OSC Targets Derivatives
December 4, 2009
Edward P. Kerwin
On October 30, 2009, the staff of the Ontario Securities Commission issued Staff Notice 91-702 Offerings of Contracts for Difference and Foreign Exchange Contracts to Investors in Ontario.
The Notice outlines the OSC staff’s view of the securities law and other regulatory requirements applicable to offerings of contracts for difference (CFDs), foreign exchange contracts (forex or FX contracts), and similar over-the-counter derivative products (OTC derivatives) to investors in Ontario.
A CFD is a derivative product that allows an investor to obtain economic exposure (for speculative, investment or hedging purposes) to an underlying asset, such as a share, index, market sector, currency or commodity, without acquiring ownership of the underlying asset. A CFD is simply an agreement between two parties — the investor and the CFD provider — to pay each other the change in the price of an underlying asset. Depending on which way the price moves, one party pays the other the difference from the time the contract was agreed to the point where it ends. CFDs are generally cash-settled, although in some cases investors may also have the option of requesting physical delivery of the underlying asset.
CFDs are currently being offered to investors in a number of foreign jurisdictions. In Canada, CFDs are also being offered to investors, including retail investors, through Internet platforms being operated by CFD providers.
The OSC staff have concluded that CFDs, forex contracts, and OTC derivatives, when offered to investors in Ontario, constitute "investment contracts" and "securities" for the purposes of Ontario securities law, and have expressed significant concerns for retail investor protection. As a result, the OSC staff are of the view that, unless statutory exemptions are available or exemptive relief is granted, these products are subject to Ontario securities law, including the registration and prospectus requirements.
The Notice is intended to provide interim guidance pending the development by the Canadian Securities Administrators (CSA) of a harmonized CSA approach to the regulation of OTC derivatives and/or the introduction of new or revised derivatives legislation in Ontario. It was indicated that CSA staff are closely reviewing a number of developments in this area, including the recent adoption of a new Derivatives Act in Québec, which was discussed in anarticle in our November 2008 issue.
In the Notice, the OSC staff acknowledged that "the prospectus requirement may not be well-suited to offerings of certain types of OTC derivative products, including CFDs and forex contracts, to [retail] investors," and that "modified requirements, focused on ensuring appropriate transparency as to the nature of the product and investor risk, imposed as terms and conditions of an exemptive relief order exempting an issuer from the prospectus requirement, may be better suited for these products." The OSC staff indicated that they would consider exemption applications on a case-by-case basis, so long as adequate safeguards and disclosure are provided that address the significant investor protection concerns raised by the offering of CFDs to retail investors.
Shortly before the issuance of the Notice, the OSC published an order of the Commission on October 19, 2009 granting relief to CMC Markets UK plc (CMC UK) and CMC Markets Canada Inc. (CMC Canada) exempting them from the prospectus requirement in respect of the distribution of CFDs and forex contracts to investors resident in Ontario, subject to conditions including:
- the continued registration of CMC UK with the Financial Services Authority in the United Kingdom;
- the continued registration of CMC Canada as an investment dealer in Ontario and a member of the Investment Industry Regulatory Organization of Canada (IIROC);
- that all distributions of CFDs by CMC Canada to clients in Ontario be conducted in accordance with IIROC Rules and IIROC acceptable practices applicable to offerings of CFDs;
- that prior to a client’s first CFD trade, CMC UK and CMC Canada have provided to the client the risk disclosure document and have delivered, or previously delivered, a copy of the risk disclosure document to the OSC;
- that prior to the client’s first CFD trade and as part of the account opening process, CMC UK and CMC Canada have obtained a written or electronic acknowledgement from the client confirming that the client has received, read and understood the risk disclosure document; and
- that the exemptive relief so granted shall immediately expire upon the earliest of:
- four years from the date that the order is issued;
- the issuance of an order or decision by a court, the FSA, the AMF or other similar regulatory body that suspends or terminates the ability of CMC UK to offer CFDs to clients in the UK or the ability of CMC UK or CMC Canada to offer CFDs to clients in Québec; and
- the coming into force in Ontario of legislation or a rule regarding the distribution of OTC derivates to investors in Ontario.
McCarthy Tétrault Notes:
It is apparent, in view of the terms of the recent exemptive relief order of the OSC and the OSC Staff Notice, that the day is coming for the introduction of specific legislation or rules in respect of the distribution of CFDs, forex contracts and other OTC derivatives to retail investors in Ontario. It remains to be seen if such legislation or rules will be patterned on the Québec Derivatives Act or will be part of a broader CSA initiative. It is hoped that the Government of Ontario will recognize the need for, and be receptive to, such legislation or rules, if, as and when they are submitted for approval — in contrast to the return by the Minister of Finance to the OSC in November 2000 of a proposed Rule 91-504 Over-the-Counter Derivatives and the related companion policy for further consideration of the need and a more detailed review of the disclosure issues at that time.
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