At the end of June 2012, the Canadian Securities Administrators Derivatives Committee (the "Committee") released its corrected version of Consultation Paper 91-406 on OTC central counterparty clearing ("Consultation Paper 91-406") [available here]. Consultation Paper 91-406 is part of a series of eight papers that expand on the proposals for the regulation of over-the-counter (OTC) derivatives set out in Consultation Paper 91-401. The comment period for Consultation Paper 91-406 will expire on September 21, 2012.
To date, the CSA have released consultation papers regarding their proposals on (i) trade repositories, (ii) surveillance and enforcement, (iii) segregation (of posted collateral) and portability (of customer accounts between clearing members) and (iv) end-user exemptions. Please see our earlier client alerts, entitled Over-The-Counter (OTC) Derivatives Market in Canada: On the Road to Reform and Regulation [available here], Canadian Securities Administrators Release Consultation Paper 91-404 [available here] and Canadian Securities Administrators Release Consultation Paper 91-405 [available here] on some of these prior consultation papers. After the release of Consultation Paper 91-406, the CSA expect to release consultation papers on the topics of (i) registration requirements, (ii) exchange and platform trading and (iii) capital and collateral requirements.
Mandatory Clearing Requirement
After reviewing the comment letters received in connection with Consultation Paper 91-401, the Committee proposes that the CSA take the necessary steps to make mandatory the CCP clearing of eligible OTC derivatives and that it adopt rules and procedures to determine: (i) which OTC derivative contracts are eligible to be centrally cleared and, of these, which should be subject to mandatory clearing; (ii) which participants should be required to clear their OTC derivative contracts; (iii) the recognition of CCPs; and (iv) the approval of CCP rules, procedures and policies in relation to the clearing of OTC derivative contracts. For purposes of determining eligibility for clearing and those derivatives for which clearing will be made mandatory, the Committee recommends both a "bottom-up approach" and a "top down approach". In the bottom-up approach, the CCP will apply to the regulator regarding all derivative contracts that it proposes to clear. The regulator will then assess whether a mandatory clearing requirement is suitable for each such contract, based on standardization, availability of pricing information, liquidity and whether the contract would bring undue risk to the CCP. Under the top down approach and using the data received from trade repositories, the regulator would have the power to identify those derivative contracts that should be subject to mandatory clearing. The rules for determining clearing eligibility should be based on international best practices, including those being developed in the United States and Europe.
The Committee also recommends that a register of those derivatives that have been determined to be eligible for central clearing and subject to mandatory CCP clearing be publicly available on each CSA member's website. With respect to existing derivative trades, the Committee recognizes the expense of requiring such trades to be "backloaded" into a CCP and suggests that mandatory clearing would only apply to new trades, whereas pre-existing trades should be backloaded only on a voluntary basis. Regarding clearing timeframes, the Committee suggests that derivative trades subject to mandatory clearing must be submitted to the CCP as soon as possible, whereas voluntarily cleared trades should be submitted to the CCP no later than the close of business on the day such trades are executed.
In order to accomplish central clearing, the Committee recommends that CCPs must be recognized to operate in Canada. In order to be recognized, the CCP must comply with the principles of financial market infrastructures (the "FMI Principles") established by the Committee on Payment and Settlement Systems and the International Organization of Securities Commissions. The FMI Principles provide broad and flexible guidelines for addressing risks and efficiencies, although the Committee recognizes that certain of these principles may need to be adapted to the particularities of the Canadian market, which has limited transaction volume, depth of liquidity and number of counterparties compared to many global markets.
In order to be recognized in Canada, a CCP will have to ensure that its governance structure addresses any conflicts of interest, access standards, risk management, ownership concentration, management compensation, board representation and transparency, while at the same time providing reasonable representation of public interest and the interests of key stakeholders. In particular, the Committee believes that a CCP's policies must ensure an appropriate proportion of independent board members that reflect the CCP's diverse stakeholders, including clearing members and persons that clear trades indirectly through clearing members. The Committee also recommends that CCPs should be required to have appropriate board committees, as well as advisory committees to allow Canadian participants to have input into operational decisions, as appropriate. Regarding participant access, the Committee is mindful of the need to balance the requirement that clearing members do not bring undue risk to the CCP with the desire to not impose access restrictions for non-competitive ends.
The rule book and procedure framework of the CCP must be clear and comprehensive and the ability to invoke emergency powers must be precisely defined. This will require regulators of both domestic and foreign CCPs to develop co-operative oversight arrangements for CCPs that are subject to multi-jurisdictional regulation. The Committee also focuses on the need for CCPs to develop and implement a robust risk management program in accordance with international best practices and the FMI Principles. In order to provide appropriate regulatory oversight, it is suggested that legislative changes will be needed to require CCPs to provide applicable information to CSA members. Finally, the Committee recognizes that given the size and make-up of the Canadian derivatives market, Canadian market participants will require access to foreign CCPs. As a result, the Committee states that the review and recognition (or exemption from recognition) of foreign-based CCPs is a priority.
If you have any additional questions on Consultation Paper 91-406 or would like our assistance in submitting comments to the Committee, please contact the authors of this alert or any other member of the BLG Derivatives Group. The BLG Derivatives Group consists of a multi disciplinary team of over 30 Financial Services, Securities and Capital Markets, Investment Funds, Energy and Tax lawyers located in offices across Canada. They are experienced in the business, regulatory and administrative issues that confront participants in the derivatives industry and market. Members of the BLG Derivatives Group routinely act on derivatives matters on behalf of financial institutions, governments, Crown corporations, securitization conduits, investment and pension funds, product manufacturers, distributors, corporate end users and other market participants.About BLG
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