Canada: The Regulation Of Derivatives in Canada - Background And New Developments

1. Introduction

The Canadian Securities Administrators OTC Derivatives Committee published on December 6, 2012 two model rules (the "Model Rules") concerning the classification of derivatives for provincial securities law purposes, as well as reporting obligations in respect to certain of those identified derivatives. The Model Rules are the first elements of a framework currently under development to regulate the derivatives market in Canada following the global economic and financial crisis of 2007-2009 (the "Financial Crisis").

The publication of the Model Rules follows upon the October 1, 2012 announcement of the Canadian Securities Administrators ("CSA") and the Bank of Canada that they were committed to clearing standardized over-the-counter ("OTC") derivatives (subject to appropriate exemptions) through central counterparties ("CCP"), including foreign CCPs, provided such counterparties are recognized by Canadian authorities and meet four safeguards identified by the Financial Stability Board ("FSB").

2. Background


The unregulated nature of the global OTC derivatives market is often cited as a major contributor to, if not a key cause of, the Financial Crisis. While the precise value of the OTC derivative market is unclear (due to a lack of any uniform global reporting requirements) – some estimates placing it as high as US$648 trillion – what is clear is that the notional value of the market is enormous. The unregulated nature of OTC derivatives means that they do not trade through central CCPs with publicly visible prices, and counterparties to trades are not subject to strict collateral requirements or otherwise required to implement prudent risk controls. Some liken OTC derivatives trades to "gentlemen's bets", agreed to in private between sophisticated counterparties such as banks and hedge funds, with nothing beyond the agreement itself to back the trade. Being unregulated, the OTC derivatives market allowed participants to amass large concentrations of OTC derivative risk, that risk being that one party to the contract may default prior to the expiration of the trade or agreement, and thus expose the other party to a loss. As the Financial Crisis deepened, and market participants such as Lehman Brothers and AIG found themselves in increasingly difficult financial condition, the opaque nature of the derivatives market made it impossible for market participants to evaluate the true financial health of their counterparties. As a result, to protect themselves, many market participants reacted by moving their trades to what they viewed as more stable counterparties, which in turn hastened the downfall of those participants perceived as financially weak, thereby creating a downward spiral in the economy at large as market participants with huge derivatives exposures on their books either failed or found themselves in deep financial trouble.

3. Key Concepts


A derivative is a financial instrument formed by contract, with its price based upon or "derived" from the value of an underlying asset, basket of assets, index or other acceptable reference. The risk associated with trading derivatives occurs as a result of the fluctuation in value of the underlying asset, examples of which include interest rates, foreign exchange, equities and commodities. Derivatives are often used as an instrument to hedge risk, but can also be used for speculative purposes. Futures, forwards, options and swaps are all examples of derivative contracts.

OTC Derivatives

Exchange-traded derivatives are traded through a central exchange with publicly visible prices. By contrast, OTC derivatives are traded and negotiated between two parties (who are generally sophisticated market participants, such as banks and hedge funds) which enter into a bilateral contract. Because there is no central exchange or other intermediary involvement, participants' exposure to counterparty risk is increased and the trades are less transparent. Standardized OTC derivatives refer to those derivatives governed by standardized documentation and master agreements that tend to improve efficiency and transparency over their non-standardized counterparts. Examples include interest rate and currency swaps using the International Swaps and Derivatives Association (ISDA) documentation architecture. Non-standardized OTC derivatives are those tailored to reflect more precise risk exposures, and they often do not lend themselves to standardization because the potential market in trading that particular exposure is perceived to be small.

Central Counterparties

The market for OTC derivatives is significantly larger than for exchange-traded derivatives and, as noted above, has historically been largely unregulated. During the Financial Crisis, lack of transparency in the OTC derivatives market caused trading to grind to a halt because market participants were unsure of which parties were exposed to what risks, causing widespread disruption. A CCP acts as an intermediary between market participants. Each party to a derivatives transaction enters into a contract with the CCP as counterparty, resulting in the CCP being counterparty to two opposing contracts for the same transaction. Therefore, each party effectively passes the risk of the other party defaulting to the CCP, and the CCP mitigates this risk by instituting appropriately structured risk controls, including requiring suitable levels of collateral to be posted by counterparties.

