On February 24, 2016, the Canadian Securities Administrators (CSA) published a revised Proposed National Instrument 94-101 Mandatory Central Counterparty Clearing of Derivatives (Proposed Clearing Rule) and a proposed companion policy for a 90-day comment period. The Proposed Clearing Rule sets out when certain over-the-counter (OTC) derivatives entered into by certain Canadian local counterparties will need to be submitted for clearing to a recognized or exempt clearing agency (an RCA).
The Proposed Clearing Rule significantly narrows the classes of counterparties for which clearing will be required and introduces new exemptions, compared to the approach that had been proposed in the CSA’s initial draft of the Proposed Clearing Rule published on February 12, 2015 (Initial Clearing Rule). In particular, the new proposal would only require mandatory clearing of certain derivatives if each counterparty to the transaction is a member of an RCA that clears the relevant type of derivative, an affiliate of such a clearing member, or a Canadian entity that, together with its Canadian affiliates, has had more than C$500-billion gross notional amount in outstanding derivatives as of a month-end date which occurs after the Proposed Clearing Rule comes into force.
The Initial Clearing Rule was described in our February 2015 Blakes Bulletin: OTC Derivatives Trading and Clearing Rules Move Closer to Implementation. This bulletin discusses the Proposed Clearing Rule and highlights key differences from the Initial Clearing Rule.
Derivatives Transactions Subject to the Proposed Clearing Rule
The only OTC derivatives that will be subject to the mandatory clearing requirement (Mandatory Clearable Derivatives) are listed in Appendix A to the Proposed Clearing Rule. The list includes a variety of single-currency interest rate swaps and forward rate agreements. Appendix A is reproduced below.
Notably, Appendix A includes Canadian dollar (CAD) interest rate swaps. Currently, no foreign jurisdiction has a rule mandating the clearing of CAD interest rate swaps. The CSA has noted that this could have a competitive impact on Canadian local counterparties and, in addition to requests for input, has asked whether subjecting CAD interest rate swaps to mandatory clearing will have significant consequences.
CSA may designate additional OTC derivatives as Mandatory Clearable Derivatives in appropriate cases, including with a view to harmonize the classes of designated derivatives, to the greatest extent possible, with international practices.
Parties Subject To the Proposed Clearing Rule
Subject to certain exceptions described below, a counterparty to a Mandatory Clearable Derivative will be caught by the Proposed Clearing Rule if:
- it is a “local counterparty” in a Canadian jurisdiction, meaning that it:
- is organized under the laws of the jurisdiction;
- has its head office or principal place of business in the jurisdiction; or
- is an affiliate of a person or company that is organized under the laws of the jurisdiction and such person or company is responsible for all or substantially all of the liabilities of the counterparty; and
- each party to the transaction:
- is a participant (i.e., a clearing member) of an RCA and subscribes for clearing services for the applicable class of derivatives (or is an affiliate of such a participant); or
- is a local counterparty in any jurisdiction of Canada that has or has had, for any month following the entry into force of the Proposed Clearing Rule, a month-end gross notional amount under all outstanding derivatives of the local counterparty and each affiliate that is a local counterparty in any jurisdiction of Canada, exceeding C$500-billion, excluding derivatives transactions eligible for the Intragroup Exemption described below (C$500-Billion Threshold).
This represents a significant narrowing of the group of counterparties that will be obligated to clear Mandatory Clearable Derivatives as compared to the Initial Clearing Rule.
A local counterparty that exceeds the C$500-Billion Threshold for the first time is not required to comply with the clearing requirement until the 90th day after the end of the month in which the threshold was exceeded (unless the local counterparty is a participant of an RCA or an affiliate of such a participant).
A local counterparty required to submit a Mandatory Clearable Derivative for clearing must do so no later than the end of the day of execution of the transaction, or if the transaction is executed after the business hours of the RCA, the end of the next business day.
The Proposed Clearing Rule provides for the following exemptions from the clearing requirement:
- Intragroup Exemption: A transaction in Mandatory Clearable Derivatives between affiliated counterparties will be exempted if:
- the financial statements of the affiliates are prepared on a consolidated basis in accordance with specified accounting standards or the two affiliates are prudentially supervised on a consolidated basis; and
- the transaction meets certain requirements, such as being subject to centralized risk evaluation, measurement and controls reasonably designed to identify and manage risks.
To rely on this exemption, the local counterparty must deliver a prescribed form to the securities regulatory authorities within 30 days from when it first relies on the exemption with a particular affiliate.
- Multilateral Portfolio Compression Exemption: A new exemption (compared to the Initial Clearing Rule) will apply if several counterparties enter into a multilateral portfolio compression exercise that changes or terminates and replaces prior uncleared transactions that were not Mandatory Clearable Derivatives when entered into, so long as the resulting transaction satisfies the following:
- the resulting transaction is entered into as a result of more than two counterparties changing or terminating and replacing prior transactions;
- the prior transactions do not include a transaction entered into after the date on which the derivative or class of derivatives became a Mandatory Clearable Derivative;
- the prior transactions were not cleared by an RCA;
- the resulting transaction is entered into by the same counterparties as the prior transactions;
- the multilateral portfolio compression exercise is conducted by a third-party provider.
- Specified Entities: The Proposed Clearing Rule will not apply to certain entities including: governments; crown corporations whose liabilities are the responsibility of the government; entities wholly-owned by one or more governments whose liabilities are the responsibility of the governments; central banks; the Bank for International Settlements; and the International Monetary Fund.
A local counterparty that relies on the Intragroup Exemption or the Multilateral Portfolio Compression Exemption must keep records demonstrating that the requirements to rely on the respective exemption were met. These records must be kept for seven years (eight in the case of Manitoba) after the relevant transaction expires or terminates.
It should be noted that the End-User Exemption provided for in the Initial Clearing Rule was removed since the C$500-Billion Threshold will significantly limit the entities subject to the Proposed Clearing Rule.
If a counterparty is only a local counterparty by virtue of being an affiliate of a person or company that is organized under the laws of a jurisdiction of Canada that is responsible for all or substantially all of the liabilities of the counterparty, it may satisfy the mandatory clearing requirement if the Mandatory Clearable Derivative is submitted for clearing in accordance with the laws of certain foreign jurisdictions to be prescribed by the CSA.
Disclosure And Reporting Requirements applicAble to RCAs
An RCA will be required to disclose on its website and report to the securities regulatory authorities its list of OTC derivatives and as to whether such derivatives are Mandatory Clearable Derivatives.
While the Initial Clearing Rule contemplated a phase-in period, the Proposed Clearing Rule requires the Mandatory Clearable Derivatives identified in Appendix A that are subject to the clearing requirement to be submitted for clearing from the rule implementation date.
Further public consultation will be required following implementation if the CSA wishes to designate a derivative or class of derivatives as a new Mandatory Clearable Derivative.
The 90-day comment period for the Proposed Clearing Rule expires on May 24, 2016.
APPENDIX A (reproduced)
Initial Set of OTC Derivatives Proposed for Mandatory Clearing under the Proposed Clearing Rule
(Click here to view table of interest rate swaps on original article)