Draft derivatives regulations and a revised draft of the uniform
Capital Markets Act (CMA) were issued in August 2015 as
part of the process to implement the new Cooperative Capital Market
Regulatory System (Cooperative System). The governments of Ontario,
British Columbia, New Brunswick, Saskatchewan, Prince Edward Island
and the Yukon (Participating Jurisdictions) intend to participate
in the Cooperative System and to adopt the CMA and these proposed
regulations. The introduction of the Cooperative System will
fundamentally overhaul the Canadian securities and derivatives
We discussed the derivatives laws that were set out in the initial September 2014 draft of the CMA in our November 2014 Blakes Bulletin: Regulation of Derivatives Trading Under the Proposed Canadian Cooperative Capital Markets Regulatory System. A number of minor changes have been made to the treatment of derivatives in the revised CMA and initial drafts of regulations to the CMA have now also been provided, including two regulations focussed on derivatives trading:
- Regulation 91-501 Derivatives and Strip Bonds (Derivatives Registration and Exemption Rule), which sets out exemptions from derivatives dealer and adviser registration requirements reflecting exemptions that currently apply in a number of provinces.
- Regulation 91-502 Trade Repositories and Derivatives Data Reporting (Trade Reporting Rule), which largely reproduces the current Ontario rule relating to derivatives trade repositories and trade reporting.
The Participating Jurisdictions and the federal government have
agreed to use their best efforts to enact the CMA by June 30, 2016.
For general background on the Cooperative System, please see our
Blakes Bulletin: Cooperative System
Legislation and Regulations Released: Fees, "Interface"
and Transition Unresolved.
Given the scope of the proposed changes, Blakes is publishing a series of bulletins discussing aspects of the proposed Cooperative System, which can be accessed here. This bulletin discusses the proposed regulation of derivatives trading under the CMA.
CURRENT DERIVATIVES REGULATORY REGIMES AND CMA IMPACT
Over the past five years, the Canadian Securities Administrators
(CSA) have worked to develop a uniform national approach to
regulate certain aspects of derivatives trading in Canada including
trade reporting and central clearing, and to develop a national
uniform registration regime for derivatives dealers and advisors
that would parallel the existing national securities registration
The proposed form of CMA and draft regulations would generally continue this harmonization process in the Participating Jurisdictions with limited changes to the current status quo. This should permit the Cooperative System's single jointly-appointed regulatory authority (Authority) to continue to develop uniform derivatives regulations in coordination with CSA members in non-Participating Jurisdictions.
The CMA will replace the existing Securities Acts of each of the Participating Jurisdictions, which govern both securities and derivatives trading, as well as the Ontario Commodity Futures Act (CFA), which currently provides a parallel regulatory regime for exchange-traded futures and options.
The CMA does not provide a prescriptive codification of derivatives rules related to registration requirements, trade reporting, central clearing, margin requirements or the use of swap execution facilities. Instead, it follows the "platform" approach and provides the Authority with a broad authority to "make regulations for carrying out the purposes and provisions of [the CMA], including regulations... governing trading, acquiring and making representations about securities or derivatives, including prescribing prohibitions and restrictions relating to trading, acquiring and making representations" and governing registration requirements.
DERIVATIVES TRADE REPORTING REQUIREMENTS
The initial draft Trade Reporting Rule is, for the most part, substantively identical to the current Ontario trade reporting rule. The main differences that may be of particular interest are as follows:
- Currently derivatives trade reporting obligations do not apply in any of the Participating Jurisdictions other than Ontario. Once in effect, the new Trade Reporting Rule will require reporting whenever either or both parties to the derivative transaction is a "local counterparty" in any of the Participating Jurisdictions.
- An entity that engages in the business of trading in derivatives in any of the Participating Jurisdictions will be considered to be a "derivatives dealer" for the purposes of the new Trade Reporting Rule in all of the Participating Jurisdictions, which will be relevant for the purposes of determining which party (or parties) has reporting responsibility.
- The draft Trade Reporting Rule permits counterparties to agree which party to a transaction will be subject to reporting obligations if both parties are derivatives dealers or neither party is a derivatives dealer. This simplifies the approach in the current Ontario trade reporting rule, which requires adherence to a specific multilateral agreement administered by the International Swaps and Derivatives Association to effectively assign reporting responsibility.
