Copyright 2009, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Securities Regulation, January 2009
The Quebec government announced on January 14, 2009 that key provisions of the Quebec Derivatives Act (QDA) will come into force on February 1, 2009. As noted in our bulletin published at the time the legislation was enacted in June 2008, the QDA embodies a comprehensive legislative framework for the regulation of over-the-counter (OTC) and exchange-traded derivatives trading, and is a first in Canada. Please see our July 2008 Blakes Bulletin on Securities Regulation – Quebec Adopts Derivatives Legislation.
In conjunction with the implementation of the QDA, a related Derivatives Regulation (Regulation) will also come into force. For a summary of the Regulation, please see our October 2008 Blakes Bulletin on Securities Regulation – Quebec Signals Implementation of Derivatives Legislation with Publication of Draft Regulation.
In anticipation of the coming into force of the QDA and Regulation, a blanket decision providing new exemptions from the application of the QDA in respect of certain options and futures contracts and three policy statements providing interpretative guidance to market participants were published on January 23, 2009. This blanket decision and the policy statements are discussed below.
OTC STATUTORY EXEMPTION AND CONTINUITY OF STATUS QUO FOR EXEMPT MARKET
Dealers, advisers and qualified persons are relieved from the registration and qualification requirements of the QDA when carrying on OTC derivatives activities or transactions involving accredited counterparties only (the Statutory Exemption). An accredited counterparty (AC) is defined in the QDA and the Regulation and includes a variety of institutional as well as high net worth market participants. For example, foreign as well as Canadian financial institutions and registered securities dealers or advisers qualify as ACs. The categories of ACs under the QDA are not necessarily identical to the categories of accredited investors (AIs) prescribed under applicable securities legislation, and may be wider or narrower depending on the particular category. For example, the tests for high net worth ACs are more stringent than those applicable to AIs. Please refer to our previous bulletins referred to above for a more complete description of the categories of ACs. In addition, certain concepts relating to the availability of the Statutory Exemption are clarified in the Policy Statement respecting Accredited Counterparties which is discussed below.
Given that new compliance procedures will need to be designed in order to rely on the Statutory Exemption, the Quebec Autorité des marchés financiers (Authority) has indicated in a notice providing guidance with respect to the new legislative framework (Notice) that it expects market participants to phase in compliance obligations during the first six months following the QDA's coming into force.
In an important development, and in recognition of the fact that certain derivatives transactions are currently taking place in the exempt market pursuant to existing securities legislation, the Authority has adopted a blanket decision (Blanket Decision) which will come into effect on February 1, 2009 in tandem with the QDA, which carves out the following instruments currently regulated by the Quebec Securities Act (QSA) from regulation by the QDA where offered to AIs in compliance with National Instrument 45 106 – Prospectus and Registration Exemptions (NI 45-106):
- options or negotiable futures contracts pertaining to securities, or Treasury bond futures contracts;
- options on commodity futures contracts or financial instrument futures contracts;
- commodities futures contracts, financial futures contracts, currency futures contracts and stock index futures contracts.
Given the distinction between the categories of AIs under the QSA and NI 45-106 and the categories of ACs under the QDA, the Blanket Decision is intended to preserve the status quo until the Authority and other Canadian securities regulators establish a harmonized position with respect to the regulatory framework for derivatives offered to the public. Note as well that the Blanket Decision covers not only OTC derivatives but so-called standardized or exchange-traded derivatives which would not be covered by the Statutory Exemption.
If a derivatives dealer or adviser is not carrying on its activities solely within the exempt market, whether under the Statutory Exemption or the Blanket Decision, it will need to register with the Authority. Because the QDA does not currently permit registration as a derivatives-only dealer or adviser, registration will need to take place under the QSA in order for the dealer or adviser to carry on business in derivatives. Once registered, the registrant would then be subject to the registrant obligations of the QDA. Dealers and advisers already registered under the QSA who carry on non-exempt derivatives business are deemed to be registered under the QDA and are subject to the registrant obligations of the QDA.
PUBLICATION OF POLICY STATEMENTS
The Authority has also published three policy statements, providing official guidance as to the manner in which it intends to exercise its discretion and interpret the QDA, in relation to accredited counterparties, hybrid products and self-certification. These policy statements will come into force on February 1, 2009.
Policy Statement respecting Accredited Counterparties
Among the categories of ACs are financial institutions, governments and municipalities. The Policy Statement respecting Accredited Counterparties specifies that these categories are intended to capture domestic as well as foreign or supranational entities, as applicable.
As well, the Policy Statement respecting Accredited Counterparties specifies that:
- the criteria for determining whether a person qualifies as an AC (for example, in the case of a high net worth AC, having the requisite level of assets) are applied at the time the derivative is entered into, and therefore do not need to be met on an ongoing basis; and
- the counterparty may rely on factual statements made by the other party to determine whether the latter qualifies as an AC, provided the counterparty does not have reasonable grounds to believe that such statements are false.
High net worth ACs are defined under the QDA as persons who have the requisite knowledge and experience to evaluate the information provided to them about derivatives, the appropriateness to them of proposed derivatives strategies and the characteristics of the derivatives to be traded on their behalf, and who also meet prescribed minimum asset tests. The QDA requires that satisfaction of these criteria must be established by such persons in a "conclusive and verifiable manner".
The Policy Statement respecting Accredited Counterparties states that an AC which intends to engage in an exempt OTC derivatives transaction is responsible for determining whether the other party is also an AC, in order to conclude that the transaction benefits from the Statutory Exemption. The Policy Statement goes on to specify that establishing compliance with the criteria for qualifying as a high net worth AC will vary significantly according to the person's circumstances and that the counterparty should be satisfied that it is able to evaluate the information obtained in order to assess that the high net worth AC has established its qualification as such in a conclusive and verifiable manner. As mentioned above, there will be a six-month phase-in period within which market participants will need to become fully compliant with QDA requirements, including in connection with reliance on the Statutory Exemption.
Policy Statement respecting Hybrid Products
A hybrid product, being a product that embodies elements of derivatives and securities, is subject to the QDA unless its terms, the terms of any collateral agreement governing it and the circumstances of its offering, issue or entering into show that it is predominantly a security within the meaning of the QSA. In this regard, the QDA provides that a hybrid product is presumed to be predominantly a security if:
- the offeror receives payment of the purchase price on the delivery of the hybrid product;
- the purchaser is under no obligation to make any additional payment beyond the purchase price as a margin deposit, margin, settlement or other such amount during the life of the hybrid product or at maturity; and
- the terms of the hybrid product do not include margin requirements based on a market value of its underlying interest.
The Policy Statement respecting Hybrid Products reviews the above conditions and concludes that a product whose purchase price is not fully payable at issue may still qualify as a security. It also concludes that notes or structured notes whose return is based on an underlying interest, while hybrid products, can qualify as securities provided they meet the conditions outlined above. The Policy Statement provides the following examples of products which have been previously offered by prospectus and will continue to be treated as securities and therefore governed by the QSA:
- Notes whose return at maturity is linked to the price increase of a reference portfolio or to an index (payable in full at issue, callable, not retractable);
- Capital-at-risk notes (payable in full at issue, payments to holders: partial repayments of capital based on ordinary distributions from an income trust portfolio);
- Six-year partially capital protected notes (payable in full at issue);
- Principal Protected Equity Index-Linked "Booster" Notes; and
- Interest coupons and notes without coupons based on debt securities of an issuer.
Policy Statement respecting Self-Certification
The Policy Statement respecting Self-Certification provides details with respect to the self-certification process in respect of rules which are adopted by recognized derivatives exchanges (including the Montréal Exchange), derivatives clearing corporations, alternative trading systems, self-regulatory organizations and other recognized regulated entities. In particular, it provides examples of rules with minor impact which would be exempt from the usual public consultation required for other rules and discusses the treatment of emergency rules. This policy statement also sets forth the kind of information the Authority expects to receive in the case of rules for new derivative products.
- Comprehensive legislation governing OTC and exchange-traded derivatives comes into force as of February 1, 2009
- Quebec financial markets authority adopts blanket order to maintain status quo for derivatives transactions involving futures – these derivatives continue to be treated as securities so that access to exempt accredited investor market is maintained
- Existing registrants under the Quebec Securities Act who carry on non-exempt derivatives business are deemed to be registered under new derivatives legislation and subject to registrant obligations thereunder
- Recognition that compliance by market participants with new legislation can be phased in over six months
- Guidance provided with respect to concepts of accredited counterparties and hybrid products
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.