Industry

NOTICE

ISSUANCE OF VARIATION ORDER TO THE CANADIAN DEPOSITORY FOR SECURITIES LIMITED AND CDS CLEARING AND DEPOSITORY SERVICES INC.

A. Background

The Ontario Securities Commission (Commission) issued an order dated July 4, 2012, as varied and restated, pursuant to section 21.2 of the Securities Act (Ontario) (Act) continuing the recognition of The Canadian Depository for Securities Limited and CDS Clearing and Depository Services Inc. (collectively, CDS) as clearing agencies (Recognition Order).

CDS has filed an application (Application) with the Commission requesting that an order be issued varying the Recognition Order to remove the requirement that one director of the CDS Board of Directors (Board) be a representative of a marketplace unaffiliated with Maple Group Acquisition Corporation (Maple) (now TMX Group Limited) and nominated by marketplaces unaffiliated with Maple (Unaffiliated Marketplace Director Requirement) and to include the establishment of a marketplace committee to provide advice and recommendations to management and the Board (collectively, Draft Variation Order).

CDS' Application and Draft Variation Order were published for public comment on August 2, 2018. Two comment letters were received. A copy of the comment letters received can be found on the Commission website at: https://www.osc.gov.on.ca/en/58201.htm.

B. Amended Variation Order

In response to the comments received the following amendments have been made to the Draft Variation Order that was published for comment (Variation Order):

(i) the Unaffiliated Marketplace Director Requirement has been replaced with a requirement that a director on the CDS Board be (i) independent; or (ii) a representative of an entity that is unaffiliated with Maple and uses services offered by, or is connected to, CDS, such as a transfer agent or a marketplace, or is a service provider to Participants, such as a technology service provider or a custodian (New Unaffiliated Director Requirement). The New Unaffiliated Director Requirement expands the types of entities unaffiliated to Maple that can be a director on the Board.

(ii) clarified that the marketplace committee's membership will be open to all marketplaces unaffiliated with Maple that access the services provided by CDS (unaffiliated marketplace committee).

(iii) included a requirement that CDS obtain prior Commission approval before making changes to the unaffiliated marketplace committee's structure or mandate.

The Commission issued the Variation Order on December 4, 2019 pursuant to section 144 of the Act. A copy of the Variation Order is published in Chapter 2 of this Bulletin.

C. Summary of Comments

As noted two comment letters were received. Attached is a letter from CDS containing a summary of the comments and CDS's responses to the comments.

Letter from CDS Summary of the Comments and CDS's Responses to the Comments

November 11, 2019

Re: Summary of Public Comments Received and Responses from The Canadian Depository for Securities Limited regarding CDS's Proposal to Eliminate the Requirement for an Unaffiliated Marketplace Representative on the CDS Board of Directors

CDS received two comment letters in response to our application ("Proposal") to remove the requirement that one director of the CDS Board be a representative of a marketplace unaffiliated with TMX Group Limited ("TMX"). We believe that this requirement reduces the pool of potential directors for one of the CDS Board seats and that it would be a governance improvement at the clearing house if this Board seat was not limited to marketplace representatives. CDS is prepared to institute a committee for marketplaces that are not affiliated with TMX to provide advice, comments and recommendations to the management and Board of CDS, which would give non-TMX marketplaces an ability to participate on an equal basis with each other, with an assurance that matters raised by these marketplaces would be brought forward to CDS. The CDS Board would be required to address recommendations brought forward by these marketplaces, including by requiring the CDS Board to report annually in this regard to the OSC and AMF. CDS's recognition order will set out these requirements, including the requirement that Commission approval must be obtained by CDS before making changes to the unaffiliated marketplace committee's mandate or structure.

Additionally, to respond to comments received from marketplaces and feedback from regulators, the requirement for an unaffiliated marketplace director will be replaced by a new requirement. In addition to existing governance requirements related to CDS Board composition, a new provision will require that one of the CDS directors must also either qualify as an independent director or be a representative of an entity that uses CDS services and is not affiliated with TMX (such as a transfer agent, marketplace, technology services provider or a custodian).

We summarize the comments to the Proposal and provide our responses below. One of the comment letters is from MatchNow TriAct Canada Marketplace ("TriAct"), and the other was submitted jointly by Aequitas NEO Exchange, CNSX Markets, and Nasdaq CXC (collectively, the "Exchanges").

