What Portfolio Managers Need to Know About The Regulation of OTC Derivatives in Canada (so far)

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Rudolf Newton
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1 What Portfolio Managers Need to Know About The Regulation of OTC Derivatives in Canada (so far) Presentation for Portfolio Management Association of Canada 2013 Toronto Compliance Forum Document #

2 Agenda Regime in 2009 G-20 Commitments OTC Derivatives Working Group CSA Derivatives Committee Consultation Papers Over-the-Counter Derivatives Regulation in Canada Trade Repositories Surveillance and Enforcement Segregation and Portability in OTC Derivatives Clearing End-User Exemption OTC Central Counterparty Clearing Registration Proposed OSC Rules Product Determination and Trade Repositories and Derivatives Data Reporting What s next? 2

3 Derivatives Regulation In February 2009 Three separate regimes in Canada Ontario and Manitoba regulated various OTC derivatives as securities (based on definition of security ) and certain exchange-traded derivatives under Commodity Futures Act BC, Alberta, Saskatchewan and New Brunswick regulated OTC and exchange-traded derivatives under Securities Act (derivatives included in definition of security ). Each jurisdiction had local rule governing OTC derivatives: BC Blanket Orders , and Alberta Blanket Order Saskatchewan General Order New Brunswick Local Rule Quebec regulated OTC derivatives and exchange-traded (standardized) derivatives under a stand-alone Derivatives Act. 3

4 Derivatives Regulation In February 2009 For OTC derivatives, the provinces (other than Quebec) applied prospectus filing and dealer / adviser registration requirements to trades. In BC, AB, SK and NB local rules created prospectus and dealer registration exemptions from requirements for trades between qualified parties and certain specific types of transactions (usually physically settled commodity contracts). In ON and MB standard prospectus and dealer registration exemptions applied. In Quebec, OTC derivatives were not subject to prospectus requirements, but dealer / adviser registration requirements applied. There was an exemption from such requirements for transactions with accredited counterparties. 4

5 Derivatives Regulation In February 2009 With some exceptions (set out below), this regime is still in place today. Amendments to the Ontario Securities Act came into force in December Derivative is defined in the Act; the OSC has rule making powers in respect of the clearing, settling and reporting of derivatives trades and may regulate derivatives exchanges, derivatives clearing agencies and derivatives trade repositories; and insider trading prohibitions and early warning requirements apply to related derivatives. There are now various business conduct requirements applicable to derivatives transactions in Ontario. Manitoba similarly amended its Securities Act in June In October 2009 Ontario released OSC Staff Notice The Notice regulates CFDs as securities under the Act and sets out basis on which OSC will recommend relief from prospectus requirements for CFD distributions. 5

6 Derivatives Regulation In February 2009 In October 2011, various Canadian securities regulators (including the OSC) granted a discretionary exemption, Re Deutsche Bank AG and DB Commodities Canada Ltd., which allowed for an entity to be exempted from prospectus filing and dealer registration requirements for trades with permitted counterparties. In October 2012, the Ontario Securities Commission granted a restricted portfolio manager registration to B.A.F. Capital with exemptions for proficiency requirements for the CCO and advising representatives because B.A.F. was limited to advising on foreign exchange and interest rate derivatives. In December 2012, Alberta Blanket Order Over-the-Counter Derivatives Transactions came into force. BOR preserves the prospectus exemption for transactions between qualified parties but sets out a new regime for dealer registration exemptions. 6

7 G-20 Commitments In September 2009, the G-20 leaders made the following statement, committing their countries to regulating OTC derivatives: All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Noncentrally cleared contracts should be subject to higher capital requirements. Note that dealer, advisor and participant registration requirements are not included in the statement. 7

8 OTC Derivatives Working Group OTC Derivatives Working Group (Bank of Canada, Department of Finance, OSFI, AMF, OSC and Alberta Securities Commission) released discussion paper on October 26, Discussion paper discussed various aspects of Canada meeting its G-20 commitments including: Central clearing Trade reporting Use of trading venues Standardization Capital and collateralization End user exemptions 8

9 CSA Derivatives Committee CSA Derivatives Committee is made up of most Canadian securities regulators and is working on creating a mostly harmonized regime for OTC derivatives regulation in Canada. Committee has published six Consultation Papers and intends to publish another three papers. In November 2010, Committee released Consultation Paper which set out general intentions of Canadian securities regulators with respect to G-20 commitments and also OTC derivative dealer / adviser registration set out that Committee would publish eight more consultation papers, each dealing with a specific topic. 9

10 Trade Repositories CSA Derivatives Committee released Consultation Paper Derivatives: Trade Repositories in June The regulators have now put out proposed rules about trade repositories which have superseded the contents of this paper. 10

11 Surveillance and Enforcement CSA Derivatives Committee released Consultation Paper Derivatives: Surveillance and Enforcement in November deals mainly with market conduct rules for OTC derivatives. Canadian securities regulators will monitor OTC derivatives markets based on trade repository data. OTC derivatives should be subject to same market conduct rules as securities generally. Fraud, Market Manipulation, Abusive Trading, Insider Trading, Misuse of Exemptions, Prohibited Representations Existing enforcement and compliance powers should be extended to OTC derivatives. Committee recommends against position limits for participants in OTC derivatives markets. 11

12 Segregation and Portability CSA Derivatives Committee released Consultation Paper Derivatives: Segregation and Portability in OTC Derivatives Clearing in February deals with how to preserve indirect clearing client positions in the event of the insolvency of a central counterparty or a direct clearing member. Basic recommendation is that client assets be segregated from dealer assets and client positions should be portable in the event of a dealer insolvency. Committee considers pros and cons of both agency ( FCM ) and principal models of indirect clearing but does not recommend one or the other. Committee considers various types of segregation and recommends Complete Legal Segregation (also known as LSOC) for cleared transactions. 12

13 End-User Exemption CSA Derivatives Committee released Consultation Paper Derivatives: End-User Exemption in April deals with exemptions from application of new OTC derivatives regulations for end-user entities. There is no exemption from the trade reporting requirement. End-users will be exempt from various other provisions including capital requirements, collateral requirements, registration, need to centrally clear. Committee recommends narrow exemption for intra-group transactions. End-user is defined narrowly. Basically a non-financial institution, low volume user of OTC derivatives for solely hedging purposes. End-users are required to identify themselves to regulators. 13

14 OTC Central Counterparty Clearing CSA Derivatives Committee released Consultation Paper Derivatives: OTC Central Counterparty Clearing in June deals with requirement for mandatory central clearing of OTC derivatives. Committee recommends mandatory clearing of eligible OTC derivatives. Eligible OTC derivatives will be determined using a bottom up (i.e. derivatives will be submitted by a CCP and regulator will decide whether clearing will be mandatory) and top down approach (i.e. requiring certain specific derivatives to be cleared whether or not a CCP brings them to regulators attention). Committee recommends that backloading of existing transactions be voluntary. Committee also establishes rules for recognition of CCPs (including rules for governance, fees and participant access). 14

15 Registration CSA Derivatives Committee released Consultation Paper Derivatives: Registration in April proposes the creation of three categories of registration: dealers, advisers and large derivatives participants. Derivatives dealers are those who are in the business of trading in derivatives. The status of federally regulated financial institutions in provinces other than Ontario in respect of this requirement is not clear. Derivatives advisers are those who are in the business of advising others in relation to derivatives. Large derivatives participants are those who are not dealers and have large aggregate derivatives exposures. The Committee has recommended further research to determine this threshold. Individuals employed by derivatives dealers and advisers would also have to register. 15

16 Registration The Committee has recommended that proficiency and experience requirements be put into place for individuals wishing to be registered. There would also be solvency and record-keeping requirements for firm registrants. Firm registrants would be subject to business conduct requirements, including the requirement that derivatives dealers provide nonqualified parties (a term which will be defined) with the opportunity to obtain independent advice on a transaction from a registered derivatives adviser. There would be registration exemptions for regulated persons and those subject to equivalent registration regimes. However parties would have to register in each Canadian jurisdiction in which they carry on derivatives business. 16

17 Registration The Portfolio Management Association of Canada submitted comments on in June PMAC commented that a registration regime solely for derivatives was not necessary because most advisers advise with respect to a variety of assets, including derivatives and therefore were already subject to regulation under existing laws. Also, advisers already had duties to have knowledge about derivatives before advising with respect to them. PMAC commented that the CSA should clarify the definition of derivatives for the purposes of the registration requirements. PMAC also commented on specific aspects of and called for further harmonization across Canadian jurisdictions, consistency of the derivatives and securities registration regimes, a de minimus exemption for the requirement to register and more clarity on the proficiency and minimum capital requirements applicable to derivatives advisers. 17

18 Proposed OSC Rules and The OSC published OSC Rule Derivatives: Product Determination (the "Scope Rule") and OSC Rule Trade Repositories and Derivatives Data Reporting (the TR Rule )for comment in June Other Canadian jurisdictions published local rules or consultation papers with substantially identical content at the same time. The Scope Rule sets out the definition of derivative to be used for determining if transactions are to be reported to a trade repository. Originally, the OSC had said the rule would apply (with necessary changes) to the definition of derivative in other rules as well, but they have removed that comment from the notice accompanying the Scope Rule. The definition of derivative set out in securities legislation is very broad and the Scope Rule excludes a variety of transactions that would not generally be considered derivatives from the application of the TR Rule. 18

19 Proposed OSC Rules and The main exclusions that have attracted market attention are physically-settled commodity contracts and short term foreign exchange transactions. The TR Rule sets out requirements for parties to report derivatives transactions to a trade repository. The TR Rule sets out which counterparties have to report transactions. Generally, the requirement is for a dealer to report the data if one is involved in the transaction. However, where the dealer is not a local counterparty, the requirement is for the local counterparty to report. The TR Rule also sets out the types of data to be reported to the trade repository. Three types of data have to be reported creation data, life-cycle data and valuation data. The TR Rule includes an exemption from reporting for counterparties with physical commodity transactions with an aggregate notional amount less than $500,

20 What s next CSA Committee to publish two more Consultation Papers Exchange and Platform Trading paper Capital and Collateral paper Product Determination and Trade Reporting rules will probably be adopted in Ontario and across Canada by early next year. No clear end date for when remaining rules will be in place 20

PROVINCIAL/TERRITORIAL COUNCIL Of MINISTERS OF SECURITIES REGULATION (Council) ANNUAL PROGRESS REPORT January 2012 to December 2012

PROVINCIAL/TERRITORIAL COUNCIL Of MINISTERS OF SECURITIES REGULATION (Council) ANNUAL PROGRESS REPORT January 2012 to December 2012 BACKGROUND Canada withstood the recent financial crisis better than most