On June 20, 2012, the Canadian Securities Administrators (CSA) published the latest in a series of over-the-counter derivatives consultation papers. Comments on the consultation paper are being accepted until September 21, 2012.
The main recommendation is that the CSA take the necessary steps to make central counterparty clearing (CCP clearing) mandatory for eligible over-the-counter derivatives (OTC Derivatives). In a central counterparty (CCP) model, after a trade is executed, either directly between two counterparties or on an exchange or electronic trading platform, the CCP becomes the counterparty to each of the contract participants.
The paper details proposals on:
- the process for determining which OTC derivatives are eligible for mandatory CCP clearing;
- the recognition, regulation and governance of CCPs;
- clearing member access; and
- risk management.
Eligibility for Mandatory CCP Clearing
The paper recommends that CCPs make recommendations to regulators about which OTC derivatives should be regulated. Since not every OTC derivative will be suitable for CCP treatment, the paper sets out the factors that a market regulator should consider, such as whether the contract is sufficiently standardized to be cleared through a CCP, whether the underlying instruments or markets for the underlying instruments provide adequate pricing information, whether there is sufficient liquidity in the contract and whether the contract would bring undue risk into a CCP.
Recognition, Regulation and Governance of CCPs
In keeping with current approaches to the recognition of self-regulatory organizations in the securities domain, the paper proposes that market regulators provide for the recognition and regulation of CCPs and the exemption from recognition of CCPs, and that market regulators have the ability to apply terms and conditions to the recognition or exemption from recognition of a CCP, to approve or reject the CCP’s rules and procedures, to apply terms and conditions to such rules, including its risk management model, to receive and review regular CCP filings, including the CCP’s financial statements, and to conduct regular and ad hoc inspections. This recognition obligation would apply not only to local CCPs, but also to CCPs from outside a CSA jurisdiction that wish to exercise clearing activity with an entity from a CSA jurisdiction. Legislation for the recognition of clearing agencies is already in force in Québec, Ontario and Alberta.
CCPs would be expected to implement governance structures to provide that board members be independent of CCP management persons, persons that have a material ownership interests in the CCP and clearing members of the CCP.
Clearing Member Access
The paper proposes the adoption of regulations that require CCPs to develop access policies that facilitate fair and open access and that do not unreasonably prohibit or limit access to services regardless of how the derivatives transaction is executed. The access requirements established by a CCP or services offered by a CCP should not create a competitive advantage for any trading facility.
The paper proposes that regulations be developed to require that a CCP create and implement a robust risk management program, in accordance with international best practices. These programs should be fully transparent to regulators, clearing members and other relevant stakeholders. The Committee proposes that the regulations set out specific requirements, including that a CCP:
- conduct a full analysis of all relevant risks and have in place appropriate risk management procedures;
- impose transparent risk limits on individual clearing members, requiring that the member inform its regulator or regulators when a clearing member is at risk of default and when any default procedures are triggered;
- undertake and report to regulators on the results of regular stress testing of the adequacy of the CCP’s financial resources;
- maintain and utilize accurate pricing and valuation procedures;
- maintain and utilize product approval procedures to ensure that new clearing products do not bring undue risk to the CCP and its members; and
- have a chief risk officer who reports to the CCP’s board of directors or risk committee, as appropriate.