- The Ontario "Scope Rule", which describes certain categories of derivatives that are not subject to the trade reporting requirement (Scope Rule), has been substantially adopted and is now included in the body of the draft Trade Reporting Rule .
- Amendments to the Ontario trade reporting rule that are expected to be implemented in the near future, such as an obligation on all derivative counterparties to obtain Legal Entity Identifiers, have not been reflected in the draft Trade Reporting Rule , but are expected to be reflected in future versions of the new Trade Reporting Rule .
- Trade repositories will make a single application to the Authority for recognition as a designated trade repository in all Participating Jurisdictions. No transitional provisions in respect of the implementation of the Cooperative System have yet been published, but we expect that a transition mechanism will be provided for trade repositories that have been designated by the Ontario Securities Commission.
DERIVATIVES DEALER AND ADVISER REGISTRATION REQUIREMENTS
The CMA provides that all dealers and advisers must be
registered with the Authority unless an exemption is applicable.
The term "dealer" includes a person who engages in, or
holds itself out as engaging in, the business of trading in
securities or derivatives as principal or agent.
"Adviser" means a person engaging in, or holding itself
out as engaging in, the business of advising others with respect to
investing in, purchasing or selling securities or trading
Permitted Client and Qualified Party Blanket Exemption
The draft Derivatives Registration and Exemption Rule provides a broad exemption from registration and prospectus requirements in respect of OTC derivatives transactions, which applies if each party to the transaction is a "permitted client" and/or a "qualified party", each acting as principal (Permitted Client Blanket Exemption). For this purpose, "permitted client" has the meaning provided in the securities registration rule (National Instrument 31-103), which includes most institutional market participants including financial institutions, registrants, pension funds, corporations with over $25million in assets and individuals with net financial assets in excess of $5million. The definition of "qualified party" largely overlaps, covering similar or identical categories of institutional market participants and also includes a hedging entity that buys, sells, trades, produces, markets, brokers or otherwise uses a commodity in its business and enters into the relevant OTC derivatives transaction to hedge that exposure, or the transaction is otherwise linked to the commodity in a specified manner.
An exemption for transactions between qualified parties is currently available pursuant to British Columbia Blanket Order 91-501 and also reflects blanket orders adopted in a number of other Canadian provinces. Accordingly, exemptions from registration requirements existing in a number of provinces will initially be preserved by the Derivatives Registration and Exemption Rule as currently drafted. However, it is important to note that dealers and advisers engaged in OTC derivatives business in Ontario are not currently subject to registration requirements unless the derivative also constitutes a "security". Consequently, derivatives dealers and advisers may need to take steps in advance of implementation of the CMA to ensure that Ontario counterparties fall within the exempt categories.
One point of contention arising from the imposition of registration requirements on OTC derivatives dealers and advisers in Ontario is that Canadian banks currently benefit from a general exemption from Ontario registration requirements, but the proposed CMA does not preserve that exemption.
To the extent an entity cannot rely on the Permitted Client Blanket Exemption, registration in one of the existing securities dealer or adviser registration categories would be required until a separate derivatives registration regime is developed. Initially, investment dealers, exempt market dealers and certain restricted dealers would be permitted to trade OTC derivatives under the proposed regime, and specific registration terms for restricted dealers may potentially be negotiated with the Authority. Entities may also make applications to the Authority seeking exemption from registration requirements, requests which may be granted if doing so is not prejudicial to the public interest.
Permitted Client Blanket Exemption's Temporary Nature
The Permitted Client Blanket Exemption is an interim exemption that is expected to ultimately be replaced once a new derivatives registration rule is developed by the CSA as contemplated in the CSA Consultation Paper discussed in our May 2013 Blakes Bulletin: Canadian Securities Administrators Unveil Proposed Derivatives Registration Regime. The CSA may issue a draft derivatives registration rule in the next nine months. The CSA rule may provide a registration exemption for Canadian banks and may also provide a registration exemption for non-Canadian dealers and advisers that are subject to derivatives registration regimes in qualifying home jurisdictions if prescribed conditions are satisfied (similar to the exemptions provided to international securities dealers and advisers from securities registration rules).
