First step aligned with US rules, cross-border harmonisation expected. Dan Barnes explores how trade reporting of OTC derivatives in evolving in Canada.
As of 31 December 2013 three provinces of Canada, Ontario and Quebec, will introduce trade reporting rules, with reporting expected to commence in July 2014. They will represent the first step in delivering on the commitment to the G20 mandate of 2009, ensuring that: “All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories (TRs). Non-centrally cleared contracts should be subject to higher capital requirements.”
The objective is to reduce systemic risk by better tracking and supporting trading positions, so uncertainty does not paralyse the market at times of stress and poor risk management only harms the firm guilty of misjudgment. Trade reporting is the first step in the process as it gives regulators in every jurisdiction some data to gauge the market in their territory. The Canadian model for trade reporting is most closely aligned with that of the US Commodity and Futures Trading Commission (CFTC), focused on over-the-counter (OTC) derivatives. Although Canada’s derivatives trading is small in global terms, industry estimates putting it at approximately 1-3% of total volume, and it represents a single national market, “the country is divided into 13 jurisdictions – 10 provinces and three territories – with a financial regulator for each, and they have historically determined their own rules for trading.
The best part of breaking up
To tackle the requirement for national regulation, the provinces divided the tasks up, explains Mike White, global head of product at buy- and sell-side derivatives trading venue, CanDeal.
“This has been a very large undertaking,” he says. “What the regulators did early on was recognise the scale and scope of the project and basically carved it up. Various provinces were given responsibility for [developing] various things so the reporting and repository part of the project fell to Ontario, Quebec and Manitoba. The registration rule and trading rule will be coming at some point in the future from British Colombia and Alberta respectively.”
The type of trading found in a province is likely to be determined by the concentration of businesses, for example, the large banks are mostly based in Ontario and Quebec so financial products such as interest rate swaps are more likely to be dealt with in those jurisdictions; by contrast in Alberta one would expect a lot of oil trading and energy products.
“The problem with derivatives is legislation is different in each jurisdiction,” says Derek West, senior director, derivatives oversight at Autorité des Marchés Financiers (AMF), the regulator for Quebec. “For example, we have the Derivatives Act, which is dedicated to derivatives whether listed or OTC and Ontario has the Commodities Futures Act that is only for listed derivatives. Any other derivatives come under the Securities Act, and that is the same in Manitoba. While those three provinces have legislation, others are working on getting something in place.”
Nevertheless, he says that the provinces have worked well to create a harmonised set of rules.
“The legislation has evolved in a harmonised fashion and we are working on that process. We have trade reporting rules coming into place on 31 December in Ontario, Manitoba and Quebec. Those rules are identical except tweaked so that each refers to local legislation. The other provinces are then expected to publish a multilateral set of rules identical to ours.”
The market reception to the trade reporting rules has been relatively positive; although delivery of the rules is some way behind the G20 target regulators have taken a considered approach, says White.
“Domestic regulators have taken a very methodical approach, they have watched what has happened south of the border with the Commodities Futures Trading Commission (CFTC) and the Securities Exchanges Commission (SEC), the two US derivatives regulators, and they are using what they see while being cognisant of the size of Canada’s market.”
The rules
Under the rules that have been published 14 November 2013 by Ontario Securities Commission (OSC), the AMF and the Manitoba Securities Commission (MSC), reporting of contract creation data is required to be completed on a real-time basis, however where it is not technologically possible to do so then the counterparty must report as soon as possible, not later than the end of the next business day. As with US rules, lifecycle event data – such as a status confirmation or partial termination – can be included in a snapshot of the trade reported by the end of each day, rather than reporting each trade event separately as required under European rules.
Kevin Fine, director for derivatives at the OSC says, “The large banks are already reporting in the US and they are the vast majority of the dealer community here in Canada so we are confident they will help the process run smoothly, particularly if it is the same TRs that get licensed here. The buy-side are less familiar with it so we are doing all we can to help them. For example on 15 January 2014 we are holding a seminar to walk them through what the reporting rules and obligations mean for them.”
