Canada: Securities Administrators Publish Final Business Conduct Rules for Derivatives Firms

Published on Oct 9, 2023

On September 28, 2023, the securities regulatory authorities of each of the provinces and territories, other than British Columbia, published Multilateral Instrument 93-101 Derivatives: Business Conduct and the Companion Policy 93-101 Derivatives: Business Conduct (together, the “Instrument”) establishing business conduct standards for participants in the over-the-counter (OTC) derivatives market. The British Columbia Securities Commission plans to adopt a similar regime. The Canadian Securities Administrators anticipate these requirements will form a national instrument.

The Instrument imposes obligations upon persons and companies that qualify as “derivatives firms” which are similar to the robust regulatory standards applicable to registered securities dealers and advisers in Canada and those applicable to derivatives firms in other jurisdictions, such as the US and the UK. The Instrument is designed to streamline business conduct standards, improve transparency and safeguard OTC derivatives market participants against improper or fraudulent misconduct, while maintaining efficient market entry.

The Instrument will become effective on September 28, 2024.

Scope and Application

The Instrument adopts a two-tiered approach to regulating the conduct of derivatives firms. General business standards must be met by derivatives firms in all cases, irrespective of the level of sophistication of the derivatives counterparty. As explained below, the Instrument also imposes additional obligations on derivatives firms when dealing with or advising “non-eligible derivatives parties”.

The Instrument applies to “derivatives dealers” and “derivatives advisers”, collectively referred to as “derivatives firms”. Derivatives firms are defined broadly to include any person or company that is in the business of trading derivatives or advising others in relation to derivatives.

The Instrument outlines a “business trigger test” to determine whether a person or company is in the business of trading derivatives or advising others in relation to derivatives and therefore subject to the Instrument. Answering affirmatively to any of the following “business triggers” indicates that a person or company is likely subject to the Instrument:

  • Do you respond to requests for quotes on derivatives?
  • Do you engage in frequent trading or advising in relation to derivatives to produce profits?
  • Do you facilitate transactions between third-party counterparties to derivatives contracts?
  • Do you solicit in relation to derivatives transactions?

This list is non-exhaustive. Whether a person or company’s activities are captured by the Instrument should be assessed holistically.

Non-Application

Licensed professionals such as lawyers, accountants and engineers providing derivatives-related advice will generally not be considered to be a derivatives firm if such activities are secondary to their bona fide professional duties.

The Instrument does not apply to certain other specified persons and institutions. For example, it does not apply to Canadian or foreign governments, the Bank of Canada and central banks of foreign jurisdictions, the Bank for International Settlements or the International Monetary Fund. The business conduct rules also do not apply to persons or companies when dealing with or advising an affiliated entity, unless the affiliated entity is an investment fund.

Notably, derivatives firms that deal with or advise any of such specified persons or institutions are not excluded from the Instrument’s application and are thus subject to it.

General Obligations Towards All Derivatives Parties

The key general obligations prescribed by the Instrument are principles-based and include requirements related to the following:

  • Fair dealing. Acting fairly, honestly and in good faith;
  • Conflicts of interest. Maintaining procedures to identify material conflicts of interest;
  • Know your derivatives party. Verifying a derivative counterparty’s identity, including its creditworthiness and the nature of its business;
  • Handling complaints. Promptly responding to complaints about any product or service;
  • Tied selling. Derivatives firms must not impose undue pressure or coerce a person or company to purchase a product or service;
  • Segregating derivatives party assets. Derivatives party assets must be separated from those of the derivatives firm and other persons or companies;
  • Compliance. Complying with applicable laws, establishing and complying with risk management policies and ensuring that individuals performing activities on behalf of the derivatives firm are appropriately educated and trained;
  • Senior derivatives managers. Senior managers must supervise their business units, monitor compliance with the Instrument and prepare annual reports;
  • Recordkeeping. In Ontario, applicable records must be retained for 7 years;
  • Reporting of material non-compliance. Includes requirements to report incidents of fraud, price fixing, manipulation of benchmark rates or front-running of trades in a timely fashion; and
  • Delivery of transaction information. Promptly delivering written confirmation of transactions to the derivatives party.

Dealing with “Eligible” and “Non-Eligible” Derivatives Parties

The Instrument adopts different rules for market participants when dealing with “eligible derivatives parties” and “non-eligible derivatives parties”. The general obligations described above apply in all circumstances to derivatives firms dealing with or advising other derivatives parties, regardless of the level of sophistication or financial resources of the derivatives party being advised. Additional business conduct rules apply to derivatives firms when dealing with or advising “non-eligible derivatives parties”, including rules related to:

  • Suitability. Ensuring a transaction is suitable for the derivative party;
  • Disclosure. Disclosing information related to fees and compensation, conflicts of interest, performance benchmarks and custody of assets;
  • Reporting Requirements. These include valuation and quarterly reporting of transactions;
  • Restrictions on referral arrangements. Derivatives firms must not participate in referral arrangements without prior disclosure of the terms of the referral arrangement and an outline of referral fees; and
  • Delivery of transaction information. Requirements to provide descriptions of derivatives transacted, the agreements governing the transactions, the transaction pricing and the notional amount, quantum or volume of underlying assets.

By reason of their attributes, regulatory oversight, financial resources or experience, eligible derivatives parties do not require the full set of protections afforded to other derivatives parties and derivatives firms dealing with eligible derivatives parties are generally subject to less onerous business conduct obligations. Certain obligations under the Instrument may also be waived if a derivatives firm is doing business with or advising a derivatives party who is an eligible derivatives party that is an individual or a specified commercial hedger.

Eligible derivatives parties include Canadian financial institutions; persons or companies registered under the securities legislation of a jurisdiction of Canada as derivatives dealers, derivatives advisers, advisers or investment dealers; the Business Development Bank of Canada; regulated pension funds; government entities; corporations with net assets of at least $25 million and individuals with a net value of at least $5 million.

Important Dates

Transactions entered into by derivatives firms from and after September 28, 2024 must comply with the Instrument. In advance of this date, derivatives firms may need to make certain updates to their policies, procedures and other contracts in order to ensure compliance with the Instrument.

There will be a five-year transition period to afford derivatives firms time to amend existing derivative transaction contracts, correctly classify counterparties and make other adjustments required by the Instrument. The transition period will expire on September 28, 2029.

For further information regarding compliance with the Instrument, please contact any member of our Structured Finance and Derivatives Group.