Derivatives Business Conduct Rule Issued by the Canadian Securities Administrators

Table of Contents

Background

Summary of the Business Conduct Rule

• Eligible Derivatives Parties

• General Obligations Applicable to All Derivatives Business With Both EDPs and Non-EDPs

• Additional Obligations When Dealing With or Advising Non-EDPs and Non-Consenting EDPs

• Obligations of Canadian Financial Institutions in Respect of Spot FX Transactions

Exemptions From the Rule

• Inter-Affiliate Transactions and Advising Affiliates

• Foreign Liquidity Providers Exemption

• Foreign Dealer and Adviser Exemptions

• Specific Compliance Exemptions for Canadian Financial Institutions, CIRO Dealer Members and Registered Securities Advisers

• Exemption for Derivatives Traded Anonymously on a Swap Execution Facility

• Low Notional Amount and Commodity Dealer Exemptions

• Delayed Implementation and Transition Period

Continuing Developments in Canadian Derivatives Markets

Background

After a 10-year long consultation process, the Canadian Securities Administrators (CSA) have published Multilateral Instrument 93-101 – Derivatives: Business Conduct (Rule), a core regulation governing dealing and advising in respect of over-the-counter derivatives (derivatives) that will take effect in September 2024. The Rule imposes business conduct requirements on Canadian and foreign persons engaged in the business of trading derivatives (Derivatives Dealers) or advising on derivatives transactions (Derivatives Advisers) in Canadian provinces and territories (Jurisdictions), subject to a range of important exemptions including certain blanket exemptions for qualifying non-Canadian dealers and advisers (Foreign Dealer and Adviser Exemptions). The Rule was issued on September 28, 2023, and updates the third version of the Rule published in January 2022. 
 
These business conduct requirements are intended to provide a uniform approach to derivatives markets conduct regulation that is applicable to all Derivatives Dealers and Derivatives Advisers (Derivatives Firms) regardless of whether or not the Derivatives Firm is registered with securities or derivatives regulators in Canada. The securities regulatory authorities in all Jurisdictions other than British Columbia are adopting the Rule at this time. The British Columbia Securities Commission (BCSC) intends to issue substantially similar rules at a later date, at which time the Rule is expected to be converted from a Multilateral Instrument to a National Instrument.
 
The Rule was previously expected to operate in conjunction with a separate registration rule for derivatives dealers and derivatives advisers, but it is now uncertain whether a registration rule will be adopted in the foreseeable future.

Summary of the Business Conduct Rule

Beginning on September 28, 2024 (Effective Date), the Rule will apply to market participants engaging in the “business of trading derivatives as principal or agent” (i.e., Derivatives Dealers) and the “business of advising others as to transacting in derivatives” (i.e., Derivatives Advisers). These “business triggers” are discussed in the Companion Policy to the Rule and are substantively unchanged from those set out in the previous consultation version of the Rule.  The Rule will subject Derivatives Firms to business conduct standards intended to help protect market participants, reduce risk, improve transparency and accountability, and promote responsible business conduct in derivatives markets. 

Eligible Derivatives Parties

Only a limited set of obligations applies to Derivatives Firms when dealing with “Eligible Derivatives Parties” (EDPs). EDPs include:

• Canadian financial institutions

• Securities and derivatives dealers and advisers registered in any Jurisdiction

• Companies that have net assets of at least C$25-million

• Persons that have represented to the Derivatives Firm in writing that they are commercial hedgers in relation to the derivatives it transacts with the Derivatives Firm

• Individuals who own financial assets with a net realizable value of at least C$5-million

• Investment funds that are managed by a registered investment fund manager or are advised by an adviser that is registered or exempted from registration in any Jurisdiction

Consultation versions of the Rule included knowledge and experience requirements that were prerequisites to qualify as EDPs under some of the above categories, but those requirements were eliminated in the final Rule.

General Obligations Applicable to All Derivatives Business With Both EDPs and Non-EDPs

Subject to exemptions such as the Foreign Dealer and Adviser Exemptions, every Derivatives Firm will owe a core set of obligations to all Derivatives Parties (defined below) including EDPs. Additional obligations will also apply when dealing with or advising Derivatives Parties who (i) are not EDPs or (ii) are EDPs who are individuals or commercial hedgers that have not waived the additional protections provided to non-EDPs (Non-Consenting EDPs). Derivatives Firms will have until September 2025 to collect waivers from relevant individuals and commercial hedgers, and in the interim, Derivatives Firms can treat such persons as if they have provided such waivers.