According to the Bank of Canada in its June 2011 Financial System Review, "The use of CCPs with proper risk-management controls reduces the systemic risk by centralizing counterparty risk – thereby making its management more uniform and transparent – and by lowering system-wide exposures to counterparty risk through multilateral netting and risk mutualization. As a result, greater use of CCPs should reduce uncertainty regarding exposures and the likelihood that a default will propagate across the network of major market participants."

4. Regulatory Reform

Toward the end of the Financial Crisis, the G-20 leaders, among others, recognized the need for reform that included effective regulation of the OTC derivatives market.

Specifically, in April 2009, the G-20 leaders announced the creation of the FSB as successor to the Financial Stability Forum and with a broadened mandate to promote financial stability. The FSB is tasked with coordinating the work of national financial authorities and international standard-setting bodies, and developing and promoting the implementation of effective regulatory, supervisory and other financial sector policies. The FSB counts among its member institutions the relevant financial and regulatory authorities of the G-20 and certain other economies (which, for Canada, are the Bank of Canada, the Office of the Superintendent of Financial Institutions ("OSFI") and the Department of Finance), international organizations including the IMF, OECD and World Bank, as well as international standard-setting bodies. Mark Carney, Governor of the Bank of Canada, currently serves as Chairman of the FSB.

Recognizing that OTC derivatives trading played a major role in the Financial Crisis, at their September 2009 Pittsburgh summit, the G-20 leaders agreed that (1) all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, (2) standardized OTC derivatives should be cleared through central counterparties by end-2012 at the latest, and (3) all OTC derivative contracts should be reported to trade repositories. Furthermore, the G-20 leaders requested that the FSB and its relevant members regularly assess implementation and whether the above-mentioned measures were sufficient to (i) improve transparency in the derivatives markets, (ii) mitigate systemic risk, and (iii) protect against market abuse.

In April 2010, the FSB formed a working group of international standard-setting bodies and authorities, led by representatives of the Committee on Payment and Settlement Systems ("CPSS"), the International Organization of Securities Commissions ("IOSCO") and the European Commission. In October 2010 the CPSS-IOSCO Working Group published a report setting out 21 recommendations for OTC derivatives market reform, including regarding central clearing. Through June 2012, the FSB published three progress reports on the implementation of OTC derivatives market reform, dated April 2011, October 2011 and June 2012. At the time of the June 2012 progress report, it was noted that the EU, Japan and the US (the jurisdictions with the largest markets in OTC derivatives) were expected to have regulatory frameworks in place by the end of 2012. In addition to the progress reports, the FSB in January 2012 identified four safeguards for a resilient and efficient global framework for central clearing (the "Four Safeguards"). Finally, in April 2012, CPSS-IOSCO published the Principles for Financial Market Infrastructures (the "Principles"). The Four Safeguards and the Principles are discussed in detail below.


Since December 2009, the CSA, the Bank of Canada, OSFI and the Canadian Department of Finance have coordinated their efforts to reform Canada's OTC derivates market and make good on Canada's G-20 commitment that all standardized OTC derivatives be cleared through CCPs by the end of 2012. Canadian authorities, however, had to deal with the issue of there being no CCP in Canada for the OTC derivatives market. Bank of Canada Deputy Governor Timothy Lane noted in 2011 that Canada's OTC market was systemically important and that the absence of CCPs was a glaring weakness in its regulatory framework. In November 2010, the CSA published a consultation paper on derivatives regulation in Canada in which it recommended mandatory central clearing of standardized OTC derivatives, but noted that further input and study was required regarding whether Canadian or international CCPs should be used. A further CSA consultation paper published in June 2012 (the "June 2012 CSA Paper") focused on central counterparty clearing for OTC derivatives, and concluded that "it is clear that Canadian market participants will require access to foreign CCPs to clear at least some OTC derivatives transactions," and that "the review and recognition ... of foreign-based CCPs is a priority to ensure that Canada meets its G20 commitments." Finally, in October 2012, the CSA and the Bank of Canada separately announced that Canadian authorities would accept the clearing of standardized OTC derivatives through any CCP, including foreign CCPs, provided that such counterparties are recognized by Canadian authorities and meet the Four Safeguards.  

