Application under section 147 of the Securities Act (Ontario) (Act) to exempt CME Clearing Europe Limited from recognition as a clearing agency under subsection 21.2(0.1) of the Act.
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
IN THE MATTER OF
CME CLEARING EUROPE LIMITED
(Section 147 of the Act)
WHEREAS CME Clearing Europe Limited (CMECE) filed an application dated August 3, 2012 (the Application) with the Ontario Securities Commission (the Commission or OSC) requesting an Order pursuant to section 147 of the Act exempting CMECE from the requirement to be recognized by the OSC as a clearing agency pursuant to subsection 21.2(0.1) of the Act;
AND WHEREAS CMECE has represented to the Commission that:
1. CMECE is a private limited company incorporated under the laws of England and Wales;
2. CMECE's ultimate parent is CME Group Inc. (CME Group). CMECE's immediate parent (100% ownership) is Chicago Mercantile Exchange Luxembourg S.à r.l; it is in turn a wholly-owned subsidiary of Chicago Mercantile Exchange Luxembourg Holdings S.à r.l, which is a wholly-owned subsidiary of CME Group;
3. CME Group is the holding company for four futures exchanges: the Chicago Mercantile Exchange Inc. (CME), the Board of Trade of the City of Chicago Inc. (CBOT), the New York Mercantile Exchange Inc. (NYMEX) and the Commodity Exchange Inc. (COMEX). In addition to being an exchange, CME offers through a division, "CME Clearing", central counterparty clearing and settlement services to all CME Group exchanges and for certain over-the-counter (OTC) derivatives transactions. CME Group is a listed corporation whose shares are traded on the NASDAQ stock exchange;
4. CMECE has been established as part of a globalization strategy by CME Group. The associated business goal is to offer clearing services from the United Kingdom (UK) for a broad range of OTC derivatives;
5. CMECE is a Recognised Clearing House (RCH) in the UK under the Financial Services and Markets Act 2000 (FSMA);
6. The Financial Services Authority of the UK (FSA) is CMECE's primary regulator. As part of its regulatory oversight of CMECE, the FSA reviews, assesses and enforces the on-going compliance by CMECE with the requirements set out in the FSMA including financial resources; suitability; systems and controls (including the assessment and management of risks to the performance of the clearing house's functions); safeguards for investors (including access to facilities); promotion and maintenance of standards; rule-making (including default rules in respect of market contracts); and arrangements regarding discipline and complaints. CMECE understands that the U.K. government is implementing a comprehensive reform of the structure of U.K. financial services regulation which, if implemented, may involve transferring sometime in 2013 the FSA's regulatory and oversight responsibilities of systemically important financial market infrastructures to the Bank of England (the FSA and Bank of England hereinafter referred to collectively or individually as the "U.K. Authorities");
7. CMECE is required to provide to the U.K. Authorities, on request, access to all records and to cooperate with other regulatory authorities, including making arrangements for information-sharing;
8. CMECE's financial safeguards model includes clear and certain rules and procedures (and other aspects of its legal framework) governing CMECE's role as central counterparty, as well as appropriate membership criteria that are risk-based. CMECE operates a robust pricing and margining/collateral methodology. CMECE also has in place appropriate banking and custody arrangements, default resources and management processes. These components are linked by daily monitoring and oversight, undertaken by an experienced risk management team, with appropriate oversight by the Board of Directors;
9. The membership requirements of CMECE for OTC derivative clearing are publicly disclosed and are designed to permit fair and open access, while protecting CMECE and its clearing members (Clearing Members). The clearing membership requirements include fitness criteria, financial standards, operational standards and appropriate registration qualifications with applicable statutory regulatory authorities. CMECE applies a due diligence process to ensure that all applicants meet the required criteria and conducts on-going monitoring of Clearing Members;
10. CMECE currently offers clearing services for over 200 OTC commodity derivative contract types. CMECE also has plans to launch clearing services for OTC interest rate swaps in the last quarter of 2012, followed by foreign exchange and credit default swap products in the first half of 2013. Any such launch of new products requires the approval of the U.K. Authorities;
11. CMECE does not have any office or maintain other physical installations in Ontario or any other Canadian province or territory. CMECE does not have any plans to open such an office or to establish any such physical installations in Ontario or elsewhere in Canada. However, CMECE offers or proposes to offer direct clearing access in Ontario for clearing OTC derivatives products to entities that have a head office or principal place of business in Ontario (Ontario Clearing Members);
12. Section 21.2 of the Act prohibits clearing agencies from carrying on business in Ontario unless they are recognized by the Commission as a clearing agency or exempted from such recognition under s.147;
AND WHEREAS based on the Application and the representations that CMECE has made to the OSC, the Commission has determined that (i) CMECE satisfies the applicable criteria set out in Schedule "A"; and (ii) it would not be prejudicial to the public interest to grant the Order requested;
AND WHEREAS the Commission will monitor developments in international and domestic capital markets and CMECE's activities on an ongoing basis to determine whether it is appropriate that CMECE continue to be exempted from the requirement to be recognized as a clearing agency and, if so, whether it is appropriate that it continue to be exempted subject to the terms and conditions in this order;
IT IS ORDERED by the Commission that, pursuant to section 147 of the Act, CMECE is exempt from the requirement to be recognized as a clearing agency under subsection 21.2(0.1) of the Act;
PROVIDED THAT CMECE complies with the terms and conditions attached hereto as Schedule "B".
DATED at Toronto this 23rd day of October 2012
Criteria for Exemption from Recognition by the OSC as a clearing agency pursuant to section 21.2(0.1) of the Act
PART 1 -- GOVERNANCE
1.1 The governance structure and governance arrangements of the clearing agency ensures:
(a) effective oversight of the clearing agency;
(b) the clearing agency's activities are in keeping with its public interest mandate;
(c) fair, meaningful and diverse representation on the governing body (Board) and any committees of the Board, including a reasonable proportion of independent directors;
(d) a proper balance among the interests of the owners and the different entities seeking access (participants) to the clearing, settlement and depository services and facilities (settlement services) of the clearing agency;
(e) the clearing agency has policies and procedures to appropriately identify and manage conflicts of interest;
(f) each director or officer of the clearing agency, and each person or company that owns or controls, directly or indirectly, more than 10 percent of the clearing agency is a fit and proper person; and
(g) there are appropriate qualifications, limitation of liability and indemnity provisions for directors and officers of the clearing agency.
PART 2 FEES
2.1 All fees imposed by the clearing agency are equitably allocated. The fees do not have the effect of creating unreasonable barriers to access.
2.2 The process for setting fees is fair and appropriate, and the fee model is transparent.
PART 3 ACCESS
3.1 The clearing agency has appropriate written standards for access to its services.
3.2 The access standards and the process for obtaining, limiting and denying access are fair and transparent. A clearing agency keeps records of
(a) each grant of access including, for each participant, the reasons for granting such access, and
(b) each denial or limitation of access, including the reasons for denying or limiting access to an applicant.
PART 4 RULES AND RULEMAKING
4.1 The clearing agency's rules are designed to govern all aspects of the settlement services offered by the clearing agency, and
(a) are not inconsistent with securities legislation,
(b) do not permit unreasonable discrimination among participants, and
(c) do not impose any burden on competition that is not necessary or appropriate.
4.2 The clearing agency's rules and the process for adopting new rules or amending existing rules should be transparent to participants and the general public.
4.3 The clearing agency monitors participant activities to ensure compliance with the rules.
4.4 The rules set out appropriate sanctions in the event of non-compliance by participants.
PART 5 DUE PROCESS
5.1 For any decision made by the clearing agency that affects an applicant or a participant, including a decision in relation to access, the clearing agency ensures that:
(a) an applicant or a participant is given an opportunity to be heard or make representations; and
(b) the clearing agency keeps a record of, gives reasons for, and provides for appeals or reviews of, its decisions.
PART 6 RISK MANAGEMENT
6.1 The clearing agency's settlement services are designed to minimize systemic risk.
6.2 The clearing agency has appropriate risk management policies and procedures and internal controls in place.
6.3 Without limiting the generality of the foregoing, the clearing agency's services or functions are designed to achieve the following objectives:
1. Where the clearing agency acts as a central counterparty, it rigorously controls the risks it assumes.
2. The clearing agency minimizes principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment.
3. Final settlement occurs no later than the end of the settlement day. Intraday or real-time finality is provided where necessary to reduce risks.
4. Where the clearing agency extends intraday credit to participants, including a clearing agency that operates net settlement systems, it institutes risk controls that, at a minimum, ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle.
5. Assets used to settle the ultimate payment obligations arising from securities transactions carry little or no credit or liquidity risk. If central bank money is not used, steps are to be taken to protect participants in settlement services from potential losses and liquidity pressures arising from the failure of the cash settlement agent whose assets are used for that purpose.
6. If the clearing agency establishes links to settle cross-border trades, it designs and operates such links to reduce effectively the risks associated with cross-border settlements.
6.4 The clearing agency engaging in activities not related to settlement services carries on such activities in a manner that prevents the spillover of risk to the clearing agency that might affect its financial viability or negatively impact any of the participants in the settlement service.
PART 7 SYSTEMS AND TECHNOLOGY
7.1 For its settlement services systems, the clearing agency:
(a) develops and maintains,
(i) reasonable business continuity and disaster recovery plans,
(ii) an adequate system of internal control,
(iii) adequate information technology general controls, including controls relating to information systems operations, information security, change management, problem management, network support, and system software support;
(b) on a reasonably frequent basis, and in any event, at least annually, and in a manner that is consistent with prudent business practice,
(i) makes reasonable current and future capacity estimates,
(ii) conducts capacity stress tests to determine the ability of those systems to process transactions in an accurate, timely and efficient manner,
(iii) tests its business continuity and disaster recovery plans; and
(c) promptly notifies the regulator of any material systems failures.
7.2 The clearing agency annually engages a qualified party to conduct an independent systems review and prepare a report in accordance with established audit standards regarding its compliance with section 7.1(a).
PART 8 FINANCIAL VIABILITY AND REPORTING
8.1 The clearing agency has sufficient financial resources for the proper performance of its functions and to meet its responsibilities and allocates sufficient financial and staff resources to carry out its functions as a clearing agency in a manner that is consistent with any regulatory requirements.
PART 9 OPERATIONAL RELIABILITY
9.1 The clearing agency has procedures and processes to ensure the provision of accurate and reliable settlement services to participants.
PART 10 PROTECTION OF ASSETS
10.1 The clearing agency has established accounting practices, internal controls, and safekeeping and segregation procedures to protect the assets that are held by the clearing agency.
PART 11 OUTSOURCING
11.1 Where the clearing agency has outsourced any of its key functions, it has appropriate and formal arrangements and processes in place that permit it to meet its obligations and that are in accordance with industry best practices. The outsourcing arrangement provides regulatory authorities with access to all data, information, and systems maintained by the third party service provider required for the purposes of regulatory oversight of the agency.
PART 12 INFORMATION SHARING AND REGULATORY COOPERATION
12.1 For regulatory purposes, the clearing agency cooperates by sharing information or otherwise with the Commission and its staff, self-regulatory organizations, exchanges, quotation and trade reporting systems, alternative trading systems, other clearing agencies, investor protection funds, and other appropriate regulatory bodies.
Terms and Conditions
REGULATION OF CMECE
1. CMECE will maintain its status as a RCH with the U.K. Authorities and will continue to be subject to the regulatory oversight of the U.K. Authorities.
2. CMECE will continue to meet the criteria set out in Schedule "A".
Filings with U.K. Authorities
3. CMECE will provide staff of the Commission, concurrently, the following information that it is required to provide to or file with the U.K. Authorities:
(a) the annual audited financial statements of CMECE;
(b) the institution of any legal proceeding against it;
(c) the presentation of a petition for winding up, the appointment of a receiver or the making of any voluntary arrangement with creditors;
(d) changes and proposed changes to its bylaws, rules, operations manual, participant agreements and other similar instruments or documents of CMECE which contain any contractual terms setting out the respective rights and obligations between CMECE and Clearing Members or among Clearing Members;
(e) new types of products to be offered for clearing to Clearing Members or products that will no longer be available for clearing to Clearing Members;
(f) the CME Clearing Europe Risk Committee Quarterly Report or other materials that provide equivalent risk management information.
4. CMECE will promptly notify staff of the Commission of any of the following:
(a) any material change to its business or operations or the information as provided in the Application;
(b) any material problem with the clearance and settlement of transactions that could materially affect the financial safety and soundness of CMECE;
(c) an event of default by a Clearing Member;
(d) any material change or proposed material change in CMECE's RCH status or the regulatory oversight by the U.K. Authorities;
(e) any new services (including client clearing) or clearing of new products that are proposed to be offered to Ontario Clearing Members.
5. CMECE will maintain the following updated information and submit such information to the Commission in a manner and form acceptable to the Commission on at least a quarterly basis, and at any time promptly upon the request of staff of the Commission:
(a) a current list of all Ontario Clearing Members;
(b) a list of all Ontario Clearing Members against whom disciplinary action has been taken in the last quarter by CMECE or the U.K. Authorities with respect to activities at CMECE;
(c) a list of all investigations by CMECE relating to Ontario Clearing Members;
(d) a list of all Ontario applicants who have been denied Clearing Member status by CMECE;
(e) the average daily volume and value of trades cleared by asset class during the previous quarter, for each Ontario Clearing Member;
(f) the portion of total volume and value of trades cleared by asset class during the previous quarter for all Clearing Members that represents the total volume and value of trades cleared during the previous quarter for each Ontario Clearing Member; and
(g) any other information in relation to an OTC derivative cleared by CMECE as may be required by the Commission from time to time to carry out the Commission's mandate.
6. CMECE will provide such other information as may be requested from time to time by, and otherwise cooperate with, the Commission or its staff.
7. CMECE will share information and otherwise cooperate with other recognized and exempt clearing agencies, as appropriate.
SUBMISSION TO JURISDICTION AND AGENT FOR SERVICE
8. With respect to a proceeding brought by the Commission arising out of, related to, concerning or in any other manner connected with the Commission's regulation and oversight of CMECE's activities in Ontario, CMECE will submit to the non-exclusive jurisdiction of (i) the courts and administrative tribunals of Ontario and (ii) an administrative proceeding in Ontario.
9. For greater certainty, CMECE will file with the Commission a valid and binding appointment of an agent for service in Ontario upon whom may be served a notice, pleading, subpoena, summons or other process in any action, investigation or administrative, criminal, quasi-criminal, penal or other proceeding arising out of or relating to or concerning the activities of CMECE in Ontario.