On April 18, 2013, the Canadian Securities Administrators Derivatives Committee (the "CSA Committee") published the sixth in a series of eight papers, entitled Consultation Paper 91-407 – Derivatives: Registration ("Consultation Paper 91-407"). In Consultation Paper 91-407, the CSA Committee proposes a registration framework for the regulation of key over-the-counter ("OTC") derivatives market participants. Key participants are generally those with high-risk OTC derivatives exposure or that are in the business of trading or providing advice in relation to OTC derivatives. Three registration categories are proposed – derivatives dealers, derivatives advisers, and large derivative participants ("LDPs"). Regulatory requirements will include minimum capital rules, internal controls, risk management, and oversight of interactions with counterparties and clients. There will also be certain limited exemptions from some regulatory requirements. The OTC derivatives registration regime will be in addition to, and not in substitution of, any necessary registration under similar securities laws.
Consultation Paper 91-407 continues to build on the high-level proposals in Consultation Paper 91-401 – Over-the-Counter Derivatives Regulation in Canada, released on November 2, 2010 ("Consultation Paper 91-401"), which reflect Canada's G20 commitments regarding OTC derivatives regulation.1 The CSA Committee recognizes that the Canadian OTC derivatives marketplace is small when compared to the global market, and it strives to ensure that Canadian market participants continue to have access to international marketplaces and that they are being regulated in accordance with international principles.
Consultation Paper 91-407 is divided into three major parts: (1) Categories of Registration; (2) Registration Requirements; and (3) Exemptions.
- categories of registration
The CSA Committee proposes three registration categories: (1) derivatives dealers, (2) derivatives advisers, and (3) LDPs. Each category requires registration in every Canadian province and territory where the person conducts the relevant derivatives business. These categories reflect existing and proposed categories of registration in the United States and Europe.2 They also reflect the Technical Committee of the International Organization of Securities Commissions' June 2012 proposals regarding OTC derivatives market intermediaries regulation.3
Certain provinces have already developed or are in the process of developing derivatives registration requirements.4 Amendments to securities acts have been approved but are not yet in force in both Ontario and Manitoba, and would require registration of persons trading in or advising on derivatives. Similar rules are being developed in other provinces. National Instrument 31-103 – Registration Requirements, Exemptions and Ongoing Registrant Obligations offers a registration system for those in the business of trading or advising on securities and for persons acting as investment fund managers. However, the CSA Committee believes that the derivatives market operates differently from the securities market and thus requires a separate and distinct registration regime. With certain exceptions, the CSA Committee proposes that all types of derivatives fall under the registration regime regardless of the nature of the underlying asset (whether it is securities-based or not).5 Consequently, those registered as securities dealers or securities advisers who are also required to register under derivatives rules – including investment funds and advisers to funds – should be subject to both regimes.
The registration requirement would be universal. Parties who are currently subject to exemptions from the requirement to register – such as federally regulated banks in Ontario or international dealers – would be required to register, but may be subject to exemptions from various regulatory requirements. For instance, entities who are resident outside of Canada will be subject to the registration requirement, even if they do not have an office or other place of business in Canada, if they conduct regular and repetitive trading or advising activity with counterparties resident in Canada or actively solicit or market derivatives trading or advisory business in Canada.
Qualified Parties. The CSA Committee distinguishes between "qualified parties" and "non-qualified parties" for certain registration requirements. Qualified parties are those who are subject to securities or derivatives registration in Canada, have sufficient financial resources to cover losses from derivatives trades and to perform all obligations relating to a derivatives trade, and understand the risks and obligations relating to trading in derivatives. All other parties are non-qualified parties. A more specific definition of qualified parties will be developed in future regulations.
Derivatives Dealer. Derivatives dealers are persons who carry on the business of trading in derivatives or hold themselves out to be carrying on that business. The CSA Committee is not recommending the de minimis exemption available in the United States.6 The definition of derivatives dealer encompasses two criteria: (1) carrying on the business of (2) trading derivatives. The CSA Committee proposes that the definition of "trade" reflect the definition of a trade in a derivative in the Ontario Securities Act.7 Trading will include entering into a derivatives contract as well as material amendments to, assignment of any or all rights under, termination of, and novation (except to a clearing agency) of a derivatives contract as well as other activities in furtherance of a trade. Second, the CSA Committee recommends that a variety of factors be considered when determining whether a person is in the business of trading derivatives. These factors include: (1) intermediating trades; (2) acting as a market maker; (3) trading with the intention of being remunerated or compensated; (4) directly or indirectly soliciting; (5) providing clearing services to third parties; (6) trading with a counterparty that is a non-qualified party who is not represented by a derivatives dealer or adviser on a repetitive basis; and (7) engaging in activities similar to those carried out by a derivatives dealer. The CSA Committee also sets out a guideline for assessing a person's jurisdiction that includes actively soliciting or marketing a derivatives trading business in that jurisdiction.
