The Saudi Arabian Monetary Authority ("SAMA") issued the SAMA Rules on Trade Repository Reporting & Risk Mitigation Requirements for Over-the-Counter ("OTC") Derivatives Contracts (the "Rules") in November 2019, replacing the existing Saudi Arabian Trade Repository rules previously issued through SAMA circular no. 341000033330. The part relating to 'trade reporting requirements' of the Rules came into effect on 1 January 2020 (see part II of this article), while the 'risk mitigation requirements' portion came into effect on 1 April 2020 (see part III of this article).
In an inauguration ceremony of the National Trade Repository (organised by Saudi Credit Bureau ("SIMAH")), which we understand to be the SAMA authorised trade repository operator ("TR Operator") referenced in the Rules, the Governor of SAMA, Dr Ahmad Alkholifey, noted the role that unlisted financial derivative markets in key markets played in the global financial crisis in 2008, which was mainly due to the fact that OTC contracts were flexible in both their terms and conditions and their structures. He further noted that this flexibility had weakened the ability of financial institutions to assess potential risks of their operations and then respond appropriately to manage them in a way that contributes to the overall health of the financial system.
As a result of the risk posed by OTC contracts, the G20 Summit in Pittsburgh in September 2009 resolved to take measures to ensure that standardised contracts for OTC derivatives should be cleared via central clearing houses. Trade repositories must also be informed of all financial derivative contracts. In response thereto, SAMA has implemented the Rules and mandated compliance with the requirements of the Payments and Infrastructure Markets Committee ("CPMI") and the International Organization of Securities Authorities ("IOSCO"). The Rules themselves are limited at present to apply to OTC-traded (cleared or non-cleared) interest rate and foreign exchange derivatives, and impose trade reporting and other risk mitigation requirements (and do not therefore impose an obligation to centrally clear derivatives).
Trade reporting requirements
Scope of reporting
The Rules apply to SAMA regulated banks (including branches of foreign banks) and set out the types of OTC derivative transactions that fall within their scope, and thus must be reported to the TR Operator. Such transactions comprise dealings in OTC derivatives where the counterparty is: (a) a licenced bank in the Kingdom of Saudi Arabia ("KSA") (in the case of a locally incorporated bank) or a KSA branch (in the case of a foreign bank); (b) a foreign financial counterparty; (c) a KSA or a foreign non-financial counterparty; or (d) a central counterparty ("CCP") if the transaction is novated to a CCP.
Exemptions apply to certain intragroup transactions. Reportable transactions also exclude FX transactions settled by way of delivery of the relevant currencies within two business days and, under most circumstances, transactions booked in a bank's local or overseas subsidiaries.
Manner of reporting
Banks are required to report electronically directly to the TR Operator, and this function may not be outsourced by the TR Operator to a third party. The reporting service agreement entered into between the bank and the TR Operator must contain a provision granting consent to the bank for the reporting of trade data to the TR Operator by its counterparties. This is deemed necessary to alleviate any potential concern on data confidentiality from bank counterparties, particularly of those with no reporting obligation under the Rules.
Moreover, the TR Operator has designed specific templates for reporting the details of the reportable transactions, primarily relating to the economic terms of a transaction and information essential for administrative purposes, which the bank is expected to complete. Reporting is obligatory when a reportable transaction is executed by a bank for the first time and when there are subsequent reportable business events, until the transaction is fully terminated (including through novation).
Timing of reporting
Under the Rules, business events are expected to be reported by adopting a life cycle approach, under which each business event will be reported according to the T+1 timeline (i.e. before 23:59:59 of the next business day). A "business day" is defined to exclude Fridays, Saturdays and Saudi public holidays. If a transaction is cancelled or fully terminated within the T+1 timeline, then reporting is generally not required, unless such cancellation or termination was done for the purposes of subjecting the transaction to central clearing (i.e. novation).
Risk mitigation requirements
The Rules require banks, which enter into non-centrally cleared OTC derivative transactions, to implement specified risk mitigation requirements (summarised below), which result in a number of instances in a requirement to re-consider the contractual arrangement in place by the bank with its counterparties:
Trading relationship documentation and confirmation
Pursuant to the Rules, documentation of the trading relationship should: (a) provide legal certainty; (b) include all material rights and obligations of counterparties concerning their trading relationship; and (c) be executed in writing or through other equivalent non-rewritable, non-erasable electronic means (e.g. emails). The Rules list examples of material rights and obligations, and indicate that such documentation must be retained for a minimum of ten years after the termination, maturity, or novation of any non-centrally cleared OTC derivative contracts.
As for trade confirmations, banks are required to confirm material terms of OTC derivatives transactions as soon as practicable after execution and implement appropriate policies and procedures to ensure a two-way confirmation is executed with a counterparty. Similar to the aforementioned requirements for documentation, confirmations should be executed in writing through: (a) paperless, non-erasable, automated methods where it is reasonably practicable for the bank; (b) manual means;19 or (c) other paperless, non-erasable electronic means.
Banks are required to agree with their counterparties the process for determining the values of the non-centrally cleared OTC derivative transactions in a predictable and objective manner. The process should cover the entire duration of the non-centrally cleared OTC derivative transaction, at any time from the execution of the contract to the termination, maturity or expiration thereof. All agreements on the valuation process should be documented in the trading relationship documentation or trade confirmation and may include matters such as the approach to valuation, the key parameters and the data sources for such parameters.
Portfolio reconciliation and compression
Banks are required to include portfolio reconciliation methods or procedures, as agreed upon with its financial parties, and another portfolio reconciliation procedure with its non-financial counterparties. Both should be designed to ensure an accurate record is kept of the material terms and valuations of non-centrally cleared in-scope OTC derivative contracts, and identify and resolve discrepancies in the material terms and valuations in a timely manner with each counterparty. The scope and frequency of reconciliation may be determined by the bank, taking various factors into consideration, such as the risk exposure profile, size, volatility and number of non-centrally cleared OTC derivatives transactions which the bank has with that counterparty.
Similarly, banks are required to establish and implement methods and procedures to regularly assess and engage in portfolio compression, as appropriate, in respect of non-centrally cleared OTC derivative portfolios. When determining whether portfolio compression is necessary, the aforementioned factors may be considered and should be proportionate to the level of exposure or activity of the bank.
Governance and dispute resolution
With respect to governance, the Rules provide that the bank's board or its delegated authority must approve the "policies and procedures governing trading relationship documentation, trade confirmation, valuation, portfolio reconciliation, portfolio compression, and dispute resolution", which shall also be subject to periodic independent review.
Banks must agree and document with counterparties the mechanism or process for determining when discrepancies in material terms or valuations should be considered as disputes and how they expect to resolve such disputes. The bank should implement clear criteria to be used when determining whether a dispute is material; where a material dispute is found, it must be escalated to senior management and the board of the bank. Material disputes that remain unresolved for more than fifteen (15) business days must be promptly reported to SAMA.
The Rules have a high degree of similarity with applicable international reporting and trade repository standards that have been enacted globally. At present, no central clearing obligation applies. Reliance on international protocols in relation to the implementation of documentary changes in response to international trade reporting and risk management standards should be avoided and changes to OTC contractual documentation should be instead considered on a case-by-case basis.
It is worth noting that the Rules provide that further reporting requirements will be enforceable at a future date in respect of other OTC derivative transactions relating to any of the following asset classes: equity, credit and commodities.
19 It is unclear what "manual means" entail, as the Rules appear to be silent in this regard.