Clearing arrangements

Transcription

1 Rules Ntice Guidance Nte Dealer Member Rules Please distribute internally t: Internal Audit Legal and Cmpliance Operatins Regulatry Accunting Senir Management Cntact: Richard J. Crner Vice President, Member Regulatin Plicy (416) January 13, 2014 Clearing arrangements While there are many back ffice sharing arrangements that may be entered int between tw dealers, including jitney r mnibus arrangements, clearing arrangements, intrducing brker / carrying brker arrangements and any ther arrangement where ne dealer prvides certain back ffice services t anther dealer, the current IIROC Dealer Member Rules fcus mainly n thse arrangements where individual client assets are held: in bulk at an external custdial lcatin (including where client assets are held in custdy by ther dealers); r in separate fully-disclsed client accunts at ne dealer as part f a back ffice service ffering prvided t anther dealer; As such is the case, there are specific rule requirements that must be met when securities are held by the Dealer Member at an external custdial lcatin r held by a carrying brker n a fullydisclsed basis fr an intrducing brker. There are, hwever, n specific rule requirements t be met when securities are a held pursuant t a jitney r mnibus accunt arrangement r ther similar accunt arrangement at anther dealer. What has been less clear t date is whether specific IIROC Dealer Member Rules apply t clearing arrangements. In the past IIROC has taken the psitin that clearing arrangements were a frm f intrducing brker / carrying brker arrangement. As such, entering int a clearing arrangement culd nly be dne by cmplying with the requirements set ut in IIROC Dealer Member Rule 35. As part f a recent review f varius back ffice sharing arrangements, IIROC has recnsidered this previus psitin and has determined that a clearing arrangement, as described in this Guidance Nte, is nt a type f intrducing carrying brker arrangement and, as a result, entering int a clearing

2 arrangement des nt require cmpliance with the requirements set ut in IIROC Dealer Member Rule 35. This Guidance Nte explains: what a clearing arrangement is; why the requirements f IIROC Dealer Rule 35 d nt apply t clearing arrangements; and the specific, practical issues and utsurcing due diligence bligatins that shuld be addressed when cnsidering whether t enter int a clearing arrangement. 1. What is a clearing arrangement? A clearing arrangement is an agreement between tw dealers, in which back-ffice services are utsurced frm ne dealer t the ther dealer and, mre specifically, where the primary purpse is the clearing and settlement f trades by ne dealer fr the ther dealer. Such arrangements are cmmn where a dealer desn t have access t the capital markets in a particular jurisdictin but wishes t transact in the securities f that particular jurisdictin fr its clients and/r fr its wn accunt. T facilitate this arrangement, the clearing dealer pens up separate delivery against payment / receipt against payment (DAP/RAP) accunts fr the utsurcing dealer and each f the utsurcing dealer s clients that wish t participate in the arrangement. In the case f client accunts, these accunts are pened up in the name f each client and represent separate accunts n the bks f the clearing brker. The clearing dealer pens up individual accunts fr each client, since, by necessity in rder t ensure that client trades are prperly settled and delivered t the crrect custdian, each client must infrm the clearing dealer f its identity and the identity f its settlement agent custdian. Executed trades are then settled by the clearing dealer by: in the case f a client purchase transactin, receiving in the settlement payment frm the client s settlement agent and delivering ut the purchased securities t the client s settlement agent; and in the case f a client sale transactin, receiving in the securities t be sld frm the client s settlement agent and delivering ut the settlement prceeds t the client s settlement agent In summary, the services prvided by the clearing dealer under a clearing arrangement are: trade executin services (in mst cases); trade clearing and settlement services; and maintenance f individual clearing client accunt recrds, detailing the settlement f purchase and sale transactins within each client s DAP/RAP accunt and the delivery-ut and receipt-in f security and investment prduct psitins relating t these transactins. IIROC Ntice Rules Ntice Guidance Nte Clearing Arrangements 2

3 2. What services are nt prvided by a clearing dealer as part f a clearing arrangement? The fllwing services are nt prvided by the clearing dealer under a clearing arrangement: trade and/r accunt financing; custdy f client cash, security and investment prduct psitins; Trade/accunt financing In the case f trade/accunt financing, this service is nt prvided by the clearing dealer given that in a DAP/RAP accunt: all trade purchase bligatins must be fully paid fr by the client n the settlement date f the trade; and all trade sales bligatins must be met by the client by delivering the security r investment prduct psitin being sld t the clearing dealer n the settlement date f the trade. There is therefre, n need fr the clearing dealer t finance purchases r t brrw securities n the client s behalf t cver shrt sale bligatins and n general need t finance client trades r client accunt balances. Custdial services Custdial services are nt prvided by the clearing dealer under a clearing arrangement, given that in a DAP/RAP accunt, the clearing dealer is never respnsible fr hlding cash and/r security psitins in custdy fr the ther dealer r the ther dealer s clients. T illustrate this pint, cnsider the example f a purchase transactin that takes place in a DAP/RAP accunt. In this example the trade either: settles, and the purchased security is delivered ut t the client s settlement agent custdian; r fails t settle, and the security becmes the legal prperty f the clearing dealer which it can hld r dispse f as it sees fit. In bth scenaris, there is n regulatry r cntractual bligatin fr the clearing dealer t prvide custdial services relating t the trade. 3. Is a clearing arrangement subject t the regulatry requirements set ut in IIROC Dealer Member Rule 35 fr intrducing brker / carrying brker arrangements? Included as part f IDA Member Regulatin Ntice MR-0096, Intrducing Brker / Carrying Brker Arrangements, was a table setting ut varius functins/services that, if perfrmed in cmbinatin by ne dealer fr anther dealer, wuld cnstitute an intrducing brker / carrying brker arrangement. This table and the discussin f the functin/service IIROC Ntice Rules Ntice Guidance Nte Clearing Arrangements 3

4 cmbinatins that are cnsidered t be an intrducing brker / carrying brker arrangement has been updated t reflect changes in IIROC rule numbering and is reprduced belw: Certain cmbinatins f functins prvided by ne firm t anther cnstitute an Intrducing Brker/Carrying Brker Arrangement, whereas ther cmbinatins f functins d nt. The fllwing are six main trading related functins that are perfrmed: #1 #2 #3 #4 #5 #6 Trade executin Trade settlement Custdy f cash Custdy f securities Bkkeeping Financing f custmer psitins s r cmbinatins f functins that d nt cnstitute an Intrducing Brker/Carrying Brker Arrangement include: s #1 and #2 s #2, #3 and #4 s #1, #2, and #5 #5 This cmbinatin f functins is a jitney r mnibus arrangement and is nt subject t the requirements f the Intrducing Brker/Carrying Brker Arrangement rules, as set ut in Dealer Member Rule 35. This cmbinatin f functins is a custdial arrangement and is nt subject t the requirements f the Intrducing Brker/Carrying Brker Arrangement rules, as set ut in Dealer Member Rule 35. Of curse this arrangement is subject t ther requirements set ut in the IIROC Dealer Member Rules relating t custdy f custmer cash and securities. This cmbinatin f functins is nt subject t the requirements f Dealer Member Rule 35. The intrducing brker/carrying brker requirements d nt apply where cash and security custdy is perfrmed at a separate [entity] and assets are nt cmmingled in any way with the service prvider s assets. This requires distinct segregatin f securities by means f individual accunt FINS #s at the Canadian Depsitry fr Securities Ltd. r ther depsitry fr securities f the service. The preparatin f bks and recrds is nt subject t the requirements f Dealer Member Rule 35. This functin is typically perfrmed by a service bureau with the firm retaining the respnsibility t cmply the IIROC Dealer Member Rule requirements fr bkkeeping. Cmbinatins f functins that d cnstitute an Intrducing Brker/Carrying Brker Arrangement include: s #1 thrugh #6 This cmbinatin f functins is subject t the intrducing and carrying brker rules and is classified as IIROC Ntice Rules Ntice Guidance Nte Clearing Arrangements 4

