Application by investment dealer (Applicant) for relief from prospectus requirement in connection with distribution of foreign exchange contracts to permit investors resident in Ontario to enter into foreign exchange transactions with Applicant, subject to four-year sunset clause and other terms and conditions -- Applicant acts as both market intermediary and as principal or counterparty to forex transaction with client -- Applicant registered in Ontario as investment dealer and a member of the Investment Industry Regulatory Organization of Canada (IIROC) -- Applicant complies with IIROC Rules and IIROC acceptable practices applicable to offerings of forex contracts -- Applicant seeking relief to permit Applicant to offer forex contracts 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 contained in OSC SN 91-702.
IN THE MATTER OF
THE SECURITIES ACT,
R.S.O. 1990, CHAPTER S.5, AS AMENDED
IN THE MATTER OF
INTERACTIVE BROKERS CANADA INC.
(Subsection 74(1) of the Act)
UPON the application (the Application) of Interactive Brokers Canada Inc. (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 in section 53 of the Act in respect of the distribution of foreign exchange contracts to permit investors resident in Ontario to enter into foreign exchange transactions with the Applicant (referred to herein as IB Forex transactions) (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:
Interactive Brokers Group
1. The Applicant is a member of the Interactive Brokers Group (Interactive Brokers), a leading global electronic brokerage group. Interactive Brokers provides its customers with direct, high-speed access to trade in more than 80 equity and derivatives exchanges and a growing number of Electronic Communication Networks (ECNs).
2. The parent company of the Applicant is IBG LLC which was founded by its Chairman and CEO Thomas Peterffy. In May 2007, Interactive Brokers Group, Inc. sold 40,000,000 shares in a public offering which represented approximately 10% interest in IBG LLC. Interactive Brokers Group, Inc. is currently listed on NASDAQ under the symbol IBKR. As of April 13, 2010, the number of shares outstanding was 41,217,000 and the market value was US$677,607,480.
3. Over the last 32 years, Interactive Brokers has grown internally to become one of the premier securities firms with over $4 billion in equity capital. Interactive Brokers' global headquarters are in Greenwich Connecticut, and it has about 800 employees in its offices in the USA, Switzerland, Canada, Hong Kong, UK, Australia, India, Hungary, Russia and Estonia. Members of the Interactive Broker Group are regulated by the US SEC, FINRA, NYSE, SFA and other regulatory agencies around the world.
4. In its broker dealer agency business, Interactive Brokers provides direct access ("on line") trade execution and clearing services to institutional and professional traders for a wide variety of electronically traded products including stocks, options, futures, forex, bonds and funds worldwide. IBG LLC and its affiliates execute approximately 1,000,000 trades per day.
5. The Applicant is a wholly-owned subsidiary of IBG LLC. On December 19, 2008, Standard & Poor's Ratings Services raised its counterparty rating on IBG LLC to 'BBB+' from 'BBB'. On March 4, 2010, Standard & Poor's Ratings Services issued a new Counterparty Credit Rating of BBB+ / Stable for IBG LLC. The Applicant is not aware of any other ratings that have been issued in respect of IBG LLC and/or any of its U.S. or Canadian affiliates.
Interactive Brokers Canada Inc.
6. The Applicant is a corporation incorporated under the laws of Canada with its principal office in Montréal, Quebec. The Applicant is registered as a dealer in the category of investment dealer in all provinces, a futures commission merchant in Ontario and Manitoba and is a member of the Investment Industry Regulatory Organization of Canada (IIROC) (formerly the Investment Dealers' Association or IDA).
7. 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.
8. As a member of IIROC, the Applicant is only permitted to enter into IB Forex transactions 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 IIROC's "Regulatory Analysis of Contracts for Differences (CFDs)" published by IIROC on June 6, 2007 (the IIROC CFD Paper), as amended on September 12, 2007, for any IIROC member proposing to offer CFDs or foreign exchange contracts to investors. To the best of its knowledge, the Applicant is in compliance with IIROC acceptable practices for its distribution of foreign exchange contracts. The Applicant will continue to offer IB Forex transactions in accordance with IIROC acceptable practices as may be established from time to time.
9. The financial statements of the Applicant are publicly-available and posted on its website at: www.interactivebrokers.ca. The financial statements are audited statements in accordance with IIROC Rule 300 Audit Requirements and are filed with IIROC on an annual basis as required by IIROC Rules and Regulations. Interim financial statements are not required to be provided; however, as disclosed in the application, the firm is required to file a monthly financial report (MFRs) with IIROC to confirm that it has maintained its requisite risk adjusted capital. Pursuant to IIROC Rule 1400, each IIROC member is required to make available to its clients, on request, a statement of its financial condition. While the IIROC Rules and Regulations stated that the information must be provided to clients upon their request, the Applicant has chosen to publish this information on their website in order to provide transparency of its financial position to their clients and nonclients.
10. The current offering of IB Forex transactions by the Applicant is by way of a bilateral arrangement in that the Applicant acts as both the market intermediary and the principal or counterparty to transactions with the client.
11. In Québec, the Applicant currently offers IB Forex transactions to both accredited and non-accredited investors (referred to herein as retail investors), pursuant to the provisions of the Derivatives Act (Québec)(the QDA) and the conditions contained in the Order dated March 13, 2009 issued by the Autorité des marchés financiers (the AMF) (the AMF Order). The AMF Order exempts the Applicant from the qualifying requirement set forth in section 82 of the QDA relating to the creation or marketing of over-the-counter derivatives, including IB Forex transactions, offered to the public, subject to certain terms and conditions.
12. The Applicant has previously offered IB Forex transactions to investors, including retail investors, in Ontario on the basis of a good faith determination that the IB Forex transactions 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 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 IB Forex transactions to investors, including retail investors, in Ontario on the basis of the exemptive relief contemplated by OSC SN 91-702.
13. Similarly, the Applicant wishes to continue to offer IB Forex transactions 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 the offering in Ontario.
14. Interactive Brokers provides two vehicles for the exchange of currencies: (i) IDEALPRO which allows a customer trade in foreign exchange and (ii) IDEAL which allows a customer to convert their balances from one currency to another (forex conversions).
15. For the purposes of this application, IB Forex transactions include those transactions entered into on IDEALPRO and the forex conversions that are conducted through IDEAL.
16. IB Forex transactions are over-the-counter (OTC) and are not transferable.
17. The ability to lever an investment is one of the principal features of foreign exchange contracts and transactions. Leverage allows clients to magnify 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 currency. Leverage is only permissible on IDEALPRO network.
18. IIROC Rules and IIROC acceptable practices set out detailed requirements and expectations relating to leverage and margin for offerings of foreign exchange contracts. The degree of leverage may be amended in accordance with IIROC Rules and IIROC acceptable practices as may be established from time to time.
19. 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.
Online Trading Platform
20. Interactive Brokers has developed a module of Interactive Brokers' TWS on-line trading platform to specifically allow IB Forex transactions called FXTrader® (FXTrader), that offers clients direct access to interbank prices and dealing for orders as small as 25,000 USD (or equivalent), and up to 10 million USD, or more. FXTrader provides best-execution functionality and a transparent pricing structure. The Applicant offers trading in 13 currencies (USD, EUR, CHF, GBP, SEK, NOK, JPY, AUD, NZD, HKD, CAD, MXN, and special conversion functionality in KRW) with market spreads as small as 1/2 PIP. The tight spreads and substantial liquidity are a result of combining quotation streams from 12 of the world's largest foreign exchange dealers which provide, directly or indirectly, more than half of the momentary capital available in the global interbank market.
21. FXTrader provides an optimized trading interface, with Interactive Broker-designed tools to trade the forex markets. The price display emphasizes the critical portion of the bid/ask, and conveys price movement at a glance by showing an increasing price in green and decreasing price in orange. Each currency pair occupies its own "cell," complete with market data and order information, where a client can create, transmit and cancel orders with a single click. Overall order, trade and portfolio information is displayed along the top of the currency pairs grid.
