Securities Law & Instruments


Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Application for a decision to exempt from the dealer registration requirement and the prospectus requirement certain trades in over-the-counter (OTC) derivatives that are made by the applicant with a “permitted counterparty” or by a permitted counterparty with the applicant.

Decision providing for the exemption defines “permitted counterparties” to consist exclusively of persons or companies that are “permitted clients” as defined in Section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations – Exemption was sought in Ontario (and is intended to be relied upon in certain other “passport” jurisdictions of Canada) as an interim response to current regulatory uncertainty associated with the regulation in Ontario and those other jurisdictions of OTC derivatives, pending the development by the CSA of a uniform framework for the regulation of OTC derivatives in all provinces and territories of Canada – Decision includes terms and conditions, including a “sunset date” that is date that is the earlier of: (i) the date that is four years after the date of the Decision; 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 derivative transactions.

Applicable Legislative Provisions

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

February 19, 2019

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
TFS-ICAP, LLC
(the Filer)

DECISION

Background

The principal regulator in the Jurisdiction has received an application (the “Application”) from the Filer for a decision under the securities legislation of the Jurisdiction of the principal regulator (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 transaction (as defined below) made by either

(a) the Filer to a “Permitted Counterparty” (as defined below), or

(b) by a Permitted Counterparty to the Filer,

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

Under the Process for Exemptive Relief Applications in Multiple Jurisdictions:

(a) the Ontario Securities Commission (the “OSC”) is the principal regulator for the Application; and

(b) the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (“MI 11-102”) is intended to be relied upon in New Brunswick (to the extent Local Rule 91-501 Derivatives does not apply), Newfoundland and Labrador, Northwest Territories, Nunavut, Prince Edward Island and Yukon (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 is a “permitted client”, as that term is defined in section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103).

Representations

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

The Filer

1. The Filer is a Limited Liability Company organized under the laws of the State of New York. Its primary regulator in the U.S. is the National Futures Association. The Filer’s head office is located at 32 Old Slip, 34th floor, New York, New York, 10005.

2. The Filer is not currently registered in any capacity in Canada. The Filer is not currently relying on any exemption from registration in Canada.

3. The Filer is not required to register under U.S. law with the U.S. Commodity Futures Trading Commission as a swap dealer or a major swap participant.

4. Subject to the matter to which this decision relates, the Filer is not in default of securities, commodity futures or derivatives legislation in any jurisdiction in Canada.

5. The Filer is in compliance in all material respects with U.S. securities, commodity futures and derivatives laws, but notes that:

(a) On September 26, 2018, TFS-ICAP Limited and the Filer (together, the “TFS-ICAP Companies”) each pleaded guilty to a single misdemeanor violation of New York’s Martin Act relating to an act which took place on or about April 6, 2015. In connection with those pleas, the TFS-ICAP Companies are required to implement remedial policies and procedures, provide training to employees, implement reasonable and practicable means to monitor brokers, retain an independent monitor for a limited period of time, remove two high managerial agents from their managerial positions and certain supervisory roles, pay $1.15 million in penalties, costs, disbursements and disgorgement, and cooperate in any ongoing investigation by the New York Office of the Attorney General in connection with the practices of the TFS-ICAP Companies’ employees.

(b) On September 28, 2018, the CFTC filed a civil complaint against the TFS-ICAP Companies alleging fraud and supervision failures relating to conduct in the foreign exchange options market from at least 2008 to 2015. In addition, the CFTC filed civil complaints against the former Chief Executive Officer and the former Head of Emerging Markets broking of the TFS-ICAP Companies alleging underlying violations and supervisory failures. The CFTC separately issued an order filing and simultaneously settling civil claims against the Chairman of the Board of each of the TFS-ICAP Companies for supervision failures.

6. The Filer will not maintain an office, sales force or physical place of business in Canada.

7. The Filer is an international inter-dealer broker of foreign exchange options. The Filer is part of the Tradition Group of companies, which is one of the largest global inter-dealer derivatives brokerage groups. The Filer is an approved member of and is regulated by the National Futures Association in the U.S. and is registered as an Introducing Broker Firm with the U.S. Commodity Futures Trading Commission. The Filer is also an approved Broker Firm Participant on Tradition SEF, Inc., which is a swap execution facility registered with the U.S. Commodity Futures Trading Commission. The Filer is not a broker-dealer registered with the U.S. Securities and Exchange Commission, is not a member of the Financial Industry Regulatory Authority and does not conduct a securities business in the U.S.