The Four Safeguards

The following are the Four Safeguards identified by the FSB in response to requests from some member jurisdictions for guidance to help them make informed decisions about the form of CCPs to use for central clearing:

(a) fair and open access by market participants to CCPs, based on transparent and objective criteria;

(b) cooperative oversight arrangements between all relevant authorities, both domestically and internationally, that result in robust and consistently applied regulation and oversight of global CCPs;

(c) resolution and recovery regimes that ensure the core functions of CCPs are maintained during times of crisis and that consider the interests of all jurisdictions where the CCP is systemically important; and

(d) appropriate liquidity arrangements for CCPs in the currencies in which they clear.

Principles for Financial Market Infrastructures

The Principles consist of 24 principles covering nine topics: general organization, credit and liquidity risk management, settlement, central securities depositories and exchange-of-value settlement systems, default management, general business and operational risk management, access, efficiency and transparency, in addition to setting out five responsibilities of central banks, market regulators, and other relevant authorities for financial market infrastructures. In a letter to the G-20 finance ministers and central bank governors dated April 16, 2012, FSB Chairman Carney noted that the Principles "set international standards that will go a long way to achieving" the Four Safeguards.

5. Clearing of Standardized OTC Derivatives Contracts

In their October 1, 2012 Statement by Canadian Authorities on Clearing of Standardized OTC Derivatives Contracts (the "Statement"), the CSA and the Bank of Canada separately announced that Canadian authorities (including OSFI and the Department of Finance) were committed to the clearing of standardized OTC derivatives (subject to appropriate exemptions) through CCPs, including global CCPs, provided such counterparties are recognized by Canadian authorities and meet the Four Safeguards.

The Statement notes that Canadian authorities have determined that global CCPs will provide a "safe, robust and resilient environment for clearing OTC derivatives," provided that they comply with the Principles and meet the Four Safeguards.

In the Statement, the CSA and the Bank of Canada confirmed that they are "satisfied with the direction and pace of the international efforts on the four safeguards, including with regard to implementation of global CCPs serving the Canadian market."

The Statement appears to indicate that CCPs with Canadian members would need to apply for recognition from Canadian regulators, or an exemption, in order to operate within the contemplated framework. However, recognition of foreign CCPs raises issues regarding effective regulatory powers and cooperation. The June 2012 CSA Paper stated that "recognition of non-Canadian CCPs will require that Canadian regulators are comfortable that they can exert appropriate and effective regulatory powers over the foreign CCP, which in many cases will require Canadian regulators to develop co-operative regulation regimes with regulators outside of Canada." Although it appears that a limited number of derivatives CCPs with Canadian members have obtained interim exemptions to operate from Canadian authorities, precisely what is required to be "recognized by Canadian authorities" will remain unclear until the Canadian regulatory framework becomes more fully developed.

6. Current Developments

The FSB published its latest progress report on the implementation of OTC derivatives market reforms on October 31, 2012. In the report, the FSB stated that: (i) the market infrastructure for clearing standardized OTC derivatives through CCPs is in place and the development of such infrastructure does not appear to be an impediment to further progress in meeting the year-end deadline, (ii) the international policy work on the Four Safeguards is substantially completed and implementation is proceeding at a national level, and (iii) it is regulatory uncertainty that remains the most significant impediment to further progress and to comprehensive use of market infrastructure.

Indeed, differences between European, Asian and US swaps rules have made compliance difficult for the financial industry, and progress on discussions between regulators has been slow. Central to the regulatory uncertainty is the proposed cross-border guidance released in late-June 2012 by the US Commodity Futures Trading Commission ("CFTC"), itself facing a year-end deadline to implement rules mandated by the US Dodd-Frank Act of 2010. Under the proposed guidance, the US purports to regulate swaps activities in other countries if they impact US commerce or financial stability. This position was received unfavourably by both the public and private sector. The European Commission, the UK, France, Switzerland and Japan asked the CFTC to reign in the reach of its proposed derivatives rules amid signs that the global derivatives market is already fragmenting. These and other international regulators called for better coordination and enhanced mutual recognition for the regulatory schemes being developed in other jurisdictions.

