The Quebec Autorité des marchés financiers (Authority) is revoking a long-standing blanket decision (Blanket Decision) that exempts persons conducting dealer or adviser activities with accredited investors in respect of exchange-traded futures and options (Specified Derivatives) from the registration and qualification requirements applicable under the Quebec Derivatives Act (QDA).
The revocation was originally announced on April 22, 2015, and was to take effect on September 5, 2015 (Original Revocation Decision). However, on August 27, 2015, the Authority announced that it would be deferring the revocation date until June 5, 2016 (Revocation Deferral Decision, and together with the Original Revocation Decision, Revocation Decision).
The Revocation Deferral Decision came on the heels of a notice by the Authority published on August 6, 2015, reminding market participants of the pending revocation.
The Revocation Deferral Decision was prompted by requests and comments received by the Authority from derivatives participants in foreign markets seeking a deferral in order to allow them the necessary time either to become registered in Quebec, or to make the necessary changes to their systems and procedures so that relevant trades can be made through a Quebec registrant. In affording an additional grace period, the Authority also noted the impact that the revocation as of September 5, 2015 would have had on Quebec accredited investors in their dealings in Specified Derivatives as well as on derivatives exchanges carrying on business in Quebec.
The Revocation Decision indicates that the Blanket Decision was intended as a transitional measure, and that the Authority always intended to apply the regime implemented by the QDA to regulate derivatives. In this fashion, the Revocation Decision makes oblique reference to the alternative standardized derivatives exemption that currently exists under the QDA’s regime (Standardized Derivatives Exemption). However, because the Standardized Derivatives Exemption is restricted to exchange-traded derivatives offered primarily outside Quebec, market participants whose activities with Quebec-based clients involve futures or options listed on the Montréal Exchange will not be able to rely on the Standardized Derivatives Exemption to carry on those activities after June 5, 2016.
This Bulletin describes the consequences of the Revocation Decision and the scope of the Standardized Derivatives Exemption.
We note that the Revocation Decision does not affect existing QDA exemptions applicable to over-the-counter (OTC) derivatives. Specifically, a broad exemption from the QDA registration and qualification requirements is available for OTC derivatives activities or transactions only involving “accredited counterparties” as discussed in our January 2009 Blakes Bulletin: Quebec Derivatives Legislation in Force as of February 1, 2009.
BLANKET DECISION SCOPE AND RELIANCE ON SPECIFIED DERIVATIVES EXEMPTION
Since the QDA came into force, the Blanket Decision has provided a broad exemption from dealer and adviser registration requirements when activities relating to Specified Derivatives in Quebec are conducted exclusively with accredited investors in compliance with National Instrument 45-106 – Prospectus Exemptions (NI 45-106). The Blanket Decision also provides broad relief from the QDA’s qualification requirement to obtain approval of the Authority for the creation or marketing of a derivative in Quebec.
Following the revocation of the Blanket Decision, the Standardized Derivatives Exemption will continue to provide relief to foreign dealers and advisers in respect of dealings with qualifying Quebec clients involving standardized derivatives traded on markets located outside of Quebec. The QDA defines a “standardized derivative” as a derivative that is traded on a published market, whose intrinsic characteristics are determined by that market and whose trade is cleared.
Specifically, the Standardized Derivatives Exemption is available for a person in respect of dealing or advising activities involving standardized derivatives if the following conditions are satisfied:
- The person is authorized to act as a dealer or adviser or exercise similar functions in a jurisdiction outside Quebec where its head office or principal place of business is located
- The person carries on business solely with “accredited counterparties” within the meaning of the QDA
- The standardized derivative is offered primarily outside Quebec
Since the Standardized Derivatives Exemption is restricted to standardized derivatives offered primarily outside Quebec, it does not allow a dealer or adviser to conduct activities in options or futures listed on the Montréal Exchange. In other words, it is not the intention of this exemption to open up the local derivatives market to foreign dealers or advisers. Thus, for example, futures commission merchants in the United States wishing to facilitate Montréal Exchange trades with their Quebec-based clients would need to do so through a Quebec-registered dealer once the Blanket Decision ceases to have effect on June 5, 2016.
While the definition of accredited counterparty used for the purposes of the Standardized Derivatives Exemption is broadly similar to the definition of accredited investor used in the Blanket Decision, there are a few notable differences, particularly in relation to non-institutional investors. For example, the minimum asset test for corporations and other types of entities under the QDA is C$10-million based on realizable value of financial assets, before taxes but net of related liabilities, whereas the corresponding test under NI 45-106 is C$5-million based on the book value of net assets. The financial tests applicable to individuals are also narrower under the accredited counterparty definition than under the accredited investor definition.
APPLYING FOR REGISTRATION IF ACTIVITES WILL NO LONGER BE EXEMPT
In its August 6, 2015 notice, the Authority had advised market participants that dealers or advisers wishing to continue to carry on activities following revocation of the Blanket Decision would, in the absence of alternative relief being available, need to file an application for registration with the Authority by September 4, 2015. Furthermore, such applicants who are not dealer members of the Investment Industry Regulatory Organization of Canada (IIROC) would also need to file an application for membership with IIROC as this is a precondition for registration as a derivatives dealer with the Authority. With the Revocation Deferral Decision, such market participants will now have until June 4, 2016 to become registered or make alternative arrangements such as transitioning such activities to an affiliate that is registered with the Authority.
PERCEIVED GAP IN THE STANDARDIZED DERIVATIVES EXEMPTION
Market participants have voiced concern over the fact that the Standardized Derivatives Exemption omits to provide relief from the QDA’s qualification requirement, which requires persons who create or market derivatives in Quebec to be qualified by the Authority unless an exemption applies. The Blanket Decision provides this exemptive relief on the condition that the derivatives activities do not involve persons that are not accredited investors, which made the potential gap in the Standardized Derivatives Exemption of little or no real consequence as long as the Blanket Decision remained in force.
It is possible to interpret the qualification requirement and the Standardized Derivatives Exemption in such a way as to view the qualification exemption as embedded within the Standardized Derivatives Exemption, at least in relation to dealer or adviser activities. However, the preferred outcome would be for the perceived gap to be addressed by way of an amendment to the Standardized Derivatives Exemption to explicitly provide for a qualification exemption that is co-extensive with the registration exemption. The additional grace period afforded by the Revocation Deferral Decision also has the salutary effect of providing more time to address this source of market uncertainty.