As we posted earlier, the Department of Finance has published for consultation legislation to create a cooperative system under which participating provincial and territorial jurisdictions would enact uniform legislation to regulate capital markets within their jurisdictions (the Provincial Capital Markets Act (PCMA)) and the federal government would enact the Capital Markets Stability Act (CMSA) to address systemic risk in national capital markets, criminal matters and data collection across all jurisdictions. A common regulator, the Capital Markets Regulatory Authority (CMRA), would administer the provincial system (in participating jurisdictions) and the federal system.
This post provides further detail on those aspects of the proposed Acts that would regulate derivatives markets.
Federal Capital Markets Stability Act Introduction
In the Securities Act Reference, the Supreme Court of Canada made it clear that the federal government had jurisdiction to regulate activities that increase or create systemic risk in Canadian financial markets. The federal CMSA is the federal government’s response and is intended to strengthen Canada’s capacity to identify and manage capital markets systemic risk on a national basis. A comprehensive regime addressing systemic risk will be new for Canada.
It is important to note that the federal legislation proposes to regulate certain activities that provincial laws currently address or have been proposed to be addressed in the various Canadian Securities Administrators OTC Derivatives Committee consultation papers. A mandate to clear certain classes of derivatives where they are considered to be “systemically important”, for example, would be addressed in federal legislation under the new regime and presumably will be implemented in a way that results in one national clearing rule and does not simply create an additional regulatory regime on top of the provincial ones.
The CMSA will be administered by the Capital Markets Regulatory Authority (CMRA). (See our related post describing the proposed infrastructure and management of the system.) A key definition in the CMSA is that of “systemic risk related to capital markets”. It delimits the scope of the CMRA’s authority generally and is characterized as:
a threat to the stability or integrity of Canada’s financial system that originates in, is transmitted through or impairs capital markets and that has the potential to have an adverse effect on the Canadian economy.
The definition of “derivative” is:
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.
Trade Reporting- Information Collection and Disclosure
The CMRA will be given authority to make national regulations regarding data reporting to the CMRA and designated trade repositories for the purpose of identifying and mitigating systemic risk. As under existing provincial legislation, trade repositories can apply for designated trade repository status to the CMRA. The CMSA contemplates regulations setting out requirements, prohibitions and restrictions for designated trade repositories.
The same power to designate trade repositories and enact regulations to govern them is conferred on the CMRA in the draft PCMA, although it will only apply in the jurisdictions that enact it (currently Ontario, British Columbia, New Brunswick, Prince Edward Island and Saskatchewan). What the PCMA provisions could add is not clear since it is the same regulator and presumably any regulations would have to be almost exactly the same at this point in order to “avoid imposing an undue regulatory burden” (which the statute directs the CMRA to do – to the extent practicable).
You may be wondering how a federal trade reporting regime would impact trade reporting regimes in provinces that are not cooperating jurisdiction. Good question! Will these provincial authorities recognize or exempt any CMRA designated trade repository? Will the federal regulation override the provincial where there is overlap?
We will have to wait and see.
Confidentiality of Information
There are some interesting provisions regarding disclosure of information in the CMRA. Various types of market participants (e.g. trade repositories, clearing organizations, dealers, SROs) “may” disclose “personal” information to the CMRA 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. This wording is odd considering the fact that market participants would not necessarily know whether the disclosure met the purpose of assisting in the administration of the CMSA or other legislation. The CMRA will have a general obligation to keep non-public information it acquires confidential. There are a number of very broad exceptions though, including:
- disclosure to law enforcement agencies if the disclosure is not otherwise prohibited by law;
- disclosure in an aggregated form from which is it “not possible” to ascertain information relating to any identifiable person is permitted;
- information the CMRA obtains may be disclosed if it is consistent with the purposes for which the information was obtained or the CMRA considers that the public interest in disclosure outweighs any private interest in keeping it confidential; and
- the Chief Regulator (the CEO of CMRA’s regulatory division) may disclose information to financial regulatory authorities, trading facilities, clearing houses, designated trade repositories, SRO or government or regulatory authorities in Canada or elsewhere if for the purpose of promoting and protecting the stability and integrity 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.
There is no provision that expressly absolves a person from its legal obligations to maintain confidentiality so as to allow disclosure of the information to a trade repository or the CMRA.
Regulation of Market Infrastructure Entities
The CMRA has authority (in consultation with the Chief Regulator) to designate various types of market infrastructure, participants, products as systemically important (or practices as systemically risky) and to regulate them once designated. These powers exist with respect to:
- Trading facilities [facilitates trading in securities or derivatives by matching orders from multiple buyers and sellers];
- Clearing houses for derivatives or securities;
- Benchmarks [make note – fairly widely defined];
- Capital markets intermediaries [e.g. dealers in derivatives or securities, underwriters, pension funds, investment managers, investment funds and others whose primary purpose is to invest money provided by their securityholders];
- Products [classes of securities or derivatives]; and
In making the order, the CMRA must consider a number of factors that vary depending on the type of order, but which are similar and relate to the risks to capital markets that they pose, the concentration of market activity they represent, the availability of substitutes, the volume of business, the number of participants and their exposure, interdependencies and relationships and any other risk related factors. Prior to making the order, the CMRA must inform the Council of Ministers of the intention to make the order and give the involved or affected entities an opportunity to make representations.
The CMSA sets out the areas that the CMRA can regulate once the designation is made. This includes such areas as risk management policies, procedures and controls, transparency, margin and collateral, trading rules, default rules, governance and structural matters, capital and financial resources, liquidity, business continuity plans and conflicts of interest.
In the case of orders involving clearing houses, the concurrence of the Bank of Canada is required.
The CMRA may make urgent orders it considers necessary to address what it sees as an immediate and serious systemic risk related to capital markets. It could order a person to stop or limit its derivatives trading, reduce of capital or financial resources or to stop (I like this part) “doing anything else”. (I do actually like that in case you think I was being sarcastic. What could be clearer? Although – could it order a person to stop omitting to do something. Hmmmm. But I digress.)
It 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 CMRA 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 CMRA and members of the Council of Ministers representing the major capital markets jurisdictions) may direct the CMRA to make, amend or release an urgent order if the direction is necessary in the Minister’s opinion to address an immediate and serious systemic risk related to capital markets.
The CMRA will have a compliance group with power to conduct in-house compliance reviews of systemically important trading facilities, clearing houses, credit rating organizations, capital markets intermediaries or designated trade repositories.
The Chief Regulator can also authorize a person to summon attendance before the person, compel them to give evidence on oath or otherwise, produce records “or other things”, and these 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, basically they can enter and use, copy, photograph any or all of your 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”.
Meanwhile, individuals found guilty of contravening a provision of the Act may, on summary conviction, be fined up to $250,000 and/or face imprisonment of up to one year. For an indictable offence, an individual may be liable to a fine of up to $5 million and/or imprisonment of up to five years. Non-individuals, meanwhile, may be liable to a fine of up to $5 million on summary conviction and up to $25 million for an indictable offence. A number of criminal offences are also set out by the Act (carrying imprisonment of a maximum of up to 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.
Violators of the Act may also be subject to administrative monetary penalties intended to promote compliance. The maximum penalty for a violation of the Act is $1 million in the case of an individual and $15 million for non-individuals.
Generally, where a violation is committed by a non-individual, directors or officers who authorized, permitted or acquiesced in the contravention are also liable under the Act. Where an investment fund commits a violation, the investment fund manager is also deemed liable for the violation. Entities may also be found liable for violations committed by their employees acting within the scope of their employment.