22. Key features of the FXTrader platform includes:
• Interbank-quality spreads allow clients to trade the best bid and ask from multiple liquidity providers with spreads as low as ½ pip;
• The ability to review order details and margin implications before a client transmits;
• Instantaneous transmission to transmit a clients orders with one click on the bid or ask;
• FXTrader supports over 15 risk-mitigation order types including trailing stop limits, brackets, limit if touched, OCA (one cancels all) and IOC (immediate or cancel);
• The functionality of the Order Book icon which appears when the small-order book has a better price available for the currency pair; and
• The ability of a client to customize the trading cell display to show position, average cost and profit and loss date.
23. Clients conduct IB Forex transactions through IB Canada's on-line trading platform, FXTrader®. The Applicant's on-line platform is similar to those developed for on-line brokerages and day-trading in that the client trades without other communication with, or advice from, the dealer. The FXTrader® 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 nondiscretionary manner. FXTrader® does not bring together multiple buyers and sellers; rather it offers clients direct access to interbank prices.
IB Forex Transactions in Ontario
24. Foreign exchange contracts and similar OTC derivative transactions, including IB Forex transactions, when offered to investors in Ontario, may be considered to be "securities" under the Act.
25. Investors wishing to enter into IB Forex transactions must open an account with the Applicant
26. Prior to a client's first IB Forex transaction 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 transaction and the risks associated with the transaction (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) (OSC Rule 91-502) and the regime for OTC derivatives contemplated by OSC SN 91-702 and 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 trade in an IB Forex transaction, 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 IB Forex transaction 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. As customary in the industry, and due to the fact that this information is subject to factors beyond the control of the Applicant (such as changes in IIROC Rules), information such as the margin or leverage rates would not be disclosed in the risk disclosure document but are part of a client's account opening package and are available on both the Applicant's website and the on-line trading platform.
29. The role of the Applicant is limited to acting as an execution-only dealer. In connection with its role as execution-only dealer, 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 brokerages 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 trade in foreign exchange contracts 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 product 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) 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 IB Forex transactions are offered in compliance with applicable IIROC Rules and other IIROC acceptable practices.
Rationale for the Requested Relief
32. The Requested Relief, if granted, would substantially harmonize the Commission's position on the offering of foreign exchange contracts 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 foreign exchange contracts to investors resident in Quebec.
33. The Requested Relief, if granted, would be consistent with the guidelines articulated by 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.
34. 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 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.
35. The Applicant also submits that the Requested Relief, if granted, would harmonize the Commission's position on the offering of foreign exchange contracts with certain other foreign jurisdictions that have concluded that a clear, plain language risk disclosure document is appropriate for retail clients seeking to trade in foreign exchange contracts.
36. The Applicant is of the view that requiring compliance with the prospectus requirements in order to enter into IB Forex transactions with clients in Ontario would not be appropriate since the disclosure of a great deal of the information required under the prospectus and under the reporting issuer regime is not material to a client seeking to enter into an IB Forex transaction. The information to be given to such a client should principally focus on enhancing the client's appreciation of product risk including counterparty risk. In addition, most IB Forex transactions 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).
37. The Applicant is regulated by IIROC which has a robust compliance regime including specific requirements to address market, capital and operational risks.
38. The Applicant submits that the regulatory regimes developed by the AMF and IIROC for foreign exchange contracts, including IB Forex transactions, 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.
39. 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 IB Forex transactions be conducted pursuant to IIROC Rules 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 IB Forex transactions with residents 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 IB Forex transactions with clients resident in Ontario shall be conducted pursuant to IIROC Rules imposed on members seeking to trade in foreign exchange contracts and in accordance with IIROC acceptable practices, as amended from time to time;
(d) all IB Forex transactions with 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 first entering into an IB Forex transaction, 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 a client's first IB Forex transaction 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 IB Forex transactions;
(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 IB Forex transactions concluded with Ontario residents during the most recent financial year; and
(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 foreign exchange contracts 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).
August 20, 2010