Canadian Derivatives: Registration Regime for Dealers and Advisers Gets Momentum
April 24, 2018
On April 19, 2018, the Canadian Securities Administrators (CSA) took a major step toward adopting a comprehensive regime for the regulation of those in the business of trading derivatives or advising on derivatives. The CSA published for comment Proposed National Instrument 93-102 Derivatives: Registration (Proposed Registration Rule), along with a proposed Companion Policy.
This initiative builds on the CSA’s efforts to establish baseline “business conduct” rules in respect of derivatives dealings, set out in Proposed National Instrument 93-101 Derivatives: Business Conduct (Proposed Business Conduct Rule) issued on April 4, 2017 (for background, see our April 2017 Blakes Bulletin: Canadian Regulators Propose Broad Derivatives Dealer and Adviser Business Conduct Rules).
Considerable work remains to complete these initiatives, including re-issuing for comment the Proposed Business Conduct Rule once it is aligned with the Proposed Registration Rule (together, the Proposed Registration Regime); populating the Proposed Registration Rule with essential details, such as who will be excluded or exempted from its application; and jurisdictional amendments and legislative enactments required for implementation in various provinces. Accordingly, the timeline for implementation of the regime will likely extend well into 2019 or beyond. Transitional provisions have not yet been developed. At this stage, the CSA is seeking industry feedback on the Proposed Registration Rule during a 150-day comment period ending September 17, 2018.
When implemented, the Proposed Registration Regime is intended to regulate derivatives dealers and advisers operating in Canada, on a basis that meets the international standards of the International Organisation of Securities Commissions. The proposed approach is conceptually similar to the “swap dealer” regulatory regimes applicable in the U.S. under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and in the E.U. under European Market Infrastructure Regulation. The specific proposals largely track the distinctions and approaches that apply in Canada with respect to securities dealers and advisers, but with many customized features, carve-outs and alternative methods for compliance designed to reflect the unique features of Canada’s derivatives market.
This bulletin outlines key requirements proposed under the Proposed Registration Rule, the entities and individuals that would be subject to those requirements (including proposed exemptions) and critical details and open points that are still to be addressed by the CSA in subsequent versions of the Proposed Registration Rule. The ultimate approach taken to resolve many of these open points will significantly impact how and when the Proposed Registration Regime will apply to derivatives market participants operating in Canada and the scope of any required changes to their current practices and procedures.
PRIMARY COMPLIANCE OBLIGATIONS OF REGISTERED FIRMS
The primary compliance obligations contemplated to apply to a person or company that registers under the Proposed Registration Rule as a derivatives dealer or adviser (a “registered firm”) include capital requirements; written compliance policies; internal procedural standards; record keeping and financial reporting obligations; and registration and proficiency requirements for certain employees and representatives. These requirements may necessitate significant changes to the current practices, procedures and the approach to compliance of derivatives dealers and advisers. However, by adopting a single registration rule and a single business conduct rule in all provinces and territories of Canada, the CSA seeks to harmonize the requirements and approach to regulation across Canada. This should increase consistency and reduce the burden of understanding and complying with the divergent approaches to the regulation of derivatives dealers and advisers, or not, that is currently applicable across the country.
Among the most significant requirements will be the need to designate a derivatives ultimate designated person (UDP), a derivatives chief compliance officer (CCO), and a derivatives chief risk officer (CRO). The responsibilities and functions of these individuals are described in the Proposed Registration Rule and Companion Policy and include supervising, monitoring and reporting on compliance with the registered derivatives firm’s policies and procedures. In particular, the Proposed Registration Rule requires a registered derivatives firm to ensure that its UPD, CCO and CRO are given reasonable access to the firm’s board of directors at such times as such individuals may consider necessary or advisable.
WHO WILL BE SUBJECT TO REGISTRATION?
The key questions to determine if and how the Proposed Registration Rule will apply are:
- Do the dealing or advising activities of a person or company operating in Canada involve an in-scope derivative?
- Do those activities cross a “business trigger” test, and/or do the transactions or advice involve any “non-eligible derivatives party”?
- Will an exemption be available from the registration obligation or in respect of specific registration requirements? If so, what terms and conditions will apply to the exemption?
These tests, exemptions and conditions are described in more detail below.
In-scope Derivatives: The Proposed Registration Rule applies in respect of all derivatives transactions except for certain excluded classes of transactions specified under applicable derivatives product determination rules – namely, in Ontario, OSC Rule 91-506 – Derivatives: Product Determination; in Manitoba, Manitoba Securities Commission Rule 91-506 – Derivatives: Product Determination; in Quebec, Regulation 91-506 respecting Derivatives Determination, and in other Canadian jurisdictions, Multilateral Instrument 91-101 Derivatives: Product Determination. Under these derivatives product determination rules, exclusions generally apply in respect of certain physically settled spot foreign exchange transactions; physically settled commodity transactions; exchange-traded futures and options on futures; regulated insurance and gaming contracts; and certain transactions and instruments that are to be regulated as securities rather than derivatives.
Business Trigger: The basic test for determining if registration as a “derivatives dealer” or a “derivatives adviser” is required is to determine if a person or company’s activities in Canada cross a “business trigger” – namely, is the person or company “in the business” of trading in derivatives or advising on derivatives. This approach will be familiar to anyone with operations in Canada’s securities markets, as it is similar to the approach taken for securities dealer and adviser registration under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (Securities Registration Rule). The Companion Policy sets out a non-exhaustive list of factors relevant to determining if a person is “in the business of trading in derivatives”, including acting as a market maker for derivatives; directly or indirectly carrying out derivatives transactions with repetition, regularity or continuity; facilitating or intermediating derivatives transactions; transacting in derivatives with the intention of being compensated; directly or indirectly soliciting in relation to derivatives transactions; engaging in activities similar to such dealer activities; or providing clearing services for derivatives. In respect of the adviser registration requirement, the Companion Policy contemplates an assessment of whether the person or company is “in the business” of conducting an activity and whether the person or company is “advising others” in relation to derivatives. This would include a registered securities adviser who provides advice to an investment fund or to other persons in relation to derivatives or derivatives trading strategies; a registered securities adviser who manages a client account and makes derivatives trading decisions; and a person who recommends a derivative or derivatives trading strategy to investors as part of a general solicitation on an online derivatives trading platform.
Additional Registration Triggers: In addition, registration will be required if a business’ activities include (i) transactions with, for, or on-behalf of, a “non-eligible derivatives party” (i.e., a person who is not an “eligible derivatives counterparty”, which in turn is defined in the Proposed Registration Rule to include substantially the same entities as are included in the definition of “accredited counterparty” under the Derivatives Act (Quebec) and in the definition of “qualified party” under various provinces’ current blanket exemption orders for over-the-counter (OTC) derivatives), (ii) soliciting or initiating contact with a non-eligible derivatives party to encourage a derivative transaction or to offer a related service, or (iii) facilitating the clearing of a derivative for unaffiliated third parties.
Transactions with Individuals: Only derivatives dealers who are dealer members of Investment Industry Regulatory Organization of Canada (IIROC) will be permitted to transact derivatives with an individual who is not an eligible derivatives party.
Individuals will also be subject to registration obligations if they are engaging in the business of trading in derivatives or advising on derivatives, including carrying on these activities on behalf of a company, subject to particular exemptions in the Proposed Registration Rule. An individual may generally register as a dealing representative and/or an advising representative and perform duties on behalf of a registered derivatives dealer or adviser if it has the education, training and experience that a reasonable person would consider necessary to perform the activity competently, including understanding the structure, features and risks of each derivative that the individual transacts or recommends, and if it otherwise satisfies proficiency requirements, generally consisting of time spent in the industry and passing industry administered examinations.
Each registered derivatives firm must use appropriately registered representatives to conduct its derivatives dealing or advising business, and, as already noted, registered firms will be required to designate registered individuals to act as the UDP, CCO and CRO of the firm. Initial and ongoing proficiency requirements would apply for registration as a UDP, CCO or CRO, based on years of experience in compliance roles, professional designations, course work and similar factors. Exemptions from the requirements to register as a derivatives dealing representative or advising representative will be available if the individual is only required to register as a result of transacting business with, or advising, an affiliate of the registered firm that is not an investment fund and provided the individual does not transact with or advise a non-eligible derivatives party.
EXEMPTIONS FROM THE REQUIREMENT TO REGISTER AS A DERIVATIVES DEALER
The Proposed Registration Rule includes several important exemptions from the requirement to register as a derivatives dealer, including in the following cases:
- Foreign Derivatives Dealers: A foreign derivatives dealer who deals only with eligible derivatives parties may obtain an exemption from the registration requirements under the Proposed Registration Rule if: (i) its head office or principal place of business is located in a foreign jurisdiction (its “home jurisdiction”) that is one of the jurisdictions to be listed in the final registration rule (yet to be identified); (ii) it engages in the business of a derivatives dealer in its home jurisdiction and is registered, licensed or otherwise authorized under its home jurisdiction’s laws to conduct the same derivatives activities that it proposes to conduct in Canada; (iii) it complies with certain yet-to-be specified requirements in its home jurisdiction and notifies applicable Canadian regulators of any material non-compliance with such requirements; (iv) it provides certain standard disclosures to certain counterparties regarding its status as a foreign unregistered dealer; and (v) it files a standard form appointment of an agent for service of process and submission to applicable Canadian regulators and provides an undertaking to provide applicable Canadian regulators with access to its books and records. This exemption is closely based on the “international dealer exemption” included in relation to foreign securities dealers in the Securities Registration Rule.
- End-user Exemptions: A dealer registration exemption will be available to someone who has not solicited or transacted with, for, or on behalf of, a non-eligible derivatives party; has not provided advice (other than limited general advice) to non-eligible derivatives parties; does not regularly make or offer to make a market in derivatives; does not regularly facilitate or intermediate derivatives transactions for another person; and does not facilitate the clearing of a derivative through the facilities of a qualifying clearing agency for unaffiliated third parties.
- Threshold Based Exemptions: A dealer registration exemption will be available to someone who has not solicited or transacted with, for, or on behalf of, a non-eligible derivatives party; has not provided advice (other than limited general advice) to non-eligible derivatives parties; and whose derivatives activity falls below a specified threshold over the previous 24 months. Generally, the threshold will be C$250-million aggregate month-end gross notional amount under outstanding derivatives by local Canadians or, in the case of non-Canadians, with Canadian counterparties. A more generous threshold of C$1-billion would apply for a derivatives dealer whose business is limited to commodity derivatives and who is not a registered derivatives or securities dealer in Canada or under commodities futures legislation in Canada or under the laws of a jurisdiction to be listed in the final registration rule (yet to be identified).
- Financial Institutions (Ontario-Only Exemption): In Ontario, financial institutions that are specified in section 35.1 of the Securities Act (Ontario) are exempt from registration requirements and so will not be required to register as a derivatives dealer or adviser. This group includes banks listed in Schedule I, II or III to the Bank Act (Canada), as well as credit unions, trust companies and caisse populaires authorized by a statute of Canada or Ontario to carry on business in Canada or Ontario.
- Affiliated Entities: An exemption from the dealer registration requirement would be available to the extent that registration would otherwise be required only as a result of dealing with an affiliated entity that is not an investment fund. Accordingly, companies should be able to manage the derivatives activities of affiliates and enter into back-to-back transactions with affiliates without concern that such inter-affiliate activities will trigger obligations under the Proposed Registration Rule.
SUBSTITUTED COMPLIANCE EXEMPTIONS FROM DEALER REGISTRATION REQUIREMENTS
Exemptions from certain specific registration requirements may be available to registered derivatives dealers, including in the following cases:
- Foreign Derivatives Dealers: It is contemplated that a foreign derivatives dealer that registers as a derivatives dealer in Canada and is also registered, licensed or otherwise authorized to conduct the relevant derivatives activities in its home jurisdiction will be exempted from certain specific registration requirements if the dealer complies with counterpart provisions applicable in its home jurisdiction. The relevant foreign jurisdictions for these substituted compliance exemptions and the applicable foreign regulatory requirements have not yet been identified by the CSA.
- Investment Dealers: Dealer Members of IIROC will be exempt from certain of the Proposed Registration Rule’s requirements, subject to substituted compliance with equivalent IIROC provisions. The particular provisions of the Proposed Registration Rule in respect of which this exemption will be available and the relevant equivalent IIROC requirements have not yet been identified by the CSA.
- Canadian Financial Institutions: The Proposed Registration Rule contemplates exemptions from specific dealer registration requirements for Canadian financial institutions that comply with corresponding regulatory requirements identified by the CSA. For example, Canadian banks and other federal entities regulated by the Office of the Superintendent of Financial Institutions (OSFI), which comply with enumerated OSFI Guidelines (including in respect of derivatives sound practices, capital requirements and corporate governance), will be exempted from a broad range of registered dealer compliance requirements (including in respect of capital requirements, trade documentation, dispute resolution, risk management, business continuity and disaster recovery, portfolio reconciliation, portfolio compression and related record-keeping requirements). The details of substituted compliance provisions have not yet been provided in respect of provincially regulated financial institutions other than those regulated by the Quebec financial markets regulator.
EXEMPTIONS FROM REQUIREMENT TO REGISTER AS A DERIVATIVES ADVISER
The Proposed Registration Rule includes several exemptions from the requirement to register as a derivatives adviser, including in the following cases:
- Generic Advice: An exemption from the adviser registration requirement will be available if all advice that is provided does not purport to be tailored to the needs of the person receiving the advice. This would include general advice circulated through newsletters or on websites that is not presented as reflecting the needs and circumstances of any particular recipient. A person relying on this exemption is subject to an obligation to provide specified disclosure with the advice if the person or certain related persons have any financial or other interest in the class of derivatives or the underlying interest of the derivatives for which a recommendation is made.
- Foreign Derivatives Advisers: A foreign derivatives adviser who only advises eligible derivatives parties may obtain an exemption from the requirement to register as a derivatives adviser if (i) its home jurisdiction is listed in the final registration rule (yet to be identified); (ii) it engages in the business of a derivatives adviser in such foreign jurisdiction and is registered, licensed or otherwise authorized under such jurisdiction’s laws to conduct the same derivatives activities that it proposes to conduct in Canada; (iii) it complies with certain yet-to-be specified requirements in such foreign jurisdiction and notifies applicable Canadian regulators of any material non-compliance with those specified requirements; (iv) it provides certain standard disclosures to certain counterparties regarding its status as a foreign unregistered adviser; and (v) it files a standard form appointment of an agent for service of process and submission to applicable Canadian regulators’ and provides an undertaking to provide applicable Canadian regulators with access to its books and records. This foreign derivatives adviser exemption is closely based on the “international adviser exemption” included in relation to foreign securities dealers and contained in the Securities Registration Rule.
- Registered Derivatives Dealers Without Discretionary Authority: A registered derivatives dealer, and any registered derivatives dealing representative acting on its behalf, will be exempt from the requirement to register as a derivatives adviser and advising representative, respectively, if the dealing representative providing the advice satisfies applicable proficiency requirements and the advice is not provided in respect of a managed account.
- Affiliated Entities: An exemption from the adviser registration requirement would be available to the extent that registration would otherwise be required only as a result of dealing with an affiliated entity that is not an investment fund.
SUBSTITUTED COMPLIANCE EXEMPTIONS FROM ADVISER REGISTRATION REQUIREMENTS
The Proposed Registration Rule contemplates that a foreign derivatives adviser who registers as a derivatives adviser in Canada and who is also registered, licensed or otherwise authorized to conduct the relevant derivatives advisory activities in its home jurisdiction will be exempted from certain specific adviser registration requirements if the adviser complies with specified provisions of its home jurisdiction. The relevant foreign jurisdictions for these substituted compliance exemptions and the applicable foreign regulatory requirements have also not yet been identified by the CSA.
IMPORTANT DETAILS THAT REMAIN TO BE ADDRESSED
As noted, many important details remain to be addressed by the CSA in subsequent publications of the Proposed Registration Rule, including the following:
Minimum Capital Requirements: The CSA has not yet specified the minimum capital requirements registered derivatives firms will be expected to meet. The Proposed Registration Rule indicates that “[the CSA] expect[s] that the minimum capital requirements will be consistent with capital requirements proposed by regulatory authorities in other jurisdictions, including the U.S.”. Also, a conditional exemption from the to-be-specified minimum capital requirements is contemplated to be included in a later version of the Proposed Registration Rule “for derivatives dealers that are already subject to equivalent capital requirements imposed by other authorities, including prudential authorities.”
Equivalent Requirements: As noted, the CSA still needs to identify the relevant equivalent IIROC and provincial prudential authority requirements for which substituted compliance will be available. The Proposed Registration Rule does note the context in which substituted compliance exemptions are intended to be available to Canadian federal financial institutions and to financial institutions subject to the regulatory oversight of the Quebec autorité des marchés financiers.
Foreign Jurisdictions: The CSA has yet to specify which foreign jurisdictions and which equivalent provisions will be recognized for the purposes of the foreign derivatives dealer and provincial prudential adviser registration exemptions and in respect of the substituted compliance exemptions that will be available in relation to particular foreign requirements.
Thresholds: Aspects of the threshold-based derivatives dealer registration exemption, noted above, remain to be finalized, including the methodology for determining the notional amounts of derivatives that reference a notional quantity or volume. Additionally, questions remain regarding whether a registration made under foreign securities, commodity futures or derivatives registration legislation will disqualify a person or company from relying on the threshold-based exemption.
Individual Representatives in Ontario: It remains unclear how the Ontario Securities Commission will approach the regulation of individual representatives of specified financial institutions, in light of the general exemption of specified financial institutions from the obligation to register as derivatives dealers in Ontario.
Large Derivatives Participants: The CSA has noted that an additional registration category may be included in a future version of the Proposed Registration Rule, based on a person’s very large gross notional amount of derivatives transactions. This would be analogous to the requirements applicable to “major swap participants” under Dodd-Frank in the U.S.
Transitional Requirements: The Proposed Registration Rule does not yet describe transitional provisions, which will be needed to facilitate the transition to the new registration regime. The CSA has indicated that such provisions will be included in a future version of the Proposed Registration Rule.
Provincial Securities Laws: In some provinces, aspects of existing provincial securities legislation will need to be addressed to facilitate implementation of the Proposed Registration Rule. For example, the Proposed Registration Rule observes that “accredited counterparties are exempt by law from the registration requirement under the Québec Derivatives Act when transacting with each other. The implementation of the Proposed Instrument is therefore subject to the Québec National Assembly’s decision to revoke this exemption”. The CSA has also indicated it will consider amendments to National Instrument 33-109 Registration Information and National Policy 11-204 Process for Registration in Multiple Jurisdictions.
The CSA has provided an extended comment period for the Proposed Registration Rule that closes on September 17, 2018. We anticipate that stakeholders will be interested in participating in the comment process, and we would be pleased to speak with you if you have questions.
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or any other member of our Structured Finance & Derivatives group.
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