CSA Publishes a Revised Derivatives Business Conduct Rule, Moving Toward Final Rule
Recently the Canadian Securities Administrators (the “CSA”) published Proposed National Instrument 93‑101 – Derivatives: Business Conduct and Proposed Companion Policy 93‑101CP – Derivatives: Business Conduct (collectively, the “Proposed Rules”) for a comment period of 60 days.
Initially published in April 2017 to establish a comprehensive regime for regulating the business conduct of participants in the over‑the‑counter (“OTC”) derivatives markets, the Proposed Rules were subsequently the focus of two consultation periods, the second of which ended in September 2018. After a three‑year wait, the CSA has revised the Proposed Rules and incorporated comments from industry stakeholders seeking an appropriate balance of investor protection, preserving derivatives market access and the impact of compliance costs.
The Proposed Rules govern the conduct of persons or companies that are in the business of trading or advising on OTC derivatives in Canada. Many of the requirements set out in the Proposed Rules are similar to existing market conduct requirements for registered securities dealers and securities advisers prescribed by National Instrument 31‑103 – Registration Requirements, Exemptions & Ongoing Registrant Obligations (“NI 31‑103”). For a detailed overview of the regime, please refer to our previous article on the Proposed Rules.
This article highlights some key changes in the third publication of the Proposed Rules.
New Changes to Eligible Derivatives Party (“EDP”) Definition
The Proposed Business Conduct Rules provide that derivatives dealers and advisers will not be required to comply with certain requirements when they are trading with or advising an EDP, which is generally a sophisticated counterparty that the CSA considers to not need the full set of protections afforded to a “retail” investor. Similar to NI 31‑103, the CSA has adopted a two‑tiered approach to investor and customer protection, with (1) certain core obligations that apply in all cases when a derivatives firm is dealing with or advising a derivatives party, regardless of level of sophistication or financial resources, and (2) additional obligations that apply if dealing with or advising a non‑EDP, or apply but may be waived if dealing with or advising a derivatives party who is an EDP that is an individual or a party that qualifies as an EDP only as a commercial hedger (“eligible commercial hedger”).
The CSA has eliminated the $10 million financial threshold in the non‑individual commercial hedger category with the result that the CSA has significantly expanded the class of persons and companies with whom (i) a foreign dealer or foreign adviser may deal on an exempt basis in reliance on the foreign dealer, adviser and sub‑adviser exemptions and (ii) a Canadian derivatives firm may deal with or advise on a “light touch” basis, as set out the Proposed Rules.
The CSA rejected suggestions from industry stakeholders that the EDP definition include any derivatives party that is a “permitted client” (as defined under NI 31 ‑103) or an “eligible contract participant” under CFTC rules. However, the Proposed Rules now include a transition period of five years to allow derivatives firms that meet certain conditions to treat existing non‑individual permitted clients, accredited counterparties, qualified parties, as well as eligible contract participants, as EDPs.
Additional Liquidity Provider Exemption and Updates for Foreign Dealers and Advisers/Sub‑Advisers
During the second comment period, many commenters expressed concerns over the potential negative impact the Proposed Rules would have on foreign dealers and advisers and have emphasized that the CSA should ensure that Canadian OTC derivatives market regulation does not significantly reduce the liquidity provided by foreign dealers by deterring these providers from continuing to participate in the Canadian OTC derivatives market. To address these concerns, the CSA updated and added new exemptions to the regime applicable to foreign dealers and advisers.
The CSA has introduced a new foreign liquidity provider exemption for foreign dealers that trade derivatives with dealers in Canada. Under this exemption, a foreign dealer is exempt from the Proposed Rules if (i) the transaction is made with a registered derivatives dealer, an investment dealer registered under securities legislation, or a derivatives dealer in Ontario that, in each case, is transacting as principal and for its own account, and the foreign dealer is registered, licensed, authorized, or operates under an exemption or exclusion under the securities, commodity futures or derivatives legislation of a foreign jurisdiction. This foreign liquidity provider exemption is available to a foreign dealer from any foreign jurisdiction.
The Proposed Rules streamline the foreign derivatives dealer and adviser exemptions so that they more closely conform to the international dealer and international adviser exemptions under NI 31‑103. In addition, a foreign derivatives sub‑adviser exemption is now included, similar to the international sub‑adviser exemption in NI 31‑103. The foreign derivatives dealer and adviser exemptions in the previous draft provided a more limited exemption from specific provisions of the Proposed Rules based on an equivalence assessment of every single provision for each approved foreign jurisdiction, whereas under the Proposed Rules, if the foreign derivatives dealer, adviser and sub‑adviser qualifies for the exemption, it may benefit from the full exemption. A foreign derivatives dealer, adviser and sub‑adviser qualifies for these exemptions only if their principal place of business is located in certain G20 jurisdictions plus certain additional foreign jurisdictions that have committed to adopting a comprehensive regulatory framework comparable to the core principles of the Proposed Rules.
