R. J. O'Brien & Associates, LLC
Application for a decision to exempt the filer from the dealer registration and prospectus requirements in connection with certain distributions of and trades in over-the-counter (OTC) derivatives that are made by the filer with a "permitted counterparty" or by a permitted counterparty with the filer -- "permitted counterparty" defined to mean "permitted client" as defined in Section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations -- Exemption sought as an interim response to current regulatory uncertainty associated with the regulation of OTC derivatives, pending the development by the Canadian Securities Administrators (the CSA) of a uniform framework for the regulation of OTC derivatives in all provinces and territories of Canada -- Decision includes customary terms and conditions, including a "sunset date" that is date that is the earlier of: (i) the date that is four years after the date of the Decision; and (ii) the coming into force in the jurisdiction of legislation or a rule that specifically governs dealer, adviser or other registration requirements applicable to market participants in connection with OTC derivative transactions.
Applicable Legislative Provisions
Securities Act, R.S.O. 1990, c. S.5, as am., ss. 25(1), 53(1) and 74.
National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, s. 1.1 ("permitted client").
March 11, 2021
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO (the Jurisdiction) AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF R. J. O'BRIEN & ASSOCIATES, LLC (the Filer)
The principal regulator in the Jurisdiction has received an application (the Application) from the Filer for a decision under the securities legislation of the Jurisdiction (the Legislation) that the dealer registration requirement and the prospectus requirement in the Legislation that may otherwise be applicable to a trade in or distribution of an OTC Derivative (as defined below) made by either:
(a) the Filer to a Permitted Counterparty (as defined below); or
(b) a Permitted Counterparty to the Filer,
shall not apply to the Filer or the Permitted Counterparties, as the case may be (the Requested Relief), subject to certain terms and conditions.
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission (OSC) is the principal regulator for this Application; and
(b) the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System is intended to be relied upon in New Brunswick (to the extent that Local Rule 91-501 does not apply), Newfoundland and Labrador, Prince Edward Island, the Northwest Territories, Yukon and Nunavut (the Passport Jurisdictions and, together with Ontario, the Jurisdictions).
Unless otherwise defined herein, terms in this decision have the respective meanings given to them in National Instrument 14-101 Definitions.
The terms OTC Derivative and Underlying Interest are defined in the Appendix to this decision.
The term Permitted Counterparty means a person or company that is a "permitted client", as that term is defined in section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103).
This decision is based on the following facts represented by the Filer:
1. The Filer is a limited liability company formed under the laws of the state of Delaware of the United States of America. The head office of the Filer is located in Chicago, Illinois, United States of America.
2. The Filer is a privately-held business wholly-owned by the O'Brien family of Chicago, Illinois. The Applicant was founded in 1914 and is based in Chicago, Illinois.
3. The Filer is a registered futures commission merchant with the United States Commodity Futures Trading Commission (the CFTC) and a member of the National Futures Association in the United States.
4. The Filer provides futures commission merchant services which include commodity clearing and execution services to various financial, industrial and agricultural institutions, including affiliates of the Filer.
5. In addition to the Filer's futures commission merchant services, the Filer's business also includes brokering or intermediating bilateral OTC Derivative transactions with counterparties located in the U.S. and is limited to transacting with, or on behalf of, institutional and other non-retail clients.
6. The CFTC de minimis exception rules provide that market participants who exceed $8 billion in gross notional swap dealing activity over a twelve-month period are required to register with the CFTC. Prior to the most recent financial year end, the Filer relied on the de minimis exemption under U.S. derivatives laws as its activities did not exceed the requisite $8 billion aggregate gross notional amount threshold. The Filer is currently in the process of registering with the CFTC as a swap dealer. As required by The Dodd-Frank Act (US), the Filer is required to report all transactions on a daily basis and quarterly valuation of positions to a designated U.S. trade repository.
7. The Filer is not currently registered in any capacity in Canada. The Filer does not maintain an office, sales force or physical place of business in Canada.
8. The Filer is in compliance in all material respects with U.S. securities, commodity futures and derivatives laws. The Filer is not in default of securities, commodity futures or derivatives legislation in any jurisdiction in Canada.
Proposed Conduct of OTC Derivatives Transactions
9. The Filer proposes to broker or intermediate bilateral OTC Derivative transactions with counterparties located in all provinces and territories of Canada that consist exclusively of persons or companies that are Permitted Counterparties. The Filer understands that the Permitted Counterparties would be entering into the OTC Derivative transactions for hedging or investment purposes. The Underlying Interest of the OTC Derivatives that are entered into between the Filer and a Permitted Counterparty will consist of one of the following: a commodity; an interest rate; a currency, a foreign exchange rate; a security; an economic indicator, an index; a basket; a benchmark; another variable; another OTC Derivative; or some relationship between, or combination of, one or more of the foregoing.
10. While a Permitted Counterparty may deposit margin or collateral with the Filer in respect of its obligations under an OTC Derivative transaction, the Filer itself will not offer or provide credit or margin to any of its Permitted Counterparties for purposes of an OTC Derivative transaction.
11. The Filer seeks the Requested Relief as an interim, harmonized solution to the uncertainty and fragmentation that currently characterizes the regulation of OTC Derivatives across Canada, pending the development of a uniform framework for the regulation of OTC Derivative transactions in all provinces and territories of Canada. The Filer acknowledges that registration and prospectus requirements may be triggered for the Filer in connection with the derivative contracts under any such uniform framework to be developed for the regulation of OTC Derivative transactions.
Regulatory Uncertainty and Fragmentation Associated with the Regulation of OTC Derivative Transactions in Canada
12. There has generally been a considerable amount of uncertainty respecting the regulation of OTC Derivative transactions as "securities" in the provinces and territories of Canada other than Québec.
13. In each of British Columbia, Prince Edward Island, the Northwest Territories, Nunavut and Yukon, OTC Derivative transactions are regulated as securities on the basis that the definition of the term "security" in the securities legislation of each of these jurisdictions includes an express reference to a "futures contract" or a "derivative".
14. In Alberta, Manitoba, Ontario, New Brunswick, Nova Scotia and Saskatchewan, OTC Derivative transactions are regulated as derivatives; however, certain OTC Derivative transactions also meet the definition of "security".
15. In Newfoundland and Labrador, it is not certain whether, or in what circumstances, OTC Derivative transactions are "securities" because the definition of the term "security" in the securities legislation of this jurisdiction makes no express reference to a "futures contract" or a "derivative" and the definition of "security" does not include any category that would specifically cover OTC Derivative transactions.
16. In October 2009, staff of the OSC published OSC Staff Notice 91-702 Offerings of Contracts for Difference and Foreign Exchange Contracts to Investors in Ontario (OSC Notice 91-702). OSC Notice 91-702 states that OSC staff take the view that contracts for differences, foreign exchange contracts and similar OTC Derivative products, when offered to investors in Ontario, engage the purposes of the OSA and constitute "investment contracts" and "securities" for the purposes of Ontario securities law. However, OSC Notice 91-702 also states that it is not intended to address direct or intermediated trading between institutions. OSC Notice 91-702 does not provide any additional guidance on the extent to which OTC Derivative transactions between the Filer and a Permitted Counterparty may be subject to Ontario securities law.
17. In Québec, OTC Derivative transactions are subject to the Derivatives Act (Québec), which sets out a comprehensive scheme for the regulation of derivative transactions that is distinct from Québec's securities regulatory requirements.
18. In each of Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia and Saskatchewan (the Blanket Order Jurisdictions) and Québec (collectively, the OTC Exemption Jurisdictions), OTC Derivative transactions are generally not subject to securities or derivative regulatory requirements, pursuant to applicable exemptions (the OTC Derivative Exemptions), when they are negotiated, bilateral contracts that are entered into between sophisticated non-retail parties, referred to as "Qualified Parties" in the Blanket Order Jurisdictions and "accredited counterparties" in Québec.
19. The corresponding OTC Derivative Exemptions are as follows:
ASC Blanket Order 91-507 Over-the-Counter Trades in Derivatives
Blanket Order 91-501 Over-the-Counter Derivatives
Blanket Order 91-501 Over-the-Counter Trades in Derivatives
Local Rule 91-501 Derivatives
Blanket Order 91-501 Over the Counter Trades in Derivatives
General Order 91-908 Over-the-Counter Derivatives
Section 7 of the Derivatives Act (Québec)
The Evolving Regulation of OTC Derivative Transactions as Derivatives
20. Each of the OTC Exemption Jurisdictions has sought to address the regulatory uncertainty associated with the regulation of OTC Derivative transactions as securities by regulating them as derivatives rather than securities, whether directly through the adoption of a distinct regulatory framework for derivatives in Québec, or indirectly through amendments to the definition of the term "security" in the securities legislation of the other OTC Exemption Jurisdictions and the granting of the OTC Derivative Exemptions.
21. Between 1994 and 2000, the OSC sought to achieve a similar objective by introducing proposed OSC Rule 91-504 Over-the-Counter Derivatives (the Proposed OSC Rule) for the purpose of establishing a uniform, clearly defined regulatory framework for the conduct of OTC Derivative transactions in Ontario, but the Proposed OSC Rule was returned to the OSC for further consideration by Ontario's Minister of Finance in November, 2000.
22. The Final Report of the Ontario Commodity Futures Act Advisory Committee, published in January, 2007, concluded that OTC Derivative contracts are not suited to being regulated in accordance with traditional securities regulatory requirements and should, therefore, be excluded from the scope of securities legislation because they are used for commercial-risk management purposes and not for investment or capital-raising purposes.
23. Ontario has now established a framework for regulating the trading of derivatives in Ontario (the Ontario Derivatives Framework) through amendments to the OSA that were made by the Helping Ontario Families and Managing Responsibility Act, 2010 (Ontario).