Scope Rule Exemption
A registration and prospectus exemption is also available for trading in certain OTC derivatives that are excluded from derivatives trade reporting requirements under the Scope Rule. This exemption applies in respect of trading in physically-settled spot foreign exchange transactions, physically-settled commodity transactions, deposit instruments of Canadian financial institutions and qualifying gaming, insurance and annuity contracts, in each case subject to certain requirements based on the Scope Rule.
Fair Dealing and Other Requirements Imposed on Registrants
The current CMA draft includes an obligation on all registrants to deal fairly, honestly and in good faith with their clients. This reflects the existing standard of conduct for securities dealers and advisers in Canada. All registrants are also required to identify, disclose and manage conflicts of interest in accordance with the regulations. Other registration requirements specifically applicable to derivatives dealers such as recordkeeping, reporting and transparency requirements and requirements in respect of margin, collateral, capital and clearing would be set out in forthcoming CSA rules or the rules of the applicable self-regulatory organization.
Trading in Exchange Contracts — Registration
The registration and exemption regime in respect of trading in exchange contracts is complicated by the divergent approaches currently followed in Participating Jurisdictions. The term "exchange contracts" is currently used in some Participating Jurisdictions and generally refers to exchange-traded derivatives that have standardized terms and conditions determined by the exchange and by their terms are cleared.
Some of the notable exemptions and divergences from existing provincial laws include:
- The Ontario CFA "hedger" exemption from dealer registration requirements will not be preserved on the basis that entities are only required to register as dealers if they are engaged in the business of trading in securities or derivatives.
- The Ontario CFA "unsolicited trade" exemption from dealer registration requirements will not be preserved, but it is noted that an exemption is provided for trades in exchange contracts made through or to a registered dealer, provided that the trade satisfies certain requirements.
- The international dealer and international adviser exemptions under National Instrument 31-103 will not apply to exchange contracts, but dealers and advisers headquartered in the United States or the United Kingdom are provided with very similar exemptions in respect of exchange contracts in the draft Derivatives Registration and Exemption Rule.
Only investment dealers and certain restricted dealers are permitted to trade exchange contracts without an exemption.
CENTRAL CLEARING, COLLATERAL AND EXCHANGE TRADING REQUIREMENTS
No derivatives clearing, margin or trade execution rules are
expected to be published in connection with implementation of the
The CSA may introduce rules in respect of mandatory clearing of specified classes of OTC derivatives as well as indirect clearing client protection rules in the next three months, for implementation in 2016. Any such rules agreed to under the CSA process would be expected to also ultimately be adopted as regulations under the CMA.
MARKET CONDUCT RULES, OTHER CMA RULES OF GENERAL APPLICATION
The CMA includes market conduct rules that are generally
applicable to both securities and derivatives trading, and are
similar to, but expand upon those set out in provincial
The CMA revisions add a prohibition on front-running information relating to an investor's intention to trade either a derivative or an underlying interest of a derivative if the information would reasonably be expected to affect relevant market prices or values. Tipping third-parties in respect of such information or encouraging third-parties to engage in such trading is also generally prohibited, subject in each case to specified defences.
The other derivatives market conduct rules included in the initial draft of the CMA have been retained with minor amendments. These rules prohibit activities such as:
- Engaging in any practice that results in a false or misleading appearance of trading activity in or an artificial price or value for a derivative.
- Making materially false or misleading statements that would reasonably be expected to have a significant effect on the market price or value of a security, derivative or the underlying interest of a derivative.
- Directly or indirectly engaging in any act or course of conduct relating to securities or derivatives "that (a) results in an unjust deprivation or a risk of an unjust deprivation of a person's money or other property or of the value of the person's property; or (b) the person knows or reasonably ought to know perpetrates a fraud on any person".
- Engaging in an unfair practice in relation to a trade, including: (a) putting unreasonable pressure on another person to trade in or hold a derivative, (b) taking advantage of another person's "inability or incapacity to reasonably protect his or her own interest because of physical or mental disability, ignorance, illiteracy, age or other inability to understand the character, nature or language of any matter relating to a decision...to trade in or hold a derivative" and (c) engaging in any other prescribed practice that is fraudulent, manipulative, deceptive or unfairly detrimental to investors.
- Improperly influencing the determination of a benchmark.
- Making false or misleading statements about something that a reasonable investor would consider important in deciding whether to maintain a relationship with the counterparty.
