Securities Law & Instruments


Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Application to the Commission to revoke a previous decision of the Commission dated November 22, 2013, In the Matter of Jefferies International Limited, Jefferies Bache Financial Services, Inc. and Jefferies Derivative Products, LLC – Previous decision had exempted the applicants from the dealer registration and the prospectus requirement, in sections 25(1) and 53(1) of the Securities Act, for certain trades in over-the-counter (OTC) derivatives with “permitted counterparties” subject to a sunset condition – The sunset condition is (i) the date that is four years after the date of the previous decision; and (ii) the coming into force in the applicable jurisdiction of legislation or a rule that specifically governs dealer, adviser or other registration requirements applicable to market participants in connection with OTC derivative transactions. – Permitted counterparties consist exclusively of persons or companies who are non-individual “permitted clients” as defined in Section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations.

New decision provides exemptions on the same terms and conditions except that: (i) the exemptions apply to an additional related entity, (ii) the “sunset” date of November 22, 2013 is extended; and (iii) the exemptions will not apply in certain jurisdictions specified in the previous decision– Exemptions have been sought in Ontario and certain other jurisdictions as interim response to current regulatory uncertainty associated with OTC derivatives in Canada – Exemptions in the new decision are subject to certain terms and conditions, including a sunset provision of up to four years.

Applicable Legislative Provisions

Securities Act, R.S.O. 1990, c. S.5, as am., ss. 25(1), 53(1) 74(1), 144.
National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, s. 1.1 (“permitted client”).

July 28, 2017

IN THE MATTER OF
THE SECURITIES LEGISLATION OF
ONTARIO
(the Jurisdiction)

AND

IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS
IN MULTIPLE JURISDICTIONS

AND

IN THE MATTER OF
JEFFERIES INTERNATIONAL LIMITED,
JEFFERIES FINANCIAL SERVICES, INC.,
JEFFERIES FINANCIAL PRODUCTS, LLC
(the Filers)

DECISION

Background

Previous Decision

Jefferies International Limited, Jefferies Bache Financial Services, Inc., and Jefferies Derivative Products, LLC (the Previous Filers) made an application (the Previous Application) to the Ontario Securities Commission (the Commission) and obtained from the Commission, as the principal regulator for the Previous Application, a decision dated November 22, 2013, In the Matter of Jefferies International Limited, Jefferies Bache Financial Services, Inc. and Jefferies Derivative Products, LLC (the Previous Decision).

The Previous Decision provided that the dealer registration requirement and the prospectus requirement in the securities legislation of the jurisdiction of the principal regulator (the Legislation) that may otherwise be applicable to a trade in or a distribution of an OTC Derivative (as defined below) made by either;

i.              a Previous Filer to a “Permitted Counterparty” (as defined below), or

ii.             a Permitted Counterparty to a Previous Filer,

shall not apply to the Previous Filers or the Permitted Counterparty, as the case may be, subject to certain terms and conditions (the Previous Requested Relief).

The Previous Decision stated that under the Process for Exemptive Relief Applications in Multiple Jurisdictions:

(a)           the Commission was the principal regulator for the Previous Application; and

(b)           the Previous Filers had provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) was intended to be relied upon in Manitoba, New Brunswick (to the extent Local Rule 91-501 Derivatives does not apply), Newfoundland and Labrador, Northwest Territories, Nova Scotia, Prince Edward Island, Yukon and Nunavut (the Previous Passport Jurisdictions).

The Previous Decision provided that the Previous Requested Relief would terminate on the date that is the earlier of: (i) the date that is four years after the date of the Previous Decision (being November 22, 2017) (the Pending Expiry Date); and (ii) the coming into force in the jurisdiction of legislation or a rule that specifically governs dealer, adviser or other registration requirements applicable to market participants in connection with OTC Derivatives transactions.