A. General Comments

1. Comment: Proposal will result in a governance imbalance

TriAct Comment

TriAct supports a "corporate governance regime that ensures proportionate representation by key stakeholders in this ecosystem". Adequate corporate governance and oversight is required to balance the rights of a for-profit entity versus the rights of stakeholders who rely on CDS as the sole equity clearing house in Canada. The Proposal will "tilt the balance of power towards the TMX shareholders", contrary to the existing requirements which were "deliberately established ... to prevent anti-competitive behaviour."

Exchanges' Comment

The Exchanges noted that having two TMX representatives on the CDS Board in addition to the CDS President results in a reduction of the director candidate pool. The Exchanges state that if the Proposal is accepted, it should be subject to the requirement that there be no TMX representatives, other than the CEO of CDS, on the CDS Board. The Exchanges believe that the challenge for CDS in managing marketplace director conflicts exists with respect to all marketplace representatives, not just non-TMX marketplaces. The Exchanges further state, "CDS is not like other subsidiaries and standard corporate governance principles supporting membership on the Board by representatives of the parent should not be applied."

CDS Response:

(i) CDS's Board should represent key stakeholders with skin-in-the-game

Indeed, CDS is not like other subsidiaries of TMX. CDS, as a systemically important entity and a financial market infrastructure ("FMI"), plays an integral role in Canadian capital markets stability. Unlike marketplaces which bear no risk in a participant default scenario, CDS has obligations that place it in a position where it bears risk of participant default. This risk is borne by CDS, its participants and its shareholders, but not by the marketplaces. While CDS is technically a for-profit entity (it ceased to operate on a cost-recovery basis following its acquisition by TMX), it is first and foremost a securities settlement system, central securities depository and central counterparty clearing house that is subject to the Principles for Financial Market Infrastructures{1} ("PFMIs") which govern the activities of FMIs{2}.

The PFMIs resulted from a multi-year formal initiative and a decade of prior experience with international standards for FMIs. This formal initiative undertaken by CPSS and IOSCO was primarily the result of the increasing risk and uncertainty in financial markets evident during the financial crisis and the increasing role and importance of FMIs in these markets. While FMIs were generally able to settle obligations when due during the 2008 financial crisis, the events highlighted important lessons for effective risk management and the need for strong governance and oversight of FMIs to handle even more severe stress conditions. The PFMIs also address access to FMIs noting that FMIs should establish access policies that provide fair and open access, while ensuring their own safety and efficiency. Through this extensive process, IOSCO determined not to mandate composition requirements for boards of FMIs, but instead to permit FMIs to have flexibility in constructing a board of directors subject to complying with certain key principles.

By their nature, the PFMIs are principles-based and recognize that different FMIs may have different approaches to achieve a particular result. In addition to the recognition orders/decisions and other laws applicable to CDS, and because of the pivotal role CDS plays in ensuring the integrity and smooth functioning of the Canadian capital markets, CDS is extremely focused on complying with the PFMIs, in particular in light of the extensive learning that underpins them.

Principle 2 on governance requires that an FMI have robust, transparent governance arrangements that focus on the safety and efficiency of the FMI and that support the stability of the broader financial system, other relevant public interest considerations, and the objectives of relevant stakeholders. The PFMIs do not specifically place any limit on constituencies of directors on an FMI board, instead requiring appropriate representation to consider the various stakeholder interests. The unique role of a clearing house for ensuring stability in capital markets requires that its governance structures be explicitly designed to protect, and focused on, shareholders and clearing members, who bear the risk of failure.

This principle mirrors guidance from the SEC which requires clearing houses to consider the interests of owners, participants, participants' customers, securities issuers and holders, and other relevant stakeholders to, consistent with the public interest requirements, strike an appropriate balance among the potentially competing views of such other stakeholders represented within the clearing house.

We believe that the Proposal and CDS's governance structure, with Board representation from its shareholders and clearing members, is appropriate given the need for active risk management input and support from those entities who bear the risk of failure in the clearing house. In addition as mentioned above, to address feedback related to having balanced Board representation, the unaffiliated marketplace director role will be replaced by a director who will be sourced from a broader pool of candidates but will remain unaffiliated with TMX.

(ii) Conflicts Management

CDS uses governance best practices in its Board operations including when a Board member has a conflict of interest related to a matter that is being discussed at a Board meeting. See our response below in subsection 4(ii).

