Article by
Marsha P. Gerhart 
,
Julie Mansi ,
Carol Derk ,
Stephen J. Redican 
,
Neil Guthrie and
David R. Surat
The Ontario government has enacted amendments to the Securities Act (OSA) that provide a legislative framework for the regulation of derivatives, credit rating organizations and alternative trading systems.
The amendments are buried in Schedule 18 of Bill 135, the Helping Ontario Families and Managing Responsibly Act, 2010, which received royal assent following third reading in the Ontario legislature on December 8, 2010. A number of the derivatives-related amendments will come into force on proclamation (as discussed below), while the balance of the amendments came into force upon royal assent.
The amendments are independent of the recent consultation paper published by the Canadian Securities Administrators (CSA) (of which the Ontario Securities Commission is a member) on November 2, 2010 concerning over-the-counter (OTC) derivatives regulation in Canada. Please see the Borden Ladner Gervais LLP Financial Services Client Update Over-the-counter (OTC) Derivatives Market in Canada: On the Road to Reform and Regulation, available here, for a discussion of the CSA's consultation paper and the discussion paper published October 26, 2010 by the Canadian OTC Derivatives Working Group.
Scope
The amendments set out a broad definition of "derivative", while preserving the current regime for the regulation of commodity futures contracts and commodity futures options under the Commodity Futures Act. Keeping a separate system for commodity futures is not entirely desirable, but incorporating a modernized legislative scheme for them in the OSA must have seemed too daunting a task.
The Ontario Securities Commission (the Commission) is empowered to determine by order that a particular contract or instrument is or is not a derivative, while the rules will permit a similar determination in respect of a contract or instrument in a class of instruments or contracts. The new rule-making powers will come into effect on proclamation. A financial product deemed to be a derivative by either process will be a "designated derivative". The Commission also has the power to make an order that a particular derivative is not a designated derivative. The Commission will have the authority, subject to proclamation, to deem products in a prescribed class of derivatives to be securities for certain regulatory purposes. These provisions will provide the flexibility to treat financial products on a case-by-case basis and to tailor their regulatory treatment accordingly. This could be used to arrive at results that are consistent with the treatment of particular products under the Québec Derivatives Act.
Trading and Market Conduct
The market conduct rules for trading in securities found in Part XIII of the OSA have been extended to trades in derivatives. Subject to proclamation, a new Part XV.1 will be added to the OSA, imposing requirements for the trading of designated derivatives. Trading in a designated derivative will be prohibited except in circumstances where a disclosure document filed with and accepted by the Director under the OSA has been provided in accordance with the regulations, subject to the possibility of exemptions. The focus of these provisions is presumably on trading by retail investors, who require disclosure of both product features and counter-party risk.
The prospectus requirements of Part XV of the OSA and related regulations will not apply to designated derivatives, derivatives with standardized terms that are traded on an exchange or derivatives traded in any other marketplace, if certain conditions (to be set out in the regulations) are satisfied.
The Commission's supervisory powers have been extended to exchanges on which derivatives are traded and new powers have been conferred in respect of the regulation of trade repositories.
Prohibitions and Enforcement
The prohibitions on insider trading and tipping, misrepresentations in disclosure documents and fraud and market manipulation have been amended to include derivatives. Civil liability for insider trading and tipping under the OSA applies to "related derivatives" (defined as derivatives with a market price, value, delivery obligation, payment obligation or settlement obligation materially derived from, referenced to or based on that of a security), which addresses a potential regulatory gap in the current legislation. The investigation and enforcement provisions of Parts VI and VII of the OSA are amended to apply to derivatives and will be amended to apply to disclosure documents for derivatives. The Commission's authority to issue sanctions in the public interest will also specifically address derivatives.
Registration Requirements for Dealers and Advisers
Under the amendments to the OSA, the registration requirement will be extended to anyone in the business of trading in derivatives or in the business of advising with respect to the buying or selling derivatives. These amendments basically impose the same registration regime on anyone in the business of dealing in or advising on derivatives that currently exists for anyone in the business of dealing in or advising on securities. While the requirement to be registered is set out in the OSA, most of the conditions of registration – e.g. proficiency, capital, insurance, compliance and other ongoing business conduct requirements – are found in National Instrument 31-103 Registration Requirements and Exemptions (NI 31-103) or in the rules of a self-regulatory organization. However, at this time, no amendments to NI 31-103 or new regulations specific to derivatives registration have been proposed, so it is unclear how a registration requirement for derivatives activities will be practically implemented. Will new categories and conditions of registration designed specifically for derivatives activities be introduced or will those in the business of trading or advising in derivatives be required to register in an existing dealer or adviser category as set out in NI 31-103? There is also is no indication at this time of whether any derivatives activities would be exempt from the registration requirements. The effectiveness of the registration-related amendments have generally been delayed until a date to be proclaimed.
In the absence of categories and conditions of registration designed specifically for derivatives activities, existing dealer categories would have to be used, the most likely being the investment dealer category (which requires membership in the Investment Industry Regulatory Organization of Canada). However, even with that category, a technical amendment to NI 31-103 would be needed to include dealing in derivatives. Similarly, anyone in the business of advising on the buying and selling of derivatives would likely be required to register as a portfolio manager (provided a technical amendment was made to NI 31-103 to that category to include advising in derivatives). But query whether existing dealer and adviser categories are appropriate for all derivatives activities. For example, do the capital and insurance requirements for a traditional investment dealer adequately address derivative market risks? It may be that the "restricted dealer" and "restricted adviser" categories introduced when NI 31-103 was implemented could be considered as an alternative to the investment dealer or portfolio manager categories, since the intention of the restricted categories is to accommodate business models that don't quite fit the more traditional dealer and adviser categories.
Rule-Making
Rule-making power has been granted with respect to listing and trading derivatives (including clearing and settlement, trade reporting and quotation and requirements for clearing through a clearing agency). Additional authority to make rules regarding the following will be effective on proclamation: prescribing requirements for classes or derivatives; disclosure documents; record-keeping, reporting and transparency; margin, collateral and capital requirements; clearing and settlement; and position limits. Rules could also preclude the trading of one or more classes of derivatives in Ontario.
Other Amendments
Other Bill 135 amendments set out a regime for the designation and regulation of credit rating organizations in a new Part IX of the OSA and for the recognition and regulation of alternative trading systems.
The definition of "reporting issuer" for the purposes of the insider trading provisions has been extended to those issuers with a real and substantial connection to Ontario and that trade on the TSX Venture Exchange.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
