Final Rule: OSC Rule - 91-504 & 91-504CP - Over-The-Counter Derivatives and Companion Policy 91-504CP

NOTICE OF FINAL RULE AND POLICY UNDER THE SECURITIES ACT

ONTARIO SECURITIES COMMISSION RULE 91-504

OVER-THE-COUNTER DERIVATIVES AND COMPANION POLICY 91-504CP

Introduction

The Commission has, pursuant to section 143 of the Securities Act (Ontario), made Ontario SecuritiesCommission Rule 91-504 Over-the-Counter Derivatives (the "Rule") and Companion Policy 91-504CP(the "Policy"). The Commission published the Rule and Companion Policy for comment on January 7,2000 at (2000), 23 OSCB 51 ("2000 Draft Rule"). The Rule and Companion Policy had previously beenpublished for comment on December 18, 1998 at (1998), 21 OSCB 7755 ("1998 Draft Rule") andNovember 1, 1996, at (1996), 19 OSCB 5929 ("1996 Draft Rule").

The Rule and Policy were delivered to the Minister of Finance on September 8, 2000. If the Ministerdoes not approve or reject the Rule or return the Rule for further consideration by November 7, 2000, orif the Minister approves the Rule, the Rule will come into force, pursuant to section 5.1 of the Rule, onDecember 1, 2000. The Policy will come into force on the day that the Rule comes into force.

During the comment period on the Rule and the Policy, which expired on February 7, 2000, theCommission received 1 submission from 1 commenter, the Canadian Bankers Association (the "CBA").A summary of the CBA's comments and the response of the Commission are contained in Appendix A tothis Notice. The Commission thanks the CBA for providing its comments on the Rule and Policy. Inconsideration of the CBA's comments, the Commission has made some minor amendments to the Ruleand the Policy. However, as these changes are not material, the Commission is not publishing the Rulefor a further comment period.

Substance and Purpose of Rule

The Rule deals with the regulation of transactions consisting of over-the-counter ("OTC") derivatives inOntario and provides complete exemptions from Ontario securities law for some transactions andprovides exemptions from the registration and prospectus requirements of the Act for other transactions.Derivatives products are, generally speaking, instruments the value of which is dependent, wholly orpartially, upon the price, level or value of an external benchmark such as a security, financial instrument,interest rate, foreign exchange rate, index or commodity price. The Rule pertains only to the OTCderivatives market, which is a general term given to the market in which parties contract directly witheach other off-exchange and without the interposition of a clearing corporation. The most commonderivatives products used in the OTC market are swaps, options and forwards on a variety of underlyinginterests.

Purpose of Policy

The Policy sets out the Commission's interpretation of certain provisions of the Rule and the applicabilityof certain aspects of the Act to transactions consisting of OTC derivatives.

Summary of Changes to the Rule

This section of this Notice describes changes proposed to be made in the Rule and Policy.

For additional background and a summary of the 1996 Draft Rule, the 1998 Draft Rule, and the 2000Draft Rule, reference should be made to the notices that accompanied the publication of thoseinstruments at (1996), 19 OSCB 5929, (1998), 21 OSCB 7755 and (2000), 23 OSCB 51.

Section 1.1

Section 1.1 has been amended by including a definition of "Chartered Financial Analyst Program".

Sections 2.3 and 2.4

Sections 2.3 and 2.4 have been amended to reflect the corrected course name of the CharteredFinancial Analyst Program.

Section 5.1

Section 5.1 has been added to provide that the Rule comes into force on December 1, 2000.

Appendix A

There have been a number of changes to the list of Qualified Parties contained in Appendix A.

First, Schedule III banks have been added to the list of Qualified Parties.

Second, insurance companies listed in paragraph (g) that are licensed to do business in Canada or aprovince or territory in Canada no longer have to have a minimum paid up capital and surplus in excessof $25 million.

Third, paragraph (i) has been amended to enable a person or company, together with its affiliates, toqualify.

Fourth, paragraph (j) enables an individual to include the net worth of his or her spouse as part of the $5million threshold.

Fifth, the minimum capital threshold for corporations listed in paragraph (n) has been changed to $25million in revenue or assets. As well, the paragraph clarifies that financial statements will have to beaudited only if the corporation is already subject to a requirement to prepare audited financialstatements.

Finally, paragraph (w) has been amended to include a reference to paragraph (j).

Text of Rule and Policy

The text of the Rule and Policy follows.

DATED: September 8, 2000

APPENDIX A

SUMMARY OF COMMENTS

The following is a summary of the comments received and the responses of the Commission.

General Comments

A. Jurisdictional Concerns

The CBA restated its view that no rule for the OTC derivatives market is appropriate or necessary. It believesthat OTC derivatives are an integral part of the business of banking and are subject to federal, not provincialjurisdiction.

Response:

The Commission continues to believe that the Rule has been carefully tailored to focus on investorprotection in the retail market and is therefore designed to protect those least able to protectthemselves. It is not aimed at ensuring the financial soundness of financial institutions, the subjectmatter and primary concern of federal legislation pertaining to derivatives.

B. Rule Not Necessary

The CBA restated its view that it does not believe that the Commissions's stated objectives are appropriatein current circumstances and even if they are, it does not believe that these objectives are met by the termsof the Rule. In the CBA's opinion, there is no significant uncertainty in the market and no investor protectionproblem that needs to be addressed. In addition, the CBA believes that the Rule is a disproportionateresponse to address a narrow or limited policy concern.

Response:

The Commission continues to be of the view that the Rule is appropriate and addresses a need insome sectors of the marketplace for regulatory certainty, and also implements a non-intrusive anduseful regime for investor protection.

C. Structure of the Rule Creates Problems

The CBA restated its opinion that the Rule is complex and will result in additional costs and administrativeburdens. The banks will have to categorize their OTC derivatives business based on whether or not the clientis a "qualified party" and obtain representations from non-qualifying parties as to whether transactions arefor hedging or speculating purposes.

Response:

The Commission remains of the view that the Rule is structured in an appropriate way and makesreference to the discussion on that issue in the 1998 Notice. In addition, the Commission believesthat it is appropriate that less sophisticated investors be identified and protected in respect of OTCderivatives transactions. This obviously will entail the implementation of procedures necessary toidentify such investors. The Commission expects that appropriate procedures will be put in place.

D. Impact on the Competitiveness of OTC Derivatives Business in Ontario/Canada

The CBA restated that any regulatory mechanism imposed will impose significant burdens on Ontario marketparticipants. The burdens of mandated fixed disclosure procedures, employee education and dealerprocessing requirements will create inefficiencies and onerous administrative difficulties and will affect thecompetitiveness of Canadian dealers and end-users in an international marketplace.

Response:

The Commission does not believe that the Rule will have a damaging effect on the OTC derivativesmarket in Ontario, and notes, as it did in the 1998 Notice, that the primary purpose of the Rule ismerely to provide exemptions to a large number of transactions. The Commission notes that as aresult of the comments received in response to the December 1999 publication, the exemptions havebeen broadened.

The CBA noted comments made by U.S. Federal Reserve Board Chairman Alan Greenspan and U.S.Treasury Secretary Lawrence Summers support rationalizing the regulatory framework applicable to OTCderivatives with a view to preventing an erosion of the international competitiveness of U.S. financialmarkets. The CBA is of the view that the Rule is an example of the type of regulation that should be avoidedand since the Ontario market is smaller than that in the U.S., the competitive effect of the Rule will besignificantly greater.

Response:

Both Chairman Greenspan and Treasury Secretary Summers provided testimony before the SenateCommittee on Agriculture, Nutrition and Forestry during February 2000. Their comments reflectedthe report of the President's Working Group on Financial Markets entitled Over-the-CounterDerivatives Markets and the Commodity Exchange Act. The Working Group sought to achieve fourobjectives - one of which was "to protect retail customers by ensuring that appropriate regulationsare in place to deter unfair practices in all markets in which they participate and by closing existingloopholes that allow unregulated entities to pursue such unfair practices." Chairman Greenspanstates in his testimony that "In the case of financial OTC derivatives transactions betweenprofessional counterparties, the working group has agreed that such regulation is unnecessary andshould be excluded from [the CEA]."

In the opinion of the Commission, the Rule provides protection to retail customers while exemptingsophisticated entities from either the Act or the prospectus and registration requirements of the Act.The Rule is consistent with movement in the U.S. to protect retail investors and provide exemptionsfor "professional counterparties" who engage in OTC derivatives transactions.

Specific Comments

A. The Rule

(i) Difficulties in characterizing OTC derivatives transactions

The CBA requests guidance regarding the criteria to be used to characterize OTC derivatives transactionsfor the purposes of registration and prospectus requirements.

Response:

It is not possible to anticipate new products that may be developed. The Commission will considerproviding exemptions on a case by case basis and has the option of amending the Rule, should theneed arise.

(ii) Sharing of Confidential Information with Dealers

The CBA restated its concern that the Rule may require the sharing of confidential information with dealers.For banks to comply with the investor protection measures of the Rule, in particular the requirement toinvolve a dealer/registered representative in the process, the bank may be asked to disclose confidentialclient information to the dealer. In addition, there will be an additional cost in imposing the administrativeburden of obtaining client authorization. The CBA recommended the deletion of the dealer requirement, andthat consideration be given to a requirement for an enhanced disclosure statement.

Response:

The Commission does not believe that the sharing of confidential information is a major problem withthe Rule. The OTC derivatives dealer that becomes involved in a transaction will have to be suppliedwith substantially the same information as any dealer involved in any securities transaction.

B. Appendix A - Qualified Parties

(i) Paragraph 3(c) - Banks and

Paragraph 3(f) - Loan and Trust Companies

Paragraph 3(h) - Insurance Companies

The CBA suggests that the Commission adopt an approach similar to the British Columbia SecuritiesCommission in Blanket Order 91-501 (the "BC Order") which does not contain a minimum paid up capitaland surplus requirement upon regulated foreign banks, loan and trust companies and insurance companiesor banks, loan and trust companies and insurance companies that have adopted the rules set out in the BaselAccord. In the view of the CBA, there is no reason to conclude that such entities are not sufficientlysophisticated if the minimum paid up capital and surplus requirement is not met.

Response:

It is the view of the Commission that minimum standards are necessary when dealing with foreignentities under foreign regulatory jurisdictions. Regulation or the adoption of Basel Accord standardsby foreign governments does not guarantee sophistication.

(ii) Paragraph 3(g) - Insurance Companies

The CBA indicate that the section imposes a minimum paid up capital and surplus requirement uponregulated Canadian insurance agencies that should be removed.

Response:

The Commission agrees and will amend paragraph 3(g) to remove the minimum paid up capital andsurplus requirement.

(iii) Paragraph 3(i) - Sophisticated Entities

The CBA recommend that the words "together with its affiliates" be added after the words "a person orcompany" in the first line of section 3(i).

Response:

The Commission accepts the recommendation and will make this change.

(iv) Paragraph 3(j) - Individuals

The CBA recommends that the words "either alone or jointly with the individual's spouse" be inserted afterthe words "an individual who" in section 3(j).

Response:

The Commission accepts the recommendation and will make this change.

(vii) Paragraph 3(n) - Corporations and other Entities

(A) Dollar Threshold

Acknowledging their suggestion to move to a revenue test, the CBA now suggests that the test should bebased on revenue or assets.

Response:

The Commission accepts this recommendation and will make this change.

(B) Audited Financial Statements

The CBA suggests that the definition in paragraph 3(n) be reworded such that audited financial statementswould be necessary only when they are otherwise required to be prepared.

Response:

The Commission accepts the recommendation and will make this change.

(viii) Paragraph 3(w) - Affiliates

The CBA suggests that section 3(w) be amended to refer to "organizations and individuals" and a referenceto paragraph 3(j) be added.

Response:

The omission of the reference to paragraph 3(j) was an oversight. Paragraph (j) will be included.

The CBA suggests that paragraph 3(w) include reference to other business organizations such as trusts orpartnerships. They suggest that a new clause be added to provide that any entity controlled by a qualifiedparty is itself a qualified party.

Response:

The Commission is of the view that it would not be appropriate to enable the business organizationcontrolled by a qualified party to be a qualified party unless it has active business. If the organizationhas an active business, then it may itself be a qualified party if it fits within paragraph 3(n).

 

ONTARIO SECURITIES COMMISSION RULE 91-504

 

OVER-THE-COUNTER DERIVATIVES

 

TABLE OF CONTENTS

PART TITLE

PART 1 DEFINITIONS

1.1 Definitions

PART 2 APPLICATION OF THE ACT

2.1 Non-Application of the Act

2.2 Application of Provisions of the Act

2.3 Registration Provisions

2.4 Prospectus Exemption

2.5 Freely Tradeable Securities

2.6 Exemption from Underwriting Conflicts Rules

PART 3 DESIGNATION OF SPECIFIED COMMODITIES

3.1 Designation

3.2 Revocation of Designation

PART 4 EXEMPTION

4.1 Exemption

PART 5 EFFECTIVE DATE

5.1 Effective Date

APPENDIX A - QUALIFIED PARTIES

APPENDIX B - RISK DISCLOSURE STATEMENT FOR OTC DERIVATIVE TRANSACTIONS

ONTARIO SECURITIES COMMISSION RULE 91-504

OVER-THE-COUNTER DERIVATIVES

PART 1 DEFINITIONS

1.1 Definitions - In this Rule

"Canadian Securities Course" means a course prepared and conducted by The Canadian SecuritiesInstitute and so named by that Institute as of the date on which this Rule comes into force, everypredecessor to that course, and every successor to that course that does not narrow the scope ofthe significant subject matter of the course;

"Chartered Financial Analyst Program" means the three level program prepared and conducted bythe Association for Investment Management and Research, and so named by that Association asof the date on which this Rule comes into force, every predecessor to that course, and everysuccessor to that course that does not narrow the scope of the significant subject matter of thecourse;

"commercial user" means a person or company that enters into a specified commodity derivativetransaction, if

(a) the person or company deals in its business with a specified commodity, and

(b) the transaction consists of a specified commodity derivative of which the underlying interest,or a material component of the underlying interest, is

(i) a specified commodity referred to in paragraph (a),

(ii) a related specified commodity to a specified commodity referred to in paragraph (a), or

(iii) a specified commodity derivative, the underlying interest of which is

(A) a specified commodity, or

(B) a related specified commodity to a specified commodity

referred to in paragraph (a);

"contract for differences" means an agreement, other than an option, a forward contract, a spotcurrency 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;

"conventional floating rate debt security" means an evidence of indebtedness of which the interestobligations are based upon a benchmark commonly used in commercial lending arrangements;

"exempt transaction" means a transaction consisting of

(a) a foreign exchange derivative in which

(i) one party to the transaction is a qualified party for that transaction, or

 

(ii) each party to the transaction is a person or company entering into the transaction forOTC derivatives hedging purposes;

(b) an interest rate derivative in which each party to the transaction is

(i) a qualified party for that transaction, or

(ii) a person or company entering into the transaction for OTC derivatives hedgingpurposes, or

(c) a specified commodity derivative in which each party to the transaction is a qualified party forthat transaction;

"foreign exchange derivative" means an OTC derivative of which the underlying interest consistsentirely of

(a) Canadian or foreign currency or a foreign exchange rate, or some relationship between, orcombination of, any of them, or

(b) a matter referred to in paragraph (a), or an agreement or instrument that has as its underlyinginterest a matter referred to in paragraph (a), or some relationship between, or combinationof, any of them;

"forward contract" means an agreement, not entered into or traded on or through an organizedmarket, stock exchange or futures exchange and cleared by a clearing corporation, to do one ormore of the following on terms or at a price established by or determinable by reference to theagreement and at or by a time established by or determinable by reference to the agreement:

1. Make or take delivery of the underlying interest of the agreement.

2. Settle in cash instead of delivery;

"freely tradeable" means, in respect of securities, that

(a) the securities are not non-transferable,

(b) the securities are not subject to any escrow requirements,

(c) the securities do not form part of the holdings of any person or company or combination ofpersons or companies referred to in paragraph (c) of the definition of "distribution" in the Act,

(d) the securities are not subject to any cease trade order imposed by a Canadian securitiesregulatory authority,

(e) all hold periods imposed by Canadian securities legislation before the securities can be tradedwithout a prospectus or in reliance on a prospectus exemption have expired, and

(f) any period of time for which the issuer has to have been a reporting issuer before thesecurities can be traded without a prospectus or in reliance on a prospectus exemption haspassed;

"futures exchange" means an association or organization operated to provide the facilities necessaryfor the trading of commodity futures";

"Futures Licensing Course" means a course prepared and conducted by The Canadian SecuritiesInstitute and so named by that Institute as of the date on which this Rule comes into force, everypredecessor to that course, and every successor to that course that does not narrow the scope ofthe significant subject matter of the course;

"interest rate derivative" means an OTC derivative of which the underlying interest consists entirelyof

(a) an interest rate, or an evidence of indebtedness of an entity other than a corporation that isnot exchangeable for or convertible into another security, or some relationship between, orcombination of, