On January 20, the Canadian Securities Administrators (the CSA) published CSA Notice and Third Request for Comments on Derivatives Business Conduct (the Notice), the CSA’s draft publication setting out rules intended to better protect OTC derivatives market participants. The two earlier consultations were published on April 4, 2017 and June 14, 2018.
The Notice sets out Proposed National Instrument 93-101 Derivatives: Business Conduct and Proposed Companion Policy 93-101CP Derivatives: Business Conduct (collectively, the Proposed Instrument). The Proposed Instrument is intended to create a uniform approach to derivatives markets conduct regulation in Canada and promote consistent protections for over-the-counter (OTC) derivatives market participants, while also ensuring that derivatives dealers and advisers operating in Canada are subject to consistent regulation. The Proposed Instrument is also intended to meet IOSCO’s international standards.
The Proposed Instrument applies to a person or company if it meets the definition of “derivatives adviser” or a “derivatives dealer”, even if they are not required to be registered as such because they don’t meet the business trigger for registration (yes – “that” business trigger test), or can utilize an exemption in the Proposed Instrument. The Proposed Instrument would thus apply to federally regulated Canadian financial institutions.
The Proposed Instrument sets out a principled approach to regulating the conduct of participants in the OTC derivatives markets, including requirements relating to fair dealing, conflicts of interest, know-your-derivatives party, suitability, pre-transaction disclosure, reporting, compliance, senior management duties, recordkeeping, and the treatment of derivatives party assets. The CSA notes that many of these requirements are similar to the existing requirements applicable to securities dealers and advisers in National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103). Further, similar to NI 31-103, the Proposed Instrument takes a two-tiered approach to investor protection by: a) having certain obligations apply in all cases when a derivatives firm is dealing with or advising a derivatives party, regardless of the level of sophistication of that derivatives party; and b) having certain additional obligations apply if the derivatives party is not an “eligible derivatives party” (EDP), and apply, but subject to being waived, if the derivatives party is an EDP that is an individual or a “specified commercial hedger”.
We wrote about the June 14, 2018 second consultation in our June 2018 Bulletin. The Notice includes a summary of changes to the Proposed Instrument since the 2018 consultation. These changes include, among others, the addition of a new foreign liquidity provider exemption for foreign dealers when they transact with derivatives dealers in Canada, a new exemption for foreign sub-advisers that is similar to the exemption for international sub-advisers in NI 31-103, a five year transition period to allow derivatives firms to treat existing permitted clients and similar entities as an EDP, a new exemption for registered advisers from certain requirements if they comply with corresponding requirements in NI 31-103 in order to leverage existing compliance systems, revisions to the rules around senior derivatives managers, and the application of a limited sub-set of requirements to certain derivatives dealers that are Canadian financial institutions with respect to short-term foreign exchange (FX) contracts in the institutional FX market. As an example of some of the changes, the proposed requirement to have a senior derivatives manager will now only apply to certain derivatives dealers with a specified notional amount of derivatives outstanding. Many of these changes are intended to address comments received on earlier consultations to the effect that there could be negative potential impacts on derivatives market liquidity as a result of the application of certain provisions. The complaint handling provisions and tied selling provisions, on the other hand, have been extended to apply to all derivatives parties.
In addition to comments on all aspects of the Proposed Instrument, the CSA is also seeking feedback on eight specific questions that include such topics as: the foreign liquidity provider exemption, the foreign derivatives dealer and adviser exemptions, the commercial hedge category of the EDP definition, exemption from the designation and responsibilities of a senior derivatives manager, short-term FX contracts in the institutional FX market, treatment of registered advisers under securities or commodity futures legislation, and conflicts of interest. The CSA is requesting comments to be submitted by March 21, 2022. Once the Proposed Instrument is released in final form, there will be a delayed effective date of one year.