New Light on Shadow Banking: The FSB's New Report on Rehypothecation of Client Assets

 Margaret Grottenthaler

The Financial Stability Board has been considering the possible harmonization of rules relating to rehypothecation of client assets in securities financing transactions (such as securities loans, repo and margin loans) for several years. On January 25, 2017, it released a report entitled Transforming Shadow Banking into Resilient Market-based Finance, which summarizes the findings of its Rehypothecation and Re-use Experts Group.

Regulatory Approaches to Shadow Banking

Those of you who want to know more about how this aspect of so-called “shadow banking” works will find the new report very informative. Specifically, it explains:

  • What rehypothecation is;
  • Why it is important to the efficient functioning of lending markets;
  • What systemic risks it poses;
  • How those risks are currently addressed by regulation and market practice; and
  • The possibilities for harmonizing regulatory approaches.
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Quebec derivatives scope rule expanded to cover CCP clearing and customer clearing instruments

Tara Mandjee

The Autorité des marchés financiers (AMF), Quebec’s financial services regulator confirmed yesterday that, subject to necessary approvals, (i) Regulation 94-101 respecting Mandatory Central Counterparty Clearing of Derivatives (Regulation 94-101) and (ii) Regulation 94-102 respecting Derivatives: Customer Clearing and Protection of Customer Collateral and Positions (Regulation 94-102) will come into force respectively on April 4, 2017 and on July 3, 2017.

Regulation 94-101 sets out mandatory requirements for central counterparty clearing of certain standardized over-the-counter derivatives transactions. It aims at reducing counterparty risk in the derivatives market and enhancing market transparency. Regulation 94-102 sets out requirements related to segregation and portability of customer collateral and positions. It aims at protecting a local customer’s positions and collateral and improving derivatives clearing agencies’ resilience to a default by a clearing intermediary. For a detailed overview of these rules and their impact on the OTC derivatives market, we refer you to Margaret's post.

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Final Customer Collateral Rule Published by CSA

Margaret Grottenthaler

On January 19, the Canadian Securities Administrators (CSA) published the final form of the segregation and portability rule relating to customer collateral for cleared derivatives.  This National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions (Customer Collateral Rule) is aimed at ensuring that clearing is carried out by clearing intermediaries and clearing agencies in a manner that protects customer collateral and positions and improves the ability of a derivatives clearing agency to withstand a clearing member default.  The rule will allow for different clearing models (principal to principal or FCM) and is broadly aligned with principles adopted in the US and other jurisdictions. This rule comes into effect on July 3, 2017.

Two types of entities are the focus of the Customer Collateral Rule: clearing intermediaries (CI) and regulated clearing agencies (RCA).

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Final Canadian Mandatory Clearing Rule Published

Margaret Grottenthaler - 

The Canadian Securities Administrators (CSA) have published the final version of proposed National Instrument 94-101 Mandatory Central Counterparty Clearing of Derivatives (the Clearing Rule) and its Companion Policy 94-101 (the Clearing CP) slated to come into effect on April 4, 2017 for clearing participants and October 4 for other parties subject to the rule.  The changes from the prior version of the Clearing Rule are relatively minor.

The Clearing Rule applies to direct clearing participants of a regulated clearing agency (and their affiliates) and major swap market participants that are local counterparties (month-end gross notional above CAD 500 billion).   For a rule directed primarily at reducing systemic risk, this is a sensible and welcome approach, and one that recognizes that the Canadian market comprises a relatively small part of the global market. Initially, the products mandated to clear will be certain interest rate derivatives and forward rate agreements. In this post we review the main features of the Clearing Rule.

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CDIC publishes guidance note on bank resolution

Margaret Grottenthaler - 

While reading the provisions of the Canada Deposit Insurance Corporation Act dealing with member institution resolution regimes is excellent brain exercise, you might prefer to read the much less challenging and newly published guidance note from CDIC.  The Guidance on Exercise of Eligible Financial Contracts Close-out Rights in a Resolution Scenario very helpfully explains how CDIC anticipates that the regulatory powers of CDIC and the Finance Ministry – particularly those new powers added in the June amendments – would in practice be exercised in relation to eligible financial contracts, including derivatives and securities financing arrangements, when a member financial institution is financially distressed.

