The revised consultation draft of the federal Capital Markets Stability Act (CMSA) significantly scales back jurisdiction over market infrastructure and participants from the prior draft published in the fall of 2014 (see our previous post). The purposes of the CMSA continue – albeit in this newly slimmed-down form – to be to ensure the stability of Canada’s financial system through the management of certain types of systemic risk and to protect capital markets investors and others from “financial crimes”.

This post will review the main features of this new version of the CMSA as they relate to derivatives markets. Comments are due by July 6, 2016.

Key Concepts

The Capital Markets Regulatory Authoritywill be responsible for (i) administering the CMSA, (ii) monitoring activity in capital markets, (iii) dealing with systemic risk, (iv) contributing to the stability of the financial system, (v) taking the lead in enforcing capital markets criminal law and (vi) coordinating Canada’s international involvement in regulating capital markets. The Authority can also be assigned administration of certain aspects of the Bank Act.

“Systemic risk related to capital markets” is one of the core definitions in the CMSA, in part because it delimits the Authority’s authority:

a threat to the stability of Canada’s financial system that originates in, is transmitted through or impairs capital markets and that has the potential to have a material adverse effect on the Canadian economy. (s.3)

“Derivative”is defined broadly to include:

an option, swap, futures contract, forward contract or other financial or commodity contract or instrument whose market price, value, delivery obligations, payment obligations or settlement obligations are derived from, referenced to or based on an underlying interest, including a price, rate, index, value, variable, event, probability or thing.

This draft, however, clarifies that the definition of “derivative” does not include contracts or instruments prescribed by regulation not to be derivatives.

Trade Reporting: Information Collection and Disclosure

I’m sure a lot of you who have been living through the implementation of the different provincial trade reporting rules in Canada think it would be great if the feds would step in and provide one uniform trade data reporting regime. Sorry, it does not look like that will happen. It seems that trade reporting will be an area of joint federal/provincial jurisdiction.

Trade repositories can apply to the Authority for designated trade repository status and presumably the application under the CMSA will be the same application made to any of the jurisdictions participating in the cooperative regulatory system. I suppose we could live in hope that a trade repository designation under the CMSA will be recognized automatically in all other non-participating jurisdictions, but there is no assurance of that.

The Authority will be given authority to make national regulations regarding data reporting for the purpose of identifying and mitigating systemic risk and conducting policy analysis. In doing so it must consider whether providing that information is already required by capital markets or financial legislation in Canada or elsewhere and the extent to which it could practicably be acquired from another source. This could suggest that there is no intention to create a national rule that supersedes the provincial rules and even that the Authority may defer to provincial rules if it can otherwise access the data.

Even though the policy basis for trade reporting requirements in the federal sphere is systemic risk mitigation it doesn’t follow that separate provincial regulations are needed to serve other policy objectives. This is not a case of needing one rule to serve one policy and a different rule to serve another; the same rule serves both – so we only need one rule and access to the data by each regulator for the purposes within their respective jurisdictions. Market participants potentially face having to comply with inconsistent trade reporting requirements within Canada, particularly with respect to non-participating jurisdictions. No doubt there will be an intention among regulators to have uniform rules when the CMSA comes into effect. But that is also their current intention and it has not exactly worked out with perfect harmony. This is a lost opportunity, which is a shame. That’s the last of my opinions in this piece. The rest is information only!

Confidentiality of Information (s.12 to 16)

There are some interesting provisions regarding disclosure of information. A person “may” disclose “personal” information to the Authority if the purpose of the disclosure is for the administration of the CMSA or assisting in the administration of capital markets or financial legislation in Canada or elsewhere. While the Authority will have a general confidentiality obligation with respect to non-public information, the exceptions are broad. The Authority can disclose:

  • to law enforcement agencies (if not otherwise prohibited by law),
  • in an aggregated anonymized form,
  • if consistent with the purposes for which the information was obtained, and
  • to financial regulatory authorities, trading facilities, clearing houses, designated trade repositories, SRO or government authorities or regulatory bodies in Canada or elsewhere if for the purpose of promoting and protecting the stability of Canada’s financial system through the management of systemic risk related to capital markets or assisting in the administration of capital markets or financial legislation in Canada or elsewhere or to anyone else in “exceptional circumstances” where necessary for such purposes.

