On December 16, 2011, Quebec's financial services regulator, the Autorité des marchés financiers (AMF), tabled proposed amendments to the Derivatives Regulation (Quebec) (QDA) which are intended to implement the provisions of the Derivatives Act (Quebec) governing "qualified persons" (the Proposals) In addition to the derivatives dealer and adviser registration requirements applicable to dealers and advisers in derivatives (the "derivatives registration requirement"), the QDA requires that a person, other than a regulated entity1 who "creates or markets a derivative" must be qualified by the AMF, as prescribed by regulation, before the derivative is offered to the public (the "qualification requirement"). Under an amendment not yet in force, the qualified person must also have the marketing of the derivative authorized by the AMF, as prescribed by regulation (the "authorization requirement").
As outlined below, the Proposals would, among other changes, significantly increase the disclosure, compliance and reporting requirements applicable to Canadian and foreign intermediaries offering listed derivatives products in the Quebec market to any person, or OTC derivatives to persons other than "accredited counterparties", unless a discretionary exemption can be obtained. The Proposals are published for a period of 30 days after which the AMF may submit the Proposals to the Minister of Finance for approval, with or without amendments. The AMF is accepting written comments on the Proposals until February 1, 2012.
Market participants conducting derivatives-related activities in the Quebec market should carefully review their product lines, and seek detailed advice as to whether the new qualification/authorization requirements will impact this business and what actions should be taken in contemplation of these new rules.
Impact of the Proposals
The Proposals are significant for several reasons.
First, the Proposals, if adopted, would round out the basic framework governing the regulation of both OTC and standardized derivatives first introduced in Quebec in 2009. They follow on the enactment of more detailed amendments to the "qualified persons" provisions of the QDA effective November 30, 2011, as described in our other post dated today.
Second, the Proposals represent an innovative means of regulating the offering of derivatives to persons other than eligible counterparties outside of the conventional prospectus-based framework of securities regulation which has generally been employed by regulators in other Canadian jurisdictions to regulate trades in all or certain categories of derivatives. The basic mechanics of this new qualification requirement are outlined below.
Third, and more importantly, upon the adoption of these rules, material transitional relief issued by the AMF in conjunction with the implementation of the QDA would lapse.2 The effect of this change is that:
- OTC derivative transactions involving eligible "accredited
counterparties" in Quebec would continue to be exempt from the
derivatives registration and the qualification/authorization
requirements.
- Market participants offering OTC derivatives to Quebec-resident
persons other than qualified "accredited counterparties"
would now be subject to the derivatives registration and the
qualification/authorization requirements.
- Market participants offering standardized (listed) derivatives to any Quebec-resident person (including to "accredited counterparties") could no longer rely on blanket and other transitional or discretionary relief previously issued by the AMF. These market participants would have to apply to the AMF for qualification/authorization within 30 days of the coming into force of the new rules and, as the case may be, comply with the derivatives registration requirement (unless an exemption is available)3, or obtain separate discretionary relief from the AMF.
The Proposals do not specify how much time, if any, will be given to the market to transition to the new "qualified persons" regime. The QDA came into force in 2009 with a six-month transition period. It is to be hoped that, in this period of intense regulatory change (particularly in the major derivatives markets outside Canada), the final rules will include a transition period at least that long.
Key Features of the Qualification Process
As noted above, the Proposals build on recent amendments to the QDA made under Bill 7, An Act to amend various legislative provisions mainly concerning the financial sector which further flesh out the cornerstones of the qualification/authorization requirements (the "qualified persons amendments").
The qualified persons amendments, once in force, would introduce general provisions governing the initial and ongoing business conduct of "qualified persons", including requirements that a qualified person have an effective corporate and organizational structure with adequate personnel, financial and technological resources and appropriate business policies and procedures and governance practices; that it take the necessary measures to ensure the security and reliability of its transactions and activities; that it offer derivatives to the public through a registered dealer or register as a dealer; that it comply with initial and periodic reporting requirements; and that it comply with safekeeping and segregation requirements.
The Proposals would further provide that:
- A qualified person must participate in a contingency fund that
protects the assets entrusted to it by its counterparties, or
comply with minimum working capital requirements as calculated on
Form 31-103F1 Calculation of Excess
Working Capital4 or under the
Joint Regulatory Financial Questionnaire and Report of the
Investment Industry Regulatory Organization of Canada
(IIROC). The minimum required capital would be C$20 million
plus 5% of amounts due to counterparties to a derivative that a
qualified person is marketing which exceed C$10 million.
- A qualified person must maintain proper books and records to
ensure efficient operations and demonstrate compliance with the
QDA.
- A qualified person must have an emergency and contingency plan
in place to ensure business continuity.
- An applicant for qualification must provide documents in
support of its compliance with specified requirements of the
qualified persons amendments, a completed Schedule B
Application for Qualification (including background
organizational, business and regulatory compliance information on
the applicant, and information on distribution methods, client
disclosure, electronic systems and operations and audited financial
information). The Schedule B application must be accompanied
by a completed Form 33-109F4 Registration of
Individuals and Review of Permitted Individuals
for each of its "permitted individuals"(e.g., directors,
the chief executive officer, the chief financial officer, the chief
operating officer and individuals having beneficial ownership of,
or direct or indirect control or direction over, 10% of the voting
securities of the applicant) unless the Form 33-109F4 information
is already on file with the AMF (e.g., as in the case of applicants
which are already Quebec-registered firms).
- An applicant for authorization must provide a completed
Schedule C Application for Authorization to Market a
Derivative, including a detailed description of the
derivative, and associated trading methods, prospective clients,
risks and costs and fees. The AMF must make any objection to
an application for authorization within 21 days after submission of
the application.
- Designated information set out in the Schedule B and Schedule C
applications must be included in the risk information document that
a derivatives dealer must provide to its clients before the first
trade in a derivative.
- A qualified person must notify the AMF "without
delay" if its excess working capital or risk adjusted capital
calculated as described above is less than zero or in the case of
"any failure, malfunction or material delay of [its] systems
or equipment".5
- A qualified person must notify the AMF of any material change
to the information provided in its applications for qualification
or authorization, within 7 days of the change. The rules
provide definitions of what constitutes a "material
change" in respect of a qualified person or a
derivative. Other changes to such information would have to be
notified within 30 days following the end of the quarter in which
the change occurred.
- A qualified person must also notify both the AMF and "the
counterparties to a derivative that [it is] marketing, including
counterparties waiting to trade such a derivative" of
"any change that could affect the trading of such a derivative
or the transactions under way in respect of such a derivative at
least 10 days prior to the change". This 10-day prior
notice requirement raises a number of conceptual and practical
issues, including the absence of any materiality threshold, the
absence of any guidance as to the type of change that would trigger
the notice requirement and the issue of changes that may arise over
which a qualified person has no reasonable ability to give a 10-day
prior notice, particularly in the case of a qualified person that
is part of a global financial services group and in a dynamic
financial markets environment. Hopefully, this requirement
will be modified or further clarified through additional
guidance.
- A qualified person must, within 90 days after the end of its
financial year provide to the AMF:
- audited financial statements prepared in accordance with
Canadian GAAP applicable to publicly accountable enterprises (there
would appear to be no provision for the delivery of financial
statements prepared in accordance with IFRS, U.S. GAAP or other
accounting principles as contemplated in Regulation 52-107 respecting Accounting
Principles and Auditing Standards), an adjustment to the Proposals
which should be contemplated given the number of foreign
stakeholders potentially affected by these rules;
- the number of contracts entered into in Quebec and their
notional value for all derivatives offered to the public during the
latest fiscal year; and
- the percentage of contracts, for each of the latest four quarters, that were profitable for counterparties.
- audited financial statements prepared in accordance with
Canadian GAAP applicable to publicly accountable enterprises (there
would appear to be no provision for the delivery of financial
statements prepared in accordance with IFRS, U.S. GAAP or other
accounting principles as contemplated in Regulation 52-107 respecting Accounting
Principles and Auditing Standards), an adjustment to the Proposals
which should be contemplated given the number of foreign
stakeholders potentially affected by these rules;
Interested stakeholders should consider submitting comments on
these proposals by February 1, 2012.
Footnotes
1. The term "regulated entity" includes exchanges, alternative trading systems, clearing houses, trade repositories and self-regulatory organizations that are subject to the requirement to be recognized by the AMF.
2. In connection with the adoption of the QDA on February 1, 2009, the AMF issued a discretionary blanket decision on January 22, 2009 (the "AMF Blanket Decision") by way of broad transitional relief (AMF decision No. 2009-PDG-0007 (January 22, 2009), as supplemented and extended by AMF notices of October 2, 2009 and September 24 2010). The AMF Blanket Decision sets out a temporary exemption from the derivatives registration requirement and the derivatives qualification requirement for specified derivatives activities carried out solely with "accredited investors" as defined under Regulation 45-106 respecting Prospectus and Registration Exemptions (45-106).
3. The Derivatives Regulation (Québec) (the "QDR") provides an exemption (the "standardized derivatives exemption") from the derivatives registration requirement under the QDA for a person authorized to act as a dealer or an adviser or authorized to exercise similar functions under legislation applicable in a jurisdiction outside Quebec where its head office or principal place of business is located to the extent it carries on business solely for an "accredited counterparty" and its activity involves a standardized derivative that is offered primarily outside Quebec. The standardized derivatives exemption does not, however, provide an exemption from the derivatives qualification or authorization requirements.
4. Regulation 31-103 respecting Registration Requirements, Exemptions and Ongoing Registrant Obligations.
5. The term "material" would appear to qualify the terms "failure", "malfunction" or "delay" in the governing French language version. We would hope that this technical translation error will be rectified in the final provision.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