The following core set of obligations will apply when transacting with or advising any person or counterparty (Derivatives Party), including when dealing with EDPs:

• An obligation to act fairly, honestly and in good faith with the Derivatives Party (Fair Dealing)

• Conflict of interest management and disclosure obligations

• “Know your Derivatives Party” requirements (KYC Requirements)

• Complaints-handling requirements

• Tied-selling prohibition

• Obligations to segregate collateral and other assets received from Derivatives Parties

• An obligation to deliver written confirmations of transactions

Derivative Firms will also be obligated to:

• Establish, maintain and apply policies, procedures, controls and supervision sufficient to provide reasonable assurances regarding compliance with derivatives laws, risk management requirements and individual competence and integrity requirements
• Satisfy documentation and record-keeping requirements

Derivatives Dealers will also be obligated to:

• Self-report non-compliance with the Rule or other laws related to trading in derivatives if the non-compliance creates or created a risk of material harm to any Derivatives Party or capital markets, or is part of a pattern of material non-compliance

• Designate one or more individuals as “Senior Derivatives Managers” who will be responsible for supervising derivatives-related activities for the Derivative Firm’s derivatives business units, addressing material non-compliance and preparing certain compliance reports for the Derivatives Firm’s board

Additional Obligations When Dealing With or Advising Non-EDPs and Non-Consenting EDPs

The additional obligations referred to below apply if a Derivatives Firm is dealing with a non-EDP or a Non-Consenting EDP:

• Specific KYC Requirements in respect of the Derivatives Party’s needs, objectives, financial circumstances and risk tolerance

• Product suitability obligations

• Disclosure obligations, including in respect of account terms, conflicts of interest, fees and charges, third-party compensation, how performance benchmarks might be used, the Derivative Firm’s method of holding collateral, and related risks

• Pre-trade disclosures must be made by Derivatives Dealers regarding the types of derivatives and services offered, transaction risks, material characteristics and terms of the derivatives, and delivery of a standard statement regarding the use of leverage, as well as price and valuation information for each individual transaction

• Daily valuations of all outstanding derivatives must be made available by Derivatives Dealers, and quarterly valuation statements (or, at the client’s request, monthly valuation statements) must be made available by Derivatives Advisers

• Quarterly account statement delivery obligations

• Requirements in respect of the holding, use and investment of initial margin

• Disclosure and documentation requirements in respect of any applicable referral arrangements or incentives, and compensation payable relating to any transaction

In addition, any Derivatives Dealer whose head office or principal place of business is not in Canada must provide Derivatives Parties with additional standard disclosure, including a statement that there may be difficulty enforcing legal rights against the Derivatives Dealer because of its head office location or principal place of business.
 
If an individual claims to qualify as an EDP on the basis that they are a commercial hedger and the individual waives the additional protections provided to non-EDPs (or is deemed to have waived the additional protections during the first year the Rule is in effect), the Derivatives Firm will nonetheless be required to treat the individual as a Non-Consenting EDP or non-EDP if the Derivatives Firm has not identified and documented the nature of the Derivatives Party’s business and the related commercial risks they are hedging, in which case the above additional business conduct obligations will apply.

Obligations of Canadian Financial Institutions in Respect of Spot FX Transactions

Spot FX transactions, which are required to be physically settled within two business days, are generally deemed not to constitute “derivatives” under the Rule, which incorporates by reference the Scope Rule definitions of derivatives used under derivatives transaction reporting rules (e.g., Ontario Securities Commission Rule 91-506 — Derivatives: Product Determination). Accordingly, physically-settled spot FX transactions are generally outside the Rule’s scope of application.
 
However, the Rule provides that any Canadian financial institution (including any Schedule I or II bank) that is a Derivatives Dealer that has had over C$500-billion notional amount of derivatives outstanding as of any month-end following the Effective Date must comply with Fair Dealing, conflicts of interest, complaints handling, compliance and record-keeping obligations in respect of their physically settled spot FX trading activity when transacting in the institutional foreign exchange market. The institutional foreign exchange market is defined in the Rule for this purpose by reference to the “global foreign exchange market comprised of persons or companies that are active in foreign exchange markets as part of their business.”
 
This application of derivatives regulatory requirements to spot FX transactions marks a significant expansion of provincial regulators’ oversight of Canadian banks’ participation in FX markets.

Exemptions From the Rule 

Inter-Affiliate Transactions and Advising Affiliates

The Rule does not apply in respect of a Derivatives Firm’s transactions with its affiliates or its advising of affiliates except where the affiliated entity is an investment fund.

