The Canadian Securities Administrators Derivatives Committee (the CSA) published Consultation Paper 91-407 – Derivatives: Registration (the Paper) on April 18, 2013. The Paper outlines a proposed registration and compliance regime that will apply to derivatives dealers, derivatives advisers and certain major participants in Canadian derivatives markets and will impose Canadian registration obligations on many Canadian and foreign derivatives market participants that previously were not required to register with securities regulatory authorities. With limited exceptions, all companies engaging in the business of trading in or advising on derivatives in Canada would be required under the proposal to be registered as derivatives dealers or derivatives advisers and to comply with specific registration requirements including proficiency, financial reporting, capital, insurance, record-keeping and honest dealing requirements and additional business conduct requirements that would apply when dealing with "non-qualified persons". Large derivatives participants (LDPs) with derivatives positions in excess of prescribed thresholds that could pose a serious risk to Canadian financial markets or to the financial stability of Canada or any provinces or territories (provinces) would also be subject to the registration obligations described in the Paper.
The Paper is the latest in a series of consultation papers published by the CSA that propose a harmonized set of provincial rules to regulate over-the-counter derivatives markets. Other consultation papers in this series discuss the implementation of rules to fulfill Canada's G20 obligations in respect of OTC derivatives, including in respect of mandatory trading on swap execution facilities, central clearing and trade reporting. Currently, most Canadian derivatives market activities are free from direct regulation by securities regulatory authorities, and registration is generally not required for most derivatives market participants due to the current scope of securities laws and existing provincial registration exemptions that are available for derivatives trading among broad classes of market participants. The Paper proposes to replace this existing patchwork exemption regime with new harmonized derivatives dealer and derivatives adviser registration categories that would apply in all provinces and that are similar to the existing harmonized provincial securities dealer and securities adviser registration requirements that apply across Canada.
Registration and Compliance Obligations for Derivatives Dealers
The Paper proposes that persons carrying on the business of trading in derivatives (or holding themselves out to be carrying on that business) should be required to register as derivatives dealers in each Canadian province where they conduct derivatives trading business, unless an exemption is available.
The Paper lists a variety of derivatives activities that may result in a person being considered to be carrying on the business of trading in derivatives and therefore required to register as a derivatives dealer if no exemption is available (referred to as the "business trigger" test) including: (i) intermediating or brokering trades between counterparties; (ii) acting as a derivatives market maker; (iii) trading with the intention of being remunerated or compensated; (iv) directly or indirectly contacting anyone to solicit derivatives trades or offer trading services; (v) providing clearing services to third parties; and (vi) engaging in activities similar to a derivatives dealer. The Paper states that this list is not complete, that the existence of any one of these factors on its own is not determinative as to whether the person is in the business of trading in derivatives and that instead a holistic analysis should be applied. The Paper also notes that, under the proposed business trigger test, a variety of companies that do not carry out derivatives dealing activities as their primary business may become subject to the derivatives dealer registration requirements.
The Paper recommends that registered derivatives dealers and all other derivatives registrants be subject to certain common registration requirements and obligations (the Common Registration Obligations), including: (a) a requirement to establish minimum proficiency standards for all individuals involved in trading in or advising on derivatives for the registrant; (b) financial requirements, including minimum capital, insurance and periodic financial reporting requirements; (c) margin posting requirements in respect of uncleared trades; (d) record-keeping requirements; (e) establishment of adequate compliance and risk management systems; (f) appointment of individual executives as the registrant's "ultimate designated person" ( UDP), chief compliance officer and chief risk officer, who will each be required to be individually registered; and (g) the obligation to act honestly and in good faith when trading in or advising on derivatives.
In addition, derivatives dealers will be required to obtain sufficient information regarding clients and counterparties to allow the derivatives dealer to act as a gatekeeper with the objective of ensuring market integrity and assessing counterparty risks (Gatekeeper Obligations) and, when trading with persons that are not "Qualified Parties" (Non-Qualified Parties), dealers will also be subject to know-your-client, suitability, conflict of interest and fair dealing obligations.
Finally, when a derivatives dealer is acting on behalf of clients, the Paper proposes that the dealer will be required to deliver to the client (a) pre-trade reports providing information on the terms and costs of trades; (b) post-trade reports describing the principal economic terms of executed trades; (c) trade confirmations that satisfy requirements to be specified in a future model rule; and (d) periodic account statements describing outstanding positions, including current market values and information regarding posted collateral. These reports, trade confirmations and account statements would also be required to be furnished by derivatives dealers to any counterparties that are Non-Qualified Parties if Canadian securities regulators decide to permit trading between derivatives dealers and Non-Qualified Parties that are not being advised by registered derivatives advisers, as discussed below.
Trading with Non-Qualified Parties
The Paper proposes to address the conflict of interest that arises when a derivatives dealer enters into a transaction with a Non-Qualified Party that is also relying on the derivatives dealer for direction or advice in relation to the trade. Two alternatives are proposed to address this conflict of interest situation. Under the first alternative, derivatives dealers would be prohibited from entering into trades with Non-Qualified Parties unless the Non-Qualified Party is receiving advice from an independent registered derivatives adviser. Under the second alternative, the derivatives dealer would be required to inform the Non-Qualified Party that there is a conflict of interest, provide details of the conflict in writing, advise the Non-Qualified Party that it has the right to obtain independent advice before entering into the transaction and, if advice is not sought, then the Non-Qualified Party would have to sign an acknowledgement indicating that it was electing not to obtain independent advice.
