution originated from a
breakdown in the payment system in June 1974 with the failure of Bankhaus Herstatt, a small
German bank active in the foreign Exchange market. The bank received a payment in German
marks and was required to make a dollar payment to its counterparty. Unfortunately the German
authorities shut the bank down in the course on the day before Bankhaus Herstatt could make the
dollar payment creating substantial losses and a serious liquidity squeeze for counterparties.
This event caused severe disruption in the payment system and has become known as Herstatt
risk. The consequence of this event led to a concerted effort by bank regulators to try to avoid
such situations, which ultimately gave birth to the Basel Committee on Banking Supervision
(BCBS). Another objective was to create a system that ensures a level-playing field for global
financial institutions. This came about because at the same time as the failure of Bankhaus
Herstatt, Japanese Banks were expanding aggressively into the global markets and were taking
away a lot of business from their competitor banks due to more lenient Japanese banking
regulation.
The BCBS consists of Central Bankers from the Group of Ten (G-10) countries and its primary
objective is to promote the safety and soundness of the global financial system. The BCBS
established minimum risk-based capital standards that apply to Securities institutions such as
banks. These capital standards have become known as the capital adequacy Rules and are
described in a series of documents known as the Basel Capital Accord. The Basel Capital Accord,
concluded on July 15, 1988, represents a landmark financial agreement for the regulation of
internationally active Securities institutions.
This Basel Capital Accord was basically implemented as the requirements for Securities
institutions and was enforced by the Central Banks of the respective countries globally (including
the countries not part of the BCBS). National regulators are permitted to adopt arrangements that
set higher levels, or other criteria than is laid out by the Accord. Failure to meet the capital
adequacy requirements by a bank will trigger regulatory action which could ultimately affect the
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type of activity in which an institution can engage and will require prompt corrective action,
including the possible liquidation.
Initially the capital charges were based on a set of standard, rigid Rules defined by the Basel
Committee which attempted to create penalties for risky assets. The 1988 Basel Accord only
covered credit risk and amounted to ensuring that bank\Securities institutions had to keep a
certain amount of capital to serve as a buffer against unexpected financial losses, thereby
protecting depositors and financial markets.
These risk-based capital adequacy requirements evolved over time, first covering credit risk,
followed by market risks. The financial markets have developed significantly since the initial
Capital Accord of 1988 which has led to a comprehensive revision to the Basel Accord. This
revision has become known as Basel II.
The new framework is based on three pillars, viewed as mutually reinforcing:-
Pillar 1: Minimum capital requirement.
These regulations are directed at covering credit risk and market risk, as before, with
the addition of operational risk. Relative to the 1998 Accord, banks now have a wider
choice of models for computing their risk charges.
Pillar 2: Supervisory review process.
Relative to the previous framework, supervisors (national regulators) are given an
expanded role. Supervisors are required to ensure that banks have procedures and
processes in place for assessing their overall capital in relation to risks, monitor that
these institutions operate above the minimum regulatory capital standards and take
the necessary corrective action if required.
Pillar 3: Market discipline.
The new accord emphasizes the importance of risk disclosures in financial
statements.
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17 THE BASICS OF THE SYSTEMS
17.1 The need for Straight Through Processing (STP)
The financial services industry has recognised the need to move to more streamlined processes –
more automation and less manual intervention. Such processes can be defined by the principles
of Straight Through Processing (STP). STP in the market refers to the automated, seamless
processing of electronic messages relating to bank payments and Securities trading, together with
the associated transactions such as Corporate Actions, product/Security master file set-up and
customer account information.
Measurement of the level of STP in any organisation or system is against three benchmarks:-
cost;
accuracy of data; and
speed.
The drivers to achieve STP come in many forms – globalisation of financial markets, the rise of e-
business, the industry‘s move towards shorter transaction and settlement cycles, technological
convergence, the migration from cross-border trades to no borders, exponential increases in
message and trading volumes plus the continuing relentless drive to cut operating costs.
Straight Through Processing is the end to end automated processing of transactions between
institutions, from, for example, trade enquiry through to final settlement. It involves the seamless,
electronic transfer of information to all parties involved in the relevant trade cycle utilising
standardised information flows, technologies and infrastructures. Achieving STP is complex.