5 either a Type 1, 2 r 3 Arrangement pursuant t Dealer Member Rule 35. s #1 thrugh #5 s #2 thrugh #6 s #2 thrugh #5 This cmbinatin f functins is subject t the intrducing and carrying brker rules where financing f custmer psitins is perfrmed by the intrducer and is classified as a Type 4 Arrangement pursuant t Dealer Member Rule 35. This cmbinatin f functins is subject t the intrducing and carrying brker rules where trade executin is perfrmed by the intrducer and is classified as either a Type 2 r 3 Arrangement pursuant t Dealer Member Rule 35. This cmbinatin f functins is subject t the intrducing and carrying brker rules where trade executin and financing f custmer psitins is perfrmed by the intrducer and is classified as a Type 4 Arrangement pursuant t Dealer Member Rule 35. A clearing arrangement is a cmbinatin f functins #1, #2 and #5 frm the abve table. As a result, a clearing arrangement is nt cnsidered t be an intrducing brker / carrying brker arrangement and is nt subject t the requirements set ut in Dealer Member Rule 35. This is because clearing arrangement services d nt bligate the clearing brker t prvide custdial services fr client cash, security and investment prduct psitins. 5. What must be cnsidered when entering int a clearing arrangement? Given that a clearing arrangement is nt cnsidered t be an intrducing brker / carrying brker arrangement, there are n specific IIROC Dealer Member Rules that apply t this business arrangement. There are hwever, relevant general rule requirements, practical cnsideratins, utsurcing due diligence bligatins and IIROC ntificatin requirements that apply t clearing arrangements. Relevant general rule requirements As a clearing arrangement invlves the executin, clearing and settlement f trades by the clearing brker n behalf f anther dealer, the clearing brker will be expsed n a daily basis t the credit risk assciated with each DAP/RAP accunt pened under the arrangement. As such, t the extent a trade settlement failure ccurs and/r an unsecured debit balance exists in ne r mre accunts, the clearing brker wuld be required t prvide fr this credit risk in accrdance with the accunt margining requirements set ut in Dealer Member Frm 1 and Dealer Member Rule 100. Practical cnsideratins The fllwing are practical issues t be addressed when a clearing arrangement is being cnsidered: IIROC Ntice Rules Ntice Guidance Nte Clearing Arrangements 5

6 IIROC Frm 1 categrizes dealers as being either regulated entities and ther brkers and dealers nt qualifying as regulated entities (bth as defined in the General Ntes and Definitins t Frm 1). Clearing arrangements entered int invlving dealers nt qualifying as regulated entities intrduce additinal credit risk and regulatry margin requirements in the event there is a trade settlement default. T mitigate the credit risk assumed by a clearing brker pursuant t a clearing arrangement, clearing brkers shuld ensure that: they have adequate credit risk management prcedures in place t minimize the likelihd f credit risk-related lsses; and the clearing arrangements they enter int hld the intrducing brker ultimately liable fr any credit risk-related lsses that arise. While IIROC rules d nt prhibit ther nn-individual clients 1 and individual clients frm pening DAP/RAP accunts, there are unique investr prtectin cncerns, including fr instance margin requirements and accunt trading restrictins resulting frm verdue balances, that apply when the clearing arrangement invlves such clients. Specifically, frm an investr prtectin standpint, IIROC s margin requirements assume that ther nn-individual clients and individual clients that fail t meet their trade settlement bligatins within a DAP/RAP accunt will be given mre time after the trade settlement date t meet these bligatins befre a dealer will sell-ut r buy-in the client s security r investment prduct psitin. While there is n regulatry r cntractual bligatin fr the clearing brker t prvide custdial services in the case f an ther client failed trade, street practice has been t prvide such services It is fr these reasns that IIROC wuld expect that fr any clearing arrangement invlving an IIROC Dealer Member, either dmestic, crss-brder inbund r crss-brder ut-bund: Fr arrangements invlving dealers ther than dealers that qualify as a regulated entity, that stricter risk cntrls be put in place t mitigate any increased credit risk assciated with such arrangements; and Fr any arrangement under which DAP/RAP accunts are pened fr ther nnindividual clients and individual clients, that these clients wuld be prvided with adequate infrmatin as t: whether temprary custdial services will be prvided by the clearing brker t the client in the event f a failed trade; and if s, the length f time such services will be prvided until the psitin is either sld ut (in the case f a failed purchase) r bught in (in the case f a failed sale). 1 Fr the purpses f this Guidance Nte, ther nn-individual client means a nn-individual client that des nt qualify as an acceptable institutin, acceptable cunterparty r regulated entity, all f which are categries f nn-individual clients defined within IIROC Dealer Member Frm 1. IIROC Ntice Rules Ntice Guidance Nte Clearing Arrangements 6

7 Outsurcing due diligence bligatins As a clearing arrangement is an utsurcing arrangement, Dealer Members are reminded f their due diligence bligatins under Natinal Instrument and Cmpanin Plicy CP, Registratin Requirements, Exemptins and Onging Registrant Obligatins, in respect f such arrangements. A separate Guidance Nte, IIROC Rules Ntice # , setting ut the key issues a Dealer Member shuld cnsider in meeting their due diligence bligatins, is under develpment and has been recently published fr public cmment. IIROC Ntificatin requirements IIROC Rules Ntice , Reprting f Changes t Business Mdels, requires Dealer Members t reprt t IIROC significant business mdel changes, including changes t material peratinal prcesses which may impact trade executin, clearing, jitney, mnibus r settlement arrangements. IIROC shuld therefre be infrmed f any material clearing arrangements that are being entered int by a Dealer Member. IIROC Ntice Rules Ntice Guidance Nte Clearing Arrangements 7