Equity Derivatives in Canada - What you need to know

William Scott and Jonathan Willson of our Toronto office and François Gilbert of our Montreal office recently co-authored the updated Canadian chapter of Getting the Deal Through: Equity Derivatives 2017 (contributing editors: John M. Brandow, Ray Ibrahim and Mark Mendez, Davis Polk & Wardwell LLP).  Published by Law Business Research Ltd., it follows a question-and-answer format and covers an array of legal, regulatory and tax issues relating to trading in OTC and listed equity derivatives in Canada and elsewhere around the world.  To access a copy of the Canadian chapter, click here 

All bets are off: Quebec AMF moves to ban short-term binary options

On February 1, 2017, the Autorité des marchés financiers (AMF), Quebec’s financial markets regulator, published proposed amendments to the Derivatives Regulation (the Proposed Amendments) made under the Derivatives Act (Quebec) (QDA). The proposals are open for comments for a period of 30 days to March 4, 2017.

The Proposed Amendments include a prohibition that would effectively ban the sale of short-term binary options in the Quebec market. The proposal, if adopted, would prohibit the sale to a Quebec-resident individual of a binary option or derivative where:

  • the holder is entitled, at maturity, to either a predetermined fixed yield if the underlying interest meets a predetermined condition, or a zero yield if the underlying interest does not meet a predetermined condition;
  • the holder cannot buy or sell the underlying interest; and
  • maturity is less than 30 days.
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Quebec AMF revisits proposal for "hedger" certification and proposes counterparty "hedger" identification requirement

On February 1, 2017, the Autorité des marchés financiers (AMF), Quebec’s financial markets regulator, published proposed amendments to the Derivatives Regulation  the Proposed Amendments made under the Derivatives Act (Quebec) (QDA).  The proposals are open  for comments for a period of 30 days to March 4, 2017. 

The Proposed Amendments include a new requirement that  an “accredited counterparty” which engages in an OTC derivatives transaction with a hedger who does not otherwise qualify as an “accredited counterparty” provide prescribed identification information on the hedger to the AMF within 30 days after the end of the quarter in which the transaction was completed.

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OSFI offers some flexibility for timing to comply with Variation Margin Rules

Alison Beer

OSFI published a letter on February 24, 2017 allowing for a transition period in limited circumstances to facilitate compliance with the requirements in Guideline E-22 on the exchange of variation margin. This is welcome news for those in the midst of negotiating credit support documentation in order to comply with the new margining requirements for non-cleared derivatives.

Scope of the Transitional Measure

OSFI indicated that federally regulated financial institutions (FRFIs) should prioritize their compliance efforts “based on the size of and risk inherent in the credit and market risk exposures presented by each counterparty,” with full compliance by March 1, 2017 required for in-scope transactions between FRFIs and counterparties to whom they have “significant exposures.” For other in-scope transactions, transitional relief from the March 1 deadline is available until September 1, 2017.  OSFI, however, stated that they still expect FRFIs to meet the variation margin requirements as soon as possible following the March 1deadline.

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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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