As we discussed earlier this month, the Ontario Securities Commission recently published final rules dealing with the regulation of trade repositories, derivatives data reporting requirements and the scope of derivatives that will be subject to such reporting requirements.
The publication of the OSC's final rules is the latest step in efforts by provincial securities regulators to fulfill Canada's G-20 commitments to regulate OTC derivatives. To that end, the OTC Derivatives Committee of the Canadian Securities Administrators published model provincial rules for comment in December 2012, while Ontario Quebec and Manitoba each published proposed harmonized rules in June 2013. The OSC's final rules make non-material revisions to those published in June and are expected to come into force on December 31, 2013, but with staggered implementation of reporting obligations over the course of the following year.
Regulators in Quebec and Manitoba have also published final versions of the rules in their jurisdictions. While the summary below addresses Ontario specifically, the rules will be essentially the same in other Canadian jurisdictions. We have focused our comments on the data reporting and dissemination aspects of the rules.
Product Determination - Rule 91-506
It is anticipated that each rule will come with a related Product Determination Rule that establishes which transaction types the rule applies to. Ontario's Securities Act includes a broad definition of "derivative", but excludes from the definition any contract or instrument prescribed by regulation not to be a derivative. Rule 91-506 and its Companion Policy thus prescribe such exclusions that apply to the trade repository and data reporting rule, namely contracts or instruments relating to: (i) regulated gaming; (ii) insurance and annuities; (iii) the purchase and sale of currency; (iv) the delivery of a commodity other than cash or currency; (v) evidence of a deposit; and (vi) derivatives traded on an exchange.
Click here to view table.
Ultimately, the final version of Rule 91-506 is similar to the draft version published earlier this year but for the clarification that item (vi) above in respect of derivatives traded on an exchange does not include a derivatives trading facility. A derivatives trading facility is described in the Companion Policy as including "any trading system, facility or platform in which multiple participants have the ability to execute or trade derivative instruments by accepting bids and offers made by multiple participants in the facility or system, and in which multiple third-party buying and selling interests in over-the-counter derivatives have the ability to interact in the system, facility or platform in a way that results in a contract."
Trade Repository and Data Reporting - 91-507
The first part of Rule 91-507 relates to the regulation of trade repositories, while the second part sets out obligations with respect to data reporting and dissemination of that data.
Rule 91-507 sets out the rules and obligations regarding the designation of trade repositories, the filing of initial, annual and interim audited financial statements and governance requirements. Among other things, designated trade repositories (DTRs) will be required to meet numerous obligations regarding such things as (i) access to services; (ii) the maintenance of data records; (iii) risk management; (iv) data security and confidentiality; and (v) outsourcing.
The key jurisdictional touchstone in the rule is that the transaction involves a “local counterparty”. A “reporting counterparty” to a transaction involving a local counterparty will be required to report or cause to be reported data for its derivative transactions to a DTR.
A local counterparty is defined as a counterparty to a transaction that, at the time of the transaction (a) is a person or company, other than an individual, organized under the laws of Ontario or that has its head office or principal place of business in Ontario; (b) is registered under Ontario securities law as a derivatives dealer or in an alternative category as a consequence of trading in derivatives; or (c) is an affiliate of a person or company described in (a) and such person or company is responsible for the liabilities of that affiliated party. The definition of local counterparty has been revised from that of the June proposal to, among other things, clarify that paragraph (b) only applies to counterparties that are required to be registered because of their derivatives business. The derivatives dealer rules are not yet published, so the scope of part (b) is unclear at this point, but the clarification that it is derivatives dealers and not all securities legislation registrants that are covered is a helpful change from the draft rule.
Meanwhile, the reporting counterparty with respect to a transaction involving a local counterparty is deemed to be: (i) the recognized or exempt clearing agency, if the transaction is cleared through a recognized or exempt clearing agency; (ii) each derivatives dealer, if the transaction is not cleared through a recognized or exempt cleared agency and is between two derivatives dealers; (iii) the derivatives dealer, 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; and (iv) each local counterparty to the transaction, in any other case. While a reporting counterparty may delegate its reporting obligations under Rule 91-507, it would remain responsible for ensuring the timely and accurate reporting of derivatives data. Recognizing that reporting counterparties that are derivatives dealers might not be local counterparties over whom the OSC has direct jurisdiction (i.e. they are not registered as derivatives dealers in Ontario or in an alternative category), the rule imposes the obligation to report on the local counterparty where the non-local dealer fails to confirm to the local counterparty by the end of the second business day following the reporting day that is has reported.
Where no DTR accepts the data required to be reported, the reporting counterparty will have to electronically report the data to the OSC.
