On January 30 2015 the Office of the Superintendent of Financial Institutions (OSFI) published the final version of Guideline B-7 – Derivatives Sound Practices, replacing the 1995 Guideline B-7 – Derivatives Best Practices. Although the final version of the guideline was released only recently, the guideline came into effect on November 1 2014 following the release of the draft guideline on October 1 2014. The draft guideline, which included updates to reflect the over-the-counter (OTC) derivatives market reforms initiated by G20 leaders, reflected the expectations of OSFI for central clearing of standardised OTC derivatives and reporting derivatives data to a trade repository.
The guideline became effective before it was published in final form in order to coincide with the timing of the provincial derivatives data reporting requirements coming into effect. The guideline refers to rules promulgated by other regulators, including provincial securities regulators, which are considered to be applicable to federally regulated financial institutions by virtue of the guideline. OSFI has stated that it will monitor federally regulated financial institutions' compliance with these requirements.
The guideline also addresses existing best practices with respect to the risk management of derivatives activities (for further details please see "Draft derivatives sound practices guideline for federally regulated financial institutions").
In the final guideline, OSFI articulates its finalised expectations for risk management processes related to derivatives activities – specifically, the management of market risk, credit risk, liquidity risk and operational risk. Accordingly, the guideline should be reviewed and implemented by federally regulated financial institutions, their subsidiaries and the Canadian branch operations of foreign institutions that engage in derivatives activities. How a federally regulated financial institution applies the risk management practices in the guideline will depend on the nature, size and complexity of its derivatives activities.
The final guideline addresses material comments received in the public consultation process that started in October 2014. In particular, OSFI clarified the following points in the guideline:
- OSFI recognises that dealers and active position takers will generally require more sophisticated models to calculate valuation adjustments than end users of derivatives.
- Federally regulated financial institutions that act as both end users and dealers will be held to a higher standard than federally regulated financial institutions that use derivatives exclusively as end users of derivatives.
- OSFI reiterates that all material terms should be agreed in writing by federally regulated financial institutions before or at the time of execution of a non-centrally cleared derivative, as a similar requirement for non-federally regulated financial institutions may be considered in the future.
- The identification and assessment of inherent operational risk is relevant only for derivatives products, activities, processes or systems that are material to a federally regulated financial institution.
- As portfolio compression may not be feasible for certain end users (ie, those with low volumes or mostly directional trades), the requirement to engage in portfolio compression is applicable only where appropriate.
- OSFI acknowledges that a federally regulated financial institution cannot compel counterparties to reconcile portfolios, hence the requirement to engage in portfolio reconciliation applies only to uncleared derivatives.
In responding to a comment requesting greater clarity on netting and margining expectations, OSFI indicated that it plans to introduce new guidance to establish initial and variation margin requirements for non-centrally cleared derivatives. This new guidance will stem from an international policy framework and will be applicable to federally regulated financial institutions. OSFI expects to communicate further on this topic sometime during 2015.
OSFI continues to monitor the development of mandatory central clearing rules by other regulators. In order to ensure a level playing field for all counterparties, OSFI will consider aligning OSFI guidance with requirements in different jurisdictions.
For further information on this topic please contact Stephen J Redican or Sienne Lam at Borden Ladner Gervais LLP by telephone (+1 416 367 6000) or email (email@example.com or firstname.lastname@example.org). The Borden Ladner Gervais website can be accessed at www.blg.com.
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