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National Instrument 93-101 – Derivatives: Business Conduct
(the “Instrument“) came into force on
September 28, 2024, establishing a comprehensive framework for the
conduct of dealers and advisers in the over-the-counter
(“OTC“) derivatives market.
Advisers registered in a Canadian jurisdiction to advise with
respect to securities (“Registered
Advisers“) who only occasionally advise with respect
to OTC derivatives (for instance, entering into currency hedges for
an investment fund client) may not be fully aware of their limited
obligations under the Instrument.
While the Instrument obligates anyone in the business of
advising with respect to OTC derivatives to comply with stringent
business conduct requirements, many of these requirements duplicate
existing obligations for Registered Advisers or are designed to
protect retail clients. Consequently, for Registered Advisers who
exclusively advise eligible derivatives parties, the
Instrument’s impact is significantly narrowed.
Eligible Derivatives Parties
The definition of eligible derivatives party
(“EDP“) in the Instrument includes a
variety of parties which regulators have determined to be
sufficiently sophisticated to manage the risks associated with OTC
derivatives.
Of greatest relevance to Registered Advisers, investment funds
which are managed by a person or company registered as an
investment fund manager (“IFM“) in a
Canadian jurisdiction are EDPs.
While investment funds not managed by a Canadian-registered IFM
are not included in the definition of EDP in the Instrument,
pursuant to Coordinated Blanket Order 93-930 Re Temporary
exemptions for derivatives firms from certain obligations when
transacting with certain investment funds and for senior
derivatives managers from certain reporting obligations
(“93-930“) investment funds managed by
an IFM registered or authorized under the securities or commodities
futures laws of a foreign jurisdiction are exempted from the same
provisions of the Instrument as an EDP would be.
Additional categories of EDPs which would be relevant to
Registered Advisers are:
- Corporations or other entities, other than individuals, with at
least CAD 25 million in net assets as shown on their most recently
prepared financial statements; - Pension funds regulated by Canadian or foreign
authorities; - Individuals with at least CAD 5 million in financial assets
(before taxes but net of related liabilities)
(“Individual EDPs”); and - Eligible commercial hedgers (which are persons or companies
that carry on a business and enter into OTC derivatives to hedge
the risks associated with such business (“Eligible
Commercial Hedgers“)) that have represented in
writing to the Registered Adviser that they are acting as a
commercial hedger with respect to the OTC derivatives for which
they are being advised.
In the case of Individual EDPs and Eligible Commercial Hedgers,
the exemptions applicable to EDPs only apply where the Individual
EDP or Eligible Commercial Hedger has provided the Registered
Adviser with a written statement that it agrees to “waive
protections” provided in the Instrument and specifically sets
out which protections it agrees to waive.
When advising EDPs (including Individual EDPs and Eligible
Commercial Hedgers which have waived all protections provided in
the Instrument), Registered Advisers are only subject to the
following requirements:
- Fair dealing (Section 9): A derivatives
adviser must deal fairly, honestly, and in good faith with
derivatives parties. - Conflicts of interest (Section 10): A
derivatives adviser must establish, maintain and apply reasonable
policies and procedures to identify all material conflicts of
interest, and material conflicts of interest that the derivatives
adviser in its reasonable opinion would expect to arise, between
the derivatives adviser and its client. Derivatives advisers must
also respond to any identified conflicts of interest. - Know your derivatives party (Section 11): A
derivatives adviser must establish, maintain and apply reasonable
common know your client (“KYC“) policies
and procedures including to ensure that it verifies the identity,
reputation, and creditworthiness of parties it deals with, assess
insider or non-public information risks, and identify key
controllers of corporate, partnership, or trust entities. It must
take reasonable steps to keep current this same information. - Policies and procedures (Section 31): A
derivatives adviser must implement policies and controls that
establish a system of controls and supervision sufficient to
provide reasonable assurance and incorporate effective risk
management, and that ensure individuals acting on its behalf are
competent, knowledgeable about derivatives, and act with
integrity.
Action Items:
Registered Advisers who advise with respect to OTC derivatives
should consider taking the following steps:
- Obtain EDP Representations from Clients: A
representation as to the EDP status of each client of a Registered
Adviser which it advises or expects to advise with respect to OTC
derivatives should be obtained. The representation should
explicitly state why such client qualifies as an EDP. In addition,
for Individual EDPs and Eligible Commercial Hedgers, a statement
should be obtained setting out which protections in the Instrument
are being waived. For investment funds which are not EDPs but
qualify for exemptions from provisions of the Instrument pursuant
to 93-930, a representation should be obtained stating that such
investment fund is managed by an IFM registered or authorized under
the securities or commodity futures laws of a foreign
jurisdiction. - Updating Policies: Review and amend existing
fair dealing, conflicts of interest and KYC policies to explicitly
include OTC derivatives. This may involve updating language to
encompass OTC derivatives alongside securities. - Updating Offering Memoranda and Client Relationship
Disclosure: Review and revise the offering memorandum for
each fund whose investment strategy includes derivatives and update
relationship disclosure documentation, in each case to reflect
policy updates and to comply with disclosure requirements with
respect to conflicts. - Proficiency and Supervision: Ensure that
individuals providing advice on OTC derivatives possess proficiency
and experience appropriate to the individual’s role. Implement
supervisory procedures to oversee OTC derivatives-related
activities effectively. This may involve requiring individuals to
take courses relating to OTC derivatives such as the Derivatives
Fundamentals Course offered by the Canadian Securities
Institute.
Please see McMillan LLP’s additional bulletins on the
Instrument:
We previously discussed the first draft of the proposed
Instrument 93-101 and its companion policy during the initial
period for request for comments in our bulletin from April 2017. The
first draft was published on April 4, 2017, and remained open for a
lengthy 150-day comment period. A second draft was published on
June 14, 2018, and was open for a 90-day comment period, during
which submissions were received from 21 commenters.
A third draft was published on January 20, 2022. The main
changes in the third draft were the elimination of the $10 million
financial threshold for the Eligible Commercial Hedgers category in
the definition of eligible derivatives party and the introduction
of a foreign liquidity provider exemption for foreign dealers. The
third draft was open for a 60-day comment period, during which
submissions were received from 10 commenters. We discussed the
third draft in our bulletin from February
2022.
On September 28, 2023, the CSA published the Instrument and our
bulletin highlighted the
changes made from the third draft to the final Instrument. These
changes were made in response to comments received during the third
consultation period.
The foregoing provides only an overview and does not
constitute legal advice. Readers are cautioned against making any
decisions based on this material alone. Rather, specific legal
advice should be obtained.
© McMillan LLP 2024