Institutions need to electronically capture the right information in order to efficiently and effectively
carry out their business from initial enquiry to clearing and settlement. Accessing the appropriate
internal and external systems and integrating these in a seamless value chain can be a major
inhibitor. Nevertheless, a fully integrated STP capability linking all the areas of the transaction
chain – banks, brokers, institutions, Exchanges, private investors and the end-customers - is seen
as a strategic requirement, for it reduces errors, through lost or incorrectly input orders or
instructions, cuts administrative costs, allows for faster clearing and settlement times, and reduces
the risk and cost of capital.
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The means adopted within the Strate environment to achieve this objective, has been the use of
the ISO15022 message standard. Connectivity to Strate is enabled through SWIFT or the Strate
CISCO Wide Area Network (WAN). The Strate WAN supports all the major industry networking
protocols such as Data Link Switching (DLSw+) and IP Security (IPSec) with 3-DES Encryption
and VPN Tunneling, and is a cost effective alternate to SWIFT.
17.2 SWIFT and interfacing with the Securities market
Society for Worldwide Interbank Financial Telecommunication (SWIFT) commenced operations in
Brussels in 1973 with the objective of creating a shared worldwide data processing and
communications link and a common language for international financial transactions.
1977 518 users 17 countries 3,400,000 messages
1983 1 046 users 52 countries 104,100,000 messages
1992 3 582 users 94 countries 405,541,000 messages
2001 7 457 users 196 countries 1,534,000,000 messages
2004 7 599 users 202 countries 2,091,410,051 messages
2005 7,668 users 203 countries 1,221,708,546 messages
2006 8,147 users 208 countries 1,064,212,680 messages
2008 8,740 users 209 countries 3,549,145,540 messages
2013 10 000 users 212 countries 4,580,100,272 messages
Whilst SWIFT provides services to banks, brokers and investment managers and span
infrastructures in payments, trade and treasury divisions, it has played a most critical role in the
Securities industry. SWIFT standards of security and reliability have guaranteed the highest levels
of performance within the Strate system. SWIFT promotes an end-to-end automated
communications infrastructure and the SWIFT standards are the accepted norm for worldwide
financial messaging.
The use of SWIFT messaging standards within the Strate environment ensures that processes
were developed and assets were passed, via means which were effective, secure, practical and
reliable.
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17.3 Bond System Participant Interface
Copy & paste from equities manual….
The following functions can be performed on the Strate Bonds System:-
Issuers
NEW ISSUES
CREATE TOPUPS
CREATE BUY BACKS
DEMATERIALISATION
Central Securities Depository
MASTER DATA MAINTENANCE
RECONCILIATIONS AND BALANCING
IMMOBILISATION OF SECURITIES (WITHDRAWAL / DEPOSITS)
INITIATE & PROCESS REDEMPTIONS
MT598
MT205
Issuers
CSD TS
Participant
JSE BESA
Participant
TRADERS
SARB
CSD
SYSTEM
On-
market /
Off-
market
SYSTEM
Strate
SWIFT
Participants
SAMOS
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DEMATERIALISATION
REPORTS
BILLING
Participants
ACCEPT TOP-UPS / BUY BACKS
SECURITIES ACCOUNT MAINTENANCE
WITHDRAWALS
DEPOSITS
TRANSFERS
PLEDGES
REPORTS
TRADE REPORTING
COMMIT
TRADE EXCLUSIONS
SETTLEMENT SCHEDULES
Strate
DOWLOAD SWIFT MESSAGES
MARK SWIFT FUNDS SETTLEMENT AS COMPLETED
MAINTAIN RELEVANT SETTLEMENT PARAMETERS
TRANSACTION BILLING
BOND STATISICS
JSE/BESA
MASTER DATA MAINTENANCE
MAINTAIN ISSUER /SECURITY LINKS
MAINTAIN RELEVANT MARKET PARAMETERS
MAINTAIN TRADE TYPES
MAINTAIN SECURITY CLASSES / CATEGORIES & TYPES
MARKET PRACTISE MONITORING
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18 GLOSSARY OF TERMS – BONDS`
Affirmation:
When used in the context of a comparison or matching system,
affirmation refers to the counterparty‘s agreement with the terms
of the trade as communicated.
