From the Regulators

Mandatory clearing of OTC derivatives intended to improve transparency

By James Langton |

Canadian securities regulators aim to improve transparency in the over-the-counter (OTC) derivatives markets and mitigate systemic risk by mandating central clearing for certain transactions.

The Canadian Securities Administrators (CSA) Thursday published Proposed National Instrument 94-101 Mandatory Central Counterparty Clearing of Derivatives, which would establish the requirements for mandatory central counterparty clearing.

The proposal for manadatory clearing follows in the wake of the global financial crisis, after which one of the central policy reforms agreed by the leaders of the G20 was to push more OTC derivatives to trade on exchanges, and for more centrally clearing of OTC transactions. The Canadian Securities Administrators (CSA) recently proposed a rule to encourage exchange trading.

See: New framework for OTC derivatives trading facilities

The proposed clearing rule aims to define the sorts of derivatives that will be subject to the requirement to submit for central counterparty clearing; and, introduces a requirement to submit a transaction in a mandatory clearable derivative to a recognized, or exempted, central counterparty for clearing.

"Achieving greater transparency in the OTC derivatives market is a key component of the post-financial crisis regulatory reform committed to by the Group of Twenty (G20) nations to reduce systemic risk," said Bill Rice, chair of the CSA and chair and CEO of the Alberta Securities Commission (ASC). "In meeting Canada's commitment to the G20, the CSA intends to establish a nationwide harmonized derivatives clearing regime that is in line with international standards."

The proposed rule requires that a local counterparty to a transaction in a mandatory clearable derivative must submit that transaction for clearing to a regulated clearing agency. It also provides substituted compliance for transactions involving an equivalent foreign jurisdiction. The rule also includes two exemptions to the clearing requirement for: end-users that are not financial firms that are seeking hedge, or mitigate, a commercial risk, and for affiliated firms that enter into a transaction in a mandatory clearable derivative.

The CSA indicates that its goal is to harmonize the determination of mandatory clearable derivatives across Canada and with international standards. That determination will look at various factors, including "the standardization of a derivative or class of derivatives, its risk profile, and the liquidity and characteristics of its market," the CSA says.

As part of the process of defining derivatives that will be subject to mandatory clearing, the CSA will publish these derivatives for comment, and the list of mandatory clearable derivatives will be included in the rule as an appendix

The CSA also indicates that it expects to phase-in the mandatory clearing requirement in line with the approach being taken in U.S., the European Union, and Australia. Under that approach, it's considering granting a six-month grace period for the three of the four phase-in stages.

The proposals are out for comment until May 13.