The obligation to report varies according to firms involved and the type of trade i.e. cleared or uncleared. If the transaction is cleared then the clearing agency reports the transaction. If it is not cleared and is between two sell-side firms then each is obliged to report it, but they may delegate, as specified under a subsection of the ruling, in order to avoid duplicate reporting. If a buy- and a sell-side firm make an un-cleared trade, the derivatives dealer will report. The local counterparty to the transaction is obliged to report in any other case.
“One thing I don’t really like about the Canadian Rules is that the reporting hierarchy is quite complicated,” says Donna Bales, managing partner of Balmoral Advisory Group, a boutique capital market advisory firm. “The local counterparty is ultimately responsible for trade reporting, so although they can delegate I don’t know that anyone will. If a reporting counterparty delegates reporting, they still need to keep records of all their transactions for seven years, the reporting counterparty must also reconcile when they have reported and when they have delegated. Some may decide it’s easier just to report.”
However, West believes that the level of work involved will not be too burdensome for firms that are not clearing their derivatives.
“If you are taking the time to negotiate the ISDA agreement because the trade is not being cleared then the regulatory burden is not huge. It will take some time but one would hope much of the work was already done.”
Next steps
On 19 December 2013 the Canadian Securities Administrators (CSA) OTC Derivatives Committee published its Central Counterparty Clearing Rule and guidance. It says that a local counterparty trading a clearable derivative – as defined by the local authority – must clear the trade via an appropriate agency, as the agency requires, by the end of the day of execution unless the transaction is executed after the business hours of the clearing agency in which case the transaction must be submitted for clearing the following business day.
If any changes are made to a transaction in a clearable derivative that had been entered into before the date of the rule coming into force, then it will also be subject to clearing once the rule is in effect.
The Governor of the Bank of Canada designated SwapClear as an eligible clearing system under the subject under the Payment Clearing and Settlement Act (PCSA), on 2 April 2013.
SwapClear, established in 1999, is significant global system for centrally clearing OTC interest rate swaps and is operated by post-trade infrastructure provider LCH.Clearnet. Clearing activity of Canadian institutions in SwapClear had already increased substantially by April, partly as a consequence of the G20 commitment. Since Canadian authorities agreed in October 2012 that any CCP, including global CCPs, that clears OTC derivatives and is recognised by Canadian authorities can be used by Canadian market participants if it follows global standards and practices it is expected that SwapClear activity will increase.
White notes that Canada would like to produce a ‘made-at-home’ solution but that the costs involved in creating a clearing house would be prohibitive given the relative level of activity in the market, and that the advantages of netting off collateral, posted as margin to underpin a trading position, would be lost across multiple houses.
“Early on the idea of having a sovereign solution was suggested as the way forward, but if all 20 countries in the G20 matrix had a sovereign solution, the cost of implementation would have been prohibitive,” he says. “The market has gravitated towards LCH.Clearnet anyway and, frankly, harmonisation is the ultimate goal for everyone concerned.”
Comment on the clearing rules proposed by the CSA is required by 19 March 2014, which Bales believes suggests that the publication of a final Rule for clearing is some way off.
Canada Snapshot:
Regulators:
British Columbia Securities Commission
The Manitoba Securities Commission
Financial and Consumer Services Commission (New Brunswick)
Office of the Superintendent of Securities Service Newfoundland and Labrador
Northwest Territories Securities Office
Nova Scotia Securities Commission
Nunavut Securities Office
Ontario Securities Commission
Office of the Superintendent of Securities (Prince Edward Island)
Autorité des marchés financiers (Quebec)
Financial and Consumer Affairs Authority of Saskatchewan
Office of the Superintendent of Securities (Yukon Territory)
Clearing houses
Canadian Derivatives Clearing Corporation (part of TMX Group)
SwapClear (part of LCH.Clearnet)
Derivatives Exchanges
Montreal Exchange (part of TMX Group)
