Securities regulators in Ontario, Quebec, Alberta and Manitoba have temporarily exempted swap execution facilities, or SEFs, from recognition as exchanges. This temporary exemption comes as a result of the recently established U.S. regulatory framework for a new type of marketplace for trading swaps.
REGULATION OF SEFS IN THE UNITED STATES
The regulatory framework for registering and operating SEFs was established by the U.S. Commodity Futures Trading Commission (CFTC) as a result of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act. This framework creates registration, operation and compliance requirements for SEFs. An SEF is a standardized electronic platform defined as "a facility, trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by other participants that are open to multiple participants in the facility or system, through any means of interstate commerce, including any trading facility that: (A) facilitates the execution of swaps between persons; and (B) is not a designated contract market."
The CFTC's final SEF rule, adopted on May 16, 2012, required all electronic platforms for trading swaps to register by October 2, 2013. Previously, swaps were traded exclusively in over-the-counter markets with very little transparency or oversight.
REACTION OF THE U.S. MARKET
The introduction of the SEF regulatory regime was met with uncertainty by market participants, largely due to the gap between the SEF registration date (October 2, 2013) and the date on which the most common types of derivatives are required to be traded on the SEFs (which will most likely fall during the first quarter of 2014). A number of existing trading platforms thought they had until the latter date to register. After a flurry of requests from SEFs, the CFTC issued temporary approvals at the beginning of October 2013. The CFTC also gave existing SEF platforms an extra month to sign up market participants and two months to begin reporting data on certain swaps.
INTERIM EXEMPTIONS PROVIDED BY THE CANADIAN REGULATORS
The Securities Act (Ontario) requires any entity carrying on business as an exchange in Ontario to be recognized by the Ontario Securities Commission (OSC), unless exempted from recognition. OSC Staff Notice 21-707 Swap Execution Facilities – Exemption from Requirement to be Recognized as an Exchange, published on October 10, 2013, states that SEFs are considered exchanges under Ontario securities law and are subject to the recognition requirement if they provide access to participants in Ontario. The OSC provided interim orders on October 1, 2013, exempting 13 SEFs from recognition as an exchange. The interim orders terminate no later than October 2, 2014, and require the SEFs to file a full application for an exemption no later than January 31, 2014. A unusual aspect of these orders is acknowledgment by the SEFs that the OSC may change the scope of the relief or the terms and conditions to the relief as a result of the OSC's monitoring of developments in international and domestic capital markets or the SEF's activities, or as a result of any changes to Ontario law affecting trading in derivatives or securities.
Similar interim orders were provided by the l'Autorité des marchés financiers in Quebec, the Alberta Securities Commission and The Manitoba Securities Commission, also terminating no later than October 2, 2014. The Quebec and Manitoba orders also require the SEFs to file an application by January 31, 2014, while the Alberta orders do not impose a specific deadline for doing so.
TERMS AND CONDITIONS FOR THE INTERIM EXEMPTIONS
The Ontario interim exemptions include the following terms and conditions:
- Continued regulation and oversight of the SEF by the CTFC
- Direct access being provided to an Ontario entity (Ontario User) only if it is appropriately registered as applicable under Ontario securities law or exempt from or not subject to a registration requirement and it qualifies as an "eligible contract participant" under the U.S. Commodity Exchange Act (CEA)
- Making available to Ontario Users appropriate training for each person who has access to trade on the SEF's facilities
- Limiting access for Ontario Users to trading in swaps and security-based swaps, as defined in section 1a of the CEA, without prior OSC approval
- Submission by the SEF to the non-exclusive jurisdiction of the Ontario courts and administrative tribunals and appointment by the SEF of an agent for service in Ontario
- Provision of disclosure to Ontario Users in respect of possible limitations on rights and remedies, that trading rules are governed by U.S. rather than Ontario law, and that the SEF is regulated by the CFTC rather than the OSC
- Provision to the OSC of copies of specified types of filings that the SEF makes with the CFTC
- Prompt notification to the OSC of any material change to the business or operations of the SEF or the information provided in the SEF's application; changes in certain applicable U.S. laws, rules or regulations; anticipated breach of governing laws, rules or regulations; any investigatory or disciplinary actions faced; any matter that may affect the SEF's financial or operational viability; and any default or bankruptcy by a participant known to the SEF or its representatives that may have a material, adverse impact on the SEF, a clearing agency or any Ontario User
- Prompt filing with OSC staff copies of any Rule Enforcement Review report regarding the SEF once issued as final by the CFTC
- Provision of quarterly reports or upon request by OSC staff of the following: a list of all Ontario Users; a list of all Ontario Users against whom disciplinary action has been taken in the last quarter by the SEF or, to the best of the SEF's knowledge, the CFTC or the U.S. Securities and Exchange Commission with respect to activities on the SEF; a list of all investigations by the SEF relating to Ontario Users; a list of Ontario applicants denied status as a participant or access to the SEF during the quarter, together with the reasons for the denial; a list of all products available for trading, identifying changes since the prior quarter; the total trading volume and value traded by Ontario Users on an individualized basis and, aggregated, as a proportion of the SEF's worldwide trades; and a list outlining every incident of a material systems failure, malfunction or delay during the quarter relating to trading activity, noting any corrective action taken.
- Prompt filing with the OSC of annual reports, annual audited financial statements and the Service Organization Controls 1 report
- Provision of information as requested by the OSC or its staff, subject to applicable privacy laws
The terms and conditions in the Quebec orders are similar to those in the Ontario orders, but direct access may be provided to any accredited counterparty under the Derivatives Act (Quebec). The SEF is required to obtain from a Quebec applicant for direct access confirmations concerning the clearing arrangements put into place by the applicant; if the applicant is not a registered dealer, confirmation that the applicant is acting on its own behalf; and if the applicant is a member of the Investment Industry Regulatory Organization of Canada (IIROC), confirmation by IIROC of the applicant's compliance with IIROC's rules and regulations.
The terms and conditions in the Alberta orders are less extensive, but for the quarterly reports require that trading volumes for Alberta users be shown separately for the buy-side and sell-side for each contract. The terms and conditions in the Manitoba orders are equivalent to those in the Ontario orders.
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