Foreign Liquidity Providers Exemption

A Foreign Liquidity Provider exemption from the entirety of the Rule applies for non-Canadian Derivatives Dealers in respect of all transactions with other Derivatives Dealers and registered investment dealers that, in each case, are transacting as principal for their own account. This Foreign Liquidity Provider exemption provides an alternative to relying on the Foreign Dealer Exemption described below and applies automatically without giving prior notice or satisfying the other requirements under the Foreign Dealer Exemption.
 
A Derivatives Firm may rely on the Foreign Liquidity Provider exemption if it is registered, licensed or authorized (or otherwise operates under an applicable exemption) under the securities, commodity futures or derivatives legislation of its home jurisdiction to carry on the activities in its home jurisdiction that registration as a Derivatives Dealer would permit it to carry on in Canada.

Foreign Dealer and Adviser Exemptions

The Foreign Dealer and Adviser Exemptions also provide exemptions from the entirety of the Rule for qualifying non-Canadian dealers and advisers solely dealing with or advising EDPs if steps are taken to comply with the exemption requirements. 
 
These exemptions generally conform to the requirements of the international securities dealer and international securities adviser exemptions in National Instrument 31-103 — Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103). The notable difference is that these exemptions are only available to non-Canadian dealers and advisers whose head office or principal place of business is in one of the foreign jurisdictions specified in the Rule (specified foreign jurisdictions). The currently specified foreign jurisdictions are: Australia, Brazil, Hong Kong, Iceland, Japan, the Republic of Korea, New Zealand, Norway, Singapore, Switzerland, the United States, the United Kingdom and all member countries of the European Union.
 
A Derivatives Dealer will be exempt from the entirety of the Rule if all of the following requirements are satisfied:

• All the Canadian counterparties with, for or on behalf of which it transacts (Canadian Derivatives Parties) are EDPs

• Its head office or principal place of business is in a specified foreign jurisdiction and it engages in the business of a Derivatives Dealer in such specified foreign jurisdiction

• It is registered, licensed or authorized under the securities, commodity futures or derivatives legislation of a specified foreign jurisdiction to conduct the derivatives activities that it proposes to conduct with Canadian Derivatives Parties

• It is subject to and complies with securities, commodity futures or derivatives legislation of the specified foreign jurisdiction relating to the activities conducted with Canadian Derivatives Parties

• It will provide prompt access to its books and records with respect to any matter relating to the activities conducted with Canadian Derivatives Parties in the relevant Jurisdiction, upon a Canadian securities regulator’s request

To benefit from the Foreign Dealer Exemption, the foreign Derivatives Dealer must provide its counterparties a specified disclosure statement and submit a completed Form 93-101F1 — Submission to Jurisdiction and Appointment of Agent for Service of Process.
 
Similarly, a Derivatives Adviser whose head office or principal place of business is in a specified foreign jurisdiction will be exempt from the entirety of the Rule if the Derivatives Adviser satisfies specified requirements and conditions that are generally analogous to those under the Foreign Dealer Exemption. 
 
In addition, a separate foreign sub-adviser exemption is available to a Derivatives Adviser. The exemption is available if a Derivatives Adviser acts as such in a specified foreign jurisdiction where its head office or principal place of business is located, and the Canadian persons it advises in respect of derivatives are other Derivatives Advisers or certain other registered securities dealers and advisers (Clients). This exemption is available only if each of its Clients has agreed in writing with the Client’s clients that the Client will be responsible for any losses that arise out of the foreign sub-adviser’s failure to exercise the powers and discharge the duties of its office honestly, in good faith and in the best interests of the Client and the Client’s clients, or its failure to exercise the degree of care, diligence and skill that a reasonably prudent person would exercise in the circumstances.
 
The previous consultation draft of the Rule also included certain non-compliance reporting obligations in connection with these exemptions that have now been eliminated in the final Rule.

Specific Compliance Exemptions for Canadian Financial Institutions, CIRO Dealer Members and Registered Securities Advisers 

Canadian banks and other Canadian financial institutions are exempt from a limited set of the Rule’s obligations, including KYC Requirements, tied selling restrictions, and obligations related to holding collateral and investing initial margin, if they comply with the corresponding prudential regulatory provisions in connection with their derivatives activities and promptly notify the CSA regulator of each instance of material non-compliance. Schedule III banks (i.e., Canadian bank branches of non-Canadian banks) are not permitted to rely on this exemption but may qualify for the Foreign Liquidity Provider exemption or Foreign Dealer Exemption.

