The Canadian securities regulators adopted a business conduct rule for derivatives dealers and advisers which will become effective on September 28, 2024 (the rule or MI 93-101). British Columbia intends to adopt substantially similar rules and when they do so, the CSA will convert this business conduct rule (which is currently a multilateral instrument) into a national instrument. Implementing business conduct standards for OTC derivatives fills a regulatory gap and aligns the standards in Canada with international standards.
This article shines a spotlight on the impact of the new rule on advisers.
The rule establishes the fair dealing obligation which is a principles-based obligation and is intended to be similar to the duty to act fairly, honestly and in good faith applicable to registered firms and registered individuals under securities legislation (the registrant fair dealing obligation).
Does the rule apply to you if you are an adviser?
The rule applies to a person or company if they are in the business of trading in or advising on OTC derivatives regardless of whether they are registered or exempted from registration. However, the rule is drafted using the catch and release approach to policy design. In other words, even if you are “caught” based on the business trigger test and would otherwise have to comply with the rule, you may be exempt from some of the requirements of the rule. This approach permits the regulators to take a nuanced approach which includes allowing already-registered securities advisers to leverage their current compliance regimes under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) to meet the requirements of the rule. But it does make the rule a bit more complicated and difficult to understand.
To explain how catch and release works, let’s look at how the rule applies to an adviser who is registered under securities or commodity futures legislation in Canada.
If you are a derivatives adviser based on the business trigger described above, you are caught by the rule. However, if you already comply with substantially similar provisions of securities legislation (in this example NI 31-103) or commodity futures legislation, you are exempt from the following business conduct requirements in MI 93-101:
- Handling complaints
- Dealing with or advising derivatives parties (in other words, KYC collection supporting suitability, suitability determination requirements and referrals)
- Derivatives party accounts (in other words, RDI, account statements, notice to clients by non-resident registrants and handling client accounts)
- Compliance and recordkeeping (in other words, general requirements for records, accessibility and retention of records).
However, you are still required to comply with the sections in MI 93-101 on fair dealing, conflicts of interest, know your derivatives party and policies and procedures.
A helpful chart that clearly sets out which sections of MI 93-101 you do not need to comply with is included as Appendix B to the Companion Policy.
Does the rule apply to you if you are a foreign adviser or sub-adviser?
There is an exemption for advisers from jurisdictions that have comparable requirements (see Appendix D). The list is dynamic, has been expanded to include Norway and Iceland and may be further expanded as staff consider the regulatory regimes in other jurisdictions. The initial and annual filings and other requirements of this exemption are similar to the international adviser exemption in NI 31-103.
When you are advising a client, can the client waive some investor protections?
For a firm that is not already registered as a securities adviser or adviser under commodity futures legislation, MI 93-101 takes a two-tiered approach to investor protection. Certain core obligations apply in all cases when you are advising a client, regardless of their level of sophistication or financial resources. Certain additional obligations apply if you are advising a client that is not an eligible derivatives party (that is, a “non-eligible derivatives party”). However, the additional obligations may be waived if you are advising a client who is an eligible derivatives party that is an individual or a specified commercial hedger.
The term “eligible derivatives party” (EDP) refers to those clients that do not need the full set of protections afforded to “retail” customers or investors, either because they are considered sophisticated, can afford professional advice or can protect themselves contractually.
When do you need to repaper client contracts and relationship documentation so that you can rely on the EDP waivers?
If you have received any of the following representations from your client before the rule takes effect in your jurisdiction, such as:
- permitted client,
- non-individual accredited investor (in Ontario),
- accredited counterparty (in Québec),
- a qualified party (in several jurisdictions),
- an eligible contract participant (in the United States),
- a financial counterparty (in the European Union and the United Kingdom) or a non-financial counterparty above certain clearing thresholds (in the European Union and the United Kingdom, which is generally referred to by the acronym NFC+),
you can treat obtaining that representation as having obtained the required EDP representation for purposes of the transition period. The transition period begins on September 28, 2024, and ends 5 years later.
What is the impact on your compliance program?
As you develop your compliance priorities for the coming year, remember to update your internal compliance programs and documentation before September 28, 2024 and establish a plan to ensure the appropriate representations have been updated before the end of the transition period. AUM Law would be happy to assist.
October 31, 2023