The CSA Clarifies the Scope of the Proposed Rules for Foreign Exchange Transactions
Comments were received on the previous draft which recommended that foreign exchange (“FX”) transactions should be excluded from the scope of the Proposed Rules if a derivatives dealer is in compliance with the FX Global Code of Conduct. However, the CSA responded by re‑iterating that FX transactions should be subject to, at a minimum, the core business conduct obligations of the Proposed Rules, including the fair dealing, know‑your‑derivatives party, conflicts of interest and the basic record‑keeping requirements. In fact, the CSA has increased the scope of transactions subject to the Proposed Rule by including short‑term FX transactions with institutional counterparties, but only for certain derivatives dealers that are Canadian financial institutions with significant derivatives activity.
Clarification of Exemptions for Unregistered Derivatives Dealers, IIROC Dealers and Canadian Financial Institutions; New Exemption for Registered Advisers
Unregistered Derivatives Dealers
A number of commenters recommended that the Proposed Rules should only apply to a person or company that is required to be registered under the proposed National Instrument 93‑102 – Derivatives: Registration (“NI 93‑102”) (see our blog post “CSA Proposes Registration Regime for OTC Derivatives Market in Canada”). The CSA maintains that derivatives dealers should be subject to the core business conduct obligations of the Proposed Rule, even if they qualify for an exemption from registration. However, the CSA accepts that, for smaller derivatives dealers, the costs of complying with certain obligations may outweigh the benefits to market participants. Accordingly, the CSA has included an exemption from the requirements to implement a senior derivatives manager regime for (i) derivatives dealers whose aggregate month‑end gross notional amount of outstanding derivatives does not exceed $250 million or (ii) derivatives dealers that exclusively deal in commodities derivatives and whose aggregate month‑end gross notional amount of outstanding commodity derivatives does not exceed $3 billion.
IIROC Dealers, Canadian Financial Institutions and Registered Advisers
The CSA has completed the equivalence appendices, which were not populated in the previous publication of the Proposed Rules, for derivatives dealers that are IIROC dealer members or Canadian financial institutions and for certain registered derivatives advisers.
The CSA has exempted IIROC dealer members from many provisions of the Proposed Rules, including know‑your‑derivatives party, suitability and pre‑transaction disclosure obligations as well as the senior derivatives manager regime, when they comply with corresponding conduct and other regulatory IIROC requirements relating to a transaction with a derivatives party.
Similarly, the CSA has exempted Canadian financial institutions from certain provisions of the Proposed Rules, including the know‑your‑derivatives party, tied selling and initial margin obligations when they comply with the corresponding conduct and other regulatory provisions of their prudential regulator or under the Bank Act (Canada) relating to a transaction with a derivatives party.
Finally, significant changes were made to the previous version of the Proposed Rules for derivatives advisers that are registered under securities legislation or commodity futures legislation in Canada. Such registered advisers are now able to leverage their existing compliance systems and are exempt from certain provisions of the Proposed Rules, including handling complains, tied‑selling and compliance and recordkeeping obligations when they comply with the corresponding conduct provisions of securities or commodity futures legislation in connection with a transaction with a derivatives party. In addition, the senior derivatives manager regime no longer applies to derivatives advisers.
Certain Obligations Reclassified as “Core” Obligations
The CSA has applied the complaints handling obligations under the Proposed Rules to all derivatives parties whereas the previous version applied these obligations only to (i) non‑EDPs or to (ii) individual EDPs or eligible commercial hedgers that did not waive the application of this provision. However, this obligation to promptly respond to each complaint made to a derivatives firm about any product or service offered by, or an individual acting on behalf of, the derivatives firm is a “reasonable person” obligation. The derivatives firm is only obligated to respond in a manner that a reasonable person would consider fair and objective and, thus, this obligation is principles‑based and context specific.
Another obligation that was re‑classified and now applies to all derivatives parties is the tied selling obligation. A derivatives firm or an individual acting on behalf of the derivatives firm must not impose undue pressure on a person or company to obtain a derivatives‑related product or service as a condition of obtaining another product or service from the derivatives firm. As noted above, an exemption from this provision remains available to Canadian financial institutions.
What’s Next for the Proposed Rules?
In addition to comments on the provisions of the Proposed Rules the CSA has also requested feedback on eight particular elements of the Proposed Rules, including such topics as: exemption from the designation and responsibilities of a senior derivatives manager, treatment of registered advisers under securities or commodity futures legislation and conflicts of interest. Comments must be submitted by March 21, 2022, and the CSA has included a one‑year implementation period after the date of final publication.
For further information on the Proposed Rules, please contact a member of our Derivatives Group.
 See also our blog article published on June 20, 2018: “CSA Republishes Derivatives Business Conduct Rules; Quebec Amends Derivatives Act”.
 See FX Global Code at https://www.globalfxc.org/docs/fx_global.pdf and see also https://www.bis.org/about/factmktc/fx_global_code.htm