24. The amendments to the OSA establishing the Ontario Derivatives Framework will not become effective until the date on which they are proclaimed in force. These amendments are not expected to be proclaimed in force until an ongoing public consultation on the regulation of OTC Derivatives has been completed. On April 19, 2018, the Canadian Securities Administrators (the CSA) published a Notice and Request for Comment on the Proposed National Instrument 93-102 Derivatives: Registration, and on June 14, 2018, the CSA published a Notice and Second Request for Comment on the Proposed National Instrument 93-101 Derivatives: Business Conduct, which, together, are intended to implement a comprehensive regime for the regulation of persons or companies that are in the business of trading or advising on derivatives.
Reasons for the Requested Relief
25. The Requested Relief would substantially address, for the Filer and its Permitted Counterparties, the regulatory uncertainty and fragmentation that is currently associated with the regulation of OTC Derivative transactions in Canada, by permitting the Filer to broker or intermediate these parties in entering into OTC Derivative transactions in reliance upon exemptions from the dealer registration and prospectus requirements of the Legislation that are comparable to the OTC Derivative Exemptions.
Books, Records and Reporting
26. The Filer will become a "market participant" for the purposes of the OSA if the Requested Relief is granted. For the purposes of the OSA, and as a market participant, the Filer is required by subsection 19(1) of the OSA to: (i) keep such books, records and other documents as are necessary for the proper recording of its business transactions and financial affairs, and the transactions that it executes on behalf of others; and (ii) keep such books, records and documents as may otherwise be required under Ontario securities law.
27. For the purposes of its compliance with subsection 19(1) of the OSA, the books and records that the Filer will keep will include books and records that:
(a) demonstrate the extent of the Filer's compliance with applicable requirements of securities legislation;
(b) demonstrate compliance with the policies and procedures of the Filer for establishing a system of controls and supervision sufficient to provide reasonable assurance that the Filer, and each individual acting on its behalf, complies with securities legislation; and
(c) identify all OTC Derivative transactions brokered or intermediated by the Filer and entered into by each of its clients, including the name and address of all parties to the transaction and its terms.
28. To the extent necessary and in respect of the OTC Derivative transactions, the Filer will comply with the derivatives trade reporting rules and instruments in effect in the provinces and territories of Canada.
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator is that the Requested Relief is granted, provided that:
(a) the counterparty to any OTC Derivative transaction that is brokered or intermediated by the Filer is a Permitted Counterparty;
(b) in the case of any trade brokered or intermediated by the Filer regarding a Permitted Counterparty, the Filer does not offer or provide any credit or margin to the Permitted Counterparty; and
(c) the Requested Relief shall terminate on the date that is the earlier of:
(i) the date that is four years after the date of this decision; and
(ii) the coming into force in the Jurisdiction of legislation or a rule that specifically governs dealer, adviser or other registration requirements applicable to market participants in connection with OTC Derivative transactions.
Clearing Corporation means an association or organization through which Options or futures contracts are cleared and settled.
Contract for Differences means an agreement, other than an Option, a Forward Contract, a spot currency contract or a conventional floating rate debt security, that provides for:
(a) an exchange of principal amounts; or
(b) the obligation or right to make or receive a cash payment based upon the value, level or price, or on relative changes or movements of the value, level or price of, an Underlying Interest.
Forward Contract means an agreement, not entered into or traded on or through an organized market, stock exchange or futures exchange and cleared by a Clearing Corporation, to do one or more of the following on terms or at a price established by or determinable by reference to the agreement and at or by a time established by or determinable by reference to the agreement:
(a) make or take delivery of the Underlying Interest of the agreement; or
(b) settle in cash instead of delivery.
Option means an agreement that provides the holder with the right, but not the obligation, to do one or more of the following on terms or at a price determinable by reference to the agreement at or by a time established by the agreement:
(a) receive an amount of cash determinable by reference to a specified quantity of the Underlying Interest of the Option.
(b) purchase a specified quantity of the Underlying Interest of the Option.
(c) sell a specified quantity of the Underlying Interest of the Option.
OTC Derivative means one or more of, or any combination of, an Option, a Forward Contract, a Contract for Differences or any instrument of a type commonly considered to be a derivative, in which:
(a) the agreement relating to, and the material economic terms of, the Option, Forward Contract, Contract for Differences or other instrument have been customized to the purposes of the parties to the agreement and the agreement is not part of a fungible class of agreements that are standardized as to their material economic terms;
(b) the creditworthiness of a party having an obligation under the agreement would be a material consideration in entering into or determining the terms of the agreement; and
(c) the agreement is not entered into or traded on or through an organized market, stock exchange or futures exchange.
Underlying Interest means, for a derivative, the commodity, interest rate, currency, foreign exchange rate, security, economic indicator, index, basket, benchmark or other variable, or another derivative, and, if applicable, any relationship between, or combination of, any of the foregoing, from or on which the market price, value or payment obligations of the derivative are derived or based.