On April 4, 2017, the Canadian Securities Administrators (CSA) published a notice and request for comment on their proposed business conduct rule that sets out a regime for regulating the conduct of dealers and advisers in over-the-counter derivatives markets. The CSA’s Proposed National Instrument 93-101 Derivatives: Business Conduct, along with Proposed Companion Policy 93-101 Derivatives: Business Conduct (together the proposed rule), is aimed at protecting parties using over-the-counter derivatives products by requiring derivatives firms to meet certain minimum standards in relation to their business conduct towards their customers and counterparties. The types of measures proposed will be familiar to dealers and advisers in securities markets, albeit with modifications tailored to the nature of the OTC derivatives market. The introduction of this proposed rule is the first of two highly anticipated regulatory developments in the Canadian OTC derivatives space, with the second being the derivatives registration rule, which is expected to be published in the summer of this year. Comments on the proposed rule are being accepted until September 1, 2017.

A separate regime for market conduct and derivatives registration

The CSA’s decision to separate the market conduct rule (which will apply to a certain extent to federal financial institutions) from the derivatives registration rule may foreshadow that federal financial institutions will be exempt from the registration rule. The proposed rule is intended to establish a robust derivatives market conduct regime that is harmonized across Canada and is consistent with IOSCO’s international standards. The regime would apply as a baseline standard to “help protect investor, reduce risk, improve transparency and accountability and promote responsible business conduct” in the OTC derivatives markets in the wake of the global financial crisis and what the CSA note have been “numerous cases of serious market misconduct in the global derivatives market including, for example, misconduct relating to the manipulation of benchmarks and alleged front running of customer orders”.

Targeted exemptions for end-users, financial institutions, investment dealers and foreign market participants

As we will discuss in our more detailed posts, the proposed instrument contemplates a range of exemptions in the case of qualified derivatives end-users, as well as IIROC-member investment dealers and Canadian financial institutions that meet equivalent regulatory requirements. Significantly, the proposed instrument would also exempt foreign derivatives dealers and advisers located in certain jurisdictions that the CSA will have determined achieve substantially the same objectives, on an outcomes basis, as the proposed instrument, subject to certain terms and conditions. The CSA note that their equivalence analysis of foreign market conduct rules in the leading derivatives markets is still pending.

Two-tiered approach to regulating market conduct

The proposed rule sets out a two-tiered approach to regulation. In the first instance, certain minimum standards (e.g., fair dealing, conflicts of interest management, know-your-client and suitability, disclosure requirements and duties imposed on “senior derivatives managers”) will apply to the conduct of all “derivatives dealers” and “derivatives advisers” (how those terms are defined will be the subject of a later post – but note that the proposed rule would apply regardless of whether or not a dealer or an adviser is registered, required to be registered or exempted from the requirement to be registered). The additional disclosure requirements, restrictions and standards of care, among other things, would only apply to activities involving less sophisticated derivatives parties (i.e., the retail market).

The criteria used to distinguish between the retail market and the more sophisticated parties that use OTC derivatives products are based on indicia of sophistication and financial thresholds, with the lighter regulatory regime reserved for dealings with customers or counterparties that qualify as “eligible derivatives parties”. According to the CSA’s notice, the proposed definition of “eligible derivatives parties” is generally consistent with definitions that many of you will already be familiar with, such as the definition of “permitted client” under National Instrument 31-103 with respect to trading and advising in relation to securities, as well as the definitions of “accredited counterparty” in the Quebec Derivatives Act and“qualified party” found in the blanket orders relating to OTC derivatives trades that are currently in place in certain provinces.

150-day comment period and proposed dealer registration rule

The publication of the proposed rule for an extended 150-day comment period (until September 1, 2017) is designed to give market participants enough time to review the proposed rule alongside the proposed derivatives registration rule, which is expected to be published in the summer of this year. We anticipate that once the CSA have time to consider the feedback they receive on the proposed rule that there will be at least a second iteration of the rule before it is published it its final form. We also understand that securities commissions will be holding roundtable discussions during the comment period to solicit feedback on the proposed rule.

Stay tuned - we expect to post more detailed analysis on this development in the upcoming weeks. In the meantime, we recommend that you review the CSA’s notice to the proposed rule in order to help you start thinking about how it might impact your business and product lines and the additional policies, procedures and controls that you may have to develop to address these new market conduct requirements.