Application by investment dealer (Applicant) for relief from prospectus requirement in connection with distribution of "contracts for difference" and foreign exchange contracts (collectively CFDs) to investors resident in Ontario, subject to four-year sunset clause and other terms and conditions -- Applicant acts as both market intermediary and the principal or counterparty to the CFD with the client -- Applicant registered in Ontario as investment dealer and a member of the Investment Industry Regulatory Organization of Canada (IIROC) -- Applicant will comply with IIROC Rules and IIROC acceptable practices applicable to offerings of CFDs -- Applicant seeking relief to permit Applicant to offer CFDs to investors in Ontario on the basis of clear and plain language risk disclosure document rather than a prospectus -- risk disclosure document contains disclosure substantially similar to risk disclosure document required for recognized options in OSC Rule 91-502 Trades in Recognized Options, the regime for OTC derivatives contemplated by former proposed OSC Rule 91-504 OTC Derivatives (which was not adopted), and the Quebec Derivatives Act -- Relief consistent with relief contemplated by OSC Staff Notice 91-702 Offerings of contracts for difference and foreign exchange contracts to investors in Ontario (OSC SN 91-702) -- Relief granted, subject to terms and conditions, including
• all CFDs offered by Applicant to clients in Ontario shall be distributed through Applicant;
• Applicant remains registered as an investment dealer and a member of IIROC;
• all distributions of CFDs by Applicant to clients in Ontario be conducted in accordance with IIROC Rules and IIROC acceptable practices applicable to offerings of CFDs;
• prior to a client's first CFD trade, the Applicant has provided the client the risk disclosure document and have delivered, or previously delivered, a copy of the risk disclosure document to the Commission;
• prior to the client's first CFD trade and as part of the account opening process, the Applicant has obtained a written or electronic acknowledgement from the client confirming that the client has received, read and understood the risk disclosure document;
• Applicant shall promptly inform the Commission in writing of any material change affecting Filer, being any change in the business, activities, operations or financial results or condition of Filer that may reasonably be perceived by a counterparty to a derivative to be material;
• within 90 days following the end of its financial year, Filer shall submit to the Commission the audited annual financial statements of Filer's parent and a statement presenting the number of contracts concluded with Ontario residents for any CFDs offered to the public during the most recent financial year; and
• the Requested Relief shall immediately expire upon the earliest of
• four years from the date that the Order is issued;
• the issuance of an order or decision by a court, the AMF or other similar regulatory body that suspends or terminates the ability of the Filer to offer CFDs to clients in Québec; and
• the coming into force in Ontario of legislation or a rule regarding the distribution of OTC derivatives to investors in Ontario.
Securities Act, R.S.O. 1990, c. S.5, as am., s. 53, 74(1).
NI 45-106 Prospectus and Registration Exemptions, s. 2.3.
OSC Rule 91-502 Trades in Recognized Options.
OSC Rule 91-503 Trades in Commodity Futures Contracts and Commodity Futures Options Entered into on Commodity Futures Exchanges Situate Outside of Ontario.
Proposed OSC Rule 91-504 OTC Derivatives (not adopted).
IN THE MATTER OF
THE SECURITIES ACT,
R.S.O. 1990, CHAPTER S.5, AS AMENDED
IN THE MATTER OF
MF GLOBAL CANADA CO.
(Subsection 74(1) of the Act)
UPON the application (the Application) of MF Global Canada Co. (the Applicant) to the Ontario Securities Commission (the Commission) for an order, pursuant to subsection 74(1) of the Act, that the Applicant and its respective officers, directors and representatives be exempt from the prospectus requirement of section 53 of the Act in respect of the distribution of contracts for difference and foreign exchange contracts (collectively, CFDs) to investors resident in Ontario (the Requested Relief) subject to the terms and conditions below;
AND UPON considering the Application and the recommendation of staff of the Commission;
AND UPON the Applicant having represented to the Commission that:
1. The Applicant is a corporation incorporated under the laws of Nova Scotia with its principal office in Toronto, Ontario.
2. The Applicant is a subsidiary of MF Global Holdings Ltd., a leading broker of exchange-listed futures and options in the world with offices in New York, London, Chicago, Paris, Mumbai, Singapore, Sydney, Toronto, Tokyo, Hong Kong, Taipei and Dubai. MF Global Holdings Ltd. is a public company listed on the New York Stock Exchange. The Applicant and its affiliates are referred to herein as MF Global.
3. MF Global provides execution and clearing services for exchange-traded and over-the-counter derivative products as well as for non-derivative foreign exchange products and securities in the cash market. MF Global operates across a broad range of trading markets, including interest rates, equities, currencies, energy and metals, agricultural and other commodities. MF Global operates in 12 countries on more than 70 exchanges, providing access to the largest and fastest growing financial markets in the world. It is the leader by volume on many of these markets and on a single day averages eight million lots, more than most of the world's largest derivatives exchanges.
4. MF Global's U.S. affiliate, MF Global Inc. (MF Global U.S.), does not offer CFDs to U.S. investors. It does, however, offer over-the-counter foreign exchange contracts to investors in the U.S. Pursuant to U.S. securities laws, MF Global U.S. is registered as a Futures Commission Merchant with the U.S. Commodity Futures Trading Commission and is a member of the National Futures Association.
5. The Applicant is registered as a dealer in the category of investment dealer in all provinces and territories and is a member of the Investment Industry Regulatory Organization of Canada (IIROC, formerly the Investment Dealers' Association or IDA).
6. The Applicant is not, to the best of its knowledge, in default of any requirements of IIROC, securities legislation in Ontario or securities or derivatives legislation in Québec.
7. The Applicant has previously offered foreign exchange contracts (but not other types of CFDs) to investors in Ontario on the basis of a good faith determination that its foreign exchange contracts did not constitute securities for the purposes of Ontario securities law. Consequently, such offerings were made in compliance with applicable IIROC Rules and other IIROC acceptable practices (as defined below) but were not made under a prospectus or an exemption from the prospectus requirement of Ontario securities law. In October 2009, OSC staff published OSC Staff Notice 91-702 Offerings of Contracts for Difference and Foreign Exchange Contracts to Investors (OSC SN 91-702). The Applicant has considered the guidance in OSC SN 91-702 and wishes to continue to offer its foreign exchange contracts to investors in Ontario on the basis of the exemptive relief contemplated by OSC SN 91-702.
8. In Québec, the Applicant has applied for an order from the Autorité des marchés financiers (the AMF) to offer CFDs to both accredited and non-accredited investors (referred to herein as retail investors) pursuant to the provisions of the Derivatives Act (Québec)(the QDA). The AMF Order will, if granted, exempt the Applicant from the qualifying requirement set forth in section 82 of the QDA relating to the creation or marketing of CFDs offered to the public, subject to certain terms and conditions.
9. The Applicant wishes to offer CFDs to investors, including retail investors, in Ontario on a similar basis as in Québec and on substantially the same terms and conditions as articulated in the QDA and in the AMF Order. For the Interim Period (defined below), the Applicant is seeking the Requested Relief in connection with this proposed offering in Ontario.
10. The Applicant is required by IIROC to maintain a certain level of capital to address the business risks associated with its activities. The capital reporting required by IIROC (as per the calculation in the Joint Regulatory Financial Questionnaire (the JRFQ) and the Monthly Financial Reports to IIROC) is based predominantly on the generation of financial statements and calculations as to ensure capital adequacy. The Applicant as an IIROC member is required to have a specified minimum capital which includes having any additional capital required with regards to margin requirements and other risks. This risk calculation is summarized as a risk adjusted capital calculation which is submitted in the firm's JRFQ and required to be kept positive at all times.
11. As a member of IIROC, the Applicant will only be permitted to distribute CFDs pursuant to IIROC Rules. The Applicant is not, to the best of its knowledge, in default of any IIROC Rules. In addition, IIROC has communicated to its members certain additional expectations as to acceptable business practices (IIROC acceptable practices) as articulated in the IIROC CFD Paper (as defined below) for any IIROC member proposing to offer CFDs or foreign exchange contracts (forex contracts) to investors. To the best of its knowledge, the Applicant is (and will be) in compliance with IIROC acceptable practices for its offerings of CFDs. The Applicant will offer CFDs in accordance with IIROC acceptable practices as may be established from time to time.
Structure of CFDs
12. A CFD is a derivative product that allows clients to obtain economic exposure to the price movement of an underlying instrument, such as a share, index, market sector, foreign currency, treasury or commodity, without the need for ownership and physical settlement of the underlying instrument.
13. CFDs offered by the Applicant may be traded via a direct market access (DMA) model or a market maker model. DMA-traded CFDs result in an order being passed directly through to the underlying physical market with no market maker intervention. In the DMA model, pricing is identical to that in the underlying market. In the market maker model, the provider will receive an order from its client and then may hedge their underlying position in a number of ways such as offsetting orders against other clients, buying shares, buying options, warrants or futures. In the market maker model, pricing approximates the underlying market but can also provide additional liquidity than that which is available in the underlying market.
14. CFDs to be offered by the Applicant shall be distributed on an OTC basis and are not transferable.
15. In the case of CFDs offered by the Applicant in respect of which the underlying interest is a security, the CFDs do not confer the right or obligation to acquire or deliver the underlying security, and do not confer any other rights of holders of the underlying security, such as voting rights.
16. The contractual relationship between the Applicant and the proposed client is one of a bilateral arrangement whereby the Applicant acts as both the market intermediary and the principal or counterparty to the CFD with the client.
17. CFDs allow clients to obtain exposure to markets and instruments that may not be available directly, or may not be available in a cost-effective manner. Commissions are charged to clients for the execution and clearing of CFDs. The commissions vary depending on the market traded and are typically quoted in basis points of the underlying value of the equity.
18. The ability to leverage an investment has traditionally been one of the principal features of CFDs. Leverage allows clients to magnify potential investment returns (or losses) by reducing the initial capital outlay required to achieve the same market exposure that would be obtained by investing directly in the underlying instrument.
19. IIROC Rules and IIROC acceptable practices set out detailed requirements and expectations relating to leverage and margin for offerings of CFDs and forex contracts. Consequently, CFDs offered in Canada in accordance with IIROC Rules and IIROC acceptable practices will generally employ the same degree of leverage as traditional margin accounts for long and short positions in securities. However, the degree of leverage may be amended in accordance with IIROC Rules and IIROC acceptable practices as may be established from time to time.
20. CFDs are currently available to retail clients without a prospectus in OTC markets in countries, including, but not limited to, United Kingdom, Germany, Switzerland, Singapore, Australia and New Zealand. With the implementation of the European Markets in Financial Instruments Directive in November 2007, CFDs are now considered "core" investment services and activities that registered investment firms can offer throughout Europe (via a "passport system" of securities regulation).
21. In Québec, the Applicant intends to offer CFDs to investors, including retail investors, pursuant to the provisions of the QDA and the conditions contained in the AMF Order.
22. A detailed description of CFDs can be found in the publication titled "Regulatory Analysis of Contracts for Differences (CFDs)" published by IIROC on June 6, 2007 (the IIROC CFD Paper), as amended on September 12, 2007.
CFDs Distributed in Ontario
23. CFDs and similar OTC derivative contracts, when offered to investors in Ontario, may be considered to be "securities" under the Act.
24. Pursuant to Section 13.12 Restriction on lending to clients of National Instrument 31-103 Registration Requirements which came into force as of September 28, 2009, only those firms that are registered as investment dealers (a condition of which is to be a member of IIROC) may lend money, extend credit or provide margin to a client.
25. Investors wishing to purchase CFDs must open an account with the Applicant and complete a trading agreement.
26. Prior to a client's first CFD trade and as part of the account opening process, the Applicant will provide the client with a separate risk disclosure document that clearly explains, in plain language, the product and the risks associated with an investment in the product (the risk disclosure document). The risk disclosure document includes the required risk disclosure set forth in Schedule A to the Regulations to the QDA and leverage risk disclosure required under IIROC Rules. The risk disclosure document contains disclosure that is substantially similar to the risk disclosure statement required for recognized options in OSC Rule 91-502 Trades in Recognized Options (which provides both registration and prospectus exemptions) and the regime for OTC derivatives contemplated by proposed OSC Rule 91-504 OTC Derivatives (which was not adopted) (Proposed Rule 91-504). The Applicant will ensure that, prior to a client's first CFD trade, a complete copy of the risk disclosure document provided to that client has been delivered, or has previously been delivered, to the Commission.
27. Prior to the client's first CFD trade and as part of the account opening process, the Applicant will obtain a written or electronic acknowledgement from the client confirming that the client has received, read and understood the risk disclosure document. Such acknowledgment will be separate and prominent from other acknowledgements provided by the client as part of the account opening process.
