Alert for Advisers: What Registered Advisers Need to Know About “National Instrument 93-101 – Derivatives: Business Conduct”

Alert for Advisers: What Registered Advisers Need to Know About “National Instrument 93-101 – Derivatives: Business Conduct”

National Instrument 93-101 – Derivatives: Business Conduct (the “Instrument”) came into force on September 28, 2024, establishing a comprehensive framework for the conduct of dealers and advisers in the over-the-counter (“OTC”) derivatives market.

Advisers registered in a Canadian jurisdiction to advise with respect to securities (“Registered Advisers”) who only occasionally advise with respect to OTC derivatives (for instance, entering into currency hedges for an investment fund client) may not be fully aware of their limited obligations under the Instrument.

While the Instrument obligates anyone in the business of advising with respect to OTC derivatives to comply with stringent business conduct requirements, many of these requirements duplicate existing obligations for Registered Advisers or are designed to protect retail clients. Consequently, for Registered Advisers who exclusively advise eligible derivatives parties, the Instrument’s impact is significantly narrowed.

Eligible Derivatives Parties

The definition of eligible derivatives party (“EDP”) in the Instrument includes a variety of parties which regulators have determined to be sufficiently sophisticated to manage the risks associated with OTC derivatives.

Of greatest relevance to Registered Advisers, investment funds which are managed by a person or company registered as an investment fund manager (“IFM”) in a Canadian jurisdiction are EDPs.

While investment funds not managed by a Canadian-registered IFM are not included in the definition of EDP in the Instrument, pursuant to Coordinated Blanket Order 93-930 Re Temporary exemptions for derivatives firms from certain obligations when transacting with certain investment funds and for senior derivatives managers from certain reporting obligations (“93-930”) investment funds managed by an IFM registered or authorized under the securities or commodities futures laws of a foreign jurisdiction are exempted from the same provisions of the Instrument as an EDP would be.

Additional categories of EDPs which would be relevant to Registered Advisers are:

• Corporations or other entities, other than individuals, with at least CAD 25 million in net assets as shown on their most recently prepared financial statements;
• Pension funds regulated by Canadian or foreign authorities;
• Individuals with at least CAD 5 million in financial assets (before taxes but net of related liabilities) (“Individual EDPs”); and
• Eligible commercial hedgers (which are persons or companies that carry on a business and enter into OTC derivatives to hedge the risks associated with such business (“Eligible Commercial Hedgers”)) that have represented in writing to the Registered Adviser that they are acting as a commercial hedger with respect to the OTC derivatives for which they are being advised.

In the case of Individual EDPs and Eligible Commercial Hedgers, the exemptions applicable to EDPs only apply where the Individual EDP or Eligible Commercial Hedger has provided the Registered Adviser with a written statement that it agrees to “waive protections” provided in the Instrument and specifically sets out which protections it agrees to waive.

When advising EDPs (including Individual EDPs and Eligible Commercial Hedgers which have waived all protections provided in the Instrument), Registered Advisers are only subject to the following requirements:

• Fair dealing (Section 9): A derivatives adviser must deal fairly, honestly, and in good faith with derivatives parties.
• Conflicts of interest (Section 10): A derivatives adviser must establish, maintain and apply reasonable policies and procedures to identify all material conflicts of interest, and material conflicts of interest that the derivatives adviser in its reasonable opinion would expect to arise, between the derivatives adviser and its client. Derivatives advisers must also respond to any identified conflicts of interest.
• Know your derivatives party (Section 11): A derivatives adviser must establish, maintain and apply reasonable common know your client (“KYC”) policies and procedures including to ensure that it verifies the identity, reputation, and creditworthiness of parties it deals with, assess insider or non-public information risks, and identify key controllers of corporate, partnership, or trust entities. It must take reasonable steps to keep current this same information.
• Policies and procedures (Section 31): A derivatives adviser must implement policies and controls that establish a system of controls and supervision sufficient to provide reasonable assurance and incorporate effective risk management, and that ensure individuals acting on its behalf are competent, knowledgeable about derivatives, and act with integrity.

Action Items:

Registered Advisers who advise with respect to OTC derivatives should consider taking the following steps:

• Obtain EDP Representations from Clients: A representation as to the EDP status of each client of a Registered Adviser which it advises or expects to advise with respect to OTC derivatives should be obtained. The representation should explicitly state why such client qualifies as an EDP. In addition, for Individual EDPs and Eligible Commercial Hedgers, a statement should be obtained setting out which protections in the Instrument are being waived. For investment funds which are not EDPs but qualify for exemptions from provisions of the Instrument pursuant to 93-930, a representation should be obtained stating that such investment fund is managed by an IFM registered or authorized under the securities or commodity futures laws of a foreign jurisdiction.
• Updating Policies: Review and amend existing fair dealing, conflicts of interest and KYC policies to explicitly include OTC derivatives. This may involve updating language to encompass OTC derivatives alongside securities.
• Updating Offering Memoranda and Client Relationship Disclosure: Review and revise the offering memorandum for each fund whose investment strategy includes derivatives and update relationship disclosure documentation, in each case to reflect policy updates and to comply with disclosure requirements with respect to conflicts.
• Proficiency and Supervision: Ensure that individuals providing advice on OTC derivatives possess proficiency and experience appropriate to the individual’s role. Implement supervisory procedures to oversee OTC derivatives-related activities effectively. This may involve requiring individuals to take courses relating to OTC derivatives such as the Derivatives Fundamentals Course offered by the Canadian Securities Institute.

Please see McMillan LLP’s additional bulletins on the Instrument:

We previously discussed the first draft of the proposed Instrument 93-101 and its companion policy during the initial period for request for comments in our bulletin from April 2017. The first draft was published on April 4, 2017, and remained open for a lengthy 150-day comment period. A second draft was published on June 14, 2018, and was open for a 90-day comment period, during which submissions were received from 21 commenters.

A third draft was published on January 20, 2022. The main changes in the third draft were the elimination of the $10 million financial threshold for the Eligible Commercial Hedgers category in the definition of eligible derivatives party and the introduction of a foreign liquidity provider exemption for foreign dealers. The third draft was open for a 60-day comment period, during which submissions were received from 10 commenters. We discussed the third draft in our bulletin from February 2022.

On September 28, 2023, the CSA published the Instrument and our bulletin highlighted the changes made from the third draft to the final Instrument. These changes were made in response to comments received during the third consultation period.

by Michael Burns, Timothy Baron, Shahen Mirakian, and Micah Zierer-Clyke

A Cautionary Note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2024