In the private sector, at least two international banks - Singapore's DBS and Sweden's Nordea Bank - have recently announced that they will not register in the US to trade swaps, choosing to forgo making the investment necessary to comply with the proposed new US rules. Following these developments, at the G-20 meeting in Mexico on November 5, 2012, FSB Chairman Carney conceded that the year-end deadline would not be met: "We are going to use all the time that is left in 2012 to get as much done in 2012 and then take stock instead of what remains to be done in a reasonable time frame." Two days later, following a meeting in Washington of the CFTC's Global Markets Advisory Committee (the "GMAC Meeting") with the US Securities and Exchange Commission (which oversees securities-based derivatives), international regulators (including from Canada) and industry representatives, CFTC Chairman Gary Gensler indicated that he expected further guidance from the CFTC by the end of 2012.

Against this backdrop, advances in the central clearing of standardized OTC derivatives have been made. As of November 1, Japan became the first G-20 country to begin the compulsory clearing of interest rate swaps. On November 13, Deutsche Boerse launched a new interest rate swap clearing service called Eurex Clearing, and two days later announced that 16 banks, including Goldman Sachs, Morgan Stanley, JP Morgan, Barclays and Credit Suisse, were backing the CCP, which plans to expand its services to other OTC derivatives in the future. In addition, ICE Clear Europe clears credit default swaps for European clients of US-owned InterContinental Exchange.

7. Looking Ahead


Despite overshooting the G-20 economies' "end-2012" deadline, progress has been made in the clearing of standardized OTC derivatives through CCPs. Canadian regulators' decision to allow standardized OTC derivatives trading through foreign CCPs was to a great extent anticipated due to (i) indications that Canadian market participants would require access to international CCPs to clear some OTC derivatives transactions, and (ii) widespread belief that the costs of establishing a Canadian CCP for OTC derivatives would outweigh the benefits. Nevertheless, the official announcement was welcomed by market participants for its flexibility and potential cost savings.

On an international scale, there has been some movement in the creation or re-tooling of CCPs for the centralized clearing of a portion of the global derivatives market. Furthermore, it is hoped that recent discussions between the CFTC, international regulators and industry representatives will continue, resulting in a cooperative international framework for the trading of standardized OTC derivatives in the near future.


While the specific regulations which will apply in Canada to central clearing parties have yet to be articulated, Canadian authorities have made progress in other areas of derivative regulation, most notably in the Model Rules published by the Canadian Securities Administrators OTC Derivatives Committee (the "Committee") which were published for a 60-day comment period on December 6, 2012.

The Model Rules consist - at this stage - of two rules referred to as "Derivatives: Product Determination" (the "Scope Rule"), and the "Trade Repositories and Derivatives Data Reporting Rule" (the "TR Rule"). The Scope Rule attempts to bring some clarity to the use of the terms "derivatives" and "securities" under provincial securities legislation, but most importantly, aims to identify certain derivatives (and securities), the use of which triggers other obligations under the Model Rules. One such other obligation is the reporting requirement stipulated under the TR Rule, which mandates the reporting of data concerning derivative use by market participants to trade repositories which meet the operational requirements specified in the TR Rule.

It is clear from the consultation paper (No. 91-301) with which the Model Rules were published that further "model" rules are forthcoming and will each be published for a consultation period of 60 days, after which time the Committee will evaluate and amend, if determined to be appropriate, the proposed model rules. After that process is complete the model rules will be referred to the individual securities regulatory authorities in each province to create the province-specific versions of the model rules, reflecting the non-uniform nature of securities legislation in Canada, and requiring in many cases, legislative action. So, while the rule making process has begun, it is quite possible that this process will continue on for many months and possibly years.

What is clear about the future of derivative regulation is that, although the landscape is evolving more rapidly now than at any time since the regulatory process began in 2009, significant challenges remain and regulatory frameworks are still a work-in-progress.

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions