Japan Securities Clearing Corporation
NI 94-102 -- protection of customer cleared derivatives collateral and positions -- applicant seeking relief from certain requirements relating to the commingling of customer positions and relief to substitute compliance of certain NI 94-102 requirements with comparable Japanese laws -- relief granted, subject to conditions.
Applicable Legislative Provisions
National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions, ss. 30(b), 32(2), 48.
October 2, 2023
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO AND QUEBEC (the Jurisdictions) AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF JAPAN SECURITIES CLEARING CORPORATION (the Filer)
The securities regulatory authority or regulator in each of the Jurisdictions (the Decision Maker) has received an application from the Filer for a decision under the securities legislation of the Jurisdictions (the Legislation) in Ontario and Quebec pursuant to section 49 of National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions (NI 94-102) and in Québec pursuant to section 86 of the Derivatives Act (Québec), CQLR, c. I-14.01, for relief from certain requirements applicable to regulated clearing agencies under NI 94-102. More specifically, the Filer
(i) seeks substituted compliance relief that would permit it to comply with applicable Japanese law in lieu of complying with the Regulated Clearing Agency Provisions (defined below); and
(ii) seeks relief to commingle customer positions in Japanese Government Bond futures contracts and options on such futures contracts (collectively, JGB Futures) as further set out below in the representations at section 20 and cleared-only interest rate swaps (IRS), and any money, securities or property used to margin, guarantee or secure such JGB Futures and IRS, in accounts of clearing participants (Clearing Participants) offering services to a local customer (Customer Accounts) (collectively, theExemptive Relief Sought).
The Exemptive Relief Sought would place the Filer in a similar position to clearing agencies domiciled in the U.S. and in Europe that are currently permitted to rely on substituted compliance under Part 9 of NI 94-102.
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a coordinated review application):
(a) the Ontario Securities Commission (the OSC) is the principal regulator for this application, and
(b) the decision is the decision of the principal regulator and evidences the decision of each Decision Maker.
Terms defined in National Instrument 14-101 Definitions and NI 94-102 have the same meaning if used in this decision, unless otherwise defined.
This decision is based on the following facts represented by the Filer:
1. The Filer is a joint-stock company under the Companies Act of Japan and is a majority-owned subsidiary of the Japan Exchange Group, Inc., a publicly traded company listed on the Tokyo Stock Exchange, Inc. The Filer's registered and head office is located at 2-1 Nihombashi Kabutocho, Chuo-ku, Tokyo 103-0026 Japan.
2. The Filer is exempt from the requirement to be recognized as a clearing agency in Ontario pursuant to an interim order dated September 29, 2023 (the OSC Interim Order). The Filer has filed a full application with the OSC for a subsequent order exempting it from the requirement to be recognized as a clearing agency in Ontario (the Subsequent Order).
3. The OSC Interim Order shall terminate on the earlier of (i) September 28, 2024 or (ii) the effective date of the Subsequent Order.
4. The OSC Interim Order provides that the Filer's activities in Ontario will be limited to Permitted Clearing Services (as defined in the OSC Interim Order and as may be redefined in the Subsequent Order).
5. The Filer is a regulated clearing agency under NI 94-102.
6. The Filer is not in any material respect in default of the Legislation and is in compliance in all material respects with applicable Japanese laws.
7. The Filer offers Permitted Clearing Services using the clearing model(s) permitted by the OSC Interim Order and as may be permitted by the Subsequent Order.
8. The Filer is licensed to perform IRS clearing services under the Financial Instruments and Exchange Act (Japan) (FIEA). The Filer is regulated and supervised by the Japanese Financial Services Agency (JFSA) under the FIEA and is subject to the oversight of the Bank of Japan in respect of its IRS clearing services.
9. The Filer is obligated under the FIEA to conduct its IRS clearing business in accordance with its Interest Rate Swap Clearing Business Rules (the IRS Business Rules), which are subject to approval by the Prime Minister of Japan.
10. The IRS Business Rules set out the rights and obligations in relation to the IRS clearing business, including the risk-management framework, to ensure the stable performance of the Filer's clearing operations. The FIEA and Cabinet Office Order on the Regulation of Over-the-Counter Derivatives Transactions require certain types of IRS and credit default swaps denominated in Japanese yen to be cleared in a licensed clearinghouse. In addition, these laws and regulations require certain over-the-counter derivative contracts to be reported to trade repositories either (i) licensed in Japan or (ii) incorporated in a foreign jurisdiction and designated by the Prime Minister of Japan.
Regulated Clearing Agency Provisions -- Substituted Compliance
11. The JFSA publishes Comprehensive Guidelines for Supervision of Financial Market Infrastructures (CCP Supervisory Guidelines), which reflect in its supervisory framework the substance of the international standards applicable to financial market infrastructures described in the April 2012 report named Principles for Financial Market Infrastructures (PFMIs) published by the Committee on Payments and Market Infrastructures of the International Organization of Securities Commissions (CPMI-IOSCO). The Filer observes the PFMIs by complying with the CCP Supervisory Guidelines. The Japanese legal and regulatory framework for CCPs, which covers its margining practices, was assessed by CPMI-IOSCO as fully consistent with the PFMIs.
12. The Filer seeks the Exemptive Relief Sought from the following sections of NI 94-102 (the Regulated Clearing Agency Provisions) so that it may, on a substituted compliance basis, comply with the comparable rules applicable to the Filer under Japanese law, as set out on Schedule A, in lieu of complying with the Regulated Clearing Agency Provisions:
• Section 28 [Collection of initial margin]
• Section 29 [Segregation of customer collateral -- regulated clearing agency]
• Section 30 [Holding of customer collateral -- regulated clearing agency]
• Section 31 [Excess margin -- regulated clearing agency]
• Section 32 [Use of customer collateral -- regulated clearing agency]
• Section 33 [Investment of customer collateral -- regulated clearing agency]
• Section 34 [Use of customer collateral -- clearing agency default]
• Section 35 [Risk management -- NI 24-102 applies]
• Section 37 [Daily records -- regulated clearing agency]
• Section 38 [Identifying records -- regulated clearing agency]
• Section 39 [Records of investment of customer collateral -- regulated clearing agency]
• Section 40 [Records of currency conversion -- regulated clearing agency]
• Section 41 [Disclosure to direct intermediaries by regulated clearing agency]
• Section 42 [Customer information -- regulated clearing agency]
• Section 45 [Disclosure of investment of customer collateral]
• Section 46 [Transfer of customer collateral and positions]
Regulated Clearing Agency Provisions -- Portfolio Margining
13. The Filer currently offers portfolio margining of (a) certain IRS and (b) certain JGB Futures, in each case, in IRS Customer Accounts in accordance with Article 59 of the IRS Business Rules.
14. The Filer states that permitting local customers to portfolio-margin IRS and JGB Futures in IRS Customer Accounts will not make such customers more susceptible to shortfalls in the event of an insolvency of a Clearing Participant or impair their ability to port positions.
15. The Filer offers Ontario resident entities an individual segregated IRS Customer Account structure. Positions and collateral in each IRS Customer Account where JGB Futures and IRS positions are commingled receive a high level of protection since each IRS Customer Account is individually segregated. Because the IRS Customer Accounts are individually segregated, the Filer cannot use the collateral of one customer to pay for the obligations of another customer. Accordingly, this is an account structure that does not introduce fellow customer risk.
16. When a Clearing Participant or a customer who uses the Filer's IRS clearing services and JGB Futures clearing services chooses to portfolio-margin its IRS and JGB Futures positions, the required amount of initial margin for the Clearing Participant or the customer, as applicable, is calculated on a portfolio basis across IRS and JGB futures in the IRS Customer Account. The Filer's Clearing Participants are allowed to apply for netting a part or the whole of their JGB futures positions with their IRS positions upon default and to calculate the required initial margin of the portfolio based on the calculation methodology for IRS.
17. If a Clearing Participant or customer that has elected portfolio-margining defaults, then, pursuant to the IRS Business Rules and corresponding business rules of the Filer in respect of JGB Futures clearing, the relevant JGB Futures positions of the defaulting Clearing Participant or customer would be automatically transferred to the Clearing Participant's or customer's IRS account, so that the default losses of the Clearing Participant or customer with respect to IRS and JGB Futures are netted in a single account for IRS.
18. The Filer also states that the Filer collects initial margin for each Customer Account, which is segregated for each individual customer, on a gross basis, and that each Clearing Participant deposits the full amount of customer margin with JSCC without delay when it receives margin from a customer. These factors increase the likelihood that each Customer Account is fully margined at the time of a Clearing Participant's default and therefore facilitate the rapid and successful porting of customer positions to one or more solvent Clearing Participants.
19. If the Exemptive Relief Sought is granted, the Filer will offer to local customers as defined in NI 94-102:
(a) portfolio-margining of JGB Futures and IRS, as conducted in accordance with the IRS Business Rules; and
(b) portfolio-margining of JGB Futures, IRS and any other instruments that may in the future be eligible under the IRS Business Rules for portfolio-margining with IRS, provided that the individually segregated IRS Customer Account structure, procedures on default and margin collection practices and rules applicable to such instruments are substantially the same as described under the foregoing Representations 14 to 18.
20. If the Exemptive Relief Sought is granted, the following JGB Futures will be eligible for commingling with IRS in IRS Customer Accounts for the purpose of portfolio margining: 10-year JGB Futures (whether "large" or "mini") with the nearest and second nearest contract months, and any other JGB Futures that may in the future be eligible under the IRS Business Rules for portfolio-margining with IRS.
21. In order that the Filer is able provide IRS clearing services to local customers in the Jurisdictions without being required to comply with the Regulated Clearing Agency Provisions, provided that such clearing services are provided in accordance with Japanese laws and regulations, including the IRS Business Rules, the Filer requests that the Exemptive Relief Sought be granted.
Each of the Decision Makers is satisfied that the decision meets the test set out in the Legislation for the Decision Maker to make the decision.
The decision of the Decision Makers under the Legislation is that the Exemptive Relief Sought is granted, provided that the Filer (i) complies with the terms and conditions of the OSC Interim Order; (ii) upon termination of the OSC Interim Order, is exempt from the requirement to be recognized as a clearing agency in Ontario pursuant to a Subsequent Order and complies with the terms and conditions of the Subsequent Order; and (iii) complies with the laws of Japan applicable to the Filer set out on Schedule A.
Laws, Regulations or Instruments
Provisions of NI 94-102 applicable to a regulated clearing agency despite compliance with the foreign jurisdiction's laws, regulations or instruments
Interest Rate Swap Clearing Business Rules of Japan Securities Clearing Corporation
Japanese Financial Services Agency, Comprehensive Guidelines for Supervision of Financial Market Infrastructures -- Clearing Organizations, Fund Clearing Organizations, Book-entry Transfer Institutions, and Trade Repositories, June 2022, as amended
Section 36 [Retention of records -- regulated clearing agency]
Section 43 [Customer collateral report -- regulatory]
Section 44 [Customer collateral report -- direct intermediary]