Written By Mark Powell, Simon Grant and David Wainer
The Canadian Securities Administrators (CSA) announced that the regulatory authorities of each jurisdiction in Canada, except for British Columbia, have adopted Multilateral Instrument 93-101, entitled Derivatives—Business Conduct (the Rule). The Rule will come into full force and effect on September 28, 2024. British Columbia is expected to adopt substantially similar rules at a later date, at which time the CSA anticipates Multilateral Instrument 93-101 will be converted to a National Instrument.
Earlier drafts of the Rule had been opened for public comment in 2022 and 2017, as we wrote about at the time in our blogs, Securities Administrators Invite Public Comment on Proposed Business Conduct Rules for Derivatives Dealers and CSA Proposes New Canadian Derivatives Business Conduct Rules and Provides Update on Derivatives Registration Rules.
The Rule will regulate the activities of over-the-counter (OTC) derivatives dealers and advisers and is the result of a coordinated effort of all provincial and territorial securities regulators to fulfill Canada's G20 commitment to protect participants in the OTC derivatives markets and harmonize Canada's regulation with the standards of the International Organization of Securities Commission. A result of an extensive consultation process, the Rule establishes requirements with respect to fair dealing, conflicts of interest, suitability, reporting non-compliance and recordkeeping.
In more detail, the Rule sets out the following:
Dealing With or Advising Derivatives Parties
The Rule will require a derivatives firm to act fairly, honestly and in good faith with a derivatives party and establishes requirements with respect to conflicts of interest, know your derivatives, and handling complaints. Derivatives firms will be restricted from coercing an entity to purchase a derivative-related product as a condition of obtaining another product or service, referred to as "tied selling."
Further, the Rule will require a derivatives firm to take reasonable steps to ensure it has sufficient information regarding the derivatives (referred to as "suitability") before proceeding with a transaction. Such information includes: (1) the derivatives party's needs and objectives; (2) the derivatives party's financial circumstances; (3) the derivatives party's risk tolerance; and (4) the nature of the derivatives party's business and operational risks it wants to manage, if applicable. If the derivatives firm believes the transaction or derivative is not suitable to the party, the derivatives firm must inform the party in writing and must not proceed unless the party instructs the derivatives firm accordingly.
The Rule will also restrict referral arrangements unless the terms of the arrangement are agreed to before a referral occurs, all referral fees are recorded, and written disclosure takes place.
Derivatives Party Account
Prior to a Transaction
Before a transaction with a derivatives party for the first time, or providing advice to a derivatives party for the first time, a derivatives firm must provide that party with all information that a reasonable person would consider important about the derivatives party's relationship with the firm, such as a description or nature of the derivatives party's account, a list of conflicts required to be disclosed, a disclosure of fees that may be required, and more. The derivatives firm must ensure the derivatives party is kept up to date with any change in the foregoing information.
Before transacting in a type of derivative with a derivatives party for the first time, a derivatives dealer must provide the party with certain elements constituting a pre-transaction disclosure: (1) a general description of the derivatives and services offered by the firm; (2) a document that enables the derivatives party to assess the risks and material characteristics of each derivative; and (3) a statement describing the financial risk of a derivatives transaction. The Rule provides sample language that may be used. There are also certain requirements for derivatives dealers who are not located in Canada, should these entities wish to transact with Canadian entities.
When the Rule takes effect, a derivatives dealer will be required to provide a written confirmation of a transaction to the derivatives party or an adviser of the party, if that party has so consented. This confirmation must include certain information, such as a description of the derivative, a description of the agreement that governs the transaction, and more, if the derivatives dealer has transacted with a non-eligible derivatives party.
At the end of each quarterly period, a derivatives firm must provide a derivatives party with a statement if the two entities transacted in that quarter or if there are outstanding derivatives resulting from a previous transaction. Such statements must include information about the transactions, including date, transaction terms, and further information sufficient to identify the agreement that governs the transaction.
Compliance and Recordkeeping
The Rule will require that derivatives firms implement policies to ensure the firms: (i) comply with securities legislation relating to trading and advising in derivatives; (ii) manage the risks of its derivative activities in accordance with their risk management procedures; and (iii) have appropriate policies in place such that each individual who may perform an activity on behalf of the firm has appropriate experience and training to do so competently and acts with integrity.
Further, the Rule will require a derivatives dealer to designate an individual as a "senior derivatives manager" (the Manager) for each derivatives business unit and, upon request, identify to the appropriate regulatory authority the applicable Manager.
The Manager will be required to supervise all derivative activities in their business unit and address any non-compliance with the Rule and applicable securities legislation. The Manager will also be required to deliver an annual report to the board of directors of the derivatives firm describing each incident of material non-compliance and any steps taken related to the incident, as well as a statement that their business unit is in material compliance with the Rule and applicable securities legislation. Further, a derivatives dealer will be required to report to the applicable securities regulatory authority any non-compliance if it may cause a risk of material harm to a derivatives party, capital markets, or if that non-compliance is part of a pattern.
The Rule will also impose new recordkeeping requirements, such as a description of its derivatives business and activities and records demonstrating the existence and nature of the derivative. These records will be required to be readily accessible and kept for seven years from the date the record is created. In Manitoba, the records must be kept for eight years from the date created.
The Rule provides for several exemptions from itself, including circumstances in which: (1) the transaction is made with an investment dealer registered in accordance with National Instrument 31-103 or a derivatives dealer transacting as principal for its own account; (2) the entity has an exemption or exclusion from a requirement to be registered, licensed, or authorized under the legislation of a foreign jurisdiction in which its head office or principal place of business is located; or (3) the entity is a derivatives dealer that is not a Canadian financial institution.
The Rule also provides for certain exemptions for end-users of derivatives and provides further detail to the foreign derivatives dealers exemption.
Finally, the Rule also provides exemptions from specific provisions of the Rule for certain entities. One example is a derivatives dealer being exempt from the fair dealing, handling complaints, and compliance and recordkeeping requirements in respect of a transaction where the execution of the transaction is subject to the rules of a derivatives trading facility and the derivatives dealer does not know the identity of the derivatives party prior to, and at the time of, execution of the transaction. There are also certain exemptions for Canadian derivatives advisers, foreign derivatives advisers, and foreign derivatives sub-advisers. Finally, the Rule grants securities regulatory authorities the discretion to grant an exemption to the Rule, in whole or in part.
If you have any questions related to Multilateral Instrument 93-101 and how to ensure your organization will be compliant with the Rule prior to when it takes effect in September 2024, please do not hesitate to contact our Trading & Derivatives team.