ACSDA:
American Central Securities Depository Association.
AMEDA:
Africa and Middle East Depositories Association.
Arbitrage:
The process of buying and selling similar Securities in different
markets to take advantage of the price difference.
BCP:
Books Closed Period. The period during which the Register of
Members is closed for registration of transfers immediately prior to
a benefit distribution.
BMA:
Bond Market Association.
Beneficial Owner:
The true owner of the Securities, as opposed to the custodian or a
nominee through whom the Securities may be held and/or in
whose name the Securities may be registered.
Benefit distribution:
A distribution made by companies to holders of their Securities in
the form of cash or Securities, usually in proportion to their
holding. Also known as entitlements and Corporate Actions.
BESA / Bond Exchange:
The bond Exchange of South Africa, a Self Regulating
Organisation (SRO) was responsible for the regulation of the bond
market and governed by the Financial Markets Control Act
(FMCA) of 1989 or any replacement Act
BIC code:
Bank Identifier Code. This is the SWIFT identifier code of
organisations with a SWIFT address.
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BOD:
Beginning Of Day - the series of processes executed by the CSD
at the beginning of every Business Day.
Bond Indenture:
A legal contract specifying the terms and conditions between the
Issuer and investor.
Book entry system:
An accounting or ledger system which facilitates the holding and
transfer of Securities electronically. This enables the transfer of
Securities between accounts, without the need for physical
movement of share certificates and other documents.
Broker:
Broker is a trading party, who trades in the Security market either
for itself or for its Clients. Also referred to as a Member or
Authorised User.
Business Day:
Any day which Strate does business, except a Saturday, Sunday
or public holiday or any other day that Strate is closed.
Strate can in it‘s discretion decide to accommodate the opening of
an operational window on a non-Business Day, provided that:-
i) Strate has three Business Days
prior notice of the requirement;
and
ii) all other parties involved have
been informed by the requesting
party.
CA:
See Corporate Actions.
Capital gains tax:
A tax on profits realised from buying a Security at one price and
selling it (or holding it to redemption and then redeeming it) at
another.
CASA:
Custody and Administration of Securities (Act No 85 of 1992) as
amended or replaced from time to time and includes regulations
issued there-under.
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Central Bank: Major regulatory bank in a nation's monetary system, generally
Government controlled. It's role normally includes control of the
credit system, note issuance, supervision of commercial banks,
management of Exchange reserves and the national currency's
value, as well as acting as the Government's banker.
Central Securities
Depository: [CSD]
Strate Limited (―Strate‖), Registration no 1998/022242/06,
licensed as a Central Securities Depository in terms of the FMA.
Central Securities
Depository Participant:
[CSDP]
or “Participant”
a person authorised by a licensed central securities depository to
perform custody and administration services or settlement
services or both in terms of the central securities depository rules,
and includes an external participant, where appropriate
Certificate:
A paper document, also known as physical Securities , attesting
to the holder's ownership of an Issuer's Securities.
Clearing:
The process, in conjunction with settlement, of determining
accountability for the Exchange of money and Securities between
counter parties to a transaction. Clearing creates binding
statements of obligation for Securities and/or cash due.
Clearing and Settlement
System:
The system which collects, processes and transmits the
information which enables settlement.
Client:
Client is a third party, individual or organisation, who through a
Broker or Participant, participates in the Security market for
trading and clearing and settlement.
Collateral:
Security provided by a borrower to a lender to secure Securities
loans.
Commitment or
Commit”:
An electronic instruction that constitutes an undertaking by a
Participant to settle a transaction in uncertificated Securities on
Settlement Date.
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Company: A company incorporated under the Companies Act, 1973 (Act
No. 61 of 1973).
Contract note:
This is a note which the Broker is required to send to a Client
recording the details of a purchase or sale of Securities, including
the commission payable, the basic charge and the settlement
period.
Corporate Actions/event:
An action taken by the Issuer or any third party, that results in
changes to the capital structure or financial position of the Issuer
of a Security, that affects any of the Securities issued by an
Issuer, and which affects the Beneficial Owner of uncertificated
Securities in terms of an entitlement.
Counterparty:
One party to a trade. A trade can take place between two or more
counterparties. Usually one party to a trade refers to its trading
partners as counterparties.
