No substituted compliance available to U.S. and EU clearing intermediaries and agencies

The first filings of customer collateral delivery reports by direct and indirect clearing intermediaries and regulated clearing agencies were due August 15, 2017 under National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions (Regulation 94-202 in Quebec) (the Customer Collateral Rule) in applicable Canadian jurisdictions.

The Customer Collateral Rule came into force on July 3, 2017 and requires that a clearing intermediary and a regulated clearing agency (as defined in the instrument) deliver the applicable form to the securities or derivative regulatory authority of each Canadian jurisdiction in which it has a local customer in relation to cleared derivatives. Interested market participants should refer to the requirements and related forms at CSA Staff Notice 94-302 Delivery of Forms Required Under National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions. These regulatory reporting obligations are in addition to the other compliance obligations under the Customer Collateral Rule.

Currently, OTC derivatives clearing infrastructure and intermediaries are largely located outside of Canada, with most clearing agencies and intermediaries concentrated in the United States and the European Union. The Customer Collateral Rule does provide for an exemption from the instrument in reliance on outcomes-based substituted compliance where a foreign clearing intermediary or regulated clearing agency in compliance with comparable U.S. and EU laws is involved in clearing a local Canadian customer’s cleared derivatives. Significantly, certain provisions do, however, continue to apply to foreign market participants notwithstanding the application of these substituted compliance provisions. These so-called “residual provisions” include record retention requirements, as well as customer collateral reporting to the customer and the local Canadian regulator.

As previously reported by Margaret Grottenthaler, the Customer Collateral Rule sets out requirements for the treatment of customer collateral by clearing intermediaries providing clearing services to local customers and derivatives clearing agencies located in Canada or providing clearing services to Canadian customers. The Customer Collateral Rule includes requirements relating to the segregation and use of customer collateral (including a prohibition on cross-margining of OTC derivatives with other products such as futures) that are designed to protect customer positions and collateral in both non-default or “business-as-usual” transfer scenarios. The Customer Collateral Rule also includes detailed recordkeeping, reporting and disclosure requirements intended to make customer collateral and positions readily identifiable. Finally, the Customer Collateral Rule contains requirements relating to the transfer or porting of customer collateral and positions with the intended result, in the event of default or insolvency of a clearing intermediary, that customer collateral and positions may be transferred to one or more non-defaulting clearing intermediaries.

By way of reminder, the Canadian Securities Administrators (CSA) also adopted National Instrument 94-101 Mandatory Central Counterparty Clearing of Derivatives (the Clearing Rule) effective April 4, 2017 for clearing participants and October 4, 2017 for other parties subject to the rule. The Clearing Rule applies to direct clearing participants of a regulated clearing agency (and their affiliates) and major swap market participants that are local counterparties (month-end gross notional above CAD 500 billion). Initially, the products mandated to clear are certain interest rate derivatives and forward rate agreements. Margaret Grottenthaler reviewed the main features of the Clearing Rule here.