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CSA Finally Adopts Derivatives Business Conduct Rule

The Canadian Securities Administrators (the “CSA”) have finally adopted Multilateral Instrument 93-101 Derivatives: Business Conduct (the “Rule”) and its companion policy, Companion Policy 93-101 Derivatives: Business Conduct (the “Companion Policy”). The Rule will come into force on September 28, 2024 and will apply in all provinces and territories of Canada, except for British Columbia. The British Columbia Securities Commission announced its intention to adopt a substantially similar rule at a later date, at which time the Rule will be converted to a national instrument.

Initially published in draft form in 2017 to establish a comprehensive regime regulating the business conduct of participants in the over-the-counter (“OTC”) derivatives markets in response to the 2008 financial crisis, the Rule is the result of an extensive consultation process that included three drafts of the Rule, several comment periods and a public roundtable. For a more detailed overview of the consultation process, the regime and previous drafts of the Rule, see CSA Proposes National Derivatives Business Conduct Rules – Proposed Derivatives Registration Rules to Follow Later this Year and CSA Publishes a Revised Derivatives Business Conduct Rule, Moving Toward Final Rule

We set out below key changes between the Rule and the third draft published on January 20, 2022, along with general information on both the scope and implementation timeline of the Rule. 

Scope of the Rule 

The Rule establishes a principles-based approach that sets out requirements relating to, among other things, fair dealing, conflicts of interest, suitability, reporting of non-compliance, compliance and recordkeeping for participants in the Canadian OTC derivatives markets. 

The Rule applies to persons or companies that engage in or hold themselves out as engaging in (i) the business of advising others in respect of derivatives (“derivatives advisers”), and (ii) the business of trading in derivatives as principal or agent (“derivatives dealers” and, collectively with the derivatives advisers, the “derivatives firms”). 

Changes to Eligible Derivatives Party Definition

Similar to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”), the CSA has adopted a two-tiered approach to investor and customer protection in the Rule with (1) certain core obligations that apply in all cases when a derivatives firm is dealing with or advising a derivatives party, regardless of the level of sophistication or financial resources, and (2) additional obligations that apply if dealing with or advising an “eligible derivatives party” (an “EDP”), or apply but may be waived if dealing with or advising a derivatives party which is an EDP that is an individual or a commercial hedger. 

Under the Rule, derivatives firms will not be required to comply with certain requirements when they are dealing with or advising an EDP, a list of institutional and individual counterparties which fall into three categories: (i) a reasonably sophisticated counterparty, (ii) a counterparty that has sufficient financial resources to purchase professional advice or (iii) a counterparty that can protect itself through contractual negotiations with the derivatives firm. 

CSA Removes Knowledge and Experience Representations

The Rule now aligns with the existing “bright-line” approach to status representations for “permitted clients” under NI 31-103 as the CSA has removed the knowledge and experience representations originally required for asset-based exemptions in the definition of EDP. Under the Rule, a person or company (other than an individual) with net assets of at least $25,000,000 and an individual with net assets of at least $5,000,000 can be eligible as an EDP without having to demonstrate requisite knowledge and experience. 

According to the CSA, this change will significantly ease the re-papering burden on derivatives firms without reducing the protections afforded to EDPs which are qualifying individuals and commercial hedgers, since all the provisions of the Rule will apply unless the qualifying individual or commercial hedger provides to the derivatives firm a written statement waiving any or all the protections provided by the Rule. If the commercial hedger is a sole proprietorship, the derivatives firm must also identify and document the nature of the sole proprietorship’s business and the related commercial risks that the sole proprietorship is hedging.

CSA Broadens the EDP Commercial Hedger Exemption 

The definition of EDP initially excluded individuals from the category of “commercial hedger”. The CSA has broadened the commercial hedger exemption in the Rule to include individuals operating as sole proprietorships, to the extent that they satisfy the conditions for qualifying as a commercial hedger. 

The CSA intends to carefully monitor the use of the commercial hedger exemption by clients of derivatives firms to ensure this prong of the definition of EDP is used for its intended purpose of managing risks inherent to a business’ commercial activities, and not for speculative purposes nor for purposes of hedging an individual’s personal investing activities.

Short-Term FX Contracts

The Rule does not generally regulate short-term (generally T+2) foreign exchange (“FX”) contracts or instruments except in the institutional FX market when such contracts or instruments are transacted by a derivatives dealer that is a Canadian financial institution with significant derivatives activity, including transactions commonly referred to as “spot FX” transactions. 

The CSA has confirmed in the Companion Policy that the limited sub-set of provisions (fair dealing, conflicts of interest, handling complaints and compliance) that apply to short-term FX contracts is intended to overlay the existing policies and procedures that have already been adopted by the Canadian financial institutions under the FX Global Code of Conduct. The Canadian financial institutions transacting short-term FX contracts will not be required to obtain any status certifications or representations from their counterparties. 

Broadening Notional Amount Exemptions for Derivatives Dealers

The notional amount exemptions allow derivatives dealers to be exempted from certain requirements of the Rule if they only solicit, transact with or advise EDPs and have less than a certain gross notional amount of derivatives outstanding in the previous 24 calendar months. 

The CSA has broadened the notional amount exemptions in two ways to harmonize them with United States and European Union regulatory frameworks. 

First, the threshold used to determine whether a commodity derivatives dealer, i.e. a derivatives dealer whose primary business purpose is to operate a physical commodities business, may rely on the exemption has been increased from $3 billion to $10 billion in gross notional amount of derivatives outstanding. 

Second, the CSA has narrowed the scope of the provisions that will apply to a derivatives dealer that qualifies under one of the notional amount exemptions (a commodity derivatives dealer with less than $10 billion in gross notional amount or a derivative dealer with less than $250 million in gross notional amount). A derivatives dealer qualifying under one of the notional amount exemptions is now exempted from the provisions of the Rule, except in respect of certain “core” obligations relating to fair dealing, conflicts of interest and the requirements to deliver a trade confirmation. The initial draft of the notional amount exemptions only relieved derivatives dealers from senior manager requirements. 

Reduced Requirements for Foreign Derivatives Dealers

The Rule provides an exemption for foreign derivatives dealers that are regulated under the laws of a foreign jurisdiction to conduct activities with an EDP in Canada that achieve comparable regulatory outcomes to the requirements in the Rule. In the previous draft, a foreign derivatives dealer had to report to the relevant Canadian regulator any non-compliance with the laws of the foreign jurisdiction under which such foreign derivatives dealer is regulated. The CSA has removed this requirement from the Rule since these additional reports to Canadian regulators were over and above what is already required under NI 31-103 for foreign securities dealers relying on a similar exemption. 

Detailed Guidance for the Registered Advisers Exemption 

A derivatives adviser registered under securities legislation or, in Ontario and Manitoba, commodity futures legislation, is exempted from certain provisions of the Rule listed in Appendix F (such as tied-selling or compliance and recordkeeping) if the  derivatives adviser complies with the corresponding business conduct provisions of securities or commodity futures legislation, as applicable. The Companion Policy includes detailed guidance for registered advisers relying on the exemption and Appendix B of the Companion Policy provides an overview of the provisions of the Rule that still apply to registered advisers, as well as a summary of the corresponding requirements in NI 31-103 in respect of the derivatives activity of the registered advisers. 

Effective Date; Transition Provisions 

The Rule will come into force on September 28, 2024. The CSA has outlined a transition period commencing on September 28, 2024 and ending on September 28, 2029 to assist derivatives firms with transitioning to the new regulatory framework. Under Part 8 of the Rule, a derivatives firm can rely on a list of status representations to consider counterparties as EDPs if the derivatives firm receives such status representation prior to September 28, 2024. For the purpose of the transition period, the list of status representations from counterparties qualifying as EDPs has been broadened by the CSA from the previous draft.  In addition to permitted clients under NI 31-103 and accredited counterparties under the Quebec Derivatives Act, non-individual accredited investors in Ontario, a financial counterparty as defined under the European Market Infrastructure Regulation (EMIR) and a non-financial counterparty as defined under EMIR which exceeds applicable clearing thresholds are now permitted to give transition representations. 

For further information on the Rule, please contact a member of our Derivatives Group



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