After a number of years waiting, the Canadian Securities
Administrators (the “CSA“) published a
third draft of Proposed National Instrument 93-101 Derivatives:
Business Conduct (“Proposed NI
93-101“) and its companion policy on January 20,
2022. This draft is open for a 60-day comment period, which is set
to expire on March 21, 2022. A new draft of the companion
registration rule, Proposed National Instrument 93-102
Derivatives: Registration (“Proposed NI
93-102“) has not been published yet and is not
expected to be published prior to the expiry of the comment period
for Proposed NI 93-101.
Key Changes to Proposed NI 93-101
We previously discussed the first draft of Proposed NI 93-101
and its companion policy during the initial period for request for
comments in our bulletin from April 2017. The
first draft was published on April 4, 2017 and remained open for a
lengthy 150-day comment period.
A second draft was published on June 14, 2018, with one of the
main changes being the introduction of the term “specified
commercial hedger” in the eligible derivatives party
definition. The second draft was open for a 90-day comment period,
during which submissions were received from 21 commenters.
In the current draft of Proposed NI 93-101, the CSA has
addressed many of the concerns raised by market participants and
considered the recommendations made in the Ontario Security
Commission’s (the “OSC“) Burden
Reduction Report with respect to facilitating the access of
commercial entities to both local and foreign dealers to hedge
their business risks.
In this publication, rather than once again describe Proposed NI
93-101 in its entirety, we will highlight the changes made from the
second draft to the third draft.
Revised Definition of “Eligible Derivatives Party “
The definition of “eligible derivatives party”
(“EDP“) has been further amended in the
third draft of Proposed NI 93-101. EDP is used to separate conduct
obligations, with stricter obligations applying to non-EDPs. The
two major changes are:
- Eliminating the $10 million financial threshold in the “eligible commercial hedger” category (which replaces the “specified commercial hedger” category included in the
second draft); and - Including a transition period to allow derivatives firms that
meet certain conditions to treat existing permitted clients,
accredited counterparties, qualified parties 1 , as well as eligible
contract participants under CFTC rules, as EDPs for up to five
years.
Additionally, the EDP definition previously only included an
investment fund “advised by an adviser registered or exempted
from registration under securities legislation or under commodity
futures legislation in Canada”. This has now been expanded to
also include an investment fund that is “managed by a person
or company registered as an investment fund manager under the
securities legislation of a jurisdiction of Canada or of a foreign
jurisdiction”.
Harmonizing the EDP definition more closely with the various
categories used to exempt derivatives counterparties (and, in some
cases, derivatives advisers) from the application of registration
and disclosure obligations under provincial capital markets
legislation allows derivatives dealers and derivatives advisers to
better determine the specific conduct obligations that will apply
to existing clients and to use existing criteria to evaluate which
new clients will be EDPs.
Introduction of a Transition Period
Proposed NI 93-101 now includes a delayed effective date of one
year from the date of the final publication. Given that this
current draft is open for comments until March 21, 2022 and the
regulators will require time to review comments and create a final
draft, we anticipate that this final publication will be released
between Q3 2022 and Q1 2023. With the one-year transition period,
that would leave the effective date around Q3 2023 and Q1 2024. We
anticipate that the final version of National Instrument 93-101
will not differ substantially from the current draft with respect
to applicable conduct obligations, therefore derivatives dealers
and derivatives advisers should begin taking the necessary steps to
comply as soon as possible.
New Foreign Liquidity Provider Exemption for Foreign
Dealers
The third draft of Proposed NI 93-101 adds a new foreign
liquidity provider exemption for foreign dealers that transact with
derivatives dealers in Canada. This is an outright exemption from
all of the instrument’s requirements and no action is required
by a foreign dealer to rely on this exemption. This exemption was
widely requested in the previous comments and by including it, the
CSA allows Canadian dealers to have the greatest access to
international pools of liquidity and hedge counterparties. It also
allows foreign dealers access to Canadian dealers to hedge the
Canada-related liabilities of those foreign dealers and their
clients.
Revised Senior Derivatives Manager Provisions
Senior derivatives managers have certain duties such as
preparing and submitting a report to the board of directors of the
respective derivatives firm at least once per calendar year. These
provisions no longer apply to derivatives advisers (i.e. they apply
solely to derivatives dealers) and an exemption from these
responsibilities is included for derivatives dealers whose
aggregate outstanding gross notional amount of derivatives
transactions falls below certain financial thresholds.
The threshold is $250 million for derivatives dealers generally
and $3 billion for commodity derivative dealers dealing exclusively
in commodity derivatives. “Commodity derivatives” is now
a defined term, and means “a derivative that has, as its only
underlying interest, a commodity other than cash, currency or a
cryptoasset”. These are the same entities that are entitled to
de minimus exemptions from registration under Proposed NI
93-102.
Additionally, for derivatives dealers with only a single line of
derivatives business which will be registered under Proposed NI
93-102, the obligations of the senior derivatives manager are now
associated with the derivatives ultimate designated person or the
derivatives compliance officer, since such firms will not have a
separate senior derivatives manager. It should be noted that
Investment Industry Regulatory Organization of Canada
(“IIROC“) Dealer Members are also
exempted from the application of the senior derivatives manager
rule as long as they comply with similar IIROC Rules.
It appears from the commentary and the amendments that the
senior derivatives manager obligations are intended almost
exclusively for Canadian banks so that each line of derivatives
business has its own supervisor who carries out the compliance
function for that line of business.
