OTC Derivatives Trading And Clearing Rules Move Closer To Implementation

Canada's securities regulators have taken two additional steps towards implementing a comprehensive regulatory framework for over-the-counter derivatives (OTC Derivatives) and satisfying Canada's G20 commitments in respect of mandatory trading and central counterparty clearing of standardized OTC Derivatives. The most recent regulatory notices discuss the basis on which certain standardized OTC derivatives will be required to be traded over organized marketplaces and provide a proposed rule regarding mandatory clearing of certain OTC Derivatives through regulated clearing agencies (referred to as "central counterparties" or "CCPs"). This bulletin discusses these developments and the proposed timeline for their implementation.

PROPOSED MANDATORY DERIVATIVES CLEARING RULE

On February 12, 2015, the Canadian Securities Administrators (CSA) published for comment Proposed National Instrument 94-101 Mandatory Central Counterparty Clearing of Derivatives (Proposed Clearing Rule). If adopted, the Proposed Clearing Rule will require that certain OTC Derivatives entered into by Canadian local counterparties be submitted to a recognized or exempt CCP for clearing, except in the limited circumstances described below. The Proposed Clearing Rule generally follows the approach set out in the draft model rule published by the CSA Derivatives Committee in December 2013 and, to ensure consistency, is proposed to be adopted in all Canadian provinces and territories in the form of a single National Instrument.

The primary objectives of requiring clearing of OTC Derivatives are to improve transparency in the derivatives market and to reduce the systemic risk to national and international credit markets that the default of a significant market participant could cause by triggering a cascade of defaults by other market participants. Central counterparty clearing interposes a central counterparty with a robust credit structure in what would otherwise be a private, bilateral contractual arrangement. When a CCP accepts a bilateral OTC Derivative contract for clearing, the CCP becomes the counterparty to each contracting party under a pair of new off-setting but independent transactions, thereby eliminating the direct credit link between the contracting parties while preserving the economic terms of the original transaction.

The CSA's methodology for identifying which OTC Derivatives are subject to mandatory clearing, together with the limited exemptions from the clearing requirements, will determine whether particular OTC Derivatives transactions will be caught by the new mandatory clearing regime.

The CSA's goal is to have the Proposed Clearing Rule come into force in the fourth quarter of 2015 or the first quarter of 2016, but clearing obligations will not apply until the CSA takes additional steps to designate specific classes of OTC Derivatives as being subject to mandatory clearing. It is expected that the CSA will also issue in the next month a revised version of the companion rule regarding Derivatives Customer Clearing and Protection of Customer Positions and Collateral, which was initially published as a model rule in January 2014.

Comments regarding the Proposed Clearing Rule may be submitted to the CSA until May 13, 2015.

Designation of Specific Classes of OTC Derivatives as Mandatorily Clearable Derivatives

Under the Proposed Clearing Rule, the CSA will, from time to time, designate specific...