On April 4, 2017, the Canadian Securities Administrators OTC Derivatives Committee (the CSA) published the following proposed national instrument and related companion policy which will be open for comment for a 150-day period, expiring on September 1, 2017:
- Proposed National Instrument 93-101 Derivatives: Business Conduct (the Instrument)
- Proposed Companion Policy 93-101 Derivatives: Business Conduct (the Companion Policy)
Collectively, the CSA has referred to the Instrument and the Companion Policy as the Proposed Instrument.
The Proposed Instrument sets out a regime for business conduct for certain derivatives market participants. The CSA indicates that it has developed the Proposed Instrument “to help protect investors, reduce risk, improve transparency and accountability and promote responsible business conduct in the over-the-counter (OTC) derivatives markets.” The business conduct regime prescribed by the Proposed Instrument is similar to existing market conduct requirements applicable to registered securities dealers and securities advisors under National Instrument 31-101 Registration Requirements, Exemptions and Ongoing Registrant Obligations.
Summary of Proposed Instrument
The CSA has summarized the Proposed Instrument, in part, as follows:
“[t]he Proposed Instrument is intended to create a uniform approach to derivatives market conduct regulation in Canada and will promote consistent protections for market participants regardless of the type of firms they deal with while also providing that persons or companies that are subject to requirements under the Proposed Instrument are subject to consistent regulation that does not result in a competitive advantage.”
The Proposed Instrument sets out a comprehensive regime regulating the conduct of derivatives dealers and derivatives advisors. The CSA refers to derivatives dealers and advisors collectively as a “derivatives firm”. The Proposed Instrument takes a layered approach to investor/customer protection. A derivatives firm has certain obligations that apply in all cases when dealing with or advising a “derivatives party”1 regardless of the level of sophistication or financial resources of the derivatives party. Other obligations contained in the Proposed Instrument do not apply if the derivatives firm is dealing with or advising a derivatives party that is an “eligible derivatives party”.2
Dealing with or advising derivatives parties
The Proposed Instrument sets out certain business conduct obligations which apply whenever a derivatives firm is dealing with or advising a derivatives party, including when it is dealing with an eligible derivatives party. Such obligations include:
- Fair dealing
- Conflicts of interest
- Know your derivatives party
There are other obligations in the Proposed Instrument that do not apply if the derivatives firm is dealing with or advising a derivatives party that is an eligible derivatives party. These other obligations are intended to protect less sophisticated market participants and include:
- Derivatives-party-specific needs and objectives
- Permitted referral arrangements
- Verifying the qualifications of the person receiving the referral
- Disclosing referral arrangements to a derivatives party
- Disclosure regarding the use of borrowed money or leverage
- Handling complaints
- Tied selling
- Fair terms and pricing
Derivatives party accounts
Derivatives firms have an obligation to provide any derivatives party that is not an eligible derivatives party with more detailed information concerning their derivatives transactions, their accounts and their assets. There is no obligation on the derivatives firm to provide the same sort of information to an eligible derivatives party.
The derivatives party must be provided with all the information that it needs to understand its relationship with the derivatives firm, the products and services the derivatives firm will provide, and any fees or other charges the derivatives party may be required to pay. The derivatives firm must also provide detailed disclosure relating to the type and characteristics of any derivatives (including associated material risks) before transacting with or on behalf of a derivatives party. The Proposed Instrument also prescribes requirements related to the segregation and holding of derivatives party assets, as well as the restrictions on use and investment of those assets. A derivatives firm is required to segregate derivatives party assets from its own property.
Compliance and record keeping
The Proposed Instrument requires derivatives firms to have policies and procedures in place that create a system of controls to manage risk and to ensure that the individuals at derivatives firms have the necessary training and expertise to meet the various compliance and record keeping obligations. Senior management in a derivatives firm has certain supervisory, management and reporting obligations, which are intended to create accountability and effective management of the derivatives firms. Further, the derivatives firm is required to respond to material non-compliance and, in certain circumstances, must report material non-compliance to the applicable regulatory authority.
Application of Proposed Instrument
The Proposed Instrument applies to “derivatives dealers” (those in the business of trading OTC derivatives), and “derivatives advisors” (those in the business of advising in OTC derivatives), regardless of whether they are registered or exempt from the requirement to register as a dealer or advisor in any given jurisdiction. In determining whether a person is in the business of trading or advising in derivatives, a number of factors should be considered, including if the person is:
- Quoting prices or acting as a market maker;
- Directly or indirectly carrying on derivatives trading or advising activity with repetition, regularity or continuity;
- Facilitating or intermediating transactions;
- Transacting with the intention of being compensated;
- Directly or indirectly soliciting in relation to derivatives transactions;
- Engaging in activities similar to a derivatives dealer or derivatives advisor;
- An “adviser” in Manitoba as defined in the Commodity Futures Act (Manitoba);
- An “adviser” in Ontario as defined by the Commodity Futures Act (Ontario); or
- An “adviser” in Québec as defined by the Securities Act (Québec).
The CSA is careful to point out that they do not consider that all of the factors discussed above are exhausted, nor do they necessarily carry the same weight. Triggering one factor will not be determinative. A person should consider their activities holistically in determining whether or not they would be considered a derivatives dealer or derivatives advisor; ad hoc or isolated instances of activities may not necessarily result in a person being a derivatives dealer or derivatives advisor.
Exemptions and limitations
A person in the business of trading or advising in OTC derivatives may qualify for an exemption from the Proposed Instrument. The Proposed Instrument does not apply to:
- Conduct when dealing with an affiliated entity of the person;
- Cearing agencies;
- Governments, central banks and international organizations;
- Persons providing general advice in relation to derivatives where the advice is not tailored to the needs of the person receiving the advice (e.g. analysis published in mass media), and the person discloses all financial or other interests in relation to the advice;
- Derivatives dealers and derivatives advisors that are regulated by comparable business conduct rules under the laws of a foreign jurisdiction; and
- Persons who use derivatives in the course of their business but do not deal with or advise other derivatives parties (i.e. end-users).
As noted above, the Proposed Instrument prescribes that a derivatives firm may have different obligations towards an eligible derivatives party than it would to retail customers or investors (i.e. derivatives parties that are not eligible derivatives parties). An eligible derivatives party does not require the full set of protections afforded to persons that do not have the same financial resources or expertise.
Further, derivatives dealers that are registered as an investment dealer and are members of the Investment Industry Regulatory Organization of Canada (IIROC), are exempt from certain laws, regulations or instruments applicable to investment dealers which are already prescribed by IIROC. Derivatives dealers that are Canadian financial institutions are exempt from certain laws, regulation or instruments applicable to Canadian financial institutions if the derivatives dealer is subject to corresponding conduct and other regulatory requirements of its prudential regulator.
The Proposed Instrument applies to the same OTC derivatives contracts and instruments in all jurisdictions of Canada. The Proposed Instrument applies only to those OTC derivatives contracts or instruments which are not excluded from being derivatives for the purpose of the applicable Product Determination Rule. 3