fsp and odp Regulation

General Overview

South African broker regulation falls under the jurisdiction of the Financial Sector Conduct Authority (FSCA), with brokers operating in South Africa obligated to adhere to the licensing criteria established by the FSCA.

For South African brokers to conduct business, they are mandated to secure two licenses. First and foremost, a Financial Services Provider (FSP) license is essential, encompassing the relevant categories as stipulated by the Financial Advisory and Intermediary Services Act (FAIS). Additionally, since its introduction in August 2018, an Over The Counter Derivatives Provider (ODP) license is required to offer Over The Counter (OTC) products, such as CFDs and options, to South African clients.

Nonetheless, an ongoing dispute has arisen between brokers and the FSCA regarding the necessity of an ODP license if the FSP exclusively acts as an intermediary to an offshore execution entity, carrying out trade execution outside of South Africa. Some international brokers presently utilize their South African FSP solely for marketing and distribution purposes and classify themselves as intermediaries solely under the FAIS Act. In this perspective, these brokers argue that this negates the requirement for an ODP license.

However, possessing a FAIS license does not grant a trading platform the authority to act as the principal issuer of over-the-counter (OTC) derivatives, such as contracts for difference (CFDs), in South Africa. To engage in such activities, the entity must secure an Over-The-Counter Derivative Provider (ODP) license.

DLA Piper's legal director, Bridget King, and associate, Byron Bromham, emphasised the importance of investors being well-informed about the licensing prerequisites for engaging in derivative trading, particularly in the case of CFDs. Engaging in CFD trading with service providers falsely representing themselves as licensed FSPs and/or ODPs, when they are not, exposes the public to substantial risks. King and Bromham advised investors to verify an entity or individual's registration as an FSP and/or an authorized ODP with the FSCA (via the toll-free number 0800 110 443) before embarking on CFD trading through any online platform.

For South African traders, it is prudent to opt for brokers who fully comply with all FSCA regulatory mandates. Brokers who operate without an ODP license, even if they possess authorised FSP status, run the risk of facing severe consequences, as has been demonstrated on previous occasions by the FSCA.

What is an FSP license

In South Africa, an FSP (Financial Services Provider) license is required for businesses and individuals engaged in providing financial services, including derivatives broking. This license is regulated by the Financial Sector Conduct Authority (FSCA) and is designed to ensure that financial services providers adhere to regulatory standards and provide services that are fair, transparent, and safe for clients.

In the context of derivatives broking in South Africa, an FSP license is necessary for firms or individuals who offer services related to derivatives trading, which may include trading in futures, options, and other derivative instruments. The license demonstrates that the broker or firm complies with the regulatory requirements set forth by the FSCA. These requirements typically encompass aspects like capital adequacy, compliance with the Financial Advisory and Intermediary Services (FAIS) Act, professional conduct, risk management, and client protection.

To obtain an FSP license for derivatives broking in South Africa, an applicant needs to:

1. Meet the regulatory and compliance requirements outlined by the FSCA, which may include minimum capital requirements, risk management protocols, and operational standards.

2. Appoint a compliance officer and a key individual who meet the necessary qualifications and experience as per the FSCA's guidelines.

3. Ensure that the business's operations are aligned with FAIS regulations, which cover various aspects of financial advisory and intermediation.

4. Submit a comprehensive application to the FSCA, including the necessary documentation and information to demonstrate compliance.

5. Comply with ongoing regulatory requirements, reporting, and monitoring as stipulated by the FSCA.

It's essential for businesses and individuals involved in derivatives broking in South Africa to obtain and maintain their FSP licenses to operate legally and provide their services in a regulated and compliant manner. The specific requirements and application process may change over time, so it's important to consult with the FSCA or a legal advisor for the most up-to-date information on FSP licensing for derivatives broking in South Africa.

What is an ODP license

As a member of the G20, South Africa has recently introduced changes to the trading of OTC derivatives. These changes are aimed at enhancing financial market governance and oversight, particularly in the realm of over-the-counter derivatives like Contracts for Difference (CFDs). The modifications involve central clearing, heightened operational requirements, adjustments to margin requirements for non-centrally cleared derivatives, and the mandatory reporting of all transactions to a trade repository.

This heightened scrutiny of both existing and new Financial Sector Conduct Authority (FSCA) licensed CFD and forex brokers is poised to bring about greater transparency in OTC market dealings. Consequently, this will have a notable impact on all forex and CFD brokers in the South African market, as they must adhere to stringent guidelines governing their operations. These operations will now be subject to close monitoring by the financial regulator, with increased regulatory obligations for both clients and brokers.

But what exactly are OTC Derivatives and CFDs? Derivatives are essentially contracts between two parties whose value is derived from an underlying asset's price, even though the parties don't possess the actual asset.

One prominent example is online forex trading or CFDs, which involve contracts between traders and brokerages for the buying or selling of currencies, stock CFDs, and more. OTC derivatives, on the other hand, are financial contracts negotiated directly between two parties at an agreed-upon price. The issuer of OTC derivative contracts is referred to as an OTC Derivatives Provider (ODP).

CFDs represent a specific form of OTC derivative, where the difference in price is settled in cash between the opening and closing trade balances of the two parties involved, namely the ODP and the client. CFDs are a popular choice for trading forex, indices, and commodities online in South Africa.

So, who is required to apply for the FSCA's ODP license? All OTC derivative brokers are mandated to obtain a license under the new ODP regime, effective from August 8, 2018, with subsequent extensions to the deadline. Any provider offering OTC derivative products to South African clients must apply for the FSCA's ODP licensing scheme and receive approval before legally providing such contracts. This new licensing framework primarily affects CFD and forex brokers, as well as banks and non-banking financial institutions that offer OTC derivatives to their clientele.

To understand the ODP regulations in South Africa, it's important to recognise that these reforms resulted in the reorganisation of the country's financial administration. The establishment of a Prudent Authority under the South African Reserve Bank (SARB) and the Financial Sector Conduct Authority (FSCA), following the Twin Peaks model, were significant outcomes.

Under the Twin Peaks model, the FSCA serves as the market conduct regulator, overseeing the practices of all financial market entities and acting as the primary regulator of the OTC derivatives market. The Twin Peaks model, which is successfully implemented in several developed countries, separates the goals of financial stability and code of conduct for market participants and investor protection.

Since 2018, OTC derivative providers (ODPs) fall under the regulation of the Financial Sector Conduct Authority (FSCA). The 2018 FSCA's ODP regulation mandates that all existing OTC derivative providers apply for a license to continue their services in South Africa and report all transactions to the FSCA's trade depository.

These regulations require due diligence, capital adequacy ratio compliance, and reporting of all transactions to an authorised trade repository. Their purpose is to enhance transparency and create a robust regulatory framework for OTC forex and CFD instruments. Since their implementation, these regulations have prompted many brokers to seek compliance, resulting in the revocation of licenses for non-compliant brokers. This has ultimately benefited South African investors and brokers by bringing greater transparency to the previously unregulated OTC derivatives sector and increasing trust in FSCA-regulated brokers for the safety of their funds.