CSA faces opposition

In April, the CSA, a group of provincial and territorial regulators, issued a proposed rule that would create a registration regime for dealers and financial advisors who trade in the OTC derivatives markets in Canada.

In June, the CSA also published a revised version of its business conduct rule for a second comment period. (That rule initially was published for consultation in 2017.) Subsequently, the Ontario Securities Commission held a public hearing in late September to review the CSA’s proposals.

Taken together, the CSA’s proposals aim to address the vulnerabilities revealed in the lack of regulation in OTC derivatives markets that the global financial crisis exposed, as well as by subsequent industry scandals. These scandals included episodes of apparent misconduct, such as those involving financial benchmark and foreign-exchange market manipulation, both of which involved derivatives traders as well.

The overarching objectives of the CSA’s proposals are to enhance oversight, transparency and accountability in the OTC derivatives markets, to boost investor protection and to curb systemic risk. To that end, the CSA seeks to establish a registration regime for the Canadian derivatives markets that would ensure that regulators have oversight of firms that are participating in the markets. The proposed regime also would introduce requirements designed to mitigate firms’ risks and to ensure their employees’ proficiency.

At the same time, the revised business conduct rule aims to create uniform rules for firms that participate in all Canadian markets, including: establishing requirements for dealing with conflicts of interest; setting “know your client” obligations; and for detailed requirements for record-keeping and compliance.

The comment period for both sets of proposals ran until late September, attracting widespread criticism of the CSA’s plans from industry groups. Submissions from lobbyists for various factions of the Canadian financial services sector, along with groups representing foreign dealers and advisors, called on the CSA to reconsider the scope of its plans.

Specifically, the groups’ comments cited concerns that the rules will drive firms out of the OTC derivatives markets in Canada, thus undermining market liquidity and, ultimately, harming the economy.

Submissions to the CSA from the investment industry expressed unanimous support for the underlying objective of enhancing oversight in the OTC derivatives markets. However, most of the groups also are concerned that the proposals are too far-reaching and would in- crease firms’ regulatory obligations to the point at which many firms simply would decide that the added costs aren’t worth the trouble in a country that represents only about 4% of the global derivatives market.

For example, the Canadian Bankers Association’s (CBA) submission argues that adopting the CSA’s proposed regime would negatively impact both the Canadian derivatives markets and the economy as a whole.

The CBA’s submission states that the regulatory requirements that would be introduced under the new rules, coupled with their broad application, “will deter foreign dealers from participating in Canadian OTC derivatives markets.”

Although Canada accounts for only a small fraction of the global derivatives market, the CBA’s submission states that 80% of the Canadian banks’ trading activity involves foreign counterparties.

“Put simply, Canadian markets require access to foreign dealers, but foreign dealers do not require access to Canadian markets,” the CBA’s submission states, adding that the impact “will be borne by clients, negatively impacting their earnings and diminishing returns to investors and pensioners. This ultimately will have a negative effect on the Canadian economy.”

The CBA’s submission adds that “the proposed rule poses significant systemic and market risks for the Canadian OTC derivatives markets, end-users and for the economy as a whole.”

With that in mind, the CBA’s submission recommends that Canadian banks be excluded completely from the proposed regime. Currently, the proposed registration rule would exempt members of the Investment Industry Regulatory Organization of Canada (IIROC) on the basis that they’re already subject to equivalent requirements that IIROC has imposed.

The submission from the Canadian Market Infrastructure Committee (CMIC) – a group representing the views of large buy- and sell-side firms, both domestic and foreign – echoes the assertion that the proposed CSA regime could end up having a negative impact on foreign firms’ participation in the Canadian derivatives markets and, ultimately, on Canada’s economy. Indeed, the CMIC’s submission warns, the regime contemplated in the CSA’s proposed rules is “not appropriate” for the Canadian markets.

Specifically, the CMIC’s submission argues that the proposed registration regime “will disrupt the OTC derivatives market[s] in Canada and will create systemic and economic risks instead of reducing [them].”

Furthermore, the CMIC’s submission also calls on the securities regulators to exempt financial services institutions that already are regulated by OSFI from the proposed registration rules and to exempt foreign dealers and advisors from registration on a basis similar to that of securities rules: “Exempting all foreign derivatives dealers is critical to maintaining liquidity in the Canadian OTC derivatives market[s].”

In addition to the concerns about the possible impact on derivatives markets’ liquidity and the economy, other submissions warn that the CSA’s proposed new derivatives regime may overlap and conflict with other CSA rules, such as the planned overhaul of the securities registration rules known as the “client-focused reforms.”