Securities Law & Instruments


Headnote

Application under section 147 of the Securities Act (Ontario) (Act) for an order exempting LME Clear Limited from the requirement in subsection 21.2(0.1) of the Act to be recognized as a clearing agency.

Applicable Legislative Provisions

Securities Act, R.S.O. 1990, c. S.5, as am., ss. 21.2(0.1), 147.

IN THE MATTER OF
THE SECURITIES ACT,
R.S.O. 1990, CHAPTER S.5, AS AMENDED
(THE OSA)

AND

IN THE MATTER OF
LME CLEAR LIMITED

ORDER
(Section 147 of the OSA)

WHEREAS LME Clear Limited (LMEC) has filed an application (Application) with the Ontario Securities Commission (Commission) pursuant to section 147 of the OSA requesting an order exempting LMEC from the requirement to be recognized as a clearing agency under subsection 21.2(0.1) of the OSA in order to provide its central counterparty (CCP) services to Ontario market participants;

AND WHEREAS LMEC has represented to the Commission that:

1.1          LMEC is a private company incorporated in England and Wales on April 21, 2011, under registered number 07611628. LMEC’s registered office and head office is at 10 Finsbury Square, London EC2A 1AJ. All corporate documentation relating to LMEC is filed with Companies House in the United Kingdom (UK).

1.2          LMEC is 100% owned by HKEX Investment UK Limited (HKEX UK), a holding company which also owns 100% of the shares in the London Metal Exchange (LME), through LME Holdings Limited. LMEC has no subsidiaries.

1.3          LMEC is authorised as a CCP pursuant to Regulation (EU) No. 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories (EMIR), which sets out clearing and bilateral risk-management requirements for derivative contracts, reporting requirements for derivative contracts, and uniform requirements for the performance of activities of CCPs and trade repositories. LMEC is primarily supervised by the Bank of England (the Bank), is regulated as a Recognised Central Counterparty in accordance with the Financial Services and Markets Act 2000 (FSMA) in the United Kingdom, and is a designated system under the Financial Markets and Insolvency (Settlement Finality) Regulations 1999. Its authorisation was obtained on 3 September 2014. LMEC is also authorised to provide Automated Trading Services in Hong Kong and is the clearing organisation for the LME under its Foreign Board of Trade Licence in the US.

1.4          LMEC is of the opinion that it fully observes the international standards applicable to financial market infrastructures described in the April 2012 report named Principles for financial market infrastructures (PFMI), having prepared a detailed assessment of its compliance against the PFMI and the associated disclosure framework as of September 2018, which has been reviewed and validated by the Bank.

1.5          LMEC is subject to regulatory supervision by the Bank. LMEC is required to deliver to the Bank monthly returns showing LME Clear’s activities, including:

  • initial margin;
  • default fund size;
  • cash and non-cash collateral data;
  • stress testing results for counterparty credit and liquidity risk;
  • capital data; and
  • details of any significant changes in the organisation, governance, structure or ownership of LMEC.

1.6          The Bank reviews LMEC’s annual financial statements and auditors’ reports and does an annual risk classification of LMEC, including an assessment of the adequacy of LMEC’s capital and risk management procedures. In addition, the Bank may carry out site audits.

1.7          In addition, LME Clear provides quarterly updates to the Securities & Futures Commission of Hong Kong (SFC) as part of its Automated Trading System Licence on the total volume of all trades cleared and settled and open interest, as well as details of the margin and collateral balances, and the default fund contribution of each Hong Kong Member (if any).

1.8          A member of LMEC (Member) is a member of the London Metal Exchange who has been admitted to use the clearing system of LMEC in accordance with Rule 3 of the LMEC Rules and Procedures (LMEC Rules) and the membership procedures. Members may be either an Individual Clearing Member (ICM) or a General Clearing Member (GCM). ICMs are permitted to clear transactions on their own behalf only. GCMs may clear transactions on their own behalf and also in respect of transactions effected (i) by the GCM with its clients, or (ii) by its clients with other non-members. Members may elect to use either the LME Base Service, the LMEprecious Service or both.

