On October 31, amendments to the Alberta Securities Act will come into force that expressly deal with derivatives, including by modifying the registration requirement with respect to derivatives dealers. This article will focus on the aspects of the Act that are relevant to dealer registration and prospectus requirements.
Currently in Alberta, an OTC derivative meets the definition of “future” and, consequently, they are “securities”, meaning that dealers in them are prima facie subject to the same registration and prospectus requirements that apply to securities. Blanket Order 91-505 Over-the Counter Derivatives Transactions, however, exempts from the registration and prospectus regimes OTC derivatives between “qualified parties” and all physical commodity contracts.
Under the amended Act, the registration requirement will apply to “derivatives” dealers, but until the CSA rules on derivatives dealer registration are developed, a replacement Blanket Order 91-706 (the Replacement Order) will provide a broadly similar qualified party and commodity contracts exemption. The draft Replacement Order is out for comment until October 17, but is expected to also come into effect on October 31. While the combined effect of the changes and the Replacement Order will generally be to maintain the status quo, there are some significant differences of which to take note.
Act adds definition of “derivative” and “trading” similar to Ontario
The amendments eliminate the definition of “future” and replace it with a definition of “derivative”. Derivatives are no longer included in the list of what constitutes a “security”. The Act generally follows the same approach as in Ontario (and the draft Provincial Capital Markets Act) in that it includes a broad definition of “derivative”, it allows certain securities to be designated as derivatives and it allows for rules that exclude certain instruments from the definition of derivative.
However, in excluding securities from the definition of derivative, the Act diverges from Ontario, where an instrument could, in theory, be both a derivative and a security, and from Quebec, which has the hybrid instrument test to draw a distinction between derivatives that will be treated as securities and those that will not. It might have been clearer drafting to state that a “security, other than a security designated under section 10 to be a derivative” is not a derivative. Unless securities designated to be derivatives are at the same time designated not to be securities, it would seem that the definition both giveth and taketh away.
Requirements of the Act
The dealer registration requirement in s. 75(1) of the Act will now apply to those in the business of trading in derivatives in Alberta. The definition of “trading” has also been amended to include entering into a derivative or making a material amendment to, terminating, assigning, selling or otherwise acquiring or disposing of a derivative, novating a derivative, participating as a trader in any transaction in a derivative through the facilities of an exchange or quotation and trade reporting system, or the receipt by a registration of an order to buy, sell, enter into, amend, terminate, assign or novate a derivative.
Until a model registration rule for derivatives is developed (expected in 2015), there will not be registration categories for derivatives dealers specifically. So unless exempted by the Replacement Order or a specifically obtained exemption, dealers in derivatives in Alberta will still be required to be registered, presumably as a securities dealer.
Under the amended Act the prospectus requirement will not apply to derivatives (since they are no longer securities) unless they also meet the definition of security and are not otherwise exempt pursuant to the Replacement Order or otherwise. They will apply to derivatives that are also securities, unless exempt pursuant to the Replacement Order or otherwise.
Pursuant to the Replacement Order, the dealer registration requirement does not apply to an “over-the-counter trade” in a “derivative” or a “derivative-like security” if either (a) at the time of the trade each counterparty is a “qualified party” or (b) the trade is in a “physical commodity contract”. Further, the Replacement Order exempts derivative-like securities from the prospectus requirement. The intention of the Replacement Order seems to be to continue the exemption that applies under the existing order, although the definition of derivative-like security seems quite a bit wider. Instruments that would seem to meet the definition of a derivative-like security are index-linked notes, options and other investment contracts. However, the exemption only applies to an over-the-counter trade in those instruments, which modifies its application somewhat.
The definition of a physical commodity contract is essentially unchanged from the existing Blanket Order, but there are some changes to the definition of a “qualified party” to conform them to the accredited investor definition. The commercial user category has also been amended materially and a new definition of managed account has been added relevant to a few of the qualified party categories. Note that the Replacement Order is intended to be a temporary measure until the new derivatives dealer registration rules are in place.