National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Application by investment dealer for relief from prospectus requirement in connection with distribution of contracts for difference and OTC foreign exchange contracts (collectively, OTC Contracts) to retail investors, subject to terms and conditions -- Filer registered as investment dealer and a member of the Investment Industry Regulatory Organization of Canada (IIROC) -- Filer complies with IIROC rules and IIROC acceptable practices applicable to offerings of OTC Contracts -- Filer seeking relief to permit Filer to offer OTC Contracts to retail investors on the basis of clear and plain language risk disclosure document rather than a prospectus -- risk disclosure document contains disclosure substantially similar to risk disclosure document required for recognized options in OSC Rule 91-502 Trades in Recognized Options, and the regime for OTC derivatives contemplated by former proposed OSC Rule 91-504 OTC Derivatives (which was not adopted) -- Relief consistent with relief contemplated by OSC Staff Notice 91-702 Offerings of contracts for difference and foreign exchange contracts to investors in Ontario(OSC SN 91-702) -- Relief granted, subject to terms and conditions.
Securities Act, R.S.O. 1990, c. S.5, as am., s. 53, 74(1).
OSC Rule 91-502 Trades in Recognized Options.
OSC Rule 91-503 Trades in Commodity Futures Contracts and Commodity Futures Options Entered into on Commodity Futures Exchanges Situate Outside of Ontario.
Proposed OSC Rule 91-504 OTC Derivatives (not adopted).
January 17, 2014
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO (the Jurisdiction)
IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS
IN THE MATTER OF BBS SECURITIES INC. (the Filer)
The principal regulator in the Jurisdiction has received an application from the Filer for a decision under the securities legislation of the Jurisdiction (the Legislation) that the Filer and its respective officers, directors and representatives be exempt from the prospectus requirement in respect of the distribution of contracts for difference (CFDs), and over-the-counter (OTC) foreign exchange (FX) spot contracts (collectively, OTC Contracts) to retail investors resident in Canada (the Requested Relief) subject to the terms and conditions below:
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 (the Principal Regulator); and
(b) the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 -- Passport System (MI 11-102) is intended to be relied upon in each of the other provinces and territories of Canada other than the provinces of Québec and Alberta (the Non-Principal Jurisdictions and, together with the Jurisdiction, the Applicable Jurisdictions).
Terms defined in National Instrument 14-101 -- Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.
This decision is based on the following facts represented by the Filer:
1. The Filer is a privately held corporation incorporated under the laws of the Province of Ontario with its head office in Toronto, Ontario.
2. The Filer is registered as a dealer in the category of investment dealer in each of the provinces and territories of Canada, and is a member of the Investment Industry Regulatory Organization of Canada (IIROC).
3. The Filer is not, to the best of its knowledge, in default of applicable securities legislation in any province or territory of Canada or IIROC Rules or IIROC Acceptable Practices (as defined below).
4. The Filer has considered the guidance in OSC Staff Notice 91-702 Offerings of Contracts for Difference and Foreign Exchange Contracts to Investors in Ontario (OSC SN 91-702) and wishes to offer OTC Contracts to retail investors in the Applicable Jurisdictions on the basis of the exemptive relief contemplated by OSC SN 91-702 and in accordance with the representations, terms and conditions described in this decision. For the Interim Period (as defined below), the Filer is seeking the Requested Relief in connection with the offering of OTC Contracts in Ontario and intends to rely on this decision and the passport system described in MI 11-102 (the Passport System) to offer OTC Contracts in the Non-Principal Jurisdictions.
5. In Québec, the Filer intends to apply for a Qualification and Authorization to market a derivative (the AMF Order) from the Autorité des Marchés Financiers (the AMF) to offer OTC Contracts to retail investors pursuant to the provisions of theDerivatives Act (Québec) (the QDA). The final AMF Order will, if granted, allow the Filer to offer specified OTC Contracts to investors in Québec on similar terms and conditions as are contained in this decision.
IIROC Rules and Acceptable Practices
6. In order to act as an investment dealer, the Filer is mandated by section 9.1 of National Instrument 31-103 -- Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) to be a "Dealer Member" of IIROC (Dealer Member).
7. As a Dealer Member, the Filer is only permitted to enter into OTC Contracts pursuant to the rules and regulations of IIROC (the IIROC Rules).
8. In addition, IIROC has communicated to its members certain additional expectations as to acceptable business practices (IIROC Acceptable Practices) as articulated in IIROC's paper "Regulatory Analysis of Contracts for Differences (CFDs)" published by IIROC on June 6, 2007 and as amended on September 12, 2007, for any Dealer Member proposing to offer OTC foreign exchange contracts or other types of CFDs to investors. The Filer will offer OTC Contracts in accordance with IIROC Acceptable Practices as may be established from time to time.
9. The Filer is also required by IIROC to maintain a certain level of capital to address the business risks associated with its activities. The capital reporting required by IIROC (as per the calculation in the Joint Regulatory Financial Questionnaire and Report (the JRFQ) and the Monthly Financial Reports to IIROC) is based predominantly on the generation of financial statements and calculations so as to ensure capital adequacy. The Filer, as a Dealer Member, is required to have a specified minimum capital, which takes into account any additional capital required in respect of margin requirements and other risks. This risk calculation is summarized as a risk adjusted capital calculation which is submitted in the Filer's JRFQ and required to be kept positive at all times.
Online Trading Platform
10. The Filer will offer online self-directed trading in OTC Contracts via an online trading platform (the Platform), which is a fully automated live application-based OTC Contracts trading platform. The Filer may provide clients with a choice of OTC Contracts web-based trading platforms in the future.
11. The Platform is an established third party FX/CFD trading application which is widely used in North American and European markets by many investment dealers.
12. The Platform technology has certain client protection mechanisms and risk management tools which, among other things, provides transparency of price to clients. The Platform is a key component of a comprehensive risk management strategy, which will enable the Filer and its clients to manage the risks associated with leveraged products. This risk management system has evolved over many years with the objective of meeting the mutual interests of all relevant parties including, in particular, clients. The attributes and services of the Platform are described in more detail below:
(a) Real-time Client reporting. Clients are provided with a real-time view of their margin balances, including how tick-by-tick price movements affect their margin balances. Account balances are updated on an ongoing basis according to the clients' relevant account activities.
(b) Automated risk management system. Clients are instructed that they must maintain the required margin against their position(s). If a client's funds drops below the required margin, margin calls are regularly issued via email, alerting the client to the fact that the client is required to either deposit additional funds to maintain the position or close/reduce it voluntarily. Where possible, daily telephone margin calls are provided as a supporting communication for clients. If a client fails to deposit additional funds, where required, the client's position is liquidated. This liquidation procedure is intended to act as a mechanism to reduce the risk of losses being greater than the value of the funds deposited by the client. The risk management functionality of the Platform ensures that client positions are closed out when the client no longer maintains sufficient margin in its account to support its position, thereby preventing the client from losing more than its stated risk capital or cumulative loss limit. This functionality also ensures that the Filer will not incur any credit risk vis-à-vis its customers in respect of transactions in OTC Contracts. In addition to the Platform's risk control module, all clients' trades will pass through the Filer's proprietary risk management system, which controls margin availability of accounts in real time. Thus, at any point in time, there will always be two levels of risk management processes being performed through the Platform.
(c) Wide range of order types. The Platform also provides risk management tools such as stops, limits, and contingent orders, which are available on all OTC Contracts. These tools are designed to reduce the risk of losses being greater than the value of the funds deposited by a client.
13. The Platform is not a "marketplace" as defined in National Instrument 21-101 -- Marketplace Operation since a marketplace is any facility that brings together multiple buyers and sellers by matching orders in fungible contracts in a nondiscretionary manner. The Platform does not bring together multiple buyers and sellers; rather, it offers clients direct access to real time currency rates and prices quotes for the OTC Contracts.
14. The Filer will be the counterparty to trades by its clients in OTC Contracts (OTC Transactions). It will not act as an intermediary, broker or trustee in respect of OTC Transactions. The Filer does not manage any discretionary accounts, nor does it provide any trading advice or recommendations.
15. The Filer will manage the risk in its clients' positions through a hedging strategy, subject to IIROC Rules and IIROC Acceptable Practices. The strategy will involve the Filer simultaneously placing the identical OTC Transaction on a back-to-back basis or its net exposure with acceptable institutions or liquidity providers. The only third party counterparties involved are Canadian chartered banks, which are "acceptable institutions" as defined in JRFQ (Form 1). In some cases, it may be desirable for the Filer to carry the hedging position itself; for example where the position would be too small to hedge efficiently. In those circumstances, the Filer will ensure that it maintains its risk adjusted capital well within acceptable levels and will not impose charges on client accounts (other than ordinary commissions relating to the clients' trades). To this extent, the Filer may from time to time profit on its positions while the corresponding position of the client incurs a profit or loss. While this may represent a conflict of interest it will be executed on a basis which is not disadvantageous to its clients. By virtue of this risk management functionality inherent in the Platform and our proprietary risk management system the Filer eliminates counterparty risk for its clients.
16. The OTC Contracts offered by the Filer are not transferable.
17. The ability to lever an investment is one of the principal features of OTC Contracts. Leverage allows clients to magnify investment returns (or losses) by reducing the initial capital outlay required to achieve the same market exposure that would be obtained by investing directly in the underlying currency or instrument
18. IIROC Rules and IIROC Acceptable Practices set out detailed requirements and expectations relating to leverage and margin for offerings of CFDs and other OTC Contracts. The degree of leverage may be amended in accordance with IIROC Rules and IIROC Acceptable Practices as may be established from time to time.
19. Pursuant to sections 9.3 and 13.12 of NI 31-103, only firms that are registered as investment dealers, including the Filer, may lend money, extend credit or provide margin to a client.
Structure of CFDs
20. A CFD is a derivative product that allows clients to obtain economic exposure to the price movement of an underlying instrument, such as a share, index, currency pair, treasury or commodity, without the need for ownership and physical settlement of the underlying instrument. Unlike certain OTC derivatives, such as forward contracts, CFDs do not require or oblige either the client or principal counterparty nor any agent of the principal counterparty to deliver the underlying instrument.
21. The OTC Contracts, including CFDs, to be offered by the Filer will not confer the right or obligation to acquire or deliver the underlying security or instrument itself, and will not confer any other rights of holders of the underlying security or instrument, such as voting rights. Rather, the OTC Contracts are derivative instruments which are represented by an agreement between a client and a counterparty to exchange the difference between the opening price of a CFD position and the price of the CFD at the closing of the position. The value of the CFD is generally reflective of the movement in prices at which the underlying instrument is traded at the time of opening and closing the position in the CFD.
22. CFDs allow clients to take a long or short position on an underlying instrument but, unlike futures contracts, they have no fixed expiry date or an obligation for physical delivery of the underlying instrument.
23. CFDs allow clients to obtain exposure to markets and instruments that may not be available directly, or may not be available in a cost-effective manner.
OTC Contracts Distributed in the Applicable Jurisdictions
24. Certain types of OTC Contracts may be considered to be "securities" under the securities legislation of the Applicable Jurisdictions.
25. All investors wishing to enter into an OTC Contract with the Filer must first open an account with the Filer.
26. Prior to a client's first OTC Transaction, and as part of the account opening process, the Filer will provide the client with a separate risk disclosure document that clearly explains, in plain language, the transaction and the risks associated with the transaction (the Risk Disclosure Document). The Risk Disclosure Document includes the required risk disclosure set forth in Schedule A to the Regulations to the QDA and leverage risk disclosure required under IIROC Rules. The Risk Disclosure Document also contains disclosure that is substantially similar to the risk disclosure statement required for recognized options in OSC Rule 91-502 Trades in Recognized Options (which provides for both registration and prospectus exemptions) (OSC Rule 91-502) and the regime for OTC derivatives contemplated by OSC SN 91-702 and proposed OSC Rule 91-504 OTC Derivatives (which was not adopted) (Proposed Rule 91-504). Prior to a client's first OTC Transaction, the Filer will ensure a complete copy of the Risk Disclosure Document will be delivered to the client through the online account application and to the Principal Regulator.
27. As part of the account opening process and prior to the client's first OTC Transaction, the Filer will also obtain a written or electronic acknowledgement from the client confirming that the client has read and understood the Risk Disclosure Document. Such acknowledgment will be separate from and prominent among other acknowledgements provided by the client as part of the account opening process.
28. As is customary in the industry, and due to the fact that some information is subject to factors beyond the control of the Filer (such as changes in the IIROC Rules), information such as the underlying instrument listing and associated margin rates would not be disclosed in the Risk Disclosure Document. Instead, such information will be part of a client's account opening package and will be available on both the Filer's website and the Platform.
Satisfaction of the Registration Requirement
29. The role of the Filer as it relates to the offering of OTC Contracts (other than it being the principal under the OTC Contracts) will be limited to acting as an execution-only dealer. In this role, the Filer will, among other things, be responsible for approving all marketing, for holding of clients funds and for client approval (including the review of know-your-client (KYC) due diligence and account opening suitability assessments pursuant to NI 31-103). The Filer will have full and instantaneous access to all client information and trade activity orders, which will be input into the Platform. Client approvals and holding of client funds will be solely under the Filer's control.
30. Although IIROC exempts Dealer Member firms that provide execution-only services from the obligation to determine whether each trade is suitable for the client, IIROC Rules impose additional requirements on Dealer Members proposing to trade in OTC Contracts which requires, among other things, that:
(a) applicable risk disclosure documents and client suitability waivers provided be in a form acceptable to IIROC;
(b) the firm's policies and procedures, amongst other things, require the Filer to assess whether trading in OTC Contracts is appropriate for a client before an account is approved to be opened. This account opening suitability process includes an assessment of the client's investment knowledge and trading experience, client identification, screening applicants and customers against lists of prohibited/blocked persons, and detecting and reporting suspicious trading and potential terrorist financing and money laundering activities to applicable enforcement authorities;
(c) the Filer's registered dealing representatives who will conduct the KYC and initial product suitability analysis, as well as their registered supervisor who oversees the KYC and initial product suitability analysis, will meet proficiency requirements for futures trading, and will maintain appropriate IIROC registration; and
(d) cumulative loss limits for each client's account be established (this is a measure normally used by IIROC in connection with futures trading accounts).
31. The OTC Contracts will be offered in compliance with applicable IIROC Rules and other IIROC Acceptable Practices.
32. IIROC limits the underlying instruments in respect of which Dealer Members may offer OTC Contracts since only certain securities are eligible for reduced margin rates. For example, underlying equity securities must be listed or quoted on certain "recognized exchanges" (as that term is defined in IIROC Rules) such as the Toronto Stock Exchange or the New York Stock Exchange. The purpose of these limits is to ensure that OTC Contracts offered in Canada will only be available in respect of underlying instruments that are traded in well-regulated markets, in significant enough volumes and with adequate publicly available information, so that clients can form a sufficient understanding of the exposure represented by a given OTC Contract.
33. IIROC Rules prohibit the margining of OTC Contracts where the underlying instrument is a synthetic product (single U.S. sector or "mini-indices"). For example, sector CFDs (i.e., basket of equities for the financial institutions industry) may be offered to non-Canadian clients; however, this is not permissible under IIROC Rules.
34. Dealer Members seeking to trade OTC Contracts are generally precluded, by virtue of the nature of the contracts, from distributing CFDs that confer the right or obligation to acquire or deliver the underlying security or instrument itself (convertible CFDs), or that confer any other rights of shareholders of the underlying security or instrument, such as voting rights.
35. The Requested Relief, if granted, would substantially harmonize the position of the regulators in the Applicable Jurisdictions (collectively, the Commissions) on the offering of OTC Contracts to investors in the Applicable Jurisdictions with how those products are offered to investors in Québec under the QDA. The QDA provides a legislative framework to govern derivatives activities within Québec. Among other things, the QDA requires such products to be offered to investors through a Dealer Member and the distribution of a standardized risk disclosure document rather than a prospectus in order to distribute such contracts to investors resident in Québec.
36. The Requested Relief, if granted, would also be consistent with the guidelines articulated in OSC SN 91-702, which provides guidance with regard to the distribution of CFDs, foreign exchange contracts and similar OTC derivative products to investors in Ontario.
37. The Principal Regulator has previously recognized that the prospectus requirement may not be well suited for the distribution of certain derivative products to investors in the Jurisdiction, and that alternative requirements, including requirements based on clear and plain language risk disclosure, may be better suited for certain derivatives.
38. In Ontario, OSC Rule 91-502, OSC Rule 91-503 -- Trades in Commodity Futures Contracts and Commodity Futures Options Entered into on Commodity Futures Exchanges Situated Outside of Ontario (OSC Rule 91-503) and Proposed Rule 91-504 provide for a prospectus exemption for trading derivative products to clients. Granting the Requested Relief would be consistent with the principles and requirements of OSC Rule 91-502, OSC Rule 91-503 and Proposed Rule 91-504.
39. The Filer is of the view that requiring compliance with the prospectus requirement in order to enter into OTC Contracts with retail clients would not be appropriate since the disclosure of a great deal of the information required under a prospectus and under the reporting issuer regime is not material to a client seeking to enter into an OTC Transaction. In addition, most OTC Contracts are of short duration (positions are generally opened and closed on the same day and are in any event marked to market and cash settled daily). The information to be given to such a client should principally focus on enhancing the client's appreciation of product risk, including counterparty risk, which is accomplished by providing the Risk Disclosure Document as described above.
40. The Filer is regulated by IIROC, which has a robust compliance regime including specific requirements to address market, capital and operational risks.
41. The Filer submits that the regulatory regimes developed by the AMF and IIROC for OTC Contracts adequately address issues relating to the potential risk to the clients of the Filer acting as counterparty. In view of these regulatory regimes, investors would receive little or no additional benefit from requiring the Filer to also comply with the prospectus requirement.
42. The Requested Relief in respect of each Applicable Jurisdiction is conditional on the Filer being registered as an investment dealer with the Commission in such Applicable Jurisdiction and maintaining its membership with IIROC and that all OTC Transactions be conducted pursuant to IIROC Rules and in accordance with IIROC Acceptable Practices.
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 under the Legislation is that the Requested Relief is granted provided that:
(a) with respect to residents of an Applicable Jurisdiction, the Filer remains registered as a dealer in the category of investment dealer with the Principal Regulator and the Commission in such Applicable Jurisdiction and a member of IIROC;
(b) all transactions in OTC Contracts with clients resident in the Applicable Jurisdictions shall be conducted pursuant to IIROC Rules imposed on Dealer Members seeking to trade in OTC Contracts and in accordance with IIROC Acceptable Practices, as amended from time to time;
(c) all transactions in OTC Contracts with clients resident in the Applicable Jurisdictions be conducted pursuant to the rules and regulations of the QDA and the AMF, as amended from time to time, unless and to the extent there is a conflict between i) the rules and regulations of the QDA and the AMF, and ii) the requirements of the securities laws of the Applicable Jurisdictions, the IIROC Rules and IIROC Acceptable Practices, in which case the latter shall prevail;
(d) prior to a client first entering into a transaction in an OTC Contract, the Filer has provided to the client the Risk Disclosure Document and has delivered, or has previously delivered, a copy of the Risk Disclosure Document to the Principal Regulator;
(e) prior to the client's first transaction in an OTC Contract and as part of the account opening process, the Filer has obtained a written or electronic acknowledgement from the client, as described in paragraph 27, confirming that the client has received, read and understood the Risk Disclosure Document;
(f) the Filer has furnished to the Principal Regulator the name and principal occupation of its officers or directors, together with either the personal information form and authorization of indirect collection, use and disclosure of personal information provided for in National Instrument 41-101 General Prospectus Requirements or the registration information form for an individual provided for in Form 33-109F4 of National Instrument 33-109 Registration Information Requirements completed by any officer or director;
(g) the Filer shall promptly inform the Principal Regulator in writing of any material change affecting the Filer, being any change in the business, activities, operations or financial results or condition of Filer that may reasonably be perceived by a counterparty to a derivative to be material;
(h) the Filer shall promptly inform the Principal Regulator in writing if a self-regulatory organization or any other regulatory authority or organization initiates proceedings or renders a judgment related to disciplinary matters against the Filer concerning the conduct of activities with respect to OTC Contracts;
(i) within 90 days following the end of its financial year, the Filer shall submit to IIROC, and the Principal Regulator upon request, the audited annual financial statements of the Filer; and
(j) the Requested Relief shall immediately expire upon the earliest of (theInterim Period)
1. four years from the date that this decision is issued;
2. the issuance of an order or decision by a court, the Commission in such Applicable Jurisdiction, the AMF (in respect of Québec) or other similar regulatory body that suspends or terminates the ability of the Filer to offer CFDs or other OTC Contracts to clients in such Applicable Jurisdiction or Québec; and
3. with respect to an Applicable Jurisdiction, the coming into force of legislation or a rule by any Commission regarding the distribution of OTC derivatives to investors in such Applicable Jurisdiction.