Introduction

Proposed National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions and the related companion policy (collectively, the 'customer clearing instrument') were published by the Canadian Securities Administrators (CSA) on January 21 2016. The customer clearing instrument is based on the model rule published as CSA Notice 91-304 on January 16 2014 and addresses comments received by the CSA on the model rule.

In publishing the customer clearing instrument, the CSA asked that it be considered together with National Instrument 24-102 Clearing Agency Requirements and the upcoming publication of proposed National Instrument 94-101 Mandatory Central Counterparty Clearing of Derivatives. The comment period for the customer clearing instrument ends on April 19 2016.

Customer clearing instrument

The purpose of the customer clearing instrument is to ensure that customer clearing is done in a manner that protects customer collateral and positions and improves derivatives clearing agencies' resilience to a clearing member default. It does not provide a detailed explanation of customer clearing; however, CSA Consultation Paper 91-404 Derivatives: Segregation and Portability in OTC Derivatives Clearing provides additional information.

The customer clearing instrument contains requirements for the treatment of customer collateral by clearing intermediaries – including clearing members – and derivatives clearing agencies, including requirements relating to the segregation and use of customer collateral. These requirements are intended to ensure that customer collateral is protected, particularly in the case of financial difficulties of a clearing intermediary. The customer clearing instrument includes detailed recordkeeping, reporting and disclosure requirements intended to ensure that customer collateral and positions are readily identifiable. It requires customer positions to be fully collateralised at the regulated clearing agency and obliges the regulated clearing agency and clearing intermediaries to keep records that identify customers and their positions. It also contains requirements relating to the transfer or porting of customer collateral and positions intended to ensure that, in the event of a clearing intermediary default or insolvency, customer collateral and positions can be transferred to one or more non-defaulting clearing intermediaries without having to liquidate and re-establish the positions.

Application

The customer clearing instrument recognises that a variety of customer clearing models and supporting legal frameworks exist in the United States, Europe and elsewhere, and permits a wide range of clearing agencies to offer their customer clearing models in Canada. The CSA's approval and oversight process for recognised or exempt clearing agencies will include a careful review of the customer safeguards provided by each clearing agency that offers customer clearing in Canada.

Unlike the model rule, which proposed a broad application, the customer clearing instrument applies to a clearing intermediary or foreign clearing agency only where it is involved in a transaction with a local customer. The customer clearing instrument also recognises that multiple clearing intermediaries may be involved in a transaction and provides that each clearing intermediary in the customer clearing chain, including both executing and clearing dealers, is subject to its full requirements. The CSA also acknowledges that derivative clearing infrastructure and service providers are primarily located outside Canada, and proposes substituted compliance in certain circumstances where a foreign entity is involved in a transaction and appropriate foreign laws apply.

The customer clearing instrument applies to transactions that are cleared on behalf of a customer if they fall within the scope of the various provincial product determination rules that are in effect. The CSA has yet to confirm which derivative instruments must be cleared. It is therefore difficult to clearly identify the business impact on derivative participants generally – in particular, on executing and clearing intermediaries.

Limitations

The customer clearing instrument does not address the treatment of customer collateral under bankruptcy legislation in Canada, although it does recognise the impact that such legislation may have on the proposed collateral arrangements. The CSA addresses this issue through disclosure requirements for both regulated clearing agencies and clearing intermediaries. As previously suggested, in order to fully protect customer collateral, changes need to be made to existing Canadian bankruptcy legislation (for further details please see "CSA publishes proposed customer clearing rule").

Similarly, the CSA will need to amend the derivative provisions found in National Instrument 81-102 Investment Funds to conform to the customer clearing instrument. If these changes are not made, investment funds subject to National Instrument 81-102 will be unable to enter into cleared trades in accordance with the customer clearing instrument without exemptive relief.

For further information on this topic please contact Carol E Derk or Julie Mansi at Borden Ladner Gervais LLP by telephone (+1 416 367 6000) or email (cderk@blg.com or jmansi@blg.com). The Borden Ladner Gervais website can be accessed at www.blg.com.

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.