CSA Republishes Derivatives Business Conduct Rules; Quebec Amends Derivatives Act

On June 14, 2018, the Canadian Securities Administrators (“CSA”) published Proposed National Instrument 93-101 ‑ Derivatives: Business Conduct and Proposed Companion Policy 93-101CP ‑ Derivatives: Business Conduct (collectively, the “Proposed Business Conduct Rules”) for an additional comment period of 95 days.

The publication of the Proposed Business Conduct Rules comes just more than one year after the initial publication in April 2017, and follows closely the publication of Proposed National Instrument 93-102 ‑ Derivatives: Registration and Proposed Companion Policy 93-102CP ‑ Derivatives: Registration (collectively, the “Proposed Registration Rules”) in April 2018.

While the Proposed Business Conduct Rules seek to introduce a framework of rules governing the conduct of participants in the over-the-counter (“OTC”) derivatives markets in Canada, the Proposed Registration Rules propose to introduce requirements for the registration of participants. Together, the Proposed Business Conduct Rules and the Proposed Registration Rules are intended to set out a comprehensive regime for the regulation of persons or companies that are in the business of trading or advising on OTC derivatives in Canada.  For a detailed overview of the regime, please refer to our previous articles on the Proposed Business Conduct Rules and the Proposed Registration Rules.

This article highlights some key changes in the second publication of the Proposed Business Conduct Rules.

On June 13, 2018, amendments to the Derivatives Act (Quebec) (“QDA”) were adopted as part of Bill 141, an omnibus bill which reforms financial sector legislation in Quebec. Highlights of amendments to the QDA are also described in this article.

Proposed Business Conduct Rules

Additional categories of eligible derivatives parties

Commercial hedgers

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 “eligible derivatives party”, which is generally a sophisticated counterparty that the CSA does not consider to require the full set of protections afforded to a “retail” investor. This approach dovetails with the Proposed Registration Rules which exempts from registration certain persons or companies dealing with or advising an “eligible derivatives party”.

The second publication of the Proposed Business Conduct Rules has expanded the list of counterparties that constitute an “eligible derivatives party” to match the list contained in the Proposed Registration Rules, by adding a category of counterparty known as a “commercial hedger”.  The definition of “commercial hedger” in the Proposed Business Conduct Rules is the same as the definition of that term in the Proposed Registration Rules.

The CSA indicated that the addition of a “commercial hedger” category to the definition of “eligible derivatives party” was in response to comments that other categories of the definition of “eligible derivatives party”, such as the category for counterparties who have net assets of $25,000,000, may be inaccessible to a number of smaller commercial entities that use derivatives to hedge their business risks.

Guaranteed entities

The CSA has also expanded the definition of “eligible derivatives party” by adding a category for counterparties whose obligations are guaranteed by another “eligible derivatives party” similar to the Proposed Registration Rules.

Removal of fair terms and pricing requirements

The initial publication of the Proposed Business Conduct Rules required a derivatives dealer to obtain the most advantageous terms reasonably available when acting as an agent for a counterparty, and to make a reasonable effort to provide a price for a counterparty that is fair and reasonable taking into consideration all relevant factors.

The CSA indicated that it received several comments from market participants that the fair terms and pricing requirements included in the initial publication of the Proposed Business Conduct Rules were inappropriate, in light of the negotiated, bilateral and bespoke nature of the OTC derivatives markets. Accordingly, the CSA has opted to remove the fair terms and pricing requirements from the Proposed Business Conduct Rules.

Although the Proposed Business Conduct Rules no longer include specific fair terms and pricing requirements, they continue to include a general requirement for a derivatives dealer or adviser to act fairly, honestly and in good faith when acting with their counterparties. In addition, the CSA has revised the Companion Policy to the Proposed Business Conduct Rules to provide guidance in relation to the pricing of derivatives.

Revisions to safeguarding of counterparty asset requirements

The Proposed Business Conduct Rules include a variety of requirements around safeguarding counterparty assets, including, for example, requirements to hold initial margin of certain counterparties in a segregated account with a prescribed depository institution, and restrictions on the use of such initial margin.

In the second publication of the Proposed Business Conduct Rules, the CSA has clarified that these requirements will not apply where a derivatives dealer or adviser is transacting with certain types of counterparties that are subject to other rules relating to counterparty assets, including securities legislation relating to margin and collateral requirements or National Instrument 81-102 Investment Funds.

In addition, the CSA has revised the Proposed Business Conduct Rules to provide that a derivatives dealer or adviser must obtain the written consent of its counterparty if it intends to use counterparty assets that have been posted as initial margin.

Revisions to compliance reporting requirements

The CSA has made several changes to the Proposed Business Conduct Rules in relation to compliance reporting in response to comments from market participants, including a change to permit senior derivatives managers to make compliance reports to the senior management of a derivatives dealer or adviser, rather than to its board of directors.

