National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Application for relief from dealer registration and prospectus requirements that may be applicable to certain trades in over-the-counter (OTC) derivatives with "permitted counterparties" -- permitted counterparties will consist exclusively of persons or companies who are non-individual "permitted clients" as defined in Section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations -- relief sought in Ontario and certain other jurisdictions as interim response to current regulatory uncertainty associated with OTC derivatives in Canada -- Filer intends to rely on comparable exemptions in orders or rules of general application in certain jurisdictions for trades with "qualified parties" and, in Quebec, the exemption under Quebec derivatives legislation for trades with "accredited counterparties" -- relief granted subject to certain terms and conditions, including sunset provision of up to four years
Applicable Legislative Provisions
Securities Act, R.S.O. 1990, c. S.5, as am., ss. 25(1), 53(1), 74.
National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, s. 1.1 ("permitted client").
November 11, 2014
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO (the Jurisdiction) AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF CITIZENS BANK, NATIONAL ASSOCIATION (the Filer)
The principal regulator in the Jurisdiction has received an application (the Application) from the Filer for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) that the dealer registration requirement and the prospectus requirement in the Legislation that may otherwise be applicable to a trade in or distribution of an OTC Derivative transaction (as defined below) made by either
i) a Filer to a "Permitted Counterparty" (as defined below), or
ii) by a Permitted Counterparty to a Filer,
shall not apply to the Filer or the Permitted Counterparty, as the case may be (the Requested Relief), subject to certain terms and conditions.
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions:
(a) the Ontario Securities Commission is the principal regulator for the Application; 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 Manitoba, Newfoundland and Labrador, New Brunswick (to the extent Local Rule 91-501 Derivatives does not apply), Northwest Territories, Nova Scotia, Prince Edward Island, Yukon and Nunavut.
Terms defined in National Instrument 14-101 Definitions or MI 11-102 have the same meanings if used in this decision, unless otherwise defined.
The terms OTC Derivative and Underlying Interest are defined in the Appendix (the Appendix) to this decision.
The term Permitted Counterparty means a person or company that
(a) is a "permitted client", as that term is defined in section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103); and
(b) is not an individual.
This decision is based on the following facts represented by the Filer:
1. The Filer is a national full-service commercial and retail bank organized under the laws of the United States of America under charter number 24571. Its primary regulator in the United States is the Office of the Comptroller of the Currency. The Filer's head office is located at One Citizens Plaza, Providence, Rhode Island, 02903, USA.
2. The Filer is not currently registered in any capacity in Canada or with the U.S. Securities and Exchange Commission.
3. The Filer is not required to register under US law with the U.S. Commodity Futures Trading Commission as a swap dealer or a major swap participant.
4. Citizens Financial Group, Inc., the holding company for the Filer, is currently wholly owned by the Royal Bank of Scotland Group PLC. Citizens Financial Group, Inc. is expected to be spun off in tranches in an initial public offering commencing in the Fall of 2014. The full divestiture by Royal Bank of Scotland Group PLC is expected to occur over a two year period. Upon the offering of the first tranche, Citizens Financial Group, Inc. would become a publicly traded company in the United States registered with the Securities and Exchange Commission.
5. The Filer is not in default of securities legislation in any jurisdiction in Canada.
Proposed Conduct of OTC Derivative Transactions
6. The Filer proposes to enter into bilateral OTC Derivative transactions with counterparties located in all provinces and territories of Canada that consist exclusively of persons or companies that are Permitted Counterparties. The Filer understands that the Permitted Counterparties would be entering into the OTC Derivative transactions for hedging or investment purposes. The Underlying Interest of the OTC Derivatives that are entered into between a Filer and a Permitted Counterparty will consist of a commodity; an interest rate; a currency; a foreign exchange rate; a security; an economic indicator, an index; a basket; a benchmark; another variable; another OTC Derivative; or some relationship between, or combination of, one or more of the foregoing.
7. The Filer will not offer or provide credit or margin to any of their Permitted Counterparties for purposes of an OTC Derivative transaction.
8. The Filer seeks the Requested Relief as an interim, harmonized solution to the uncertainty and fragmentation that currently characterizes the regulation of OTC Derivatives across Canada, pending the development of a uniform framework for the regulation of OTC Derivative transactions in all provinces and territories of Canada.
Regulatory Uncertainty and Fragmentation associated with the Regulation of OTC Derivative Transactions in Canada
9. There has generally been a considerable amount of uncertainty respecting the regulation of OTC Derivative transactions as "securities" in the provinces and territories of Canada other than Quebec (the Relevant Jurisdictions).
10. In each of British Columbia, Saskatchewan, Prince Edward Island and New Brunswick, and in each of the Yukon, the Northwest Territories and Nunavut, OTC Derivative transactions are regulated as securities on the basis that the definition of the term "security" in the securities legislation of each of these jurisdictions includes an express reference to a "futures contract" or a "derivative".
11. In Alberta, the term "security" no longer includes an express reference to a "futures contract". Following the introduction, effective October 31, 2014, of a new framework and terminology for the regulation of derivatives, Alberta securities legislation now includes a definition of "derivative".
12. In each of Manitoba, Ontario, Nova Scotia and Newfoundland and Labrador, it is not certain whether, or in what circumstances, OTC Derivative transactions are "securities" because the definition of the term "security" in the securities legislation of each of these jurisdictions makes no express reference to a "futures contract" or a "derivative".
13. In October 2009, staff of the OSC published OSC Staff Notice 91-702 Offerings of Contracts for Difference and Foreign Exchange Contracts to Investors in Ontario (OSC Notice 91-702). OSC Notice 91-702 states that OSC staff take the view that contracts for differences, foreign exchange contracts and similar OTC Derivative products, when offered to investors in Ontario, engage the purposes of the Securities Act (Ontario) (the Ontario Act) and constitute "investment contracts" and "securities" for the purposes of Ontario securities law. However, OSC Notice 91-702 also states that it is not intended to address direct or intermediated trading between institutions. OSC Notice 91-702 does not provide any additional guidance on the extent to which OTC Derivative transactions between the Filer and a Permitted Counterparty may be subject to Ontario securities law.
14. In Quebec, OTC Derivative transactions are subject to the Derivatives Act (Quebec), which sets out a comprehensive scheme for the regulation of derivative transactions that is distinct from Quebec's securities regulatory requirements.
15. In each of British Columbia, Alberta, Saskatchewan and New Brunswick (the Blanket Order Jurisdictions) and Quebec (collectively, the OTC Exemption Jurisdictions), OTC Derivative transactions are generally not subject to securities or derivative regulatory requirements, pursuant to applicable exemptions (the OTC Derivative Exemptions), when they are negotiated, bi-lateral contracts that are entered into between sophisticated non-retail parties, referred to as "Qualified Parties" in the Blanket Order Jurisdictions and "accredited counterparties" in Quebec.
16. The corresponding OTC Derivative Exemptions are as follows:
Blanket Order 91-501 Over-the-Counter Derivatives
ASC Blanket Order 91-506 Over-the-Counter Trades in Derivatives
General Order 91-907 Over-the-Counter Derivatives
Section 7 of the Derivatives Act (Quebec)
Local Rule 91-501 Derivatives
17. Before March 27, 2010, section 3.3 [Accredited investor] of National Instrument 45-106 Prospectus and Registration Exemptions (NI 45-106) provided an exemption from the dealer registration requirement for certain trades made to "accredited investors", which may have been relied upon by persons or companies entering into OTC Derivative transactions considered to be securities. However, in Ontario and Newfoundland and Labrador this exemption was not available to most "market intermediaries" due to section 3.0 [Removal of exemptions -- market intermediaries].
The Evolving Regulation of OTC Derivative Transactions as Derivatives
18. Each of the OTC Exemption Jurisdictions has sought to address the regulatory uncertainty associated with the regulation of OTC Derivative transactions as securities by regulating them as derivatives rather than securities, whether directly through the adoption of a distinct regulatory framework for derivatives in Quebec, or indirectly through amendments to the definition of the term "security" in the securities legislation of the other OTC Exemption Jurisdictions and the granting of the OTC Derivative Exemptions.
19. Between 1994 and 2000, the OSC sought to achieve a similar objective by introducing proposed OSC Rule 91-504 Over-the-Counter Derivatives (the Proposed OSC Rule) for the purpose of establishing a uniform, clearly defined regulatory framework for the conduct of OTC Derivative transactions in Ontario, but the Proposed OSC Rule was returned to the OSC for further consideration by Ontario's Minister of Finance in November, 2000.
20. The Final Report of the Ontario Commodity Futures Act Advisory Committee, published in January, 2007, concluded that OTC Derivative contracts are not suited to being regulated in accordance with traditional securities regulatory requirements and should therefore be excluded from the scope of securities legislation, because they are used for commercial-risk management purposes and not for investment or capital-raising purposes.
21. Ontario has now established a framework for regulating the trading of derivatives in Ontario (the Ontario Derivatives Framework) through amendments to the Ontario Act that were made by the Helping Ontario Families and Managing Responsibility Act, 2010 (Ontario).
22. The amendments to the Ontario Act establishing the Ontario Derivatives Framework will not become effective until the date on which they are proclaimed in force. These amendments are not expected to be proclaimed in force until an ongoing public consultation on the regulation of OTC Derivatives has been completed.
23. In 2013, Ontario, Quebec and Manitoba introduced Rule 91-507 Trade Repositories and Derivatives Data Reporting which requires, in certain circumstances, local counterparties to report certain information pertaining to derivatives transactions to a designated trade repository.
Rationale for Requested Relief
24. The Requested Relief would substantially address, for the Filer and its Permitted Counterparties, the regulatory uncertainty and fragmentation that is currently associated with the regulation of OTC Derivative transactions in Canada, by permitting these parties to enter into OTC Derivative transactions in reliance upon exemptions from the dealer registration and prospectus requirements of the securities legislation of each Relevant Jurisdiction that are comparable to the OTC Derivative Exemptions.
Books and Records
25. The Filer will become a "market participant" as a consequence of this decision. For the purposes of the Ontario Act, and as a market participant, the Filer is required by subsection 19(1) of the Ontario Act to: (i) keep such books, records and other documents as are necessary for the proper recording of its business transactions and financial affairs, and the transactions that it executes on behalf of others; and (ii) keep such books, records and documents as may otherwise be required under Ontario securities law.
26. For the purposes of its compliance with subsection 19(1) of the Ontario Act, the books and records that the Filer will keep will include books and records that:
(a) demonstrate the extent of the Filer's compliance with applicable requirements of securities legislation;
(b) demonstrate compliance with the policies and procedures of the Filer for establishing a system of controls and supervision sufficient to provide reasonable assurance that the Filer, and each individual acting on its behalf, complies with securities legislation;
(c) identify all OTC Derivative transactions conducted on behalf of the Filer and each of its clients, including the name and address of all parties to the transaction and its terms; and
(d) set out for each OTC Derivative transaction entered into by the Filer, information corresponding to that which would be required to be included in an exempt distribution report for the transaction, if the transaction were entered into by the Filer in reliance upon the "accredited investor" prospectus exemption in section 2.3 [Accredited investor] of NI 45-106.
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 is that the Requested Relief is granted, provided that:
(a) the counterparty to any OTC Derivative transaction that is entered into by the Filer is a Permitted Counterparty;
(b) in the case of any trade made by the Filer to a Permitted Counterparty, the Filer does not offer or provide any credit or margin to the Permitted Counterparty; and
(c) the Requested Relief shall terminate on the date that is the earlier of:
(i) the date that is four years after the date of this decision; and
(ii) the coming into force in the Jurisdiction of legislation or a rule that specifically governs dealer, adviser or other registration requirements applicable to market participants in connection with OTC Derivative transactions.
Ontario Securities Commission
Ontario Securities Commission
"Clearing Corporation" means an association or organization through which Options or futures contracts are cleared and settled.
"Contract for Differences" means an agreement, other than an Option, a Forward Contract, a spot currency contract or a conventional floating rate debt security, that provides for
(a) an exchange of principal amounts; or
(b) the obligation or right to make or receive a cash payment based upon the value, level or price, or on relative changes or movements of the value, level or price of, an Underlying Interest.
"Forward Contract" means an agreement, not entered into or traded on or through an organized market, stock exchange or futures exchange and cleared by a Clearing Corporation, to do one or more of the following on terms or at a price established by or determinable by reference to the agreement and at or by a time established by or determinable by reference to the agreement:
(a) make or take delivery of the Underlying Interest of the agreement; or
(b) settle in cash instead of delivery.
"Option" means an agreement that provides the holder with the right, but not the obligation, to do one or more of the following on terms or at a price determinable by reference to the agreement at or by a time established by the agreement:
(a) receive an amount of cash determinable by reference to a specified quantity of the Underlying Interest of the Option.
(b) purchase a specified quantity of the Underlying Interest of the Option.
(c) sell a specified quantity of the Underlying Interest of the Option.
"OTC Derivative" means one or more of, or any combination of, an Option, a Forward Contract, a Contract for Differences or any instrument of a type commonly considered to be a derivative, in which:
(a) the agreement relating to, and the material economic terms of, the Option, Forward Contract, Contract for Differences or other instrument have been customized to the purposes of the parties to the agreement and the agreement is not part of a fungible class of agreements that are standardized as to their material economic terms;
(b) the creditworthiness of a party having an obligation under the agreement would be a material consideration in entering into or determining the terms of the agreement; and
(c) the agreement is not entered into or traded on or through an organized market, stock exchange or futures exchange.
"Underlying Interest" means, for a derivative, the commodity, interest rate, currency, foreign exchange rate, security, economic indicator, index, basket, benchmark or other variable, or another derivative, and, if applicable, any relationship between, or combination of, any of the foregoing, from or on which the market price, value or payment obligations of the derivative are derived or based.