The Paper does not propose a final definition for the term "Qualified Parties" but indicates that to qualify as a Qualified Party a person should be either (a) a securities or derivatives registrant or (b) a sophisticated market participant with experience and knowledge in trading derivatives that has adequate resources to perform all of its obligations pursuant to the derivatives trade and to absorb losses from derivatives trades without undue hardship.
Registration and Compliance Obligations for Derivatives Advisers
The Paper proposes that persons carrying on the business of advising others in relation to derivatives (or holding themselves out to be carrying on that business) should be required to register as derivatives advisers in each Canadian province where they conduct such business, unless an exemption is available.
The Paper indicates that a person would be considered to be "advising" in relation to derivatives where they provide another person with any advice or direction relating, either directly or indirectly, to trading derivatives, including the provision of advice in relation to hedging strategies, the management of a portfolio of derivatives, or the use of derivatives as all or part of an investment strategy. The Paper also lists the following specific factors that may indicate that a person is carrying on the business of providing derivatives advice: (i) frequent or regular provision of advice in relation to derivatives transactions or in relation to the ongoing management of a portfolio of derivatives; (ii) receiving (or expecting to receive) any form of compensation for providing advice about derivatives; (iii) directly or indirectly contacting anyone to solicit business related to advising on derivatives trades, and (iv) engaging in activities similar to a derivatives adviser. The Paper notes that the frequent or regular provision of derivatives advice does not have to be a person's sole or even primary endeavour in order for such person to be considered to be in the business of advising in derivatives.
The Paper proposes that registered derivatives advisers should be subject to the Common Registration Obligations and Gatekeeper Obligations described above and, when advising Non-Qualified Parties, advisers will also be subject to the know-your-client, suitability, conflict of interest and fair dealing business conduct requirements.
Treatment of Foreign Dealers and Advisers Registered Outside of Canada
The Paper proposes that foreign entities that are engaged in the business of trading in or advising on derivatives in Canada and are also subject to regulation in their home jurisdiction will still be subject to the obligation to register under and comply with the proposed Canadian registration requirements.
However, where an equivalent regime exists in the foreign entity's home jurisdiction that applies to the foreign registrant, then exemptions may be provided from certain Canadian requirements, including financial requirements and requirements relating to compliance and risk management systems and entity-level record-keeping.
Registration and Compliance Obligations for Large Derivatives Participants
The Paper proposes to require any market participant that is not registered as a derivatives dealer to register as an LDP if: (a) the entity is a Canadian resident entity that maintains a substantial position in a derivative or a category of derivatives; or a foreign resident entity that holds a substantial position in a derivative or a category of derivatives with Canadian resident counterparties (regardless of whether such positions are held for hedging purposes or for speculative purposes); and (b) the entity's exposure in Canadian derivatives markets results in counterparty exposure that could pose a serious risk to Canadian financial markets or to the financial stability of Canada or a province.
The Paper recommends that additional work should be undertaken, including analysis of derivatives trade repository data, before establishing the exact thresholds that will be used for this LDP registration requirement.LDPs would be subject to the Common Registration Obligations and also to obligations with respect to holding counterparty collateral. Foreign LDPs are expected to be exempted from specific registration requirements where they are subject to equivalent regulatory requirements in their home jurisdictions.
Exemptions from Registration Requirements
The Paper proposes that the following market participants should be exempt from regulation under the provincial registration regime:
- Canadian banks and other persons regulated by Canadian authorities other than the CSA may be exempted from provincial registration obligations if the other Canadian regulatory regime provides for equivalent supervision and regulatory requirements. The Paper indicates that further analysis of existing regulatory regimes imposed by other Canadian regulatory authorities will be required before determining whether such exemptions should be provided but it would be surprising in light of past discussions in this area if federally chartered banks were not fully exempt from provincial registration requirements as long as they only trade with or provide advice to Qualified Parties.
- Canadian federal, provincial, territorial and municipal governments will be exempt from the registration regime and federal and provincial Crown corporations whose obligations are fully guaranteed by the applicable government should be exempt from the requirement to register as an LDP or as a derivatives dealer where the entity's trading activity is restricted to trading as a counterparty with persons that are Qualified Parties.
- Derivatives clearing agencies recognized (or exempted) under the applicable provincial clearing agency regime will not be subject to a requirement to register as a derivatives dealer or adviser or as an LDP if the obligation to register results solely from carrying on its ordinary business as a clearing agency.
- Persons subject to registration solely as a result of trading with or on behalf of affiliates or providing derivatives advice to affiliates will be exempted from the registration regime.
- Registered derivatives dealers will not be required to also register as derivatives advisers if advice only relates to derivatives trades to which the dealer is a party and the dealer does not have discretionary trading authority over the counterparty's account, does not charge a fee for advice, and has complied with relevant registration requirements that apply to derivatives advisers.
The CSA have requested comments on the proposed regulatory regime during a 60-day comment period, with comments being due by June 17, 2013. The Paper includes 23 specific questions regarding the proposals, which commenters are invited to address in their responses.