3. Section B
3.1 Risk Mitigation Requirements for Non-Centrally Cleared Over-the-Counter (OTC) Derivative Contracts
3.1.1 Trading Relationship Documentation
1. The trading relationship documentation should:
a) Provide legal certainty for non-centrally cleared over-the-counter derivatives contracts;
b) Include all material rights and obligations of counterparties concerning their trading relationship with regard to non-centrally cleared over-the-counter derivatives contracts. Such rights and obligations of the counterparties may be incorporated by reference to other documents in which they are specified; and
c) Be executed in writing or through other equivalent non-rewritable, nonerasable electronic means (without prejudice to subparagraph (b) above).
2. The material rights and obligations referred to in paragraph 1(b), where relevant, may include:
a) Payment obligation;
b) Netting of payments;
c) Events of default or other termination events (For instance, any rights to early termination)
d) Calculation and any netting of obligations upon termination;
e) Transfer of rights and obligations;
f) Governing law;
g) Processes for confirmations, valuation, portfolio reconciliation and dispute resolution; and
h) Matters related to credit support arrangements (e.g. initial and variation margin requirements, types of assets that may be used for satisfying such margin requirements and any asset valuation haircuts, investment and rehypothecation terms for assets posted to satisfy such margin requirements, guarantees and custodial arrangements for margin assets such as whether margin assets are to be segregated with a third party custodian).
3. The retention period for trading relationship documentation should be a minimum of ten (10) years after the termination, maturity or assignment of any non-centrally cleared over-the-counter derivatives contracts.
3.1.2 Trade Confirmation
4. Banks are required to confirm the material terms of a non-centrally cleared over-the- counter derivatives transaction as soon as practicable after execution of the transaction, including a new transaction resulting from novation. Banks are also required to adopt policies and procedures to confirm material changes to the legal terms of, or rights and obligations under, the non-centrally cleared over-the-counter derivatives contract, such as those relating to termination prior to scheduled maturity date, assignment, amendment or extinguishing of rights or obligations.
5. The material terms confirmed should include terms necessary to promote legal certainty to the non-centrally cleared over-the-counter derivatives transaction, including incorporating by reference, the trading relationship documentation or any other documents that govern or otherwise form part of the trading relationship documentation.
6. The confirmation should be executed in writing through:
A. Non-rewritable, non-erasable automated methods where it is reasonably practicable for the bank to do so;
B. Manual means; or
C. Other non-rewritable, non-erasable electronic means (such as email).
7. Banks are required to implement appropriate policies and procedures to ensure a two-way confirmation is executed with a counterparty (financial and non-financial).
8. For non-centrally cleared over-the-counter derivatives transactions concluded after the bank’s dealing system cut off time, or with a counterparty located in a different time zone, banks are required to execute the confirmation as soon as practicable.
3.1.3 Valuation
9. Banks are required to agree with their counterparties the process for determining the values of the non-centrally cleared over-the-counter derivatives transactions in a predictable and objective manner. The process should cover the entire duration of the non-centrally cleared over the-counter derivatives transaction, at any time from the execution of the contract to the termination, maturity, or expiration thereof. All agreements on 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.
10. The valuation determinations should be based on economically similar transactions or other objective criteria. Banks should be able to compute the valuation internally and be able to corroborate any valuations done by their counterparts or third parties. Where a bank uses a proprietary valuation model, it must use a model employing valuation methodologies with mainstream acceptance. If new methodologies are used, these should have a sound theoretical basis and the bank will need to justify their use, e.g. by showing that the new methodology addresses a limitation of an existing methodology or improves the reliability of the valuation.
11. Banks are required to perform periodic review of the agreed upon valuation process to take into account any changes in market conditions. Where changes are made as a result of the review, the relevant documentation must be updated to reflect such changes.
12. Banks are required to agree on and document:
A. The alternative process or approach by which the bank and its counterparty will determine the value of a non-centrally cleared over-the counter derivatives transaction in the event of the unavailability, or other failure, of any inputs required to value the transaction;
B. Any changes or procedures for modifying the valuation process at any time so long as the agreements remain consistent with the applicable law; and
C. How a dispute on valuation, if it arises, should be resolved.
3.1.4 Portfolio Reconciliation
13. Banks are required to include in their policies and procedures –
A. The process or method for portfolio reconciliation that it has agreed with its financial counterparties; and
B. The process or method that reflects its efforts to conduct portfolio reconciliation with its non-financial counterparties, e.g. by providing, on a periodic basis, a non-financial counterparty with a statement on the material terms and valuations of the non-centrally cleared over-the-counter derivatives contracts entered into with that non-financial counterparty.
14. The process or method of portfolio reconciliation should be designed to ensure an accurate record of the material terms and valuations of the non-centrally cleared over- the-counter derivatives contracts, and identify and resolve discrepancies in the material terms and valuations in a timely manner with the counterparty.
15. Banks are required to determine the scope and frequency of portfolio reconciliation with a counterparty, taking into account the risk exposure profile, size, volatility and number of non-centrally cleared over-the-counter derivatives transactions which the bank has with that counterparty. Portfolio reconciliation should be carried out more frequently where the bank has a higher number of outstanding transactions with its counterparty.
16. Banks are required to establish and implement policies and procedures to ensure that the material terms are exchanged and valuations (including variation margin) are reconciled with counterparties, at regular intervals. The frequency of portfolio reconciliation with each counterparty should be commensurate with the counterparty’s risk exposure profile and the number of outstanding transactions.
3.1.5 Portfolio Compression
17. Banks are required to consider factors such as the risk exposure profile, size, volatility and number of outstanding transactions in assessing whether to conduct a portfolio compression with one or more counterparties. Banks are required to establish and implement policies and procedures to regularly assess and engage in portfolio compression as appropriate in respect of non-centrally cleared OTC derivative portfolios. This should be proportionate to the level of exposure or activity of the bank.
3.1.6 Dispute Resolution
18. Banks are required to agree and document with their counterparties the mechanism or process for determining when discrepancies in material terms or valuations should be considered disputes and how such disputes should be resolved as soon as practicable.
19. Material disputes should be escalated to senior management and the Board of the bank. There should be clear criteria used by the bank to determine when a dispute is considered material.
20. Banks are required to promptly report to SAMA material disputes (as determined by the bank in 19 above) which remains unresolved beyond 15 business days.
3.1.7 Governance
21. The policies and procedures governing trading relationship documentation, trade confirmation, valuation, portfolio reconciliation, portfolio compression, and dispute resolution should be approved by the board of directors or its delegated authority, and be subject to periodic independent review.