Regulation of Market Infrastructure Entities

The Authority will have authority to designate benchmarks and various types of products as systemically important and certain practices as systemically risky, and to regulate them once designated. Proposed provisions that got the axe in this draft include those that would have conferred on the Authority power to regulate certain types of market infrastructure entities, namely trading facilities, clearing houses, credit rating organizations and capital markets intermediaries. Those areas are left to provincial regulation.

Benchmarks (s.18, 19)

The Authority can designate a “benchmark” (a term that is broadly defined) as systemically important if it believes that impairment of the benchmark’s reliability or a loss of public confidence it its integrity or credibility could pose a systemic risk related to capital markets. In making such an order, the Authority must consider a number of factors, such as (i) the value of securities or derivatives that reference it, (ii) the markets whose securities or derivatives are referenced in it, (iii) the number and type of persons that rely on it, (iv) the availability of substitutes, (v) the process for determining it, (vi) whether it is already regulated, and (vii) any other risk-related factors. The regulations may include requirements in relation to submission of information for the purpose of determining the benchmark, design, determination and dissemination, continuity plans, governance, and compliance. Before making such an order, the Authority must give the involved or affected entities an opportunity to make representations.

Products (s.20, 21)

The Authority may designate a class of derivatives as systemically important if it believes dealing in them could pose a systemic risk. It must consider certain risk related factors in making the designation which are specified in the CMSA. Regulations can address trading on a trading facility, clearing and settlement, public disclosure, transparency of trading, pricing and valuation processes, rates, indices and other underlying interests, capital, leverage and financial resources, liquidity, margin, collateral, credit protection and position limits, policies and procedures and retention of credit or investment risk.

Practices (s.22, 23)

Practices can be designated as systemically risky if the Authority considers specified factors such as (i) the financial effect of engaging in the practice, (ii) the manner in which it makes use of maturity transformation, liquidity transformation, credit risk transfer or leverage, (iii) the extent of the practice, (iv) whether it has a contagious nature, (v) the types of persons that engage in it, and (vi) how it is otherwise regulated.

Regulations can address policies and procedures for risk management and internal controls, public disclosure, transparency, governance and ownership, capital, leverage and financial resources, margin, collateral, credit protection and position limits, use of ratings, and conflicts of interest related to credit ratings.

Reviews and Orders

Compliance Reviews (s.26 to 28)

The Authority will have a compliance group with power to conduct in-house compliance reviews of any person. The Chief Regulator can designate an authorized person who can summon the attendance of a person and compel them to give evidence on oath or otherwise and to produce records “or other things”. Such orders are enforceable through the Federal Court’s contempt powers. The authorized person could also be empowered to enter places to examine anything, use means of communications, examine data systems and make copies of any records. In other words, they can basically enter and use, copy, photograph any or all of anyone’s stuff. They can take some of it away for a closer look. Interestingly, they can do this for purposes of enforcing the CMSA or compliance with “a foreign jurisdiction’s capital markets legislation”.

Urgent Orders (s.24, 25)

The Authority may make urgent orders it considers necessary to address what it sees as an immediate and serious systemic risk related to capital markets. For example, it could order a person to stop or limit its derivatives trading, to stop or limit reductions of capital or financial resources or just generally to stop “engaging in a practice”. I can’t believe they took out my favourite part of the previous draft, which was the power to prevent a person from “doing anything else”.

The Authority could also suspend or restrict trading in derivatives or classes of derivatives on a trading facility. These are temporary orders (15 days initially but subject to extension for a further 15-day period). If the Authority believes it would undermine the effect of the order, or would not be practicable or appropriate, it does not have to give an affected party an opportunity to make representations. There is some scope for keeping the orders and the reasons for making them confidential.

The Minister of Finance (after consulting the Authority and members of the Council of Ministers representing the major capital markets jurisdictions) may direct the Authority regarding such orders if the Minister believes it necessary to address a serious and immediate systemic risk.

Dealing with Violations

Non-Criminal Penalties (s.33, 37, 38, 48, 49, 51)

Contraventions of the Act may be dealt with either administratively or by the courts. Substantial monetary consequences are possible in either case, but the court process can also lead to a term of imprisonment even in certain situations that do not fall under the Act’s criminal law provisions (which are discussed separately below).

Criminal Offences (Part 5)

A number of criminal offences are also set out by the Act (with the possibility of imprisonment for a maximum of 14 years), including in respect of fraud, insider trading, false information or manipulation in respect of benchmarks, criminal breach of trust, retaliation against whistleblowers, misrepresentation and forgery.