Counterparty risk:
The risk that the counterparty involved in the transaction will
default on its obligations.
Coupon:
The amount of interest an Issuer has agreed to pay through the
life of the bond to the investor.
Cross border trading:
Trading which takes place between persons or entities from
different countries.
Current market value:
The market price of the listed Security at the time of settlement
default by the Member.
Custodian:
An entity which holds Securities in safe custody on behalf of third
parties.
Cum:
Including or qualifying for an entitlement arising from a Corporate
Action.
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Custody:
The safekeeping and administration of Securities and financial
instruments on behalf of third parties.
Declaration Date: (DD)
The date on which the Corporate Action and the Declaration data
(including any conditions precedent to which the Corporate Action
is subject) are announced.
Declaration data:
The minimum information to be announced on the declaration
date. (e.g. Security name, ISIN, event type, LDR.)
Default:
When one party to trade fails to consummate the terms of its
agreement.
Delivery versus
Payment: [DVP]
The good delivery of Securities in exchange for the simultaneous,
final and irrevocable payment of cash.
Dematerialisation:
The elimination of physical certificates or documents of title which
represent the ownership of Securities so that the Securities exist
only as electronic records.
Deposit:
A deposit of Securities for safe custody.
Derivative:
A derivative is an instrument whose value is derived from
something else.
EOD:
End Of Day - the series of processes executed by the CSD at the
end of every Business Day.
Entitlement:
See Benefit Distribution and Corporate Actions.
Election:
The exercise of any or all of the elective, voting, conversion,
redemption or other rights attached to Securities.
Ex:
Excluding or non-qualifying for an entitlement arising from a
Corporate Action.
184
Failed Trade:
Any Securities transaction that does not settle on contracted
Settlement Date because one of the settlement parties does not
meet the settlement conditions. A failed trade may have negative
consequences for the party at fault, including buy-ins and
penalties.
First day to trade: (FDT)
This is the first Business Day on which newly issued Securities
may be traded.
FMA Financial Markets Act (No 19 of 2012)
Foreign investment
restrictions:
Regulations designed to control foreign investment activity in a
particular country. Restrictions are used to maintain and protect a
country's financial system. Restrictions include:
Foreign Exchange controls - to maintain and protect the value of
its currency; Foreign investment regulations - to control foreign.
Form CM42:
A transfer form deed to be executed by the transferor and to be
executed by the transferee if he/she wishes to register the
Security in his/her (transferee's) name. (Used for certificated
Securities).
Forwards:
A forward contract is a contract made today for future delivery of
an asset at a pre-specified price.
Forward-dated trade:
A trade that is to be settled at a future date more than three
Business Days after Trade Date.
FSB:
Financial Services Board.
G30:
The Group of Thirty, a private group of prominent financial
industry participants which in 1989 proposed nine standards for
improving the world Securities industry's efficiency and reducing
settlement risks. The G30 Standards have been adopted as goals
by financial market regulators worldwide.
Gross settlement:
The settlement of transactions on a trade-by-trade basis, without
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aggregation or netting.
GSTPA:
Global Straight-Through-Processing Association.
Inside information:
Is defined as: means specific or precise information, which has not
been made public and which-
(a) is obtained or learned as an insider; and
(b) if it were made public would be likely to have a material effect
on the price or value of any Security listed on a regulated market
Immobilisation:
Immobilisation is the central storage of share certificates or
documents of title in the vault of a CSD. Each depositor
(Participant) is entitled to a share of the depository's entire holding
of each class of Security in the proportion of his/her deposit to the
aggregate holding, and these records are maintained
electronically. Transfers between Participants are recorded
electronically, without the need for any physical movement of the
certificates or documents, unless they are withdrawn from the
depository.
IOSCO:
International Organization of Securities Commissions.
Market capitalisation:
The total valuation of all Securities listed on a stock Exchange or
the total value of particular types of Securities.
Nett settlement:
The settlement of Securities or cash, or both, based on the
arithmetic sum of trades in the same class of Securities for
settlement on the same day by the same person.
Netting:
A process of summing trades to arrive at a nett settlement
position. This means settlement of cash or Securities balances by
summing all credits and countervailing debits for a given day or
session, then moving cash or Securities only in the amount of the
nett total.