28. Clients purchase CFDs through the Applicant's on-line trading platform which is similar to those developed for on-line brokerages and day-trading in that the investor trades without other communication with, or advice from, the dealer. The on-line platform is not a "marketplace" as defined in National Instrument 21-101 Marketplace Operation since a marketplace is any facility that brings together multiple buyers and sellers by matching orders in fungible contracts in a non-discretionary manner. The on-line platform does not bring together multiple buyers and sellers; rather it offers clients direct access to the underlying market.
29. The role of the Applicant is limited primarily to acting as an execution-only dealer except where it provides broker assistance to certain types of foreign exchange trades. The Applicant is, among other things, responsible for marketing, trade execution, administration of account opening and investor approval (including know-your-client diligence and suitability confirmations) for all Canadian clients.
30. IIROC Rules exempt member firms that provide execution-only services such as discount brokerage from the obligation to determine whether each trade is suitable for the client. However, IIROC has exercised its discretion to impose additional requirements on members proposing to issue CFDs and requires that:
(a) Applicable risk disclosure documents and client suitability waivers provided must be in a form acceptable to IIROC.
(b) The firm's policies and procedures, amongst other things, must assess the depth of investment knowledge and trading experience of the client to assess whether the CFD product itself is appropriate for the client before an account is approved to be opened. IIROC has also imposed its proficiency requirements for futures trading on the Applicant's registered salespeople, who conduct the know your client and initial product suitability analysis, as well as their supervisory trading officer.
(c) The relationship and responsibilities, including conflicts of interest between the issuer and dealer, must be fully disclosed to the client and acknowledged in writing.
(d) Cumulative loss limits for each client's account must be established (this is a measure normally applied by IIROC in connection with futures trading accounts).
31. The CFDs shall be offered in compliance with the leverage (margin) rates approved by IIROC and other IIROC acceptable practices. IIROC has prescribed margin limits for CFDs based on IIROC methodologies and principles as applied to existing products offered in Canada (particularly Montreal Bourse single stock futures).
32. IIROC limits the underlying instruments in respect of which a member firm may issue CFDs since only certain securities are eligible for reduced margin rates. For example, underlying equity securities must be listed or quoted on certain "recognized exchanges" (as that term is defined in IIROC rules) such as TSX or the NYSE. The purpose of these limits is to ensure that CFDs offered in Canada will only be available in respect of underlying instruments that are traded in well-regulated markets, in significant enough volumes and with adequate publicly available information, so that investors can form a sufficient understanding of the exposure represented by a given CFD.
Rationale for the Requested Relief
33. The Requested Relief, if granted, would substantially harmonize the Commission's position on the offering of CFDs to investors in Ontario with how those products are offered to investors in Quebec under the QDA. The QDA provides a legislative framework to govern derivatives activities within the province. Among other things, the QDA requires such products to be offered to investors through an IIROC member and the distribution of a standardized risk disclosure document rather than a prospectus in order to distribute CFDs to investors resident in Quebec.
34. The Requested Relief, if granted, would be consistent with the guidelines articulated by OSC Staff in OSC SN 91-702. OSC SN 91-702 provides guidance with regards to the distributions of contracts for difference (CFDs), foreign exchange contracts (forex or FX contracts) and similar OTC derivative products to investors in Ontario.
35. The Commission has previously recognized that the prospectus requirement may not be well suited for the distribution of certain derivative products to investors in Ontario, and that alternative requirements, including requirements based on clear and plain language risk disclosure, may be better suited for certain derivatives. Both OSC Rule 91-502 Trades in Recognized Options (OSC Rule 91-502) and OSC Rule 91-503 Trades in Commodity Futures Contracts and Commodity Futures Options Entered into on Commodity Futures Exchanges Situate Outside of Ontario (OSC Rule 91-503) provide for a prospectus exemption for the trading of derivative products to clients. The Requested Relief is consistent with the principles and requirements of OSC Rule 91-502, OSC Rule 91-503 and Proposed Rule 91-504.
36. The Applicant also submits that the Requested Relief, if granted, would harmonize the Commission's position on the offering of CFDs with certain other foreign jurisdictions. Other CFD providers distribute CFDs to retail clients in numerous other jurisdictions around the world. Securities regulators in these jurisdictions appear to have concluded that a clear, plain language risk disclosure document is appropriate for retail CFD clients.