Although senior derivatives managers will no longer be required to make compliance reports to the board of directors, the Proposed Business Conduct Rules contemplate that the chief compliance officer will make such reports in their place.

Additional exemptions for persons advising in respect of managed accounts of eligible derivatives parties

The Proposed Business Conduct Rules initially provided that the exemptions afforded to a derivatives firm that advises an “eligible derivatives party” would not be applicable if such derivatives firm were acting in the capacity as an adviser with respect to a managed account of an “eligible derivatives party”.  The CSA has now reversed its position. The CSA indicated that several commenters argued that the exemptions with respect to an “eligible derivatives party” should continue to be available even where a derivatives firm is acting as an adviser in respect of a managed account of an eligible derivatives party.

According to the CSA, commenters suggested that all eligible derivatives parties are sophisticated investors, and the fact that an eligible derivatives party may appoint an agent with discretionary authority to enter into transactions on its behalf should not alter its status.

Additional exemptions for transactions executed on a derivatives trading facility

Transactions executed anonymously on a derivatives trading facility and submitted for clearing

The CSA indicated that a number of commenters expressed concerns that it may not be possible to comply with certain requirements of the Proposed Business Conduct Rules in respect of transactions that are executed anonymously over a derivatives trading facility.

In response to these comments, the CSA has revised the Proposed Business Conduct Rules to include a new exemption for transactions that are executed anonymously over a derivatives trading facility. In particular, a derivatives dealer or adviser will not need to comply with the know-your-client and transaction confirmation reporting requirements in respect of a transaction that is executed on a derivatives trading facility, if the derivatives dealer or adviser does not know the identity of its counterparty prior to the execution of the transaction.

The new exemption will only be available to a derivatives dealer or adviser if the transaction is submitted for clearing to a qualified clearing agency as soon as technologically practicable following the completion of such transaction and the derivatives party is an eligible derivatives party.

Transactions executed by foreign derivatives dealers and advisers on an exchange or a derivatives trading facility

The Proposed Business Conduct Rules include exemptions from specific requirements for foreign derivatives dealers and advisers that are regulated under the laws of a foreign jurisdiction whose business conduct rules are comparable to the Proposed Business Conduct Rules.

The initial publication of the Proposed Business Conduct Rules provided that such substituted compliance exemptions would not be available to foreign derivatives dealers and advisers that are in the business of trading or advising on derivatives that are traded on an exchange or a derivatives trading facility designated or recognized in Canada. According to the CSA, several commenters argued that these substituted compliance exemptions should continue to be available to foreign derivatives dealers and advisers irrespective of whether they are in the business of trading on an exchange or derivatives trading facility in Canada.

The CSA has revised the Proposed Business Conduct Rules so that a foreign derivatives dealer or adviser that is in the business of trading in derivatives on an exchange or a derivatives trading facility is no longer prohibited from qualifying for substituted compliance exemptions.

Additional transitional rules regarding representations from eligible derivatives parties

Several market participants argued that they should be permitted to rely on existing disclosures and representations to determine whether a counterparty constitutes an “eligible derivatives party”.

Accordingly, the CSA has revised the Proposed Business Conduct Rules to include a transitional rule that permits a derivatives dealer or adviser to rely on a counterparty’s “permitted client” status under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, its “accredited counterparty” status under the Derivatives Act (Quebec), or its “qualified party” status under the relevant blanket orders in the provinces of Alberta, British Columbia, Manitoba, New Brunswick or Nova Scotia for transactions entered into prior to the Proposed Business Conduct Rules coming into force.

Although derivatives dealers and advisers will be able to rely on this new transitional rule to claim relief from certain requirements of the Proposed Business Conduct Rules, they will still need to comply with certain fair dealing and reporting obligations, even in respect of pre-existing transactions with eligible derivatives parties.

Comments on the Proposed Business Conduct Rules

The CSA has requested comments on the second publication of the Proposed Business Conduct Rules by September 17, 2018, which coincides with the deadline for providing comments on the initial publication of the Proposed Registration Rules. The CSA has also requested feedback on six particular elements of the Proposed Business Conduct Rules. Comments must be submitted to the CSA in writing by September 17, 2018.

For further information on the Proposed Business Conduct Rules, please contact a member of our Derivatives Group.

Amendments to the Quebec Derivatives Act

A “derivatives negotiation platform” is now included in the definition of a “regulated entity” under the QDA and will not be able to operate in Quebec without recognition by the Autorité des marchés financiers (“AMF”).  However, this change will not come into force until a later as yet undetermined date.

As of June 13, 2019, derivatives dealers and advisors registered under the QDA must adopt a complaints policy, keep a complaints register and submit periodic complaint reports to the AMF.  The AMF may, with the parties’ consent and without charge, act as mediator in any dispute between a derivatives dealer or advisor and a complainant.

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