Canada: Cleared For Clearing — Canadian Rules Finalized On Mandatory Clearing Of Derivatives

Background

On January 19, 2017, the Canadian Securities Administrators ("CSA") published final versions of two new national instruments as part of the CSA's ongoing commitment to the regulation of over-the-counter ("OTC") derivatives markets: National Instrument 94-101 Mandatory Central Counterparty Clearing of Derivatives and its companion policy (collectively, the "Clearing Rule"), which introduces mandatory clearing of certain OTC derivative transactions, and National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions and its companion policy (collectively, the "Customer Clearing and Collateral Rule"), which is designed to protect customer collateral and positions.

The Clearing Rule (available here) will come into force on April 4, 2017 and the Customer Clearing and Collateral Rule (available here) will come into force on July 3, 2017 (in each case, provided that all necessary approvals are obtained). Each of these rules is similar to rules that were proposed by the CSA early in 2016.1

The Clearing Rule

The purpose of the Clearing Rule is to impose central counterparty clearing of certain OTC derivative transactions in order to mitigate counterparty risk in the derivatives market and to increase financial stability.

The Clearing Rule is separated into two parts: the requirement (with limited exemptions) to submit a transaction involving a mandatory clearable derivative to a regulated clearing agency for clearing; and the determination of those derivatives that are subject to the mandatory clearing requirement (each, a mandatory clearable derivative).

Requirement to Clear

The Clearing Rule establishes a duty on a local counterparty to submit, or cause to be submitted, for clearing to a regulated clearing agency each mandatory clearable derivative that it enters into if it and the other counterparty are one or more of the following:

  • a participant of a regulated clearing agency that offers clearing services for the mandatory clearable derivative and subscribes for clearing services for the appropriate class of derivatives;
  • an affiliated entity of a participant referred to above that has a month-end gross notional amount under all outstanding OTC derivatives exceeding $1 billion, excluding certain intragroup transactions;
  • a local counterparty that, together with its affiliated entities that are also local counterparties, have a month-end gross notional amount under all outstanding OTC derivatives of more than $500 billion, excluding certain intragroup transactions.

A local counterparty in a province is a person (other than an individual) organized under the laws of that province or that has its head office or principal place of business in that province, as well as an affiliate of such person if that person is responsible for all or substantially all of the liabilities of that affiliate. A regulated clearing agency in British Columbia, Manitoba, Ontario and Québec is one that is recognized, or exempted from recognition, by the applicable securities regulator; a regulated clearing agency in every other province and territory is one that is recognized, or exempted from recognition, by the securities regulator of any province or territory.

The Clearing Instrument includes certain exemptions from the clearing requirement. An intragroup exemption applies with respect to transactions between affiliated entities if: the financial statements for each affiliated entity are prepared on a consolidated basis in accordance with certain standards; both counterparties agree to rely on the exemption; the mandatory clearable derivative is subject to a centralized risk management program; and the affiliates have entered into a written agreement that sets out the terms of the mandatory clearable derivative. Affiliates that wish to rely on this exemption must file an electronic report (that will be kept confidential) with the applicable securities regulator no later than 30 days after the first time that they rely on the exemption. A multilateral portfolio compression exemption is also available, provided that certain conditions are met. Under both exemptions, appropriate supporting documentation must be kept.

Certain specified entities are excluded from the application of the Clearing Rule, including governments, certain crown corporations, central banks, the Bank for International Settlements and the International Monetary Fund.

Mandatory Clearable Derivatives

The CSA Derivatives Committee examined a number of areas to determine whether mandatory central clearing is suitable for each OTC derivative or class of OTC derivatives for which regulated clearing agencies provide clearing services. The Committee also considered international harmonization to mitigate against regulatory arbitrage or other distortions in market participants' choices as to where to conduct business.

The initial list of the mandatory clearable derivatives, which is set out in Appendix A to the Clearing Rule, includes certain classes of interest rate derivatives denominated in U.S. dollars, euros, British pounds and Canadian dollars.

Summary of Changes to the Clearing Instrument

As indicated above, the Clearing Rule is based on an earlier proposed version of the rule. As a result of comments received by the CSA, certain other changes were made, including:

  • Foreign Rules: Counterparties established in a foreign jurisdiction but for whom a local counterparty is responsible for all or substantially all of their liabilities may comply with United States or European Union law when submitting their mandatory clearable derivatives for clearing. Certain other requirements of the Clearing Rule will still apply to such foreign counterparties. The CSA adopted this approach after determining that on an outcome-based approach, the foreign rules were substantially equivalent.
  • Affiliated Entities: An affiliated entity of a clearing participant only needs to comply with the Clearing Rule if the affiliated entity's month-end gross notional amount of outstanding OTC derivatives exceeds $1 billion, excluding intragroup transactions. There is a transition period of 90 days following the date on which the affiliated entity first reaches this threshold. This change results in excluding smaller affiliates of clearing participants with de minimis trading activities from the additional operational burden and costs of the Clearing Rule.
  • Transition Period: There is a 6-month transition period, from the date the Clearing Rule comes into effect, for market participants that are not clearing participants, but that are subject to the Clearing Rule, in order to allow for the setting up of clearing relationships.

