Canada: Sounding Out The Market: OSFI Publishes Draft Guideline B-7 Derivatives Sound Practices For Comment

Last Updated: October 23 2014
Article by Shahen A. Mirakian and Prithviraj Shankar (Articling Student)

On January 24, 2013, the Office of the Superintendent of Financial Institutions ("OSFI") issued a letter highlighting OSFI's progress in implementing the G-20 reforms for over-the-counter ("OTC") derivatives markets.1 This letter stated that OSFI intended to revise the Derivatives Best Practice Guideline (B-7) (the "1995 Guideline") before the end of 2013 to reflect the commitments made by the Canadian government to the G-20 regarding issues such as central clearing principles and counterparty risk management.2

Although 2013 ended without any revisions to the 1995 Guideline, on October 1, 2014 OSFI published a revised draft guideline for comment reflecting Canada's G-20 commitments and setting out OSFI's approach to regulating the OTC derivatives activities of Canadian federally regulated financial institutions ("FRFIs").3 The draft guideline is titled "Guideline B-7 Derivatives Sound Practices" (the "Proposed Guideline") to underscore that the practices set out in the draft guideline are OSFI's expectations rather than the highest possible standard for a FRFI engaged in derivatives activities.

The title is not the only difference between the 1995 Guideline and the Proposed Guideline. The Proposed Guideline builds upon the principles articulated in the 1995 Guideline along with the general framework for OTC derivatives regulation articulated in the discussion paper published by the Canadian OTC Derivatives Working Group (of which OSFI is a member) published in October 2010 titled Reform of Over-the-Counter (OTC) Derivatives Markets in Canada ("OTCD WG Paper").4

In addition to dealing with capital standards and standardization of OTC derivatives, the OTCD WG Paper recommended that regulators take steps to force Canadian financial institutions to move towards centrally clearing OTC derivatives transactions and adopting stricter counterparty risk management standards for bilateral transactions (including setting minimum margin requirements). The OTCD WG Paper also recommended that regulators require the reporting of OTC derivatives transactions to trade repositories and encourage the movement of OTC derivatives onto electronic trading platforms.

Most of these recommendations are adopted by the Proposed Guideline. The major exception is that OSFI has not included any discussion of minimum initial and variation margin requirements in the Proposed Guideline saying that it will do so at a future date when an international framework for bilateral OTC derivative transaction margining has been adopted.

Central Clearing

In addition to the basic principles on settlement risk adopted from the 1995 Guideline, the Proposed Guideline provides guidance for FRFIs who are adopting central clearing. As the Proposed Guideline notes, OSFI implemented capital incentives for central clearing of derivatives on January 1, 2013 in the Capital Adequacy Requirements (CAR) Guideline.5 In response to these guidelines many FRFIs have been moving transactions on to central counterparties ("CCPs").

The Proposed Guideline recommends that FRFIs establish risk ratings and credit limits for CCPS consistent with their particular risk appetite and policies. The Proposed Guideline also states that all central clearing of standardized derivatives by FRFIs should be done using global CCPs which are regulated in a jurisdiction which applies rules consistent with the international standards for CCPs and recognized by Canadian authorities (such CCPs are termed "Qualified Central Counterparties" or "QCCPs"). If no Canadian-recognized QCCPs are available, then FRFIs should use QCCPs recognized in a foreign jurisdiction. Intra-group transactions between a FRFI and its affiliates are not required to be centrally cleared provided a risk management framework is available to monitor the risks involved with such transactions.

Trade Reporting

OSFI expects that FRFIs will comply with the requirements set out by the provincial securities regulator in their principal place of business for derivatives reporting. OSFI says that it will monitor the compliance of FRFIs with this requirement and FRFIs should include an assessment of their compliance with trade reporting requirements in their annual compliance reports to OSFI. The Proposed Guideline also states that not only should FRFIs obtain global Legal Entity Identifiers ("LEIs"),6 but they should also encourage their clients and counterparties to do so as well. This is in keeping with the views of provincial securities regulators that LEIs are a fundamental element of trade reporting.

Risk Management

The Proposed Guideline advocates an integrated approach to the management of risks associated with derivatives. The Proposed Guideline recommends that FRFIs integrate derivative risks into their overall risk management framework through the adoption of policies and guidelines. The Proposed Guideline suggests, for example, that the risk arising from the uncertainty of valuing derivatives with complex payoffs should be handled with robust control processes and documented procedures and that the Board of Directors and senior management should play an active role in managing this risk. The Proposed Guideline divides the discussion of risk into (1) market risk, (2) credit risk, (3) liquidity risk, and (4) operational risk.

1.Market Risk

The Proposed Guideline defines market risk as "the risk of losses arising from fluctuations in the market value of the underlying reference asset". Examples of market risks include the risks arising from a change in interest rates, credit spreads, equity prices, etc. The Proposed Guideline recommends that in tackling this risk, that based on their risk appetite framework, FRFIs must identify the drivers of this risk, estimate the extent of exposure to such risks, and importantly set limits on the exposure to such risk.

2.Credit Risk

The Proposed Guideline states that a risk of default by a counterparty (i.e. credit risk) can be mitigated by using timely reporting measures based on established policies and procedures. Credit risk management must be delinked from those units involved with trading functions that create the risk. The ideal requirements for a credit risk management framework include approving counterparty credit exposure measurement standards, and assigning and approving internal credit risk ratings.

3.Liquidity Risk

Liquidity risk is basically the risk arising from the uncertainty that a derivatives position can be offset or eliminated at the market price due to a lack of market liquidity. A FRFI in establishing its market risk exposure limits and policies should consider what the appropriate holding periods should be for positions, especially those which are in historically illiquid markets or have few hedging alternatives. FRFIs should also consider the risks arising from having to meet margin requirements for QCCPs in illiquid margin conditions. Liquidity risk management strategy should focus on active management of collateral positions and preparing for unexpected situations where additional collateral may be required (for instance, a decline in credit rating).

4.Operational Risk

Operational risk is the risk arising from people, inadequate controls or processes or from external events (it is a catch-all category for the risks which are not described in the other sections). Operational risks include legal risk, regulatory compliance risk and business continuity risk.

To mitigate the legal risk, a FRFI must determine the authority of a counterparty to enter into derivatives transactions and ensure that all material terms, rights and obligations are in writing especially in scenarios where there is no central clearing of contracts. A FRFI should also satisfy itself that the transaction documentation is adequate especially regarding the timing of the termination of outstanding transactions, and the settlement amount calculations upon the termination of such transactions.

In mitigating regulatory compliance risk a FRFI should maintain knowledge of regulatory requirements of all jurisdictions which may apply to its derivatives activities. Among other things, a failure to follow these requirements can lead to a loss of reputation.

The Proposed Guideline recommends that FRFIs should have business resiliency and continuity plans to limit losses if a severe business disruption occurs. Business impact analysis, recovery strategies and testing are some strategies that help develop a business resiliency and continuity framework. An assessment of possible business disruptions from a financial, operational and reputational perspective must be considered in developing resiliency and continuity plans.

System Infrastructure Considerations

The Proposed Guideline states that FRFIs should ensure that their systems infrastructure meets current and long term needs by supporting the size and complexity of the derivatives market. The features of a good system are:

" Ensuring that data is disseminated quickly, accurately and efficiently throughout the FRFI, and allowing for effective monitoring and control of risks from trade execution to settlement.

  • Allowing for portfolio compression to reduce the risk, cost, and inefficiency of maintaining redundant transactions.
  • Allowing for portfolio reconciliation of uncleared derivatives and the efficient resolution of any disputes or discrepancies in a timely manner.
  • Supporting the trading of OTC derivatives through organised platforms (such as electronic trading venues and exchanges).


Similar to the 1995 Guideline, the Proposed Guideline applies to all Canadian federally-regulated financial institutions (banks, foreign bank branches, federally-regulated trust and loan companies, co-operative credit associations, life insurance companies, and property and casualty insurance companies). The application to the Canadian branches of foreign bank branches is particularly important because regulating branch operations of foreign banks has been a topic of substantial discussion during meetings of regulators from various jurisdictions and there is not yet any resolution on exactly which regime will apply to such branches.


OSFI encourages market participants and the public to submit comment letters addressing any issues or raised by the Proposed Guideline. Comments must be submitted by November 14, 2014.

We invite market participants to discuss any comments and questions with us. We are available to assist those wishing to submit comments to OSFI regarding the Proposed Guideline.


1. Office of the Superintendent of Financial Institutions ("OSFI"), "G-20 Commitments for OTC Derivative Market Reform", Letter dated January, 2013.

2. OSFI, "Derivatives Best Practices", Guideline dated May 1995.

3. OSFI, "Derivatives Sound Practices", Draft Guideline No B7 effective date November 2014.

4. OTC Derivatives Working Group, "Reform of Over-the-Counter (OTC) Derivatives Markets in Canada: Discussion Paper from the Canadian OTC Derivatives Working Group", Discussion Paper dated October 26, 2010; Please see our bulletin, Shahen Mirakian & Maria Sagan, change is near but unclear: Canadian regulators publish initial proposals on OTC derivatives (2010).

5. OSFI, "Capital Adequacy Requirements (CAR) Guideline", Guideline Impact Analysis Statement December 2012.

6. Global Legal Entity Identifiers are unique 20 character identifiers issued by Local Operating Units (such as GMEI in North America) that can be obtained by legal entities and are used to identify entities in derivatives trade reporting.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2014

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.

Shahen A. Mirakian
Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

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