Further Guidance on Business Trigger and Schedule III
Banks
In response to the comments, the commentary in the companion
policy to Proposed NI 93-101 relating to the “business trigger
test” has been expanded to explain how it applies to foreign
dealers engaging in activities with Canadian counterparties. The “business trigger test” is used to determine if the
person or company is in the business of trading or advising others
with respect to over the counter derivatives.
Similarly, the companion policy now includes guidance that
Schedule III banks are considered foreign dealers (despite having
branches in Canada) and can rely on the foreign derivatives dealer
exemption or the foreign liquidity provider exemption.
New Exemption for IIROC Dealer Members or Canadian Financial
Institutions
Derivative dealers that are IIROC Dealer Members or Canadian
Financial Institutions are now exempt from many provisions of
Proposed NI 93-101 if they comply with their respective IIROC,
Bank Act or OSFI requirements relating to a transaction
with a derivatives party. Notably, some of the sections for which
exemptions have been granted do not currently have equivalent
sections in the IIROC Rules, so it is expected that the IIROC Rules
will be amended to include such sections.
A number of other significant changes have been made:
- Short-term foreign exchange contracts in the wholesale
market will be subject to certain provisions of Proposed NI
93-101: “Short-term foreign exchange (FX) contract or
instrument” is now a defined term and Proposed NI 93-101
adopts the definition used in each province’s derivatives
product determination rule to describe spot FX contracts. Certain
provisions of Proposed NI 93-101 (fair dealing, conflicts of
interest, handling complaints and compliance provisions) are now
applied to spot FX contracts in the wholesale market. Proposed NI
93-101 applies to short-term FX contracts or instruments where the
derivatives dealer is a Canadian financial instruction and had a
month-end gross notional amount under all outstanding derivatives
that exceeds $500,000,000,000.As such, this only applies to a very
limited set of large derivatives dealers, namely the Canadian banks
in transactions with each other and is largely meant to support the
voluntary FX Code of Conduct developed by, among others, these same
banks. This provision is the first regulation of the spot foreign
exchange market (wholesale or otherwise) by Canadian securities
regulators and it remains to be seen if further regulation will be
forthcoming for other aspects of the spot FX market. - New Foreign Sub-Adviser Exemption : A new
foreign derivatives sub-adviser exemption has also been added that
is similar to the international sub-adviser exemption in National
Instrument 31-103 Registration Requirements, Exemptions and
Ongoing Registrant Obligations (” NI
31-103 ” ). This exemption allows foreign derivatives
advisers to provide advice to derivatives advisers and derivatives
dealers without having to comply with any business conduct
requirements based on supervision by such derivatives advisers or
derivatives dealers. - Foreign Derivatives Dealer and Foreign Derivatives
Adviser Exemptions : In addition to reformatting the
exemptions in order to conform them to the structure of the
exemptions in NI 31-103, Proposed NI 93-101 has populated the lists
of foreign jurisdictions from which foreign dealers and foreign
advisers can rely on the exemptions. The list includes most major
capital markets with whom Canadian counterparties can expect to
transact. Surprisingly, the list does not include Canada’s
North American trade partner Mexico, though the CSA has said it
will consider exempting derivatives dealers and derivatives
advisers from other foreign jurisdictions on a case-by-case
basis. - Core Conduct Obligations : The complaints
handling provisions and tied selling provisions will now apply to
all derivatives parties, whereas they previously only applied to
transactions involving (i) non-EDPs or (ii) individual EDPs or
eligible commercial hedger EDPs that did not waive the application
of the provisions. The CSA has decided that these obligations are
fundamental to the functioning of the derivatives markets and
should apply regardless of the sophistication of a derivatives
counterparty.
Regulatory Burden Analysis
As required under the Securities Act (Ontario), the OSC
has provided information relating to the impact of Proposed NI
93-101 on Ontario market participants (in particular on entities
that will be regulated pursuant to Proposed NI 93-101). The OSC
anticipates that the costs will not be substantial for IIROC Dealer
Members or federally regulated financial institutions. However, the
OSC’s own estimates are that 70 local derivatives dealers do
not fall into either category. For these “other derivatives
dealers”, the OSC anticipates a maximum of $25,000 in
additional costs to implement the changes required by Proposed NI
93-101 as well as about $29,000 annually for ongoing compliance.
While the OSC has not asked for comments on this analysis, entities
that will be subject to Proposed NI 93-101 may want to provide
information to the OSC if they believe that these estimates are
incorrect, so that future regulatory burden estimates by the OSC
will be more accurate.
Conclusion
The changes made to the second draft of Proposed NI 93-101
should generally be received positively by market participants
(both regulated entities and business who rely on such entities to
hedge their commercial risks). This demonstrates that the CSA is
open to working with the market through the comment process to
develop rules that protect the public while not unnecessarily
harming market participants. The third draft of Proposed NI 93-101
is much closer to achieving that perfect balance, but there always
remains room for improvement.
As mentioned above, the CSA has invited interested parties to
submit written comments on Proposed NI 93-101 until March 21, 2022.
It is likely that with the one-year effective delay, a final
version of the draft may be available between Q4 2022 and Q1 2023
with an effective date no earlier than Q4 2023 or Q1 2024.
Footnote
1. Permitted client is a category currently used by
derivatives counterparties who rely on the international dealer
exemption. Accredited counterparty is a category of counterparty to
whom exemptions currently apply under the Derivatives Act (Quebec).
Qualified party is a category of counterparty to whom registration
and prospectus exemptions apply under various provincial rules or
orders relating to over-the-counter derivatives.
The foregoing provides only an overview and does not
constitute legal advice. Readers are cautioned against making any
decisions based on this material alone. Rather, specific legal
advice should be obtained.
© McMillan LLP 2021