The strong message in the Guidance is that the intention of the amendments is to implement the Financial Stability Board’s Key Attributes of Resolution Regimes for Financial Institutions (FSB Key Attributes).  The FSB Key Attributes require that termination rights triggered by resolution events – such as bail-in measures or transfers to a bridge institution or creditworthy third-party purchasers – be suspended so as not to compromise the effectiveness of those measures, but that termination rights otherwise be enforceable or only temporarily suspended.  The part of the Guidance that best explains the overall effect of the resolution regime is the following:

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Compromise cash collateral proposal recommended - Ontario seeking input

Margaret Grottenthaler - 

Ontario’s Business Law Advisory Committee, which advises the province’s Ministry of Government and Consumer Services, is proposing a compromise solution to the issue of perfecting security interests in cash collateral.  As those following the cash collateral saga know, the sticking point with amending the regime to allow perfection by control (and a first priority based on control) for cash collateral has been the statutory priority that pension plans enjoy over “accounts” with respect to contributions owed by the debtor employer. As a result of the Sun Indalex case, the potential priority liability includes unfunded liabilities in defined benefit plans. The Committee’s proposed solution is to allow perfection by control for all accounts while subordinating the pension plan priority under the PPSA if and only if the obligations secured relate to “derivatives”. 

While it’s easy to appreciate the need for some form of compromise, it is not going to be all that easy to implement this proposal. Among the many issues that will need to be addressed are the following:

  • How will “derivative contract” be defined?  The report seems to suggest that this refers only to OTC derivatives, but futures will also have to be included.
  • Why not securities loans and repos, which also need certainty in order to qualify for capital relief?  Including them would be consistent with the federal insolvency laws.
  • How will this affect rights of set-off under section 40 with respect to other types of obligations?  It would be a shame if this proposal were implemented in a way that compromised the section 40 rights that should apply to title transfer collateral arrangements used in many lending markets, not just derivatives. 
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Notice issued to help interpret product determination and trade reporting rules in Canadian jurisdictions governed by MI 96-101

Alison Beer - 

On September 29, 2016, the securities regulators of Alberta, British Columbia, New Brunswick, Newfoundland & Labrador, Northwest Territories, Nova Scotia, Nunavut, Prince Edward Island, Saskatchewan and Yukon (the Participating Jurisdictions) published CSA Multilateral Staff Notice 91-305. This Notice answers specific questions about how certain aspects of the product determination and trade reporting rules (and related companion policies) should be interpreted.[1]

The Notice will be a useful reference for those who haven’t already spent a lot of time considering the rules. However, while it provides useful clarification on a number of points, it isn’t a substitute for a close reading of the rules, which (as always) are full of nuances and subtleties that can significantly influence the analysis of a real-world fact situation.

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Canadian Securities Administrators publish consultation paper on margin requirements for non-centrally cleared derivatives

Alison Beer

Yesterday the CSA published for comment a Consultation Paper proposing a framework for margin requirements on non-centrally cleared derivatives. The invitation to provide comments on the proposal ends September 6, 2016.

The requirements under the Consultation Paper are based on the minimum standards for margin requirements for non-centrally cleared derivatives developed by the Basel Committee on Banking Supervision (BCBS) and the International Organization for Securities Commission (IOSCO) (the BCSBS-IOSCO Standards) that apply to certain financial entities and systemically important non-financial entities. The CSA has also stated that the proposed framework is largely consistent with OSFI Guideline E-22 on Margin Requirements for Non-Centrally Cleared Derivatives applicable in Canada to federally regulated financial institutions (FRFIs). FRFIs will not be subject to the proposed framework (although FRFI’s are included in the definition of “financial entities” for the purpose of defining the “covered entities” with which a counterparty that is not a FRFI will be required to exchange margin).  

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ASC and other securities regulators issue limited blanket relief from certain derivatives trade reporting requirements

The securities regulatory authorities in Alberta, New Brunswick, Nova Scotia and Saskatchewan are providing discretionary relief from certain requirements Multilateral Instrument 96-101 Trade Repositories and Derivatives Data Reporting (MI 96-101).  Blanket Order 96-501 Relief from Certain Derivatives Reporting Requirements (Blanket Order 96-501) exempts reporting counterparties from some requirements of MI 96-101 where reporting counterparties are unable to obtain certain information from their counterparties and where foreign laws prevent or hinder reporting.

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BCSC issues guidance on trade reporting and product determination rules

The British Columbia Securities Commission (BCSC) has advised market participants that Multilateral Instrument 91-101 Derivatives: Product Determination and Multilateral Instrument 96-101 Trade Repositories and Derivatives Data Reporting (MI 96-101) as well as amendments to MI 96-101 are targeted to come into force before July 29, 2016, subject to obtaining necessary governmental approvals.  That is also the date when mandatory trade reporting begins for clearing agencies and derivatives dealers in Alberta, British Columbia, New Brunswick, Newfoundland and Labrador, the Northwest Territories, Nova Scotia, Nunavut, Prince Edward Island, Saskatchewan and Yukon.

The BCSC has advised clearing agencies and derivatives dealers that the onboarding process with trade repositories may take several weeks to complete. The BCSC also reminded market participants that persons eligible to receive a legal entity identifier (LEI), other than individuals, must obtain a LEI prior to entering into a derivatives transaction that must be reported under MI 96-101.  

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