Securities Law & Instruments

Headnote

Application under section 144 of the Securities Act (Ontario) (OSA) to vary and restate the interim order of LCH.Clearnet Limited (LCH) to extend its interim exemption, which exempts LCH under section 147 of the OSA on an interim basis from recognition as a clearing agency under subsection 21.2(0.1) of the OSA.

Applicable Legislative Provisions

Securities Act, R.S.O. 1990, c. S.5, as am., ss.21.2(0.1), 147 and 144

IN THE MATTER OF

THE SECURITIES ACT

R.S.O. 1990, c. S.5, AS AMENDED

(the Act)

AND

IN THE MATTER OF

LCH.CLEARNET LIMITED (LCH)

VARIATION TO THE INTERIM ORDER

(Section 144 of the Act)

WHEREAS the Ontario Securities Commission (Commission) issued an interim order dated March 1, 2011 pursuant to section 147 of the Act exempting LCH from the requirement to be recognized as a clearing agency under section 21.2(0.1) of the Act (Initial Order);

AND WHEREAS LCH filed an application received on May 2, 2011 with the Commission pursuant to section 144 of the Act requesting that the Commission vary and restate the Initial Order;

AND WHEREAS on May 17, 2011, the Commission issued an order that varied and restated the Initial Order (Interim Order) to clarify that LCH may provide additional clearing services, including the LCH Enclear OTC service to Ontario-resident clients;

AND WHEREAS LCH filed an application received on July 21, 2011 (Application) with the Commission pursuant to section 144 of the Act requesting that the Commission vary and restate the Interim Order which expires on the earlier of (i) September 1, 2011 and (ii) the effective date of a Subsequent Order (as defined in the Interim Order);

AND WHEREAS the Commission has received certain representations from LCH in connection with their Application to vary and restate the Interim Order;

AND WHEREAS the Commission has determined that it is not prejudicial to the public interest to issue this order that varies and restates the Interim Order to extend LCH's interim exemption from the requirement to be recognized as a clearing agency under section 21.2(0.1) of the Act, subject to additional terms and conditions;

IT IS ORDERED, pursuant to section 144 of the Act, that the Interim Order be varied and restated as follows:

IN THE MATTER OF

THE SECURITIES ACT

R.S.O. 1990, c. S.5, AS AMENDED

(the Act)

AND

IN THE MATTER OF

LCH.CLEARNET LIMITED (LCH)

ORDER

(Section 147 of the Act)

WHEREAS LCH filed an application dated January 13, 2011 (January Application) with the Ontario Securities Commission (Commission) pursuant to section 147 of the Act requesting an interim order exempting LCH from the requirement to be recognized as a clearing agency under section 21.2(0.1) of the Act;

AND WHEREAS the Commission had granted such order dated March 1, 2011 (Initial Order);

AND WHEREAS LCH filed an application received on May 2, 2011 (May Application) with the Commission pursuant to section 144 of the Act requesting that the Commission vary and restate the Initial Order to clarify that LCH may provide additional clearing services, including the LCH EnClear OTC service (EnClear), to Ontario-resident clients;

AND WHEREAS the Commission granted such order dated May 17, 2011 (Interim Order);

AND WHEREAS LCH filed an application received on July 21, 2011 (July Application) with the Commission pursuant to section 144 of the Act requesting that the Commission vary and restate the Interim Order to extend LCH's interim exemption from the requirement to be recognized as a clearing agency under section 21.2(0.1) of the Act (Order);

AND WHEREAS LCH has represented to the Commission that:

1.1 LCH is a clearing house incorporated under the laws of England and Wales;

1.2 LCH is a Recognised Clearing House (RCH) in the United Kingdom (UK) under the UK's Financial Services and Markets Act 2000 (FSMA) and, as such, is approved by the UK Financial Services Authority (FSA) to clear a broad range of asset classes including: securities, exchange traded derivatives, energy, freight, interest rate swaps and euro and sterling denominated bonds and repurchase transactions;

1.3 As of May 25, 2010, LCH.Clearnet Group Ltd., the parent company of LCH, is owned 83 percent by users (clearing members) and 17 percent by exchanges;

1.4 LCH operates as an industry utility and receives most of its revenue from clearing fees charged to its members;

1.5 LCH works closely with market participants and exchanges to identify and develop clearing services for new asset classes;

1.6 Pursuant to FSA approval, LCH clears a broad range of asset classes including: securities, exchange traded derivatives, commodities, energy, freight, interest rate swaps, credit default swaps and euro and sterling denominated bonds and repos. More specifically, exchange-traded futures and options on futures, exchange-traded options on equity indices and individual equities, and exchange-traded cash equities. The exchange-traded futures and options on futures relate to underlyings in short-term interest rates (Euro, Sterling, Swiss Franc); government bonds (UK Gilts and Japanese Government Bonds); medium and long-term swap rates (Euro); equity indices (UK-related FTSE indices and FTSE and MSCI pan-European indices); and individual stocks (British, Dutch, French, German, Italian, Spanish and US companies); and to a broad range of commodities (non-ferrous metals -- aluminium (primary and secondary), copper, lead, nickel, tin and zinc; plastics; and 'softs' and agriculturals -- cocoa, coffee, white (refined) sugar, wheat, barley and potatoes). In addition, LCH clears cash-settled OTC freight forwards and options, OTC emissions contracts, iron and fertilizer swaps and clears cash-settled electric power and natural gas futures on two platforms, a screen-traded nodal auction market and an OTC negotiated (broker-matched) trade submission facility, for participants of the Nodal Exchange;

1.7 Currently, LCH provides clearing services for the following UK Recognised Investment Exchanges: NYSE Liffe Futures & Options, the London Metal Exchange and EDX London, as well as for the London Stock Exchange and in Switzerland, SIX Swiss Exchange AG;

1.8 LCH has approximately 130 members consisting of banks, securities houses/investment banks, commodity brokers and traders and, to a very limited extent, industrial companies;

1.9 LCH does not have any office or maintain other physical installations in Ontario or any other Canadian province or territory;

1.10 LCH currently offers Ontario-resident clients access to its RepoClear, SwapClear and EnClear, and intends to offer Ontario resident-clients access to LCH Nodal Service and other clearing services;

1.11 RepoClear is a service clearing cash bond and repo trades across a number of European markets and is the second largest clearer of fixed income and repo products in the world;

1.12 RepoClear clears cash bond and repo trades in the following markets: Austrian, Belgian, Dutch, German, Irish, Finnish, Portuguese and UK government bonds. Additional markets served include: German Jumbo Pfandbriefe and Supranationals, Agency and Sovereign. RepoClear accepts the following types of specific bond repo trades: classic fixed rate repos with 1st leg settlement on a same day and forward start basis with a term not greater than one year;

1.13 A RepoClear participant has to either be a clearing member or have a clearing arrangement with a firm that is a clearing member. A RepoClear participant who clears repos is a RepoClear Clearing Member (RCM). A participant who has a clearing arrangement with an RCM is a RepoClear Dealer;

1.14 SwapClear was launched in 1999 and has grown to become the largest central counterparty for OTC interest rate derivatives globally. LCH anticipates clearing an expanded list of swap products and OTC derivatives on exempt commodities. Transactions cleared through SwapClear are traded by LCH members on a bilateral basis, either inter-office, or through brokers, or on automated trading systems recognized by LCH;

1.15 There are broadly two recognised participants in SwapClear: (i) members; and (ii) clients of these members. A SwapClear Clearing Member is eligible to clear trades on their own behalf, and on behalf of their branches, affiliated companies and clients. A SwapClear Dealer is an affiliate company of a SwapClear Clearing Member which is identified separately within SwapClear and whose trades clear through the affiliated SwapClear Clearing Member based on a clearing agreement between the SwapClear Clearing Member and the SwapClear Dealer;

1.16 An applicant for either RepoClear or SwapClear must enter into a Clearing Membership Agreement with LCH before it can become a member of LCH. Applicants that wish to clear trades through RepoClear or SwapClear on their own behalf or on behalf of others must enter into a Clearing Membership Agreement. RepoClear Dealers and SwapClear Dealers must clear trades through a RepoClear Clearing Member or SwapClear Clearing Member and are not considered clearing members of LCH;

1.17 EnClear is comprised of three divisions, namely, the Energy Division, Freight Division, and Precious Metals Division;

1.18 EnClear's Energy Division provides independent multilateral netting and clearing for the global OTC spot and forward carbon allowance markets. It clears OTC emissions spot and forward contracts, specifically OTC Spot and Forward European Union Allowances contracts issued in accordance with the terms of Directive 1003/87/EC and OTC Spot and Forward Certified Emissions Reductions contracts issued pursuant to Article 12 of the Kyoto Protocol;

1.19 EnClear's Freight Division clears Forward Freight Agreement products, Container Freight Swap Agreement products and commodities (e.g., iron ore swaps, steel swaps, fertilizer swaps, coal swaps and coal options);

1.20 EnClear's Precious Metals Division only clears OTC gold bullion contracts;

1.21 EnClear's OTC emissions contract clearing solution gives the end user the option to use its preferred voice broker or broker trading platform to capitalize on a single pool of open interest. OTC emissions contracts can be manually entered or uploaded in batch format into LCH's Extensible Clearing System (ECS), an electronic platform accessible to Approved Emissions Brokers;

1.22 EnClear's OTC spot emissions contracts cleared by LCH are physically delivered and therefore place an obligation on Clearing Members that hold an open position at expiry to deliver emissions credits;

1.23 LCH's OTC emissions clearing services allow for spot and forward contracts that have been concluded either bilaterally or through Approved Emissions Brokers to be registered for clearing. Trades are entered using the ECS by Approved Emissions Brokers, subject to the following criteria:

(a) Each party to the spot and forward trade must either be a Clearing Member or a client of a Clearing Member of LCH; and

(b) The terms of the OTC spot and forward contracts to be registered must adhere to those of an eligible trade as specified by LCH;

1.24 Applicants that wish to clear trades through EnClear on their own behalf or on behalf of others must either enter into a Clearing Membership Agreement with LCH or extend their current membership to include EnClear;

1.25 LCH Nodal Service clears cash-settled electric power and natural gas futures for participants of the Nodal Exchange on two platforms, a screen-traded nodal auction market and an OTC negotiated (broker-matched) trade submission facility;

1.26 LCH Nodal Service does not cover options contracts and there is no provision for allocation or give-ups;

1.27 LCH Nodal Service allows for futures contracts that have been concluded either bilaterally or through a broker-matched trade submission facility to be registered for clearing. Trades executed or registered through the Nodal Trading System in accordance with Nodal Exchange Rules will be designated as "Nodal Transactions" eligible for registration by LCH, subject to satisfying LCH's requirements as set out in LCH's Rules;

1.28 To date, LCH has admitted four Ontario-resident clients as SwapClear Clearing Members;

1.29 LCH currently has two Ontario-resident clients that are RepoClear Dealers but are not RepoClear Clearing Members. These clients clear through a non-Canadian, third party RepoClear Clearing Member;

1.30 An existing Ontario-resident Clearing Member wishes to utilize LCH Nodal Service for clearing of electric power and natural gas contracts;

1.31 The new section 21.2 of the Act, that became effective March 1, 2011, prohibits clearing agencies from carrying on business in Ontario unless they are recognized by the Commission as a clearing agency;

1.32 On May 3, 2011, LCH submitted an application to the Commission for relief pursuant to section 147 of the Act exempting LCH from the requirement to be recognized as a clearing agency pursuant to section 21.2(0.1) of the Act, and such application explains how LCH meets the relevant criteria for recognition and exemption for clearing agencies (Subsequent Order); and

1.33 Commission staff is currently reviewing LCH's application for the Subsequent Order. LCH understands that the standard process for review of the Subsequent Order can not be completed by September 1, 2011;

AND WHEREAS based on the January Application, the May Application and the July Application, and the representations LCH has made to the Commission, the Commission has determined that the granting of the exemption on an interim basis from recognition as a clearing agency under section 21.2(0.1) of the Act would not be prejudicial to the public interest;

IT IS HEREBY ORDERED by the Commission that, pursuant to section 147 of the Act, LCH is exempt on an interim basis from recognition as a clearing agency under section 21.2(0.1) of the Act;

PROVIDED THAT:

1. This Order shall terminate on the earlier of: (i) September 1, 2012 and (ii) the effective date of the Subsequent Order;

2. LCH shall:

(a) continue to be a RCH under the FSMA;

(b) promptly notify staff of the Commission of:

(i) any material change or proposed material change in the regulatory oversight by the FSA;

(ii) any material problems with the clearance and settlement of transactions in its RepoClear, SwapClear, EnClear, LCH Nodal Service or other clearing services that could materially affect the financial viability of LCH; and

(iii) any new Ontario-resident clients of the RepoClear, SwapClear, EnClear, LCH Nodal Service or other clearing services;

3. LCH shall provide 60 days prior written notice and a detailed description of any new clearing service to be offered to Ontario-resident clients;

4. LCH shall maintain the following updated information and submit such information to the Commission on at least a quarterly basis, and at any time promptly upon request of staff of the Commission:

(a) for each LCH clearing service provided to Ontario-resident clients, the average daily trading volume and average aggregate outstanding notional amount during the previous quarter, for each Ontario-resident client;

(b) for each LCH clearing service provided to Ontario-resident clients, the aggregate outstanding notional amounts and the associated mark-to-market values of the outstanding positions held by each Ontario-resident client at the end of the previous quarter;

(c) for each LCH clearing service provided to Ontario-resident clients, the portion of total global trading volume conducted by each Ontario-resident client for the previous quarter and outstanding notional held by each Ontario-resident client as at the end of the previous quarter; and

(d) for each LCH clearing service provided to Ontario-resident clients, the quarter-end outstanding collateral value (variation and initial margins) provided by each Ontario-resident client;

5. LCH shall provide such information as may be requested from time to time by, and otherwise cooperate with, the Commission or its staff; and

6. LCH shall share information and otherwise cooperate with other recognized and exempt clearing agencies as appropriate.

DATED March 1, 2011, as varied on May 17, 2011 and August 19, 2011.

"Edward P. Kerwin"
 
"Vern Krishna"