The CMA also makes it an offence to do or omit to do anything
for the purpose of aiding, abetting or counselling a contravention
of capital markets law or to conspire with any person to contravene
capital markets law.
Other CMA rules of general application include proposed employee whistleblower protections and rules granting the Authority and the Chief Regulator investigative powers such as the authority to order any market participant to provide specified information or records for the enforcement of capital markets laws or the regulation of capital markets.
PRESCRIBED DISCLOSURE DOCUMENTS FOR 'DESIGNATED DERIVATIVES' AND TAILORED OBLIGATIONS FOR OTHER CLASSES OF DERIVATIVES
The draft Derivatives Registration and Exemption Rule provides
that OTC derivatives constitute "securities" for the
purposes of CMA prospectus requirements. As noted above, an
exemption from prospectus requirements for OTC derivatives entered
into between permitted clients and/or qualified parties is provided
by the Permitted Client Blanket Exemption. If the conditions
applicable for that exemption are not satisfied for a particular
OTC derivatives transaction, then standard securities prospectus
exemptions such as the accredited investor exemption would also be
available, though securities trade reporting obligations may also
apply in this case. The terms of the securities prospectus
exemptions will be set forth in a forthcoming version of National
Instrument45-106 Prospectus Exemptions. Given the breadth
of these exemptions, securities prospectus obligations generally
are not expected to apply to OTC derivatives trading except in
respect of transactions with retail investors.
The CMA also provides that for trading in "designated derivatives" a disclosure document in prescribed form must be filed with the Chief Regulator and, if required by the rules, a receipt must be obtained from the Chief Regulator (similar to a receipt for a prospectus, which suggests a review and comment process).
The commentary issued with the revised draft of the CMA indicates that it "is anticipated that designated derivatives will include derivatives that raise investor protection concerns, but for which traditional securities regulatory requirements are not appropriate. The regulations will prescribe varying levels of disclosure depending on the specific circumstances, including the nature of the product and the identity of the parties."
Finally, classes of derivatives may be made subject to any prescribed provisions of the CMA or related regulations. The commentary indicates that this "will allow the applicable requirements to be tailored to the class of derivative and to address other relevant factors such as the type of counterparty and the method of transacting".
REGULATION OF CLEARING AGENCIES AND MARKETPLACES
Clearing agencies, including derivatives central counterparties,
which carry on business in a Participating Jurisdiction will be
required to apply to obtain either recognition or an exemption from
recognition from the Authority. The Authority will maintain broad
regulatory and rule-making authority over all clearing agencies
similar to under current provincial securities legislation. This
approach maintains the status quo in respect of regulation
of clearing agencies in Ontario. Draft transition provisions
describing whether and how clearing agencies may maintain or renew
existing recognition and exemption orders have not yet been
Currently, derivatives clearing agencies are not subject to any specific rule or instrument governing their conduct but rather are subject to conditions set out in individual recognition and exemption orders issued by securities commissions. These conditions reflect established practice and staff policies including OSC Staff Notice 24-702 – Regulatory Approach to Recognition and Exemption from Recognition of Clearing Agencies. The commentary issued with the draft CMA regulations indicates that the treatment of existing staff notices, local policies and interpretation notes is under review and that new instruments such as National Instrument 24-102 Clearing Agency Requirements would be expected to be adopted under the Cooperative System if adopted by the Participating Jurisdictions prior to commencement of operations.
Exchanges will also be required to obtain either recognition or an exemption from the Authority in order to carry on business in a Participating Jurisdiction. The term "exchange" is not defined in the draft CMA or regulations but may generally be considered to include traditional commodities futures exchanges but not OTC derivatives trading facilities. Exchanges will continue to be subject to existing National Instruments, including National Instrument 21-101 Marketplace Operation and National Instrument 23-103 Electronic Trading and Direct Electronic Access to Marketplaces, which are being adopted under the Cooperative System.
Under Ontario law, the term "alternative trading system" included certain OTC derivatives trading platforms, which subjected such platforms to rules in respect of operations and trading that apply to marketplaces. In contrast, under the draft CMA, only prescribed OTC derivatives trading platforms would be included as marketplaces subject to those rules.
DEADLINE FOR COMMENT
The comment period for the draft CMA and regulations runs through December 23, 2015.
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.