CSA Consultation Paper 91-301 – Derivatives: Model Provincial Rules

On December 6, 2012, the Canadian Securities Administrators OTC Derivatives Committee (the “Committee”) published for interim guidance and comment, CSA Staff Consultation Paper 91-301 (“Consultation Paper 91-301”).

Released as part of ongoing efforts by the Committee and the Canadian OTC Derivatives Working Group1 to fulfill Canada’s G-20 commitments, Consultation Paper 91-301 sets out two model provincial rules with accompanying model explanatory guidance that relate to the regulation of the trading of derivatives.  The model provincial rules, which have been drafted based on the Securities Act (Ontario) and which the Committee states should be considered in the context of that legislation, are open for comment for a consultation period of 60 days.

Model Provincial Rule - Derivatives:  Product Determination

The first model provincial rule proposed by the Committee pertains to the determination of products which will be treated as derivatives (the “Scope Rule”).

The Scope Rule provides a foundation for the regulation of derivatives, which the Committee feels is both responsive and flexible.  As the definitions of “derivative” and “security” in provincial securities legislation are generally quite broad, and in some cases, overlapping, the Committee drafted the Scope Rule with the intent of resolving conflicts that arise when a contract or instrument meets both the definition of derivative and of security.  By making clear which contracts or instruments are to be regulated as
derivatives or securities, or are outside the scope of securities and derivatives legislation, the Scope Rule is intended to provide the flexibility to appropriately tailor regulations to a broad range of existing and emerging products.

The Scope Rule will initially only apply for the purposes of the TR Rule (as defined below). However, the Committee expects that elements of the Scope Rule, subject to amendments, will also become applicable to existing provisions of securities legislation, and to future derivatives rules that will be brought into force, including but not limited to rules relating to over-the-counter central counterparty clearing, end-user exemptions, trading platforms, capital and collateral, and registration.  The Committee points out that there may be variations in the application of the Scope Rule for these new rules.

Until the Scope Rule has been extended to other derivatives rule-making areas, any legislation, rules, notice or other policies applicable to derivatives will continue to apply.

Model Provincial Rule - Trade Repositories and Derivatives Data Reporting

The second model provincial rule proposed by the Committee pertains to trade repositories and derivatives data reporting (the “TR Rule”).

The TR Rule outlines proposed requirements for the operation and ongoing regulation of designated or recognized trade repositories and the reporting of derivative transaction data by market participants.  It reflects proposals contained in the CSA Staff Consultation Paper 91-402 which was released on June 23, 2011.  The Committee states that the purpose of the TR Rule is to improve transparency in the derivatives market to regulators and the public, and to ensure that designated trade repositories operate in a manner that promotes the public interest.

The TR Rule can generally be divided into two rule-making areas: (i) those relating to the regulation of trade repositories (including rules with respect to the designation/recognition process, requirements and restrictions relating to data dissemination and ongoing operational requirements), and (ii) those relating to reporting requirements of derivatives market participants.

In order for any trade repository, local or foreign, to be an acceptable venue for local market participants to comply with the reporting obligations contained in the TR Rule, the trade repository must be designated or recognized in the applicable provincial jurisdiction.  However, the Committee recommends that exemptions to certain requirements of the TR Rule be made available to a foreign-based trade repository if the trade repository is subject to an equivalent regulatory and oversight regime in its home jurisdiction.  The Committee recognizes that some foreign-based trade repositories are already subject to equivalent regulation in their home jurisdiction and acknowledges that the imposition of a duplicate regime would be inefficient.

The TR Rule outlines the general requirements that an entity must meet in order to obtain and maintain a designation as a trade repository.  Pursuant to the TR Rule, an applicant must demonstrate that: (i) the designation is in the public interest; (ii) it is, or will be in compliance with securities legislation; and (iii) it has established, implemented, maintained and enforced appropriate written rules, policies and procedures in accordance with standards applicable to trade repositories.

In outlining the reporting obligations for transactions, the Committee has identified the counterparties that will be subject to the duty to report and the data that is required to be reported, and has prescribed the reporting time.  The Committee notes that it has attempted to harmonize reporting requirements under the TR Rule with international practice.  Where minor differences exist between a foreign regime’s reporting requirements and those in the TR Rule, the Committee states that it would be possible to apply for an exemption on the grounds of equivalency.

In addition to the general guidance and comment the Committee is seeking in connection with the two model provincial rules, the Committee is seeking specific feedback on subsection 40(2) of the TR Rule.  This subsection pertains to an exemption from reporting requirements for derivatives transactions in the physical commodities market involving market participants with small derivatives exposures.  The intention of the proposed exemption is to reduce regulatory burdens for small market participants whose physical commodity transactions may unwittingly become subject to the transaction reporting requirements of the TR Rule.  The Committee seeks guidance as to whether the exemption and its proposed $500,000  threshold are appropriate.

Status of Consultation Paper 91-301

The model provincial rules published in Consultation Paper 91-301 will be open for comment until February 4, 2013.  After this date the Committee will evaluate comments received and recommend appropriate amendments to the proposed rules.  Each province will then publish province-specific rules for comment in accordance with the legislative requirements of each jurisdiction.  Following a subsequent comment period, final rules will be implemented by the provinces.