By Carol E Derk,  Melanie Bradley, Michelle M Wilkinson – Borden Ladner Gervais LLP From International Law Office

On February 24 2016 the Canadian Securities Administrators (CSA) published for comment the proposed National Instrument 94-101 Mandatory Central Counterparty Clearing of Derivatives and its companion policy (collectively, the ‘clearing rule’), introducing mandatory clearing of certain over-the-counter (OTC) derivative transactions.(1) The 90-day comment period for the clearing rule expires on May 24 2016.

Background

The clearing rule is based on the Draft National Instrument 94-101 Mandatory Central Counterparty Clearing of Derivatives, which the CSA published for comment on February 12 2015. The CSA also considered comments received on the proposed Model Provincial Rule on Mandatory Central Clearing of Derivatives published as CSA Staff Notice 91-303 on December 19 2013 and CSA Consultation Paper 91-406 OTC Central Counterparty Clearing (for further information please see “Don’t be late to the party: mandatory central counterparty clearing rules” and “CSA publishes proposed customer clearing rule”).

Purpose of the clearing rule

Central counterparty clearing of OTC derivative transactions is meant to mitigate counterparty risk in the derivatives market, increase financial stability and eliminate opportunities for regulatory arbitrage.

The clearing rule provides for:

the requirement (and limited exemptions) to submit a transaction involving a derivative that is required to be cleared to a recognised or exempted clearing agency for clearing; and
the determination of those derivatives (each a mandatory clearable derivative) subject to the mandatory clearing requirement.
Requirement to clear
The clearing rule establishes a duty on a local counterparty to submit – or cause to be submitted – for clearing to a regulated clearing agency each mandatory clearable derivative transaction that it enters into, if it and the other counterparty include one or more of the following:

a participant that subscribes to the services of a regulated clearing agency for a mandatory clearable derivative;
an affiliated entity of a participant referred to above; or
a local counterparty that, together with its local affiliated entities, has or has had an aggregate month-end gross notional amount under all outstanding OTC derivatives of more than $500 billion, excluding intragroup transactions.
A local counterparty in a province is a party (other than an individual) that:

is organised under the laws of that province;
has its head office or principal place of business in that province; or
is an affiliate of such party, if such party is responsible for all or substantially all of the liabilities of that affiliate.
A regulated clearing agency is one that is recognised or exempted from recognition by the relevant provincial securities regulator.

The clearing rule includes proposed exemptions from the clearing requirement, including an intragroup exemption and a multilateral portfolio compression exercise exemption.

The proposed intragroup exemption applies with respect to transactions between:

two counterparties that are prudentially supervised on a consolidated basis; or
affiliated entities, where the financial statements for each affiliated entity are prepared on a consolidated basis in accordance with standards.
Affiliates that wish to rely on this exemption will be required to file electronic reports (that will be kept confidential) with the applicable securities regulator no later than 30 days after the first time they rely on the exemption. This exemption is also subject to other conditions, including having a written agreement between the parties.

The proposed multilateral portfolio compression exercise exemption applies when two or more counterparties are changing, terminating and replacing prior uncleared transactions that were not mandatory clearable derivatives on the date of the prior transactions. This exemption may be used only when the resulting transaction is entered into by the same counterparties as the prior transactions and the prior transactions were not cleared by a regulated clearing agency.

Any counterparty relying on either exemption from the clearing requirement must keep appropriate supporting documentation for each clearing-exempt transaction.

Certain entities are excluded from the clearing rule, including:

the government of Canada;
certain crown corporations;
central banks;
the Bank for International Settlement; and
the International Monetary Fund.
Mandatory clearable derivatives
The second part of the clearing rule relates to the determination of mandatory clearable derivatives.

To determine whether mandatory central clearing is suitable for each OTC derivative or class of OTC derivative for which the regulated clearing agencies provide clearing services, the CSA Derivatives Committee examined:

the standardisation of legal documentation and operational processes at the regulated clearing agency;
whether there was sufficient transaction activity and participation;
fair, reliable and generally accepted pricing information made available in the relevant class of derivatives; and
whether there was sufficient liquidity in the market to allow for close out or hedging of outstanding derivatives.
It is proposed that certain classes of interest rate derivatives settled in various currencies will be mandatory clearable derivatives. The list of the proposed mandatory clearable derivatives for all Canadian jurisdictions apart from Quebec is included in the clearing rule as an appendix. The list for Quebec will be published at a later date.

For further information on this topic please contact Carol E Derk, Melanie M Bradley or Michelle M Wilkinson at Borden Ladner Gervais LLP by telephone (+1 416 367 6000) or email ([email protected], [email protected] or [email protected]). The Borden Ladner Gervais website can be accessed at www.blg.com.

Endnotes

(1) A copy of the clearing rule is available here: http://www.osc.gov.on.ca/documents/en/Securities-Category9/csa_20160224_94-101_roc-derivatives.pdf

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