Derivatives: Business Conduct and Registration Kevin Fine Director OSC, Derivatives Branch February 21, 2019

Introduction CSA proposal for business conduct and registration regimes for derivatives dealers and derivatives advisers (derivatives firms): Proposed National Instrument 93-101 Derivatives: Business Conduct (the Business Conduct Rule) published for second comment on June 14, 2018 – comment period ended September, 2018 Proposed National Instrument 93-102 Derivatives: Registration (the Registration Rule) published for first comment last April Intended to establish business conduct and registration regimes for derivatives firms comparable to NI 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) for securities firms, but tailored to reflect different nature of derivatives markets

Why are we developing these rules? Globally derivatives markets have had many examples of misconduct, including market manipulation and front running (e.g., LIBOR, FX rates, gold and silver price, CDS prices, energy and other commodity prices Gaps in our current regulatory regime Regulated financial institutions are significant derivatives market participants, subject to prudential regulation but not conduct regulation Canada is one of the only advanced economies in the world without a business conduct regime that applies to derivatives dealers operating in its market Registration of non-FRFI derivative dealers who only deal with sophisticated counterparties Proposed rules , together with existing rules (trade reporting, clearing and protection of customer collateral) address underlying market risks including those that resulted in the 2008 crisis

Rationale for two-rule approach For securities firms, registration and business conduct requirements generally set out in a single rule – NI 31-103 Rationale for splitting the regime for derivatives firms into two rules: Section 35.1 of the Securities Act (Ontario) exempts certain federally regulated financial institutions (FRFIs) from registration requirement Separate business conduct rule ensures derivatives firms, including FRFIs, are subject to minimum standards of conduct, regardless of whether or not they are registered Registration and business conduct rules are intended to operate together to mitigate a variety of risks relating to the firm’s derivatives related activities, particularly the growing retail derivatives market in Canada

Purpose of the proposed rules Registration rule is intended to ensure that derivatives firms and individuals acting on their behalf meet prescribed standards of integrity, proficiency and solvency and are otherwise “fit” for registration to allow Canadian securities regulators to deny registration to a firm or individual, or suspend registration of a firm or individual, in appropriate circumstances. Business conduct rule is intended to Protect market participants, improve transparency and promote responsible business conduct in the OTC derivatives markets

Purpose of registration rule Proposed registration regime (including exemptions) will apply to Foreign dealers Foreign and domestic commodities dealers Retail CFD/Forex providers Canadian FRFIs (in all provinces except Ontario) Foreign and domestic advisers

Overview of registration rule Unless otherwise exempt, individuals must register if they act as the ultimate designated person (UDP), chief compliance officer (CCO) or chief risk officer (CRO) of a registered derivatives firm a dealing representative or advising representative of a registered derivatives firm—if they trade with or advise non-EDPs CRO is new—no analogue in NI 31-103

Two-tiered application of requirements Certain obligations apply in all cases when a derivatives firm is dealing with or advising a derivatives party, regardless of the level of sophistication or financial resources of the derivatives party; and Certain obligations: do not apply if the derivatives firm is dealing with or advising a derivatives party that is an “eligible derivatives party” and is neither an individual nor a specified commercial hedger, and apply but may be waived if the derivatives firm is dealing with or advising a derivatives party who is an “eligible derivatives party” that is an individual or a specified commercial hedger.

Application of the rules Who do the rules apply to? Derivatives dealers and derivatives advisers Definition of “derivatives dealer”: “derivatives dealer” means a person or company engaging in or holding himself, herself or itself out as engaging in the business of trading in derivatives as principal or agent, and any other person or company required to be registered as a derivatives dealer under the securities legislation of a jurisdiction of Canada; Similar definition for “derivatives adviser”

Application of the rules Definitions based primarily on a “business trigger” concept Note: A firm may be a derivatives dealer even though it is not registered as a derivatives dealer The derivatives dealer definition (in both rules) uses the same language as the business trigger for registration but is not tied to registration status a derivatives firm may be exempt from registration (in some jurisdictions) but still subject to conduct requirements Similar to approach under CSA trade reporting rules – they apply to “derivatives dealers” regardless of whether registered or not

Business Trigger Criteria Business trigger guidance in 93-101CP for derivatives firms: acting as a market maker directly or indirectly carrying on the activity with repetition, regularity or continuity  facilitating or intermediating transactions transacting with the intention of being compensated (e.g. spreads, built in fees) directly or indirectly soliciting in relation to derivatives transactions engaging in activities similar to a derivatives adviser or derivatives dealer providing derivatives clearing services These factors are elaborated on in CP 93-102. Similar factors are set out for advising.

Key concept – commercial hedger New prong added to both registration and business conduct rules based on industry comments relating to market liquidity Concept applies to a business entering into a transaction for the purpose of reducing the inherent risks of its business Similar to the definition of “Eligible Contract Participant” under CFTC rules and is based on the definition of hedger that currently exists in the Quebec Derivatives Act Term is referenced in the definition of “eligible derivatives party” (EDP) A commercial hedger is subject to a lower financial threshold (i.e., $10 million) to qualify as an EDP when compared to other, non-individual, persons or companies

Exemptions from registration Derivatives dealer with limited notional amount “de minimis” exemptions may be available if all of a trading activity is below a specified threshold general exemption—if all derivatives activity is less than $250 million in aggregate notional amount, or commodities dealers exemption—if all derivatives activity exclusively involves commodities derivatives and is less than $1 billion in aggregate notional amount Conditions include: Cannot be registered as a dealer or adviser in Canada or a foreign jurisdiction does not solicit or transact with non-EDPs

Exemptions from registration Foreign derivatives firms Foreign derivatives dealers and advisers subject to equivalent regulatory requirements in their home jurisdictions may be exempt from registration (e.g. CFTC registered swap dealers), or required to register but exempt from specific requirements (e.g. dealers from a foreign jurisdiction with a less developed regulatory regime for derivatives) Conditions include: does not solicit or transact with non-EDP (i.e., retail) licensed to conduct derivatives dealing or advising activity in home jurisdiction and complies with the applicable requirements IIROC members and FRFIs exemptions to be based on an equivalency analysis (e.g., investment dealers/IIROC members and Canadian financial institutions) In Ontario registration exemption in s. 35.1 of the Securities Act (Ontario) for FRFIs

Exemptions to consider Statutory exemption for FRFIs from the registration requirement under subsection 35.1(1) of the Securities Act (Ontario) because a credit union is already subject to the Bank Act (Canada); registration exemption may not be available in other provinces. End-users exemption a person or company that frequently and regularly transacts in derivatives may qualify for the exemption if it does not engage in other dealer like activity (e.g., soliciting, quoting prices, intermediating)

IIROC membership IIROC membership to be mandatory if the registered derivatives dealer transacts derivatives with any derivatives party that is an individual, and not an EDP Other derivatives dealers may choose to be IIROC members (e.g., if also carrying on a securities business) but are not required to be Derivatives dealers not required to become IIROC members will be regulated by the relevant CSA authorities (akin to CSA oversight of exempt market dealers and portfolio managers)

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