Canada is home to the third-largest financial center in North America, Toronto.
Whilst the United States has been engaged for the last three years in setting forth exhaustive measures by which to reform the means by which the financial markets economy is regulated on a federal basis, Canada emulates this on a provincial basis.
Yesterday, the Ontario Securities Commission (OSC), which is the provincial regulatory authority responsible for ensuring that Toronto’s market participants adhere to rulings has announced a Scope Rule, whose purpose is to define the types of derivatives that will be subject to reporting requirements under the Trade Repositories (TR) Rule.
The Scope Rule will initially only apply for the purposes of the TR Rule. Any other legislation, rules, notice or other policies applicable to derivatives will continue to apply. For example, OSC Staff Notice 91-702, which refers to Offerings of Contracts for Difference and Foreign Exchange Contracts to Investors in Ontario would continue to apply to these types of instruments until any new rules replacing the treatment as described in the notice have been implemented.
The Scope Rule prescribes certain contracts or instruments that fall within the broad definition of “derivative” in the Ontario Securities Act (the Act), not to be derivatives.
The excluded contracts are contracts that have not traditionally been considered to be over-the-counter derivatives. The Scope Rule also addresses the fact that the definitions of derivative and security in securities legislation are expansive and, in some cases, overlapping. The Scope Rule resolves conflicts that arise when a contract or instrument meets both the definition of “derivative” and the definition of “security”.
United States Leads The Way
The United States government, along with the Commodity Futures Trading Commision (CFTC) were instrumental in pioneering the regulations which the OSC is now setting forward, most of which were addressed in the Dodd-Frank Wall Street Reform Act which contains an extensive set of stipulations surrounding the transparent reporting of trades by which providers of OTC FX must adhere to.
Ontario’s provincial regulator in today’s release reflects this line of thinking, and applies it to FX as well as Toronto’s traditional equities and stock trading industry sectors.
Collectively, the Scope Rule, the Scope for counterparties (CP), the TR Rule and the TR CP will be referred to as the rules.
Ministerial approvals within the Canadian government are required for these Rules to come into force. The Rules were delivered to the Minister of Finance on October 17, 2013. The Minister may approve or reject the Rules or return them for further consideration.
If the Minister approves the Rules or does not take any further action by December 16, 2013, the Rules will come into force on December 31, 2013.
Full Detail of Scope Rule
The Scope Rule provides guidance as to which types of contracts or instruments will be treated as derivatives or securities, or are excluded in whole or in part from regulation. The definition of derivative according to the Act is intended to include the types of instruments traditionally referred to as derivatives (for example, swaps and forwards) as well as other novel instruments.
However, the definition of “derivative” is broad enough to capture many contracts and instruments that are not traditionally considered to be derivatives. The Scope Rule tailors the application of regulatory requirements to a broad range of existing and emerging products by making clear which contracts or instruments are to be regulated as derivatives or securities, or are outside the scope of securities or derivatives legislation.
As far as FX contracts are concerned, provided that the contract settles within prescribed timelines, is intended by the counterparties to be settled by delivery of the currency referenced in the contract, and is not rolled-over, it will be excluded from the OSC’s definition of what constitutes a derivative.
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On this basis, according to the OSC’s rulings, any contract or instrument excluded from the definition of “derivative” under the Scope Rule will not be required to be reported to a designated trade repository.
Regulation of Trade Repositories in Ontario
To obtain and maintain designation as a trade repository, a person or entity must apply to the Commission for designation and must comply with the designated trade repository requirements set out in the TR Rule, as well as all terms and conditions imposed by the Commission in any designation order made.
When determining whether or not to designate a trade repository, the Commission will consider various factors, including whether it is in the public interest to do so, whether the applicant is in compliance with securities law and whether the applicant has established policies and procedures that meet standards applicable to trade repositories. The TR CP provides additional guidance on how the Commission will assess such factors.
Once designated, a trade repository will be required to provide the Commission with interim and year-end financial statements, and to provide notice of any significant changes to the information submitted in its Form 91-507F1 before implementing the changes.
A designated trade repository will be subject to a variety of on-going requirements including ensuring the adequacy of its governance arrangements, meeting board composition requirements, clearly defining management roles and responsibilities, maintaining policies and procedures for material aspects of its business, retaining records, ensuring data security and confidentiality, establishing a comprehensive risk management framework and meeting other requirements related to systems and operational risks. A designated trade repository will also be required to appoint a chief compliance officer and to clearly define his or her role and responsibilities.
Once operational, a designated trade repository will be expected to accept derivatives data for each asset class set out in the Commission’s designation order. Any fees charged by a designated trade repository must be fairly and equitably allocated amongst its participants and must be publicly disclosed. Designated trade repositories will also have an obligation to confirm derivatives data with all participants of their service.
The designated trade repositories will be required to provide full details regarding counterparties to any transaction, and will have access to derivatives data relevant to their transactions, as well as being able to ascertain and aggregate data on open positions, volume, number and prices related to transactions will be required to be reported publicly.
In terms of timing, initial reporting is required to be completed on a real-time basis. However, where it is not technologically possible to do so, the reporting counterparty must report as soon as possible, but not later than the end of the next business day following the day that the transaction was entered into.
Transactions that were entered into prior to the TR Rule coming into force will be required to be reported, provided they have not expired or been terminated within a prescribed period after the TR Rule comes into force.
Three main types of data must be reported under the TR Rule: (i) creation data, (see Appendix A to TR Rule for more details); (ii) life-cycle event data, which includes any change to derivatives data previously reported; and (iii) valuation data, which includes the current value of the transaction.
Local Counterparty Definition
The OSC has made revisions to the local counterparty definition so that guaranteed affiliates of registered foreign derivatives dealers are not local counterparties.
This revision was made in response to a number of comments regarding the potential extra-territorial effect of the definition of local counterparty as proposed. The Committee determined that guaranteed affiliates of foreign derivatives dealers do not have a sufficient nexus to Ontario to warrant treatment as local counterparties.
Despite Toronto’s established financial markets industry having its roots in the equities and stock segments, with the implementation of this rule, it is clear that the OSC is well aware of the city’s potential within the FX sector.