Similarly, investment dealer members of the Canadian Investment Regulatory Organization (CIRO) are exempted from a broader set of the Rule’s obligations, including KYC Requirements, suitability requirements, relationship disclosure and pre-transaction disclosure obligations, obligations related to holding collateral and investing initial margin, if they comply with the corresponding CIRO regulatory provisions in connection with their derivatives activities and promptly notify the CSA regulator of each instance of material non-compliance.

In addition, a Derivatives Adviser registered as a securities adviser or commodity futures adviser in a Jurisdiction is exempted from a number of the Rule’s obligations, including complaint-handling, tied-selling, compliance, documentation and record-keeping obligations, if it complies with the corresponding business conduct provisions of securities or commodity futures legislation in connection with relevant transactions or other derivatives activities.

Exemption for Derivatives Traded Anonymously on a Swap Execution Facility 

The Rule provides that a Derivatives Dealer will be exempt from its provisions, except for those sections relating to Fair Dealing, handling complaints, and compliance and record-keeping, in respect of a transaction that is entered into and is subject to the rules of a derivatives trading facility (which is the CSA’s term for a Swap Execution Facility), if the Derivatives Dealer does not know the identity of the derivatives party prior to and at the time of execution of the transaction.

Low Notional Amount and Commodity Dealer Exemptions 

A Derivatives Dealer that does not solicit or otherwise transact with or advise any non-EDPs and has not had greater than C$250-million notional amount of derivatives outstanding in any of the preceding 24 months (in aggregate with transactions entered into by certain affiliates, but without regard to inter-affiliate transactions) is exempt from the Rule other than the Rule’s Fair Dealing and conflict of interest management and disclosure obligations, and transaction confirmation delivery obligations.
 
Similarly, a Derivatives Dealer categorized as a Derivatives Dealer only as a result of transactions in respect of commodity derivatives is exempt from the Rule other than the Rule’s Fair Dealing and conflict of interest management and disclosure obligations and transaction confirmation delivery obligations if: (i) it does not have any affiliate that would be classified as a Derivatives Dealer other than as a result of transactions in respect of commodity derivatives, (ii) it does not solicit or otherwise transact with or advise any non-EDPs, and (iii) it has not had greater than C$10-billion notional amount of commodity derivatives outstanding in any of the preceding 24 months (based on aggregate month-end gross notional amounts as determined in aggregate with transactions entered into by certain affiliates, but without regard to inter-affiliate transactions and, for non-Canadian dealers, only including transactions entered into with Canadian counterparties). This exemption is not available in respect of commodity derivatives for which the underlying interest is a cryptocurrency or other cryptoasset.

Delayed Implementation and Transition Period

The Rule will come into force in one year’s time on the Effective Date.
 
Furthermore, a grandfathering provision provides that the Fair Dealing obligation is the only obligation in the Rule that applies to transactions entered into prior to the Effective Date if the Derivatives Firm has taken reasonable steps to confirm that the counterparty qualifies as a permitted client (as defined in NI 31-103), a Quebec accredited counterparty, an eligible contract participant as defined under section 1(a)(18) of the United States Commodity Exchange Act (US ECP) or in a similar recognized category under one of the other specified institutional or hedging client categories. This grandfathering protection may no longer apply if a derivative’s term is extended or if there are any material amendments to the terms of the derivative after the Effective Date.
 
In addition, the Rule includes a transition provision that applies until September 2029 that allows Derivatives Firms to treat a Derivatives Party as an EDP if the Derivatives Party qualifies as a permitted client (as defined in NI 31-103), a Quebec accredited counterparty, a US ECP or in a similar recognized category under one of the other specified institutional or hedging client categories.

Continuing Developments in Canadian Derivatives Markets

Some revisions to the Rule may be introduced in the coming months and British Columbia’s version of the Rule may also introduce additional considerations.
 
For Derivatives Firms that do not benefit from broad exemptions or carve-outs from compliance requirements, the Rule’s impact on operations and compliance functions may be significant and implementation may be time-consuming. The availability and application of particular exemptions, limitations and carve-outs will require careful analysis by all those engaged in the business of trading or advising in relation to OTC derivatives. This analysis, and any related compliance steps, may be time-consuming and should be commenced well in advance of the Effective Date.
 
For further information on the Rule or any current market developments and regulatory initiatives, please contact:

or any other member of our Derivatives group.