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IIROC Re-publication of Proposed Derivatives Rule Modernization, Stage 1

Letter Summary:

The purpose of the amendments to the IIROC rules is to set up a harmonized framework for securities and derivatives, whether they are listed or traded OTC. The republication does not alter many of the amendments as first proposed in November, 2019 but has made further amendments to accord with updated IIROC rules (such as the CFRs) and in response to comments. One amendment changes the definition of “security” so that it more clearly excludes derivatives, for additional clarity as to which rules apply to each of the asset classes. There is a new proposed requirement for dealers with institutional clients or hedgers to have records relating to the dealer’s assessment of those qualifications. IIROC is proposing to amend the provisions regarding a dealer’s BCP, such that it will no longer be invoked automatically if there is a significant disruption in business, but instead the dealer would be required to notify IIROC with the prescribed information included in the notice. The derivatives risk disclosure statement has also been amended in response to the CAC’s comments to include specific common risks and not just general risks of utilizing derivatives. A new requirement would also require disclosure of the percentage of accounts that were profitable for clients for each of the four most recent quarters, applicable to dealer members offering OTC derivatives to retail clients when offered though OEO accounts.

Overview of the Council’s Comments:

The CAC supports the revised proposals, which will better harmonize the application of the IIROC rules to securities and derivatives-related activities.

The CAC appreciates that many of the revisions to the proposals reflect prior CAC comments. These include the removal of the requirement for hedging positions to have a high degree of negative correlation with the underlying interest or position (as noted in the CAC’s previous comments, correlations change over time), and the addition of new guidance confirming that it is possible to hedge only part of an underlying interest or position and still have the transaction regarded as a hedge.

The CAC is particularly supportive of IIROC’s proposed definition of a “hedger”, including the exclusion of individuals from this potential classification, which will address potential mis-selling and suitability concerns. IIROC should, however, consider making technical revisions to make clear that the definition includes non-individuals who engage in qualifying hedging activities with respect to some, but not necessarily all, of the risks to which they are exposed. Guidance also would be appreciated on what it means for a hedger to “materially” offset market value changes in the interest or position being hedged.

The CAC suggests IIROC undertake further policy research to assess whether options or similar derivative contracts ought to be made subject to the current derivatives-specific business conduct requirements (under the revised proposals, they are excluded from these requirements). And it would be helpful for the proposed Derivatives Risk Disclosure Statement to specifically inform derivatives clients about the concept of counterparty risk and clients’ potential exposure to the creditworthiness of their dealer and any OTC counterparties.