While the above addresses the situation where all marketplace representatives (including TMX representatives) could have a conflict with CDS, one conflict that is unique to unaffiliated marketplace representatives occurs when the CDS Board discussion involves information that is confidential and proprietary to CDS's affiliates, in particular the TMX marketplaces. In these circumstances, it is inappropriate for marketplaces that are competitors to the TMX marketplaces to be granted access to TMX confidential and proprietary information. On the occasions where it would be beneficial for the CDS Board to review information that is confidential to CDS's affiliates, the presence of a Board member who is affiliated with a non-TMX marketplace results in a scenario that needs to be managed by CDS's management. This conflict arises solely because of the presence of the Board member who represents a non-TMX marketplace.

2. Comment: CDS should have the same Board independence requirements as its parent, TMX Group Limited

TriAct noted that TMX Group Limited is required to have 50% independent board members, whereas CDS is required to have only 33% of its board be independent. TriAct submits that the Proposal would result in decreased board independence at CDS.

CDS Response:

As stated above, the existing requirement for an unaffiliated marketplace director will be replaced by a provision that requires one CDS director to either qualify as independent or represent an entity that uses CDS services and is not affiliated with TMX. Thus, the new requirement that replaces the unaffiliated marketplace director requirement addresses TriAct's concern that the change as originally set out in the Proposal would result in a decrease in CDS Board independence.

We believe that it is important to note that exchanges are fundamentally different entities from clearing houses in that a main role of a clearing house is to take on risk from its participants as it executes its core clearing operations. The requirement to manage this risk, and the impact on the owner of the clearing house and its participants in the event of a failure or default, means that owners and participants must have a leading role in how the clearing house is governed and how risk is managed. This is why regulators have mandated a majority of independent directors for exchanges, while they have not done so for clearing houses.{3} In keeping with the way clearing houses are regulated internationally, the Canadian regulators have mandated significant participant representation on the CDS Board because of the risk that participants naturally bear as clearing house members. The voice of the independent director who exercises independent judgment and advocates for the public interest remains important at a clearing house, but this must be balanced against the interests of the owners and participants who bear the clearing risk, and without whose resources the clearing house cannot operate.

B. Comments that are based on incorrect facts

3. Comment: The CDS Board has supported anti-competitive changes

The Exchanges have alleged anti-competitive behaviour by TMX with respect to two matters which we respond to below. The Exchanges' allegations are unfounded.

(i) Marketplace Fees

The Exchanges refer to a CDS fee proposal related to marketplace fees that, in the end, was not implemented, as it was not approved by CDS's regulators. The Exchanges advise that "a non-TMX marketplace representative could have provided insights" on this matter and that a "robust discussion at the Board would have been of assistance".

CDS Response:

CDS followed its fee approval process for this fee proposal, as set out in its Recognition Order. Pursuant to this process, the fee proposal was:

• submitted to the CDS Participant Fee Committee for review and comment;

• submitted to CDS's management Strategic Development Review Committee;

• tabled with the CDS Risk Management and Audit Committee (RMAC) of the CDS Board for review and comment;

• published for comment;

• discussed with regulators (including responding to comments made during the public comment process).

We believe that the CDS process for fee review and approval, which includes a public consultation process, is more than sufficient to obtain stakeholder feedback (including from marketplaces). To our knowledge, the fee review regime imposed on CDS is the most prescriptive, regimented and time consuming fee review process of any clearing house globally.{4}

In this particular instance, the unaffiliated marketplace director representative was in transition at the time this proposal was brought to the CDS Board (i.e. the unaffiliated marketplace director representative had resigned and the new director had not been appointed). Therefore this representative did not attend the Board meeting in question. The new unaffiliated marketplace director was approved at this Board meeting subject to an independent screening process which concluded a few weeks after the Board meeting. We note that if a marketplace advisory committee (as proposed by CDS in lieu of the marketplace representative Board seat) had been in place at the time of this fee proposal, CDS would have consulted with this committee and all marketplaces would have been afforded the ability to comment on the proposal directly to CDS, in addition to participating in the public comment process. If the marketplaces' recommendation to CDS on the fee proposal had not been heeded by management, then consistent with our proposal, management would have been required to discuss same with the CDS Board and the CDS Board would have been required to report to the OSC and AMF.

(ii) Cannabis

The Exchanges state that the CDS Board initially supported a proposal to cease clearing issuers with US cannabis operations or assets.

CDS Response:

On August 17, 2017 TMX published a statement regarding the clearing of securities of issuers with marijuana-related activities in the U.S. TMX stated that it was working with regulators to arrive at a solution to clarify this matter. In the August 17, 2017 statement, TMX advised that there was no CDS ban on the clearing of such securities, despite media reports. On February 9, 2018 CDS announced the signing of a memorandum of understanding with all Canadian exchanges, following discussions with regulators regarding the clearing of securities of issuers with marijuana-related activities in the U.S. The MoU confirms that CDS relies on the exchanges to review the conduct of listed issuers and as a result, there is no CDS ban on the clearing of securities of issuers with marijuana-related activities in the U.S. This is the extent of public information on this matter. CDS does not comment publicly on Board discussions.

4. Comment: CDS has not followed its original process that includes obtaining Board nominations from all of the non-TMX marketplaces

(i) Nomination Process

The Exchanges state that requests for nominations from all marketplaces would have provided deeper pools of candidates.

CDS Response:

Pursuant to the CDS Governance Committee Charter, the Governance Committee is to review on an annual basis the CDS Procedure for the Nomination and Election of the Board of Directors (Procedure). The Procedure was initially implemented following completion of the Maple transaction and was based on the procedure that Maple Group Acquisition Corporation used to populate the CDS Board following completion of the transaction.

The Governance Committee reviewed the Board composition under the Procedure as required in 2013 and 2014, however in 2014 the Governance Committee and the Board decided that the potential for turnover in Directors on an annual basis was not in the best interests of CDS and that more stability and continuity for CDS was necessary to ensure strong governance. They determined to instead review the composition on a bi-annual basis. The last such formal review was in 2016 and it was followed in early 2018 by a review by the Governance Committee and the Board to create the mirror board structure with CDCC. On February 20, 2014, CDS sent letters to seven unaffiliated marketplaces. Three of the seven submitted a nominee. Four did not respond. On February 11, 2016, CDS sent letters to eight unaffiliated marketplaces. Three of the eight submitted a nominee. Five did not respond. The 2018 review included a decision by the Governance Committee and the Board to pursue the Proposal and so no canvas of the unaffiliated marketplaces was conducted.

(ii) Board Meeting Procedures

The Exchanges advise that all "marketplace directors" should be allowed to remain for at least part of the discussion on issues impacting marketplaces -- and then recuse themselves so the CDS Board has as much information as possible on which to make the decision.

CDS Response:

Our standard good governance practices operate in the manner suggested by the Exchanges. Directors are only asked to recuse themselves from the portions of the Board meeting where a conflict of interest places them in a situation where the Canada Business Corporations Act prescribes that they cannot vote on a matter. The remainder of the CDS Board, led by the independent Chair, has historically determined, once notified of a conflict, how the conflicted director should or should not participate in a discussion so as to ensure that the best interests of CDS are always paramount.

Respectfully submitted,

"The Canadian Depository for Securities Limited"

{1} Published in April 2012 by the Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization of Securities Commissions (IOSCO).

{2} CDS must operate in compliance with National Instrument 24-102 which requires PFMI compliance (see section 3.1 of NI 24-102). CDS's AMF and OSC Recognition Orders also require PFMI compliance (see sections 9.1 and 10.2 of the CDS OSC Recognition Order and sections 28.1 and 29.2 of the CDS AMF Recognition Order).

{3} Under their respective recognition orders, CDS, CDCC and the TMX exchanges are required to consider their participants as not independent for purposes of board composition requirements.

{4} Based on our review of securities legislation, PFMI disclosure documents, and consultation with foreign counsel in 2016, we found that clearing agencies in other jurisdictions that are comparable to or competitive with Canada are not subject to regulatory approval of fee changes. Specifically, European countries, South Africa and Australia do not require clearing agencies to submit fee changes for approval. In Europe, consistent with PFMI requirements, fees are subject to transparency requirements. In the United States, the CFTC requires that clearing agency fee changes be subject to a 10-day self-certification period with the exception of certain fees under $1.00. The SEC requires notification at the time of the fee change. The only exception is a fee charged to non-members which would either need (i) for noncontroversial changes, 30 days delay after filing (or shorter at the SEC's discretion), or (ii) for more significant or controversial changes, SEC approval.