1.9          LMEC anticipates that banks based in Ontario and certain other market participants that have a head office or principal place of business in Ontario may be interested in becoming Members of LMEC.

1.10        The LMEC Rules act as the master agreement between LMEC and its Members in respect of all transactions cleared by LMEC.

1.11        LMEC provides services to persons who are admitted to membership on the terms of the LMEC Rules (LMEC Rule 3.1.1). The LMEC Rules are binding on Members (LMEC Rule 2.1.1) by virtue of the LME Clear Membership Agreement. LMEC's membership criteria have been designed to operate on an objective basis to all applicants. LMEC applies its membership criteria to applicants on a non-discriminatory basis, with the aim of ensuring fair and open access to its clearing system.

1.12        LMEC’s membership criteria covers professional qualifications, financial integrity, regulated status of an applicant, and the ability of the applicant to meet and continue to meet the standards set out by LMEC.

1.13        The membership criteria are set out in membership procedures which are contained in the LMEC Rules, Part B. There are some additional criteria for applicants applying to become a GCM which are summarised below.

1.14        The criteria to become a GCM are that the applicant must:

(a)           meet the conditions (if any) in LMEC’s pro forma membership agreement;

(b)           satisfy the minimum net capital for a Member; and

(c)           pay its contribution to the LMEC default fund.

1.15        A Member clearing for the LME business must also:

(a)           be a clearing member of the LME (this status is only available to certain categories of LME member specified in the LME Rules);

(b)           be a member of the LMEsmart system; and

(c)           meet the minimum net capital requirement for a Member of US$10,000,000;

1.16        A GCM is required be regulated in the conduct of its business under the securities and/or banking legislation of an European Economic Area State or of any other country or countries acceptable to LMEC, and must not be prohibited by such legislation or its regulator from becoming a Member or from performing the obligations of a Member under the LMEC Rules. A GCM must also have sufficient financial resources and operational capacity to clear transactions on behalf of clients.

1.17        The LMEC Executive Risk Committee may approve an application to become a Member upon a determination that the applicant meets the membership criteria and after conducting a risk assessment and assigning an internal credit rating to the applicant.

1.18        Each Member shall provide to LMEC and maintain on a daily basis for so long as it is a Member, eligible collateral with a value sufficient to satisfy its margin requirement, which shall comprise as security, cover and/or credit support for the performance by that Member of all of its present and future obligations to LMEC pursuant to the LME Rules or the operation of the LMEC’s clearing system.

1.19        The margin requirement for each Member will be the amount which LME Clear may determine and notify the Member from time to time.

1.20        LMEC requires all Members posting non-cash collateral to execute one or more security deeds and/or pledge agreements granting charges in favour of LMEC over all collateral and default fund contributions held by Members with LMEC.

1.21        The LMEC Rules (including in particular the default procedures contained within them) govern the processes that apply to Members in the case of a clearing Member default; clearing Members remain responsible for the credit risk of their Clients. These procedures facilitate transparent and practical market action in stress situations. In broad terms LMEC will look to neutralise risk by hedging the overall house position of a defaulting Member against the most liquid market dates and roll forward any prompt physical delivery positions to manage its risk. LMEC will then seek to auction the defaulting Member’s remaining house portfolio to other participants as its preferred method of disposal; however it will also be able to execute the close out of all remaining open house positions if required. A Member must successfully complete simulated default tests to demonstrate they have the appropriate expertise and operational processes in place prior to beginning clearing operations. Once live, all Members are required to participate in fire drills regularly to confirm their operational readiness to manage a Member default.

1.22        LMEC seeks an exemption from the clearing agency recognition requirement in relation to all products eligible to be cleared on LMEC (Eligible Products). The Eligible Products as at the time of this order are as follows:

(a)           Exchange Traded Forwards relating to metals;

(b)           Exchange Traded Futures relating to metals;

(c)           Exchange Traded Futures relating to metal indices;

(d)           Exchange Traded American Options relating to metals;

(e)           Exchange Traded Average Price Options (TAPOs) relating to metals;

(f)            Exchange Traded Monthly Average Futures relating to metals;

(g)           Exchange Traded LMEprecious futures; and

(h)           Exchange Traded LMEprecious options.