Proposed conduct of OTC Derivative transactions

8. The Filer proposes to broker or intermediate bilateral OTC Derivative transactions with counterparties located in all provinces and territories of Canada that consist exclusively of persons or companies that are Permitted Counterparties. The Filer understands that the Permitted Counterparties would be entering into the OTC Derivative transactions for hedging or investment purposes. The Underlying Interest of the OTC Derivatives that are entered into between the 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.

9. The Filer will not offer or provide credit or margin to any of their Permitted Counterparties for purposes of an OTC Derivative transaction.

10. The 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. The Filer acknowledges that registration and prospectus requirements may be triggered for the Filer in connection with the derivative contracts under any such uniform framework to be developed for the regulation of OTC Derivative transactions.

Regulatory uncertainty and fragmentation associated with the regulation of OTC Derivative transactions in Canada

11. 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.

12. In each of British Columbia, Prince Edward Island, the Northwest Territories, Nunavut and Yukon, 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”.

13. In Alberta, Manitoba, Ontario, New Brunswick, Nova Scotia and Saskatchewan, OTC Derivative transactions are regulated as derivatives; however, certain OTC Derivative transactions also meet the definition of “security.”

14. In Newfoundland and Labrador, 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 this jurisdiction makes no express reference to a “futures contract” or a “derivative” and the definition of “security” does not include any category that would specifically cover OTC Derivative transactions.

15. In October 2009, staff of 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 Securities Act (Ontario) (the “OSA”) 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 on the extent to which OTC Derivative transactions between the Filer and a Permitted Counterparty may be subject to Ontario securities law.

16. 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.

17. In each of Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia and Saskatchewan (the “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 Blanket Order Jurisdictions and “accredited counterparties” in Quebec.

18. The corresponding OTC Derivative Exemptions are as follows:

Alberta

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

British Columbia

Blanket Order 91-501 Over-the-Counter Derivatives

Manitoba

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

New Brunswick

Local Rule 91-501 Derivatives

Nova Scotia

Blanket Order 91-501 Over the Counter Trades in Derivatives

Saskatchewan

General Order 91-908 Over-the-Counter Derivatives

Quebec

Section 7 of the Derivatives Act (Quebec)

The evolving regulation of OTC Derivative transactions as derivatives

19. 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 other OTC Exemption Jurisdictions and the granting of the OTC Derivative Exemptions.

20. 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.

21. The Final Report of the Ontario Commodity Futures Act Advisory Committee, published in January, 2007, 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.

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

23. The amendments to the OSA 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. On April 19, 2018, the Canadian Securities Administrators (the “CSA”) published a Notice and Request for Comment on the Proposed National Instrument 93-102 Derivatives: Registration, and on June 14, 2018, the CSA published a Notice and Second Request for Comment on the Proposed National Instrument 93-101 Derivatives: Business Conduct, which, together, are intended to implement a comprehensive regime for the regulation of persons or companies that are in the business of trading or advising on derivatives.

Rationale for Requested Relief

24. The Requested Relief would substantially address, for the 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 the Filer to broker or intermediate these parties in entering into OTC Derivative transactions in reliance upon exemptions from the dealer registration and prospectus requirements of the securities legislation of Ontario and each Passport Jurisdiction that are comparable to the OTC Derivative Exemptions.

Books and Records

25. The Filer will become a “market participant” for the purposes of the OSA if the Requested Relief is granted. For the purposes of the OSA, and as a market participant, the Filer is required by subsection 19(1) of the OSA 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.

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

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

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

(c) identify all OTC Derivative transactions brokered or intermediated by the Filer and entered into by 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 Derivative transaction brokered or intermediated by the Filer, 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 parties (having been brokered or intermediated by the Filer) in reliance upon the “accredited investor” prospectus exemption in section 2.3 [Accredited investor] of National Instrument 45-106 Prospectus Exemptions.

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 brokered or intermediated by the Filer is a Permitted Counterparty;

(b) in the case of any trade brokered or intermediated by the Filer regarding 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 that specifically governs dealer, adviser or other registration requirements applicable to market participants in connection with OTC Derivative transactions.

“Grant Vingoe”
Vice Chair
Ontario Securities Commission

“Tim Moseley”
Commissioner
Ontario Securities Commission


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.

"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.