Derivatives Adviser. Derivatives advisers are persons who carry on the business of advising others in relation to derivatives or who hold themselves out as being in that business in any Canadian jurisdiction. According to the CSA Committee, the concept of advising in relation to derivatives is similar to that of advising in securities, and would include providing advice relating to managing a portfolio of derivatives, using derivatives as an investment strategy, and providing advice on hedging strategies. The business trigger for advising includes: (1) directly or indirectly providing advice about derivatives trading activity with repetition, regularity or continuity; (2) being or expecting to be remunerated or compensated; (3) directly or indirectly soliciting; and (4) engaging in activities similar to those carried out by a derivatives adviser. Criteria similar to those for derivatives dealers are proposed with respect to jurisdiction.
LDPs. LDPs are entities, other than derivatives dealers, that have a substantial aggregate derivatives exposure. The CSA Committee recommends additional analysis to establish registration thresholds for LDPs. The CSA Committee defines an LDP as being either a Canadian or foreign resident that maintains a substantial position in a derivative category (for foreign residents, this would have to be with Canadian resident counterparties), and where the entity's exposure in Canada results in high-risk counterparty exposure posing a threat to the stability of Canadian financial markets. Those entities registered as derivatives dealers would not also be required to register as LDPs.
Individual Registrants. The CSA Committee believes that individual representatives of derivatives dealers and derivatives advisers should also be required to register, with certain limited exceptions. Similarly, the ultimate designated person, chief compliance officer and chief risk officer of a registrant should be registrants as well. Registration should apply to management as well as frontline staff. Individuals trading with counterparties that are non-qualified parties may also be subject to registration if not already captured by one of the three registration categories.
Where appropriate, the CSA Committee proposes reliance on third-party regulators including foreign regulators, prudential regulators, and self-regulatory organizations.
- registration requirements
The CSA Committee proposes that all registrants be subject to the following regulatory requirements:
- proficiency, developed through taking educational courses, passing relevant exams, or work experience;
- financial and solvency rules, including requirements for minimum capital, margin, insurance, maintenance of financial records and periodic financial reporting;
- compliance systems and internal business conduct systems approved by the registrant's board of directors including appointment of an ultimate designated person, chief compliance officer and chief risk officer, record keeping, and complaint handling;
- honest dealing; and
- preventing misappropriation when holding client or counterparty assets.
The CSA Committee recommends that derivatives dealers and derivatives advisers be subject to additional requirements, which include: (1) a gatekeeper role, such as the obtaining of sufficient information relating to clients; (2) registration requirements to protect derivative market participants, including addressing the conflict of interest that occurs where a derivatives dealer trades with a non-qualified party; and (3) business conduct. The CSA Committee recommends that trades with non-qualified parties either be prohibited unless the non-qualified party receives independent advice from a registered derivatives adviser or be specially addressed by, among other things, requiring the dealer to advise the counterparty that it has the right to independent advice prior to the transaction taking place. The CSA Committee is concerned that the latter approach would not inhibit unfair business practices. The business conduct requirement would apply, with certain exceptions, to derivatives advisers, derivatives dealers acting as an intermediary on behalf of clients, and, if the second approach described above is implemented, dealers trading with counterparties that are non-qualified parties. It would include requirements based on know-your-client or counterparty rules, determining the suitability of the OTC derivatives trade, addressing conflicts of interest, and practicing fair dealing.
Lastly, the CSA Committee recommends certain regulatory requirements that would apply only to derivatives dealers. These include pre-trade reports, post-trade reports, and account statements.
The CSA Committee has considered but not yet recommended that registrants be required to become members of a self-regulated organization. More detailed registration requirements will be published in draft rules, which will be provided for comment.
Certain registrants – including regulated persons,8 foreign derivatives dealers and advisers, and foreign LDPs – may be exempted from some regulatory requirements. First, those regulated by an equivalent regime should not be subject to redundant requirements. Canadian securities regulators would determine where such equivalent regimes exist. Second, foreign derivatives dealers and advisers may become subject to Canadian regulation while already being regulated in their home jurisdiction. With certain exceptions (such as business conduct requirements and requirements to provide trade reporting and account statements), such foreign entities would be exempt from specific equivalent regulatory requirements. Third, foreign LDPs may already be subject to regulation and would be required to register in each jurisdiction where their trading obligations exceed the prescribed thresholds.
Further, the CSA Committee recommends that dealers providing advice as an element of trading services under specified circumstances, governments, clearing agencies, and those participating in transactions with affiliated entities be exempt from the requirement to register.
next steps and comments
The CSA Committee encourages market participants and the public to submit comment letters addressing any issues or questions raised by Consultation Paper 91-407. Comments must be submitted by June 17, 2013. The CSA committee will consider the comments and finalize the rule-making guidelines, after which time each province will begin the rule-making process. The CSA Committee will also be releasing the remaining two consultation papers, including a consultation paper on minimum capital requirements, in the coming months.9 Throughout its proposals, the CSA Committee is striving to balance regulation requirements, which are being proposed to protect OTC derivatives market participants from unfair practices and to promote risk management, with its goals of minimizing the burden and cost of regulation on market participants.