Nos perspectives

Strengthening investor protection in the Canadian derivatives market

New proposed rules introduce registration requirements for over-the-counter (OTC) derivatives

Governments around the world continue to introduce regulations that strengthen capital markets. In Canada, a new regulatory regime for the derivatives market is moving closer to implementation. Proposed new measures, expected to be finalized in 2019, are intended to bring Canada’s regulatory regime in line with international standards.

Key insights

  • The growing role of derivatives in the Canadian marketplace has spurred the drafting of a new regulatory regime to govern the registration and conduct of dealers and advisers in over-the-counter derivatives markets in Canada
  • New proposed National Instruments will function to extend the existing regulatory regime for dealers in securities to derivatives markets, to provide a more harmonized regulatory environment and will require existing market participants to review and assess their existing, derivatives-specific approaches to confirm any required changes
  • Consultation on the proposed regulations, which are expected to be announced in their proposed final form in 2019, has extended over more than five years and began with the release of a consultation paper on derivatives registration published in April 2013

“Derivatives are now mainstream financial products that play an important role in global and Canadian economies,” says Maureen Jensen, Chair and CEO of the Ontario Securities Commission (OSC), which administers and enforces securities law in Ontario. “We are seeing more derivatives products being promoted to retail market participants, and there is also an increased interest by retail investors in the trading of derivatives on cryptocurrencies.”1

Canadian securities markets are governed by national and multilateral instruments that are largely aligned. This coordination is the result of efforts by the Canadian Securities Administrators (CSA), an umbrella organization of Canada’s provincial and territorial securities regulators whose objective is to improve, coordinate, and harmonize regulation of the Canadian capital markets.

The new derivatives regime will bring the same coordinated and harmonized regulation to OTC derivatives markets across Canada in the form of proposed new National Instruments (NIs) 93-101 (Derivatives: Business Conduct) and 93-102 (Derivatives: Registration).

“The proposed rules are an important milestone for Canada,” comments Louis Morisset, Canadian Securities Administration Chair and President and CEO of the Autorité des marchés financiers, the organization responsible for financial regulation in the province of Québec. “They will help protect against market abuse and together, the proposed business conduct instrument along with the proposed registration instrument, will align us with international standards.”2

Increased regulation matches the rise of derivatives as mainstream financial products

With the exception of Quebec, no Canadian jurisdiction has a dealer or adviser registration regime targeted to participants in the OTC derivatives market. In certain Canadian jurisdictions, securities legislation currently requires the registration of derivatives dealers and advisers, but many of these jurisdictions also concurrently provide exemptions that allow dealers and advisers to deal with qualified parties without registration. The new rules will provide a derivatives-specific registration regime to replace the existing exemptions and harmonize the rules across Canada.

The new rules will
provide a derivatives-specific
registration regime to
replace the existing
exemptions and
harmonize the rules
across Canada

The national instruments set out two categories of dealer registration, as well as registration categories and requirements for individuals who represent registered dealers. They were first published for comment in April 2017, and a second round of comments on a revised regulatory package closed on September 17, 2018. The regulations are more than five years in the making as they stem from a CSA consultation paper on derivatives registration first published in April 2013.

“The newly proposed National Instruments adopt a two-tiered approach,” comments David Petiteville, Director, Regulatory Solutions at RBC Investor & Treasury Services. “Some of the obligations on derivatives advisers and dealers will apply to all derivatives parties, regardless of their sophistication. Others, however, apply only to less sophisticated parties who would not be considered ‘eligible derivatives parties’ under the new rules.”

The results of the second round of consultation, along with any potential changes to the regulation and guidance on implementation, are expected to be released by the CSA in 2019.

Key provisions

The proposed new regime includes the following key provisions which are investor protection-focused:
  • Fair dealing obligation: Under the new rules, derivatives advisers and dealers would be obliged to act fairly, honestly, and in good faith with “derivatives parties” (the terms used in the regime to mean, essentially, clients), including the firm's customers and counterparties
  • Conflicts of interest: Firms would be required to develop and implement policies and procedures to identify, address, and disclose conflicts of interest
  • Know-Your-Client (KYC): A new obligation to “know your derivatives party” would arise under the proposed rules, requiring firms to assess a party’s identity, the nature of their business, needs and objectives, as well as potential insider status
  • Pre-transaction suitability: In advance of any derivatives transaction, derivatives firms would need to ensure the proposed transaction is suitable (i.e., appropriate for the derivatives party, in light of their sophistication, needs, and objectives), as well as providing written disclosure on the derivatives’ potential risks to that party
  • Prohibition on tied selling: Derivatives firms would be prohibited from engaging in sales practices that include pressuring or requiring a non-eligible derivatives party to obtain a product or service as a condition of obtaining other products or services from the firm

 

New regime similar to existing registration requirements for the distribution of securities

The proposed regime for derivatives is similar to the conduct and registration requirements applicable to registered securities dealers and advisers under NI 31-103 (Registration Requirements, Exemptions, and Ongoing Registrant Obligations).

We anticipate that the new rules will provide better protection for investors in derivatives, matched with better transparency, and accountability from their advisers and dealers

Those entities currently subject to NI 31-103, including Canadian banks as well as advisers and dealers registered with the Investment Industry Regulatory Organization of Canada, may already be compliant with the proposed requirements, but will likely need to review their internal derivatives-specific conduct and practices to discover whether any changes are required.

“The biggest area of change we expect to see,” says Petiteville “is for those derivatives advisers and dealers who are not working under the existing registration rules for the distribution of securities. This group might include foreign entities that are doing business in derivatives in Canada and new technology-based entrants that are looking to trade in derivatives, which is a rapidly growing area.”

“Overall,” Petiteville adds “we anticipate that the new rules will provide better protection for investors in derivatives, matched with better transparency, and accountability from their advisers and dealers. As a result of these enhancements, we think the existing derivatives market may expand as market participants will be exposed to a larger opportunity set that now includes derivatives.”

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