On November 14, 2013, the Ontario Securities Commission published in final form OSC Rule 91-506 Derivatives: Product Determination (the Scope Rule, OSC Rule 91-507 Trade Repositories and Derivatives Data Reporting (the TR Rule and companion policies with respect to both of these rules.
The Scope Rule and the TR Rule are part of international efforts to bolster the oversight and monitoring of the trading of derivatives in order to identify and address systemic risk and the risk to investors. The Scope Rule and the TR Rule will apply only in Ontario; however, other jurisdictions are working to introduce rules/regulations that are intended to be consistent across Canada and harmonized with international standards1 On November 14, 2013, the Autorité des marchés financiers and the Manitoba Securities Commission also published similar rules for their respective provinces.
Scope Rule
The purpose of the Scope Rule is to define the types of derivatives that will be subject to reporting requirements under the TR Rule. The Scope Rule only applies to the TR Rule and does not determine how derivatives will be treated for any other purposes. In particular, the OSC notes that OSC Staff Notice 91-702 - Offerings of Contracts for Differences and Foreign Exchange Contracts to Investors in Ontario will continue to apply.
The Scope Rule prescribes that certain types of contracts are not derivatives for purposes of the TR Rule and, therefore, are excluded from the requirement to be reported under the TR Rule. Such contracts include insurance and annuity contracts with a licensed insurer, and contracts for the purchase and sale of currency or the delivery of other commodities (subject to prescribed conditions). Derivatives traded on certain prescribed exchanges are excluded from the definition because trading on the exchange provides a measure of transparency to regulators and the public. Derivatives trading facilities, such as swap execution facilities, are not considered "exchanges" for purposes of this exemption.2
The Companion Policy to the Scope Rule also describes other contracts that the OSC does not consider to be "derivatives" for purposes of securities or derivatives legislation. The OSC states that a common feature of such contracts is "that they are entered into for consumer, business, or non-profit purposes that do not involve investment, speculation or hedging" and they typically provide for the transfer of ownership of a good or the provision of a service. Stated examples of such contracts include a consumer contract to purchase non-financial products or services at a fixed, capped or collared price, a retirement benefit arrangement, a performance bond or a guarantee.
Some contracts or instruments fall within both the definition of "derivative" and the definition of "security" under the Securities Act (Ontario). The Scope Rule clarifies which of these contracts or instruments are subject to regulation under the TR Rule. Derivatives that also fit the definition of a "security" under the Securities Act solely because they are investment contracts or options are prescribed to be derivatives for purposes of the TR Rule. Derivatives that also fit the definition of a "security" for other reasons are prescribed not to be derivatives for purposes of the TR Rule. Contracts or instruments used by an issuer (or affiliate) solely to compensate an employee or service provider (e.g., stock options) or as a financing instrument (e.g., warrants) and whose underlying interest is a share or stock of that issuer (or affiliate) are prescribed not to be derivatives.
In the Companion Policy to the Scope Rule the OSC states that it anticipates it will again review the categorization of instruments as derivatives or securities once the intended comprehensive derivatives regime has been implemented.
TR Rule
The purpose of the TR Rule is to improve transparency in the derivatives market by prescribing (a) the type of information to be reported and (b) rules for the entities to which reports are to be made (i.e., designated trade repositories).
Designated Trade Repositories
The TR Rule prescribes the rules and process for oversight of designated trade repositories, including applications for designation and operational requirements. There is no prohibition on an undesignated trade repository operating in Ontario. However, a counterparty that reports a transaction to such an undesignated trade repository would not be in compliance with that counterparty's reporting obligations under the TR Rule.
Designated trade repositories must file annual and interim financial statements, have governance arrangements that meet the standards prescribed by the TR Rule, appoint a chief compliance officer, address risk management, data security and confidentiality, and have fair and equitable fees for all those participating in the designated trade repository.
The rules with respect to designated trade repositories (other than the obligation to provide data to the public) come into force on December 31, 2013.
Data Reporting Obligation
The TR Rule prescribes the reporting obligations of counterparties to derivatives transactions. The data reporting obligations come into force on July 2, 2014.
Data reporting obligations arise in the context of derivatives transactions with a local counterparty. A local counterparty is a counterparty to a derivatives transaction3 if, at the time of the transaction, one or more of the following apply:
(a) the counterparty is a person or company, other than an individual, organized under the laws of Ontario or that has its head office or principal place of business in Ontario;
(b) the counterparty is registered under Ontario securities law as a derivatives dealer or in an alternative category as a consequence of trading in derivatives;
(c) the counterparty is an affiliate of a person or company described in paragraph (a), and such person or company is responsible for the liabilities of that affiliated party.
The TR Rule prescribes a hierarchy with respect to which a counterparty to a derivatives transaction is required to report, based on the OSC's assessment of who would be in the best position to fulfill the reporting obligation. The reporting counterparty will be:
(a) if the transaction is cleared through a recognized or exempt clearing agency, the recognized or exempt clearing agency;
(b) if the transaction is not cleared through a recognized or exempt clearing agency and is between two derivatives dealers, each derivatives dealer;
(c) if the transaction is not cleared through a recognized or exempt clearing agency and is between a derivatives dealer and a counterparty that is not a derivatives dealer, the derivatives dealer; and
(d) in any other case, each local counterparty to the transaction.
However, a local counterparty to a transaction must act as the reporting counterparty to the transaction if:
- the reporting counterparty determined under paragraph (c) above is not a local counterparty; and
- by the end of the second business day following the day on which derivatives data is otherwise required to be reported, the local counterparty has not received confirmation that the derivatives data for the transaction has been reported by the reporting counterparty.
A reporting counterparty may delegate its reporting obligations but remains responsible for ensuring the timely and accurate reporting of data. Although there may be situations in which more than one counterparty is a reporting counterparty under the TR Rule, the OSC states that it expects the practical outcome in such circumstances will be that one counterparty will delegate the reporting function to the other (or to a mutually agreed upon third party) and that only one report will be filed in respect of the transaction.
In the event that there is no designated trade repository that accepts the data of a reporting counterparty, the data is to be electronically reported to the OSC. The OSC states that it will provide public guidance prior to July 2, 2014 on how reports should be electronically submitted to the OSC in such cases.
Prescribed Data
The data to be reported includes a legal identifier of each counterparty, a unique transaction identifier, and a unique product identifier for the transaction.
Creation Data - Upon execution of a derivatives transaction, creation data must be reported in real time. If it is not technologically practicable to report creation data in real time, it must be reported as soon as practicable and in no event later than the end of the business day following the day on which the data would otherwise be required to be reported.
Life-Cycle Event Data - A reporting counterparty also must report all life-cycle event data by the end of the business day on which such events occur.
Valuation Data - Valuation data (based on industry accepted valuation standards) must be reported daily if the reporting counterparty is a derivatives dealer or a recognized or exempt clearing agency. For other reporting counterparties, valuation data must be reported quarterly (as of the last day of each calendar quarter and no later than 30 days after the end of the quarter).
Pre-existing Transactions – Certain prescribed creation data will have to be reported no later than December 31, 2014 for transactions entered into before July 2, 2014 and that had outstanding contractual obligations on that date. The obligation to report life-cycle event and valuation data in respect of such transactions will only commence after the relevant creation data has been reported. The OSC makes the following statement in the Companion Policy to the TR Rule:
"The derivatives data required to be reported for pre-existing transactions under section 34 is substantively the same as the requirement under CFTC Rule 17 CFR Part 46 -- Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps. Therefore, to the extent that a reporting counterparty has reported pre-existing transaction derivatives data required by the CFTC rule, this would meet the derivatives data reporting requirements under section 34. This interpretation applies only to pre-existing transactions."
Data Dissemination and Access
A designated trade repository must provide access to data in its possession to the OSC and the counterparties to a reported derivatives transaction. A designated trade repository also must, on a periodic basis and at no cost, make available to the public aggregate data on open positions, volume, number and price related to transactions reported to it. Such aggregated information also must be complemented at a minimum by breakdowns, where applicable, by currency of denomination, geographic location of reference entity or asset, asset class, contract type, maturity and whether the transaction is cleared. The identity of counterparties must not be disclosed to the public.
Exclusions
A local counterparty has no obligation to report a transaction if:
- the transaction relates to a derivative the asset class of which is a commodity other than cash or currency;
- the local counterparty is not a derivatives dealer; and
- the local counterparty has less than $500,000 aggregate notional value, without netting, under all its outstanding transactions at the time of the transaction including the additional notional value related to that transaction.
Also, a counterparty is under no obligation to report derivatives data in relation to a transaction if it is entered into between:
- Her Majesty in right of Ontario or the Ontario Financing Authority when acting as agent for Her Majesty in right of Ontario; and
- an Ontario crown corporation or crown agency that forms part of a consolidated entity with Her Majesty in right of Ontario for accounting purposes.
Broader Rules
The implementation of the Scope Rule and the TR Rule represent the fulfilment of just one part of Canada's broader G20 commitment to regulate over-the-counter (OTC) derivatives. The Canadian Securities Administrators have also published consultation papers relating to other areas of OTC derivatives regulation, including proposals which would impose requirements relating to collateral, make central counterparty clearing mandatory, and impose registration requirements. It is anticipated that future developments in the regulation of OTC derivatives may result in amendments to the Scope Rule and the TR Rule.
Footnote
[2] Swap execution facilities are considered "exchanges" under Ontario securities law for other purposes: http://www.osc.gov.on.ca/en/Marketplaces_swap-execution-facilities_index.htm.
[3] "transaction" means entering into, assigning, selling or otherwise acquiring or disposing of a derivative or the novation of a derivative.
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