After the Previous Decision was issued:

(i)            Manitoba and Nova Scotia issued blanket orders in respect of OTC Derivatives (the New Blanket Order Jurisdictions);

(ii)           Jefferies Bache Financial Services, Inc. changed its name to “Jefferies Financial Services, Inc.”;

(iii)          Jefferies Derivative Products, LLC was merged into Jefferies Financial Services, Inc.; and

(iv)          Jefferies Financial Products, LLC, which is an affiliate of the Previous Filers, was established.

New Decision

The principal regulator has now received an application (the Application) from Jefferies International Limited, Jefferies Financial Services, Inc. and Jefferies Financial Products, LLC (collectively, the Filers) for: (a) revocation of the Previous Decision, and (b) issuance of a new replacement decision, on substantially the same terms as the Previous Decision, except that the new decision being sought would: (i) extend the Pending Expiry Date; (ii) also apply to Jefferies Financial Products, LLC, (iii) reflect the name change of Jefferies Bache Financial Services, Inc. to “Jefferies Financial Services, Inc.” and the subsequent merger of Jefferies Derivatives Products, LLC into Jefferies Financial Services, Inc., and (iv) not be relied upon by the Filers in the New Blanket Order Jurisdictions.

Under this Application, the Filers have applied to the Commission, as the principal regulator for the Application, for a decision under the Legislation that the dealer registration requirement and the prospectus requirement in the Legislation that may otherwise be applicable to a trade in or distribution of an OTC Derivative made by either;

i.              a Filer to a Permitted Counterparty, or

ii.             a Permitted Counterparty to a Filer,

shall not apply to the Filers or the Permitted Counterparty, as the case may be (the Requested Relief).

Under the Process for Exemptive Relief Applications in Multiple Jurisdictions:

a)            the Commission is the principal regulator for the New Application; and

b)            the Filers have provided notice that section 4.7(1) of MI 11-102 is intended to be relied upon in Newfoundland and Labrador, Northwest Territories, Prince Edward Island, New Brunswick (to the extent Local Rule 91-501 Derivatives does not apply), Yukon and Nunavut (the Passport Jurisdictions).

Interpretation

Terms defined in National Instrument 14-101 Definitions or MI 11-102 have the same meanings if used in this decision, unless otherwise defined.

The terms OTC Derivative and Underlying Interest are defined in the appendix (the Appendix) to this decision.

The term Permitted Counterparty means a person or company that

(a)           is a "permitted client", as that term is defined in section 1.1 [Definition of terms used throughout this Instrument] of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103); and

(b)           is not an individual.

The term Home Jurisdiction means the jurisdiction in which each Filer’s head office is located, specifically for:

(a)           Jefferies International Limited, London, United Kingdom;

(b)           Jefferies Financial Services, Inc., New York, United States of America; and

(c)           Jefferies Financial Products, LLC, New York, United States of America.

Representations

This decision is based on the following facts represented by the Filers:

The Filers

1.             Each of the Applicants is an affiliate of the other as a result of their common parent, Jefferies Group LLC.

2.             Jefferies International Limited (JIL) is a financial services firm that has been granted permission to conduct a number of different financial services in the United Kingdom by the Financial Conduct Authority. These services include arranging and dealing in investments as both a principal and an agent in respect of, among other things, securities, contracts for differences, options, futures, rolling spot forex contracts and commodity futures contracts. JIL is therefore qualified to rely on the international dealer exemption (the IDE) that is available pursuant to section 8.18 of NI 31-103 in Ontario and each of the Passport Jurisdictions. JIL’s head office is located in London, United Kingdom.

3.             Jefferies Financial Services, Inc. (JFSI) is a provisionally registered swap dealer with the U.S. Commodity Futures Trading Commission (CFTC) and it is a member of the National Futures Association (the NFA). JFSI carries on the business of trading on a principal basis with market counterparties in interest rate swaps, swaptions (defined in the Appendix), credit default swaps, and foreign exchange products, including, but not limited to, spot, forward, non-deliverable forward, option and swap transactions. Such transactions may be cleared by a derivatives clearing organization or may be uncleared, and are executed either over-the-counter or on a swap execution facility/exchange, as applicable, depending on the transaction. The head office of JFSI is located in New York, United States of America.