Nominee:
Person that acts as the registered holder of Securities or an
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interest in Securities on behalf of other persons.
Non-standard trade:
A trade which is to be settled less than three Business Days after
Trade Date.
Off-market trade or
Off-Exchange or OTS:
An Off-market order is a trade in uncertificated Securities which
is not concluded through the Exchange and is reported by the
seller and purchaser of the uncertificated Securities to the
relevant Participant for settlement through the CSD.
Omnibus account:
An account held in the name of an entity or person which may be
used for placing and clearing the trades of one or more
undisclosed customers of the account holder.
On-market trades or On-
Exchange or BMA Order:
An On-market trade is a transaction (buy or sell) in uncertificated
Securities which is concluded through the Exchange (via a
broker) for settlement through the CSD.
Payment Date: (PD)
This is the date on which entitlements will be paid or posted.
Payments system:
The system used to achieve settlement of cash in a Securities
transaction.
Pledge:
The use of Securities as collateral in a financial transaction.
Securities may be pledged electronically within a central
depository, or physically outside of a central depository.
Principal/Nominal
Amount/ Face Value/Par:
This is the amount that will be paid at maturity.
Proxy:
Written authority to act or speak for an absent shareholder at
shareholder meetings.
Proxy voting:
aa
AActing or speaking for an absent shareholder on issues
surrounding the management of the company at shareholders'
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meetings.
Ratio:
Basis of Security entitlement reflected as a ratio.
Recall:
The right exercised by a lender whereby a borrower is requested
to return the Securities that have been borrowed within a specified
time frame.
Refinance:
The process whereby a borrower closes out a loan with one
lender and re-borrows it from another lender at a cheaper rate.
Redemption:
Partial or full return of the debt or Securities to the Issuer in
Exchange for a cash value.
Register of Members:
A register maintained by an Issuer or his Agent, which contains
the identity and shareholdings of holders of Securities. It is also
known as the register of shareholders.
Registration:
The recording of legal title to Securities in the books of the
Issuer.
Rematerialisation:
The issuance of certificates to permit the physical withdrawal of
previously dematerialised Securities positions held at the CSD.
Retail investor:
Individual investors who generally deal in smaller amounts than
the professional or institutional investors.
Rolling settlement:
A settlement environment in which transactions (Securities and
funds) become due for settlement a set number of Business
Days after Trade Date.
RTGS:
Real Time Gross Settlement.
S:
Settlement Date.
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SAFEMS: South African Futures Exchange Management System.
SAMOS:
South African Multiple Options System - National Payments
System of SARB.
SARB:
South African Reserve Bank.
SCA:
Safe Custody Account.
SRO:
Self Regulatory Organisation.
SSA:
Securities Services Act (No 36 of 2004).
Standard trade:
Trade that is to be settled on the third Business Day after Trade
Date. This is also referred to as a ―Spot‖ trade.
Secured versus
Unsecured Debt:
Secured debt is backed by a legal claim on some specified
property/collateral. The debt holders (lenders)will have a senior
claim on the assets in the event of default.
Settlement:
The completion of a transaction, whereby Securities and
corresponding cash are delivered and received, into the
appropriate accounts of Clients.
SFIDvP:
Simultaneous, Final, Irrevocable, Delivery versus Payment.
SI:
Settlement Instruction.
Trade reversal:
A reported Member-Client trade which cannot be settled by the
Client‘s Participant or by the Member owing to a lack of
Securities, cash or settlement instructions on the part of the
Client, and which is accordingly rescheduled for settlement on a
subsequent date.
Transfer secretaries:
An individual or organisation that maintains the Register of
Members on behalf of the Issuer of Securities.
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T: Trade Date.
Trade Matching:
Matching of buy and sell orders.
Trade reversal: A reported Member-Client trade which cannot be settled by the
Client‘s Participant or by the Member owing to a lack of
Securities, cash or settlement instructions on the part of the
Client, and which is accordingly rescheduled for settlement on a
subsequent date.
Yield to Maturity: (YTM)
The ―Yield to Maturity‖ (YTM) of a bond can be equated to the
required return an investor requires from the bond given the risk
profile of the Issuer.