37. The Applicant is of the view that requiring compliance with the prospectus requirements for the distribution of CFDs to retail clients in Ontario would not be appropriate for the following reasons:
a. the disclosure of a great deal of the information required under the prospectus and under the reporting issuer regime is not material to a CFD client. The information to be given to a CFD client should principally focus on enhancing the client's appreciation of product risk including counterparty risk;
b. CFDs are in continuous distribution;
c. most CFDs are of short duration (positions are generally opened and closed on the same day and are in any event marked to market and cash settled daily); and
d. there are frequent changes to the array of available underlying financial instruments.
38. The Applicant is regulated by IIROC which has a robust compliance regime including specific requirements to address market, capital and operational risks.
39. The Applicant submits that the regulatory regimes developed by the AMF and IIROC for the offering of CFDs adequately addresses issues relating to the potential risk to the client of the Applicant acting as counterparty. In view of these regulatory regimes, investors would receive little or no additional benefit from requiring the Applicant to also comply with the prospectus requirement for the distribution of CFDs to investors in Ontario.
40. The Requested Relief is conditional on the Applicant being registered as an investment dealer with the Commission and maintaining its membership with IIROC and that all CFD trades distributed by the Applicant be conducted pursuant to IIROC Rules imposed on members seeking to distribute CFDs and in accordance with IIROC acceptable practices.
AND UPON the Commission being satisfied that to do so would not be prejudicial to the public interest;
IT IS ORDERED, pursuant to subsection 74(1) of the Act, that for the duration of the Interim Period (as defined below) the Requested Relief is granted, provided that:
(a) all CFDs offered by MF Global to clients resident in Ontario shall be distributed through the Applicant;
(b) the Applicant remains registered as a dealer in the category of investment dealer with the Commission and a member of IIROC;
(c) all distributions of CFDs by the Applicant to clients resident in Ontario be conducted pursuant to IIROC Rules imposed on members seeking to distribute CFDs and foreign exchange contracts and in accordance with IIROC acceptable practices, as amended from time to time;
(d) all distributions of CFDs by the Applicant to clients resident in Ontario be conducted pursuant to the rules and regulations of the QDA and the AMF, as amended from time to time, unless and to the extent there is a conflict between i) the rules and regulations of the QDA and the AMF, and ii) the requirements of Ontario securities law, the IIROC Rules and IIROC acceptable practices, in which case the latter shall prevail;
(e) prior to a client's first CFD trade, the Applicant has provided to the client the risk disclosure document described in paragraph 26 and have delivered, or have previously delivered, a copy of the risk disclosure document provided to that client to the Commission;
(f) prior to the client's first CFD trade and as part of the account opening process, the Applicant has obtained a written or electronic acknowledgement from the client, as described in paragraph 27, confirming that the client has received, read and understood the risk disclosure document;
(g) the Applicant has furnished to the Commission the name and principal occupation of its officers or directors, together with either the personal information form and authorization of indirect collection, use and disclosure of personal information provided for in National Instrument 41-101 General Prospectus Requirements or the registration information form for an individual provided for in Form 33-109F4 of National Instrument 33-109 Registration Information Requirements completed by any officer or director;
(h) the Applicant shall promptly inform the Commission in writing of any material change affecting the Applicant, being any change in the business, activities, operations or financial results or condition of the Applicant that may reasonably be perceived by a counterparty to a derivative to be material;
(i) the Applicant shall promptly inform the Commission in writing if a self-regulatory organization or any other regulatory authority or organization initiates proceedings or renders a judgment related to disciplinary matters against the Applicant concerning the conduct of activities with respect to CFDs; and
(j) within 90 days following the end of its financial year, the Applicant shall submit to the Commission the audited annual financial statements of the Applicant and a statement presenting the number of transactions concluded with Ontario residents for any CFD offering to the public during the most recent financial year.
(k) the Requested Relief shall immediately expire upon the earliest of
(i) four years from the date that this Order is issued;
(ii) the issuance of an order or decision by a court, the AMF or other similar regulatory body that suspends or terminates the ability of the Applicant to offer CFDs to clients in Quebec; and
(iii) the coming into force in Ontario of legislation or a rule regarding the distribution of OTC derivatives to investors in Ontario (the Interim Period).
July 16, 2010