Federally regulated financial institutions can engage directly in physically settled commodity trading, the Office of the Superintendent of Financial Institutions has ruled.

The ruling came in response to a request from a foreign bank, which asked OSFI to reconsider its legal interpretation that FRFIs may engage in physically settled energy trading in Canada only through their securities dealer subsidiaries. The unnamed foreign bank believed the risks would be essentially the same as having its Canadian branch directly engage in physically settled commodity trading transactions as opposed to the current practice of indirectly engaging in the practice through a securities dealer subsidiary.

OSFI says that the issue was whether physically settled commodity trading should be regarded as a financial service, which is a permitted activity; or, dealing in goods, wares or merchandise, or engaging in any trade or other business, which are prohibited activities under the federal financial institution statutes.

OSFI concluded that FRFIs are permitted to engage in physically settled commodity trading, under certain conditions. It said an FRFI must enters into such transactions only with customers who are producers or end users in the context of financial risk-management services to those customers, or with other market intermediaries to manage its exposure to the relevant commodity. The FRFI must also take title to the commodity only on a “transitory” basis and only in connection with, or for the purpose of facilitating, the settlement of the transaction.

OSFI said that from a prudential standpoint, when an FRFI engages in physically settled commodity trading, it will have appropriate risk measurement and management policies and procedures in place; and, that it will be adequately capitalized for the risk assumed from engaging in physically settled commodity trading.