The final rule improves on the draft rule by incorporating a limited substitute compliance provision. If the only local counterparty is a derivatives dealer or a guaranteed affiliate of a local counterparty (i.e. part (b) or (c) of the local counterparty definition), then the reporting obligation is satisfied if the reporting counterparty reports to a designated trade repository pursuant to the securities legislation in another province or the laws of a designated foreign jurisdiction, and the reporting counterparty instructs the designated trade repository to give the OSC access to the derivatives data that it was required to report and otherwise uses its best efforts to give the OSC that access. This provision is intended to avoid duplicative reporting in cases where the trading activity in question may have little connection with Ontario. The rule does not specify which jurisdictions are deemed to have equivalent reporting obligations for purposes of this provision; rather such designations will be made by the OSC from time to time. The final rule clarifies that data must be reported to the same DTR as the initial report was made to.
Errors or omissions must be reported as soon as technologically practicable after their discovery which can’t be later than the end of the business day following the discovery. (The draft rule imposed a one day delay from the date of the reportable event.)
Creation data is generally to be reported in real time and life-cycle event data must generally be reported by the end of the business day on which the life cycle event occurs.
Valuation data based on industry accepted standards must be reported to the DTR daily, based on previous day’s closing market data, if the reporting counterparty is a derivatives dealer or clearer or, in other cases, quarterly as of the last day of the calendar quarter and within 30 days of the end of the quarter.
Provisions have been included for the reporting of data for trades entered into before the rule becomes effective on July 2, 2014 and that have not expired or terminated before December 31. A more limited set of creation data for those transactions must be reported by December 31, 2014. Once the creation data is reported, life-cycle and valuation data must be reported. Reporting counterparties will also have to identify each reported transaction with a unique product identifier and Rule 91-507 also outlines the minimum data fields that are required to be reported to a designated trade repository.
A reporting counterparty must keep transaction records in a safe and durable form for 7 years after the date on which the transaction expires or terminates. Commentators had asked for this to be reduced to 5 years.
Ultimately, the changes made to the earlier draft version of the rule are intended to, among other things, insulate affiliates of registered foreign derivatives dealers from being deemed local counterparties, clarify the reporting counterparty hierarchy and provide limited substituted compliance for counterparties residing primarily outside of Ontario but that are otherwise subject to the rule.
Data Dissemination and Access
DTRs must provide the OSC with electronic access to such data as the OSC requires and must create aggregate data and make it available to the OSC as it requires. A reporting counterparty is obligated to use its best efforts to provide the OSC with access.
DTRs must provide the properly authorized representatives of counterparties with access to all the data relevant to their transactions. The rule deems each counterparty to consent to that disclosure and it applies despite any agreement to the contrary.
A DTR must give the public aggregate data on open positions, volume, number and price relating to transactions with breakdowns by currency, location of reference entities or assets, asset class, type of contract, maturity and whether or not it is cleared. It must not disclose the identity of the parties. A DTR is not required to publicize any data for transactions between affiliated companies (“affiliated companies” is defined in the Securities Act).
There are two exclusions noted in the rule itself.
First, if the asset class of the transaction is a commodity (other than cash or currency) and the local counterparty is not a derivatives dealer and the local counterparty has less than $500,000 aggregate notional value, without netting, under all its outstanding transactions (whether or not they are commodity transactions) at the time of the transaction (including the notional value of this transaction), then the rule does not apply. There is nothing in the rule that permits reliance by a reporting counterparty on a representation of the local counterparty or any other indication of how the reporting counterparty could confirm that assessment. The use of gross notional value seems somewhat meaningless. We suspect this particular exclusion will not be seen as very important.
The second applies only to intergovernmental transactions so it not of much interest (unless you happen to be in the Ontario government of course).
The Director of the OSC can also grant exemption orders.
As stated previously, the requirements are expected to come into force beginning on December 31, 2013 with the implementation of some requirements staggered over the next year.
Most importantly, data reporting obligations for reporting counterparties involving a derivatives dealer come into effect on July 2, 2014.
To deal with confidentiality concerns raised about public dissemination of transaction level data by DTRs and the adverse impact such disclosure may have on large transactions, , the rule requiring public dissemination of such data will not come into effect until December 31, 2014to allow some time to further consider those concerns.
Where both counterparties are non-dealers, no reporting will be required until September 14, 2014.
Reporting does not apply to transactions entered into prior to July 2, 2014 that expire or terminate prior to December 31, 2014.
According to the OSC, other areas of potential regulation recommended for the CSA include mandatory clearing, electronic trading, registration and capital and collateral requirements. The OSC has advised that future rule-making in respect of these areas may require consequential amendments to the rules described above.