Québec Legislates in the Canadian Derivatives Market and Releases a New Derivatives Act
Alix d'Anglejan-Chatillon and Sterling H. Dietze| 
Version française
A legislative proposal to establish a new Derivatives Act was tabled by the Québec Minister of Finance on April 9, 2008. Bill 77 follows the publication in August 2007 by the Autorité des marchés financiers (Québec's financial markets regulator) of a proposed framework for the regulation of the derivatives markets in Québec and an earlier concept paper in May 2006, both of which attracted detailed comments by Canadian and foreign stakeholders in the industry. The proposed Québec Derivatives Act would regulate both over-the-counter (OTC) and exchange-traded derivatives in standalone legislation, subject to certain carve outs for OTC derivatives activities involving designated "accredited counterparties".
The stated purpose of the Act is to "foster honest, fair, efficient and transparent derivatives markets and to protect the public from unfair, improper and fraudulent practices and market manipulation." In the Québec Minister of Finance's April 9, 2008 press release, Minister Monique Jérôme-Forget stated that the legislation is intended to "provide the industry with a clear legislative framework that meets its needs for legal security, flexibility and efficiency. It will afford users of derivatives the protection they need, helping make Québec one of the best places in the world to trade derivatives".
Some of the highlights of the proposals are noted below. However, since the key provisions of the Act cross-reference regulations which have yet to be published, it is too early to size up the exact scope and detailed application of the Act and its potential impact on the various segments of the Canadian and cross-border derivatives market.
The Québec Derivatives Landscape
The driving factor underlying this initiative is the Québec government's determination to stake Québec's position as the lead jurisdiction in the derivatives space in Canada centered on the trading activities of the Montreal Exchange (MX). Maintaining Québec's hold on the highly lucrative Canadian exchange-traded derivatives business has been a key issue underlying the proposed combination of the MX and TSX Group to create TMX Group. It has also propelled Québec's move to capture early-stage carbon trading opportunities through the establishment of the Montréal Climate Exchange (MCeX) as the leading platform for publicly traded environmental products in Canada. The MCeX, a joint venture of the Montréal Exchange (MX) and the Chicago Climate Exchange (CCX), plans to launch trading of futures contracts on Canada carbon dioxide equivalent (CO2e) units on May 30, 2008, subject to regulatory approval. See http://www.stikeman.com/cps/rde/xchg/se-en/hs.xsl/10915.htm
The MX also has stakes in the Boston Options Exchange (BOX), a U.S. automated equity options market, for which the MX is the technical operator, and the Canadian Resources Exchange (CAREX), established with NYMEX, to develop the Canadian energy trading market and OTC and exchange-traded derivatives with financial or physical settlement on Canadian-based energy (including natural gas, heavy crude oil and power), metals and soft commodities. The combined TMX will also have a position in Natural Gas Exchange (NGX), a leading North American exchange for the trading and clearing of natural gas and electricity contracts.
Key Features of the Proposed Derivatives Act
The proposed Derivatives Act would regulate trading and advisory activities with respect to all forms of "derivatives" (broadly defined), including both "standardized derivatives" and OTC derivatives. The proposed Act would define an "over-the-counter derivative" as "any derivative other than a standardized derivative" and a "standardized derivative" as "a derivative that is traded on a published market, whose intrinsic characteristics are determined by that market and whose trade is cleared and settled by a clearing house".
The proposed Derivatives Act would impose a dealer registration requirement on any person who engages or purports to engage in (1) derivatives trading on the person's own behalf or on behalf of others; or (2) any act, advertisement, solicitation or conduct directly or indirectly in furtherance of an activity described in (1). The proposed Act would also impose an adviser registration requirement on any person who engages or purports to engage in the business of advising others as to derivatives or the buying or selling of derivatives, or in the business of managing derivatives portfolios. A dealer or adviser registered under the Québec Securities Act which meets the conditions under the proposed Derivatives Act for registration to carry on business in derivatives and pays the prescribed fees would be deemed to be registered under the new Act. Existing Québec registrants could also transition their registration under the new Act.
The proposed Act would also provide for the recognition by the Autorité des marchés financiers (AMF) of "regulated entities" seeking to carry on derivatives-related activities in Québec as an exchange, alternative trading system, published market, clearing house, regulation services provider, information processor or self-regulatory organization. Recognized regulated entities would be subject to various requirements covering their operating rules, activities, governance practices and information disclosure and the filing with the of annual audited financial information. The AMF has not issued any guidance on what will constitute derivatives-related activities in Québec. This will be an important jurisdictional issue for US and international exchanges, ATSs, clearing organizations, etc.
Any person other than a recognized "regulated entity" or a registered dealer would have to be "qualified" by the AMF in the manner to be prescribed by regulation before offering standardized or OTC derivatives.
Significantly, the proposed legislation would not completely exempt OTC derivatives from the application of the Act. The proposed Act would carve out OTC derivatives "involving accredited counterparties only or in any other cases specified by regulation" from the application of certain specified provisions, including the dealer and adviser registration and qualification procedure and certain limited procedural and enforcement-related provisions, except with respect to market manipulation and fraud. The remaining provisions of the proposed legislation, including the offence provisions and the broad rulemaking authority which is delegated to the AMF to, among other things "make rules concerning derivatives transactions" would equally apply to OTC derivatives.
The list of "accredited counterparties" would include governments, municipalities, "financial institutions" (to be defined by regulation), dealers and advisers registered in and outside Québec, as well as certain qualified individuals (to be defined by regulation), certain qualified investment funds, charities, persons wholly owned by "accredited investors" within the meaning of National Instrument 45-106 and "hedgers".
The companion regulations to the proposed Derivatives Act have not yet been published, so the exact scope and the detailed application of the legislation are currently uncertain. One of the perennial areas of concern with the proposal to broadly regulate derivatives in Québec has been the extent to which the legislation would purport to regulate products, services and activities which are subject to the exclusive federal jurisdiction over banks and other financial institutions.
Certain comments in response to the earlier proposals had urged the government to adopt the more targeted definition of OTC derivatives recommended by the Ontario Commodity Futures Act Advisory Committee in its final report of January 20071 in conjunction with the principles-based approach to derivatives regulation generally favoured by the industry. The Québec government, however, has elected to adopt the "catch and release" approach to the definition and regulation of derivatives recommended by the AMF. The proposed Derivatives Act does not trace any kind of clear line in the sand to expressly exclude federally regulated financial products so the draft regulations will be of critical importance in ensuring that any jurisdictional and related characterization issues are clearly resolved.
Once the proposed regulations are published, specific derivatives contracts or activities in the Québec derivatives market will have to be reviewed to review potential jurisdictional, legal and operational issues which may be raised by the new derivatives legislation.
1Final Report to Minister Gerry Phillips, Minister of Government Services and Minister responsible for securities regulation, January 2007.
