In the e-Lert that we published on November 6, 2014, we commented on new securities legislation that imposes reporting obligations on entities that engage in derivative transactions.  Entities such as financial institutions that engage in more than the occasional derivatives transaction but do not carry out derivatives dealing activities as their primary business need to consider whether they constitute a “derivatives dealer” as that term is understood in such legislation.  To the extent that you are a “derivatives dealer,” it may impact your reporting obligation under the trade reporting rules, such as Ontario Securities Commission Rule 91-507 Trade Repositories and Derivatives Data Reporting (the “OSC TR Rule”), and may require you to register as a derivatives dealer.  

Who is a Derivatives Dealer in Ontario?

The term “derivatives dealer” is defined in subsection 1(1) of the OSC TR Rule to mean ‘a person or company engaging in or holding himself, herself, or itself out as engaging in the business of trading in derivatives in Ontario as principal or agent.’  

a)    Determining Whether one is “Engaging in the Business of Trading Derivatives”  

Canadian Securities Administrators (“the CSA”) Consultation Paper 91-407 Derivatives: Registration (the “Consultation Paper”) was published on April 18, 2013, and proposed a framework for the regulation of key derivatives market participants through a registration regime. While not having the force of law, the Consultation Paper provides some guidance as to whether a person is ‘in the business of’ trading derivatives. Factors to determine if one is trading in derivatives for a business purpose include whether one is:

Intermediating trades – providing services relating to the intermediation of trades between counterparties to derivative contracts as a broker;

  • Acting as a market maker – making an effort to take both a long and a short position in a derivative or category of derivatives;
  • Trading with the intention of being remunerated or compensated – receiving, or expecting to receive, any form of compensation for carrying on a derivatives trading activity;
  • Directly or indirectly soliciting – contacting someone by any means, including advertising that offers derivatives trading or participating in a derivatives trade, or that offers services for these purposes;
  • Providing clearing services to third parties – providing clearing services for derivatives trades;
  • Trading with a counterparty that is a non-qualified party that is not represented by a derivatives dealer or adviser on a repetitive basis – entering into transactions with counterparties that are non-“qualified parties.” This may be considered to be in the business of trading derivatives unless that non-qualified party is represented by a derivatives dealer or adviser. A “non-qualified party” would include a party other than a derivatives dealer or a sophisticated, well financed counterparty; and
  • Engaging in activities similar to a derivatives dealer – carrying out any activities related to trading of derivatives.

b)    Determining Whether one is “Engaging in the Business in Ontario”   The Consultation Paper makes it clear that residency is not required for a party to be engaged in the business of derivative trading in a particular jurisdiction.  A person engaged in the business of trading derivatives may be a derivatives dealer in Ontario, even if they do not have a permanent office or other place of business in Ontario, if:

  • it intermediates a trade or trades on behalf of a resident of Ontario;
  • it conducts trading activity with or on behalf of counterparties located in Ontario on a regular or repetitive basis;
  • it actively solicits or markets a derivatives trading business in Ontario; or
  •  acts as a market maker to a resident in Ontario.

Registration Requirements For Derivative Dealers

Québec is the only Canadian jurisdiction to currently mandate registration for derivatives dealers. Section 54 of the Derivatives Act (Québec) provides that no person may carry on business as a dealer unless registered as such with the Autoritié des Marchés Financiers. However, this registration requirement does not apply to

  • persons conducting activities or transactions in over-the-counter derivatives involving only “accredited counterparties,” and
  • persons authorized to act as a dealer or authorized to exercise similar functions under legislation applicable in a jurisdiction outside Québec where its head office or principal place of business is located to the extent it carries on business solely for an accredited counterparty and its activity involves a standardized derivative and that is offered primarily outside Québec.

Securities regulators in Ontario, Manitoba and other Canadian jurisdictions have indicated their intention to impose a registration requirement on derivative dealers in their jurisdictions but the publication of draft rules are not expected until well into 2015.

Reporting Obligations For Derivative Dealers

An entity’s status as a derivatives dealer will impact what reporting obligations, if any, it may have in connection with a derivative transaction.

The OSC TR Rule requires derivative transactions involving a “local counterparty” to be reported to a designated trade repository. However, to determine the counterparty on which the obligation to report falls, an entity must first consider the reporting hierarchy set out in section 25 of the OSC TR Rule. For example, if the transaction is not cleared through a recognized or exempt clearing agency and is between a derivatives dealer and a counterparty that is not a derivatives dealer, the obligation to report lies with the derivatives dealer. Hence the importance for a financial institution to determine whether it is a derivatives dealer for purposes of the OSC TR Rule and similar instruments in other jurisdictions in Canada.

Conclusion

The determination of whether someone is a derivative dealer and the obligations that flow from such a determination is a somewhat complex analysis and this e-Lert is only intended to provide an overview of the relevant considerations. To the extent that you would like to discuss the application of this legislation to you in further detail, please contact any of the writers at your convenience.