Canada: CSA Publishes Revised Draft Segregation And Porting Rules For Customer Collateral In Cleared Derivatives

As part of a series of developments in the area of derivatives regulation, the Canadian Securities Administrators (CSA) proposed a rule, on January 21, 2016, aimed at ensuring that clearing is carried out by clearing intermediaries and clearing agencies in a manner that protects customer collateral and positions and improves the ability of a derivatives clearing agency to withstand a clearing member default.  The rule will allow for different clearing models (principal to principal or FCM) and is broadly aligned with principles adopted in the US and other jurisdictions.  Comments are due by April 19.

Two types of entities are the focus of Proposed National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions (NI 94-102): clearing intermediaries (CI) and regulated clearing agencies (RCA).

A RCA for the purposes of NI 94-102 is a clearing agency that is registered as such or has an exemption from registration in the particular province or territory. For Alberta, the three Territories and the four Maritime provinces, it includes a clearing agency that is registered in or exempted by another province.

A CI can be a "direct intermediary" or an "indirect intermediary".  A direct intermediary is an entity that is a participant in the relevant RCA, provides clearing services (directly or indirectly) for a customer and requires, receives or holds the customer's collateral in providing those services.  An indirect intermediary is an entity that provides those services but is not the RCA participant with respect to the transaction.

CIs and RCAs are, pursuant to NI 94-102, subject to rules related to the treatment of customer collateral, record-keeping, reporting and disclosure and the transfer of customer collateral and positions to a non-defaulting CI (i.e. porting).  In addition, NI 94-102 provides for substituted compliance.  Some of the more pertinent aspects of NI 94-102 are addressed below.

1. Treatment of Customer Collateral

The heart of NI 94-102 is the segregation requirements and limits on the use of customer collateral, which are summarized as follows:

  • Segregation of collateral. CIs and RCAs are required to segregate customer collateral (as a whole) from their own property and that of other persons.  In addition, CIs must segregate the customer collateral of the customer of an indirect intermediary from the indirect intermediary's property.  Importantly "segregation" means to separately hold "or account for" customer collateral and positions,, meaning that segregation is very much a record keeping matter.
  • Permitted depositories.  CIs and RCAs must hold all customer collateral in one or more accounts at a "permitted depository" and clearly identify such accounts as holding customer collateral.  A permitted depository includes Canadian financial institutions and Schedule III banks, RCAs, registered investment dealers, prudentially regulated foreign entities, and certain foreign banks and trust companies.
  • Initial margin. While all customer collateral may be held in omnibus accounts and variation margin calculated by an RCA on a net basis across customers of the CI, initial margin must be provided to the RCA on a gross basis by customer. The RCA may, however, calculate the initial margin requirement based on netting all of the transactions of the particular customer.  
  • Use - General.  There is a general prohibition on RCAs or CIs using or permitting the use of customer collateral.  It can, however, be used to margin, guarantee, secure, settle or adjust cleared derivatives of the customer. No surprise there since that's why it's posted.  
  • Permitted Liens. No liens or claims are allowed on the customer's collateral or its positions except liens securing a claim resulting from a cleared derivative in favour of: (i) the customer itself; or (ii) the RCA or relevant CI responsible for clearing the cleared derivative to which the position or customer collateral relates.  The lien in favour of the customer is helpful in the context of principal to principal clearing models where the collateral legally speaking belongs to the CI.  
  • Use on CI Default. In the case of a CI's default, the customer collateral can only be used (by a CI or the RCA) to satisfy the obligations of the CI that relate to the customer's cleared derivatives.  So for example if the customer's positions are closed out on a CI default because they cannot be ported, the RCA can apply the collateral to the CI's obligations that relate to the customer's closed out derivatives.  
  • Excess margin.  CIs and RCAs must have rules, policies or procedures in place with respect to daily identification and recording of the value of excess margin that it holds attributable to each customer.  Excess margin is customer collateral with a value in excess of the amount required by the RCA to clear and settle that customer's cleared derivatives.  Unlike the case with initial or variation margin, CIs and RCAs may use excess margin to secure or extend the credit of the customer.  So, for example, it can stand as security for the customer's futures transactions or uncleared derivatives obligations.  The rules regarding the holding of customer collateral still apply to excess margin so presumably this permission does not go so far as to allow a title transfer credit support arrangement or rehypothecation rights.  
  • Investment. Property received as customer collateral may also be invested in a "permitted investment" – essentially cash or a highly liquid financial instrument with minimal risk. It may also be used to buy or sell permitted investments under written repo agreements with a term of no more than one business day, among other conditions.  Any losses on investments are borne by the CI or RCA.  Transforming collateral to a form required for posting to a CI or RCA is not considered to be investment of the collateral.    These investment limits apply to excess margin as well.