1.23        LMEC would provide its services to participants in Ontario without establishing an office, accessing systems from, or having a physical presence in Ontario or elsewhere in Canada.

1.24        LMEC submits that it does not pose a significant risk to the Ontario capital markets and is subject to an appropriate regulatory and oversight regime in a foreign jurisdiction.

AND WHEREAS LMEC has agreed to the respective terms and conditions as set out in Schedule “A” to this order;

AND WHEREAS based on the Application and the representations that LMEC has made to the Commission, the Commission has determined that granting an order to exempt LMEC from the requirement to be recognized as a clearing agency would not be prejudicial to the public interest;

AND WHEREAS LMEC has acknowledged to the Commission that the scope of and the terms and conditions imposed by the Commission attached hereto as Schedule “A” to this order, or the determination whether it is appropriate that LMEC continue to be exempted from the requirement to be recognized as a clearing agency, may change as a result of the Commission's monitoring of developments in international and domestic capital markets, LMEC's activities, or as a result of any changes to the laws in Ontario affecting trading in or clearing and settlement of derivatives or securities;

IT IS HEREBY ORDERED by the Commission that pursuant to section 147 of the OSA, LMEC is exempt from the requirement to be recognized as a clearing agency under subsection 21.2(0.1) of the OSA;

PROVIDED THAT LMEC complies with the terms and conditions attached hereto as Schedule “A”.

DATED this 21st day of December 2018.

“Deborah Leckman”

“Robert P. Hutchison”


 

SCHEDULE “A”

Terms and Conditions

Definitions:

For the purposes of this Schedule “A”:

“client clearing” means the ability of a Clearing Member to clear transactions on LMEC for and on behalf of a client.

Unless the context requires otherwise, other terms used in this Schedule “A” shall have the meanings ascribed to them in Ontario securities law (including terms defined elsewhere in this order).

                COMPLIANCE WITH ONTARIO LAW

1.             LMEC will comply with Ontario securities law (as defined in the OSA) and, where applicable, Ontario commodity futures law (as defined in the Commodity Futures Act (Ontario)).

                SCOPE OF PERMITTED CLEARING SERVICES IN ONTARIO

2.             LMEC’s activities in Ontario will be limited to the clearing of transactions described in paragraph 1.22 of LMEC’s representations set out above in this order.

                REGULATION OF LMEC

3.             LMEC will maintain its status as a CCP under EMIR and FSMA or any comparable successor legislation and will continue to be subject to the regulatory oversight of the Bank or any successor supervisory authority.

4.             LMEC will continue to comply with its ongoing regulatory requirements as a CCP under EMIR and FSMA or any comparable successor legislation and with the ongoing regulatory requirements of the Bank or any successor supervisory authority.

                GOVERNANCE

5.             LMEC will promote within LMEC a governance structure that minimizes the potential for any conflict of interest between LMEC and its shareholders that could adversely affect the clearing services permitted under this order or the effectiveness of LMEC's risk management policies, controls and standards.

                FILING REQUIREMENTS

                Filings with the Bank

6.             LMEC will provide staff of the Commission the following information to the extent that it is required to provide or to file such information with the Bank or its successor:

(a)           details of any material legal proceeding instituted against LMEC;

(b)           notification that LMEC has failed to comply with an undisputed obligation to pay money or deliver property to a Clearing Member for a period of thirty days after receiving notice from the Clearing Member of LMEC's past due obligation;

(c)           notification that LMEC has instituted a petition for a judgment of bankruptcy or insolvency or similar relief, or to wind up or liquidate LMEC or has a proceeding for any such petition instituted against it;

(d)           notification that LMEC has initiated its recovery plan;

(e)           the appointment of a receiver or the making of any voluntary arrangement with creditors;

(f)            the entering of LMEC into any resolution regime or the placing of LMEC into resolution by a resolution authority;

(g)           material changes to its bylaws and rules where such changes would impact the services permitted by this order to be used by Ontario residents (whether as a Clearing Member or otherwise); and

(h)           new services or clearing of new types of products to be offered to a Clearing Member having a head office or principal place of business in Ontario (Ontario Clearing Member) or services or products that will no longer be available to an Ontario Clearing Member.