4.             Jefferies Financial Products, LLC (JFP) is a provisionally registered swap dealer with the CFTC and it is a member of the NFA. JFP carries on the business of trading equity swaps, equity options and credit default swaps on a principal basis with other institutional counterparties. It may also begin trading interest rate swaps at some future date. All of JFP`s derivative transactions are currently conducted as uncleared OTC Derivative transactions. In the future, it is possible that JFP may conduct transactions that will be cleared and/or executed on a swap execution facility/exchange, as applicable, depending on the transaction. The head office of JFP is located in New York, United States of America.

5.             Although JFP intends to register as a security-based swap dealer with the U.S. Securities and Exchange Commission (the SEC), neither JFSI nor JFP is currently registered in any capacity with the SEC. As such, each of JFSI and JFP is unable to rely on the IDE because it is not registered under the securities legislation of its home jurisdiction in a category of registration that permits it to carry on the activities in that jurisdiction that registration as a dealer would permit it to carry on in a local Canadian jurisdiction.

Proposed Conduct of OTC Derivative Transactions

6.             Each Filer proposes to enter into bilateral OTC Derivatives with counterparties located in all provinces and territories of Canada that consist exclusively of persons or companies that are Permitted Counterparties, or their equivalent in jurisdictions other than Ontario and the Passport Jurisdictions. The Underlying Interest of the OTC Derivatives that are entered into between a Filer and a Permitted Counterparty will consist of a commodity; an interest rate; a currency; a foreign exchange rate; a security; an economic indicator, an index; a basket; a benchmark; another variable; another OTC Derivative; or some relationship between, or combination of, one or more of the foregoing.

7.             The Filers will not offer or provide credit or margin to any of their Permitted Counterparties.

8.             Each Filer seeks the Requested Relief as an interim, harmonized solution to the uncertainty and fragmentation that currently characterizes the regulation of OTC Derivatives across Canada, pending the development of a uniform framework for the regulation of OTC Derivative transactions in all provinces and territories of Canada.

Regulatory Uncertainty of the Regulation of OTC Derivative Transactions in Canada

9.             There has generally been a considerable amount of uncertainty respecting the regulation of OTC Derivative transactions as "securities" in the provinces and territories of Canada other than Quebec.

10.          In each of British Columbia, Prince Edward Island, the Yukon, the Northwest Territories and Nunavut, OTC Derivative transactions are regulated as securities on the basis that the definition of the term "security" in the securities legislation of each of these jurisdictions includes an express reference to a "futures contract" or a "derivative".

11.          In Alberta, the term “security” no longer includes an express reference to a “futures contract”. Following the introduction of a new framework and terminology for the regulation of derivatives effective October 31, 2014, Alberta securities legislation now includes a definition of “derivatives”.

12.          In each of Manitoba, Ontario, New Brunswick, Newfoundland and Labrador, Nova Scotia and Saskatchewan, it is not certain whether, or in what circumstances, OTC Derivative transactions are "securities" because the definition of the term "security" in the securities legislation of each of these jurisdictions makes no express reference to a "futures contract" or a "derivative".

13.          In October 2009, staff of the Ontario Securities Commission (the OSC) published OSC Staff Notice 91-702 Offerings of Contracts for Difference and Foreign Exchange Contracts to Investors in Ontario (OSC Notice 91-702). OSC Notice 91-702 states that OSC staff take the view that contracts for differences, foreign exchange contracts and similar OTC Derivative products, when offered to investors in Ontario, engage the purposes of the Act and constitute "investment contracts" and "securities" for the purposes of Ontario securities law. However, OSC Notice 91-702 also states that it is not intended to address direct or intermediated trading between institutions. OSC Notice 91-702 does not provide any additional guidance to the Filers on the extent to which OTC Derivative transactions between a Filer and a Permitted Counterparty may be subject to Ontario securities law.

14.          In Quebec, OTC Derivative transactions are subject to the Derivatives Act (Quebec), which sets out a comprehensive scheme for the regulation of derivative transactions that is distinct from Quebec's securities regulatory requirements.

15.          In each of British Columbia, Alberta, Saskatchewan, New Brunswick, the New Blanket Order Jurisdictions, and Quebec (collectively, the OTC Exemption Jurisdictions), OTC derivative transactions are generally not subject to securities or derivative regulatory requirements, pursuant to applicable exemptions (the OTC Derivative Exemptions), when they are negotiated, bi-lateral contracts that are entered into between sophisticated non-retail parties referred to as "Qualified Parties" in the New Blanket Order Jurisdictions, British Columbia, Alberta, New Brunswick, Saskatchewan, and as "accredited counterparties" in Quebec.

16.          The corresponding OTC Derivative Exemptions are as follows:

British Columbia

Blanket Order 91-501 Over-the-Counter Derivatives

Alberta

ASC Blanket Order 91-507 Over-the-Counter Trades in Derivatives

Saskatchewan

General Order 91-908 Over-the-Counter Derivatives

Manitoba

Blanket Order 91-501 Over-the-Counter Trades in Derivatives

Quebec

Section 7 of the Quebec Derivatives Act

New Brunswick

Local Rule 91-501 Derivatives

Nova Scotia

Blanket Order 91-501 Over the Counter Trades in Derivatives

The Evolving Regulation of OTC Derivative Transactions as Derivatives

17.          Each of the OTC Exemption Jurisdictions has sought to address the regulatory uncertainty associated with the regulation of OTC Derivative transactions as securities by regulating them as derivatives rather than securities, whether directly through the adoption of a distinct regulatory framework for derivatives in Quebec, or indirectly through amendments to the definition of the term "security" in the securities legislation of the OTC Exemption Jurisdictions and the granting of the OTC Derivative Exemptions.

18.          Between 1994 and 2000, the OSC sought to achieve a similar objective by introducing proposed OSC Rule 91-504 Over-the-Counter Derivatives (the Proposed OSC Rule) for the purpose of establishing a uniform, clearly defined regulatory framework for the conduct of OTC derivative transactions in Ontario, but the Proposed OSC Rule was returned to the OSC for further consideration by Ontario's Minister of Finance in November, 2000.

19.          The Final Report of the Ontario Commodity Futures Act Advisory Committee published in January, 2007 (the CFA Report) concluded that OTC Derivative contracts are not suited to being regulated in accordance with traditional securities regulatory requirements and should therefore be excluded from the scope of securities legislation, because they are used for commercial-risk management purposes and not for investment or capital-raising purposes.

20.          Ontario has now established a framework for regulating the trading of derivatives in Ontario (the Ontario Derivatives Framework) through amendments to the Ontario Act that were made by the Helping Ontario Families and Managing Responsibility Act, 2010 (Ontario).

21.          The amendments to the Ontario Act establishing the Ontario Derivatives Framework will not become effective until the date on which they are proclaimed in force. These amendments are not expected to be proclaimed in force until an ongoing public consultation on the regulation of OTC Derivatives has been completed.

Rationale for Requested Relief

22.          The Requested Relief would substantially address, for each Filer and its Permitted Counterparties, the regulatory uncertainty and fragmentation that is currently associated with the regulation of OTC Derivative transactions in Canada, by permitting these parties to enter into OTC Derivative transactions in reliance upon exemptions from the dealer registration and prospectus requirements of the securities legislation of each Passport Jurisdictions that are comparable to the OTC Derivative Exemptions.

Books and Records

23.          Each Filer will become a "market participant" as a consequence of this decision. For the purposes of the Ontario Act, and as a market participant, each Flier is required by subsection 19(1) of the Ontario Act to: (i) keep such books, records and other documents as are necessary for the proper recording of its business transactions and financial affairs, and the transactions that it executes on behalf of others; and (ii) keep such books, records and documents as may otherwise be required under Ontario securities law.

24.          For the purposes of its compliance with subsection 19(1) of the Act, the books and records that each Filer will keep will include books and records that:

(a)           demonstrate the extent of the Filers’ compliance with applicable requirements of securities legislation;

(b)           demonstrate compliance with the policies and procedures of the Filers for establishing a system of controls and supervision sufficient to provide reasonable assurance that the Filers, and each individual acting on its behalf, complies with securities legislation;

(c)           identify all OTC Derivatives transactions conducted on behalf of the Filers and each of its clients, including the name and address of all parties to the transaction and its terms; and

(d)           set out for each OTC Derivatives transaction entered into by the Filers, information corresponding to that which would be required to be included in an exempt distribution report for the transaction, if the transaction were entered into by the Filers in reliance upon the "accredited investor" prospectus exemption in section 2.3 [Accredited investor] of NI 45-106.

Representations

25.          The Filers are not in default of any requirements of securities, commodity futures or derivatives legislation in any jurisdiction of Canada.

26.          The Filers are in material compliance with securities, commodity futures and derivatives laws of their Home Jurisdictions.

Decision

The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.

The decision of the principal regulator is that the Requested Relief is granted provided that:

a)            the counterparty to any OTC Derivative transaction that is entered into by a Filer is a Permitted Counterparty;

b)            in the case of any trade made between a Filer and a Permitted Counterparty, the Filer does not offer or provide any credit or margin to the Permitted Counterparty; and

c)             the Requested Relief shall terminate on the date that is the earlier of (i) the date that is four years after the date of this decision; and (ii) the coming into force in the jurisdiction of legislation or a rule which specifically governs the conduct of OTC Derivative transactions.

In addition, it is the decision of the principal regulator that the Previous Decision is revoked.

“William Furlong”
Commissioner 

“Mark Sandler”
Commissioner 


Appendix

Definitions

"Clearing Corporation" means an association or organization through which Options or futures contracts are cleared and settled.

"Contract for Differences" means an agreement, other than an Option, a Forward Contract, a spot currency contract or a conventional floating rate debt security, that provides for

(a)           an exchange of principal amounts; or

(b)           the obligation or right to make or receive a cash payment based upon the value, level or price, or on relative changes or movements of the value, level or price of, an Underlying Interest

"Forward Contract" means an agreement, not entered into or traded on or through an organized market, stock exchange or futures exchange and cleared by a Clearing Corporation, to do one or more of the following on terms or at a price established by or determinable by reference to the agreement and at or by a time established by or determinable by reference to the agreement:

(a)           make or take delivery of the Underlying Interest of the agreement; or

(b)           settle in cash instead of delivery.

"Option" means an agreement that provides the holder with the right, but not the obligation, to do one or more of the following on terms or at a price determinable by reference to the agreement at or by a time established by the agreement:

(a)           receive an amount of cash determinable by reference to a specified quantity of the Underlying Interest of the Option.

(b)           purchase a specified quantity of the Underlying Interest of the Option.

(c)           sell a specified quantity of the Underlying Interest of the Option.

"OTC Derivative" means one or more of, or any combination of, an Option, a Forward Contract, a Contract for Differences or any instrument of a type commonly considered to be a derivative, in which:

(a)           the agreement relating to, and the material economic terms of, the Option, Forward Contract, Contract for Differences or other instrument have been customized to the purposes of the parties to the agreement and the agreement is not part of a fungible class of agreements that are standardized as to their material economic terms;

(b)           the creditworthiness of a party having an obligation under the agreement would be a material consideration in entering into or determining the terms of the agreement; and

(c)           the agreement is not entered into or traded on or through an organized market, stock exchange or futures exchange.

“Swaption” means a right, but not the obligation, to enter into a swap transaction, usually an interest rate swap transaction, on the exercise date. The buyer of the swaptions gains the right to cause the issuer to enter into the swap transaction. The rates under the swap transaction are determined on the trade date of the swaption.

"Underlying Interest" means, for a derivative, the commodity, interest rate, currency, foreign exchange rate, security, economic indicator, index, basket, benchmark or other variable, or another derivative, and, if applicable, any relationship between, or combination of, any of the foregoing, from or on which the market price, value or payment obligations of the derivative are derived or based.