2. Record-keeping, Reporting and Disclosure

NI 94-102 contains record-keeping, reporting and disclosure requirements which are aimed at ensuring that individual customer collateral and positions are readily identifiable. 

CIs and RCAs are required to keep certain prescribed records for 7 years in a readily accessible location.  The record-keeping requirements range from recording on a daily basis the amount of customer collateral the CI and RCA requires to the total amount of excess margin held by the CI or RCA.

There are extensive disclosure requirements in NI 94-102.  For example, investment policies and guidelines, the treatment of collateral and the effect of bankruptcy laws on the customer's rights are some of the disclosures CIs are required to make to the customers or indirect intermediaries it services prior to clearing any derivatives for them.  Some of these disclosures are in turn required to be provided by RCAs to direct intermediaries. 

Certain prescribed disclosures are required in the other direction as well: a direct intermediary must provide the RCA with information sufficient to identify the customer, the customer's positions and the customer collateral and, at least once each day thereafter, provide information that identifies the positions and collateral.  Indirect intermediaries must provide the same information to the CI through which it provides clearing services.

There is also a requirement for RCAs and CIs to make monthly collateral reports to the relevant regulatory authorities.

3. Transfer of customer collateral and positions

Finally, NI 94-102 contains requirements aimed at ensuring that if a CI is in default, customer collateral and positions can be transferred to one or more non-defaulting CIs without having to liquidate and re-establish the positions.  The obligation is framed quite generally. If the porting is required because a CI is in default, the RCA and the defaulting CI must "facilitate" a transfer of customer positions and collateral (or their liquidation proceeds) to a non-defaulting CI.  This is also required when the CI is not in default, but presumably instigated by a customer request. These porting obligations are subject to several conditions, including that the customer's account is not in default, there are appropriate margins to support transferred positions and the customer and receiving direct intermediary have consented to the transfer.

Where a CI is providing clearing services for an indirect intermediary it must have policies in place that facilitate porting if it is in default or if the indirect intermediary is in default or its customer requests the porting.

4. Substituted Compliance

A substituted compliance provision has been included to ease the regulatory burden on foreign CIs and RCAs.  More specifically, foreign CIs that are regulated under the laws of a foreign jurisdiction equivalent to NI 94-102 and foreign RCAs that are recognized or exempt from recognition by a Canadian securities regulatory authority and that are in compliance with the laws of a foreign jurisdiction that is equivalent to NI 94-102 can qualify for substituted compliance with respect to certain obligations under the rules. Appendix A will eventually set out the NI 94-102 rules that substituted compliance can apply to together with the equivalent foreign substitute rule.   According to the CSA, the provisions specified for substituted compliance are to be determined on a jurisdiction by jurisdiction basis and will depend on a review of the laws and regulatory framework of the foreign jurisdiction.

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 Mondaq.com.

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

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
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
Password
Confirm Password
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (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 www.mondaq.com

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 Mondaq.com’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.

Disclaimer

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.

Registration

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 by clicking here .

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 unsubscribe@mondaq.com 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.

Cookies

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.

Links

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.

Mail-A-Friend

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.

Security

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 webmaster@mondaq.com.

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 EditorialAdvisor@mondaq.com.

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 enquiries@mondaq.com.

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