                Prompt Notice

7.             LMEC will promptly notify staff of the Commission of any of the following:

(a)           any material change or proposed material change to LMEC’s status as a CCP under EMIR or FSMA or in its regulatory oversight by the Bank.

(b)           any material problems with the clearing and settlement of transactions that could materially affect the safety and soundness of LMEC;

(c)           the admission of any new Ontario Clearing Members;

(d)           any event of default by, or removal of the ability to clear transactions through LMEC of, any Ontario Clearing Member; and

(e)           any system failure, malfunction or delay, or security incident, at LMEC that is material and that affects an Ontario Clearing Member including cybersecurity incidents.

                Quarterly Reporting

8.             LMEC will maintain and submit the following information to the Commission in a manner and form acceptable to the Commission on a quarterly basis within 30 days of the end of each calendar quarter, and at any time promptly upon the request of staff of the Commission:

(a)           current list of all Ontario Clearing Members with their corresponding legal entity identifier (LEI), if any;

(b)           a list of all Ontario Clearing Members against whom disciplinary or legal action has been taken in the quarter by LMEC with respect to activities at LMEC, or to the best of LMEC's knowledge, by any other authority that has or may have jurisdiction with respect to the relevant Ontario Clearing Member’s clearing activities at LMEC;

(c)           a list of all investigations by LMEC in the quarter relating to Ontario Clearing Members;

(d)           a list of all Ontario-resident applicants who have been denied Clearing Member status in the quarter by LMEC;

(e)           quantitative information in respect of the services used by Ontario Clearing Members for transactions in the asset classes listed in paragraph 1.22 of LMEC’s representations set out above in this order, including in particular the following:

(i)            as at the end of the quarter, level, maximum and average daily open interest, number of transactions and notional value of transactions cleared during the quarter for each Ontario Clearing Member;

(ii)           the percentage of end of quarter level and average daily open interest, number of transactions and the notional value cleared during the quarter for all Clearing Members that represents the end of quarter and average daily open interest, number of transactions and the notional value of transactions cleared during the quarter for each Ontario Clearing Member;

(iii)           the aggregate initial margin amount required by LMEC ending on the last trading day during the quarter for each Ontario Clearing Member;

(iv)          the portion of the initial margin required by LMEC ending on the last trading day of the quarter for all Clearing Members that represents the initial margin required during the quarter for each Ontario Clearing Member; and

(v)           the aggregate total margin amount required by LMEC ending on the last trading day during the quarter for each Ontario Clearing Member;

(f)            the default fund contribution, for each Ontario Clearing Member on the last trading day during the quarter, and its proportion to the total default fund contributions;

(g)           if known to LMEC, for each Clearing Member (identified by LEI) offering client clearing to an Ontario resident that seeks to clear transactions through such Clearing Member, the identity of the Ontario resident client (including LEI, if any) receiving such services, and the value and volume cleared by asset class or transaction type during the quarter for and on behalf of each Ontario resident client;

(h)           a summary of the risk management analysis related to the adequacy of LMEC’s default funds, including but not limited to stress testing and backtesting results; and

(i)            a copy of all circulars published during the quarter that describe and show changes to the LMEC Rules made during the quarter.

                INFORMATION SHARING

9.             LMEC will promptly provide such information as may be requested from time to time by, and otherwise cooperate with, the Commission or its staff, subject to any applicable privacy or other laws that would prevent the sharing of such information and subject to the application of solicitor-client privilege.

10.          Unless otherwise prohibited under applicable law, LMEC will share information relating to regulatory and enforcement matters and otherwise cooperate with other recognized and exempt clearing agencies on such matters, as appropriate.