The Customer Clearing and Collateral Rule

The objectives behind the Customer Clearing and Collateral Rule are twofold: to ensure that clearing is carried out by clearing intermediaries and regulated clearing agencies in a way that protects customer collateral and positions; and to improve the ability of a derivatives clearing agency to withstand a clearing member default. The CSA's aim is to provide investor protection for local customers using clearing services that mirror the protections offered in larger foreign markets.

The Customer Clearing and Collateral Rule applies to a clearing intermediary and a regulated clearing agency when it is involved in an OTC derivatives transaction with a local customer.

Key Provisions

The Customer Clearing and Collateral Rule requires clearing intermediaries and regulated clearing agencies to segregate customer positions and customer collateral from their own property and from that of other persons. Clearing intermediaries must also segregate customer positions and customer collateral of the customer of an indirect intermediary from the positions and property of the indirect intermediary. Customer collateral must be held in one or more accounts at a permitted depository, which accounts must be clearly identified as holding customer collateral. Investments of customer collateral are limited to permitted investments, which are essentially cash or highly liquid financial instruments with minimal risk. Any loss on such investments is borne by the clearing intermediary or the regulated clearing agency. The Customer Clearing and Collateral Rule also contains requirements regarding the use of customer collateral to ensure that such collateral is protected, especially when a clearing intermediary is experiencing financial difficulties. Mutual funds governed by National Instrument 81-102 ("NI 81-102") should note that there are conflicts between the Customer Clearing and Collateral Rule and the requirements under NI 81-102.

Detailed record-keeping is required by clearing intermediaries and regulated clearing agencies to ensure that customer collateral and positions are readily identifiable.

The Customer Clearing and Collateral Rule also contains extensive disclosure requirements, such as disclosure on the investment policies and guidelines with respect to customer collateral, the treatment of customer collateral, and the impact of bankruptcy and insolvency laws on the local customer's rights. Clearing intermediaries and regulated clearing agencies are also obligated to provide monthly collateral reports to the applicable securities regulator.

In the event of a default or the insolvency of a clearing intermediary, the Customer Clearing and Collateral Rule requires the transfer of customer collateral and customer positions to one or more non-defaulting clearing intermediaries.

A clearing intermediary or regulated clearing agency whose head office or principal place of business is located outside Canada may be exempt from the Customer Clearing and Collateral Rule if it complies with the requirements of comparable legislation in the United States or the European Union. Despite this available exemption, foreign clearing intermediaries and regulated clearing agencies that offer clearing services to local customers are still subject to certain of the provisions of the Customer Clearing and Collateral Rule.

Summary of Changes to the Customer Clearing and Collateral Rule

As mentioned above, the Customer Clearing and Collateral Rule is based on an earlier proposed version of the rule. As a result of comments received by the CSA, certain other changes were made, including:

  • Not Apply to Option on a Security: The Customer Clearing and Collateral Rule does not apply to an OTC option on a security. Options on securities will continue to be regulated as securities under existing securities legislation in most of the provinces of Canada and as derivatives in Québec. The CSA adopted this approach to conform to the regulatory regimes in the United States and the European Union.
  • Transfer Obligations: The CSA addressed comments on the challenges associated with the transfer obligations of customer collateral and positions by creating separate provisions for the transfer of a customer's positions and collateral upon default by a direct intermediary. This gives additional flexibility to facilitate a transfer while taking into account any instructions that a customer may have provided in contemplation of a clearing intermediary's default.
  • Customer Collateral Reporting: In order to align the reporting requirements with similar reporting requirements under the rules in the United States, information on customer collateral is required to be reported on an aggregate basis for all customers, rather than on an individual customer basis.

Implications

The implementation of these new rules will require all derivative market participants to consider the technological, operational and internal policy changes that need to be undertaken to ensure compliance. In some cases, these rules may conflict with other laws that govern a party, so exemptive relief may be required. In addition, a party's derivatives documentation and policies and procedures should be reviewed and amended as required.

Footnotes

1. For further details on the proposed earlier rules, please see our bulletins Is It Clear Yet? — Final Countdown to Clearing of Derivatives in Canada (March 2016) and Proposed Canadian Rule on Customer Clearing and Protection of Customer Collateral and Positions (February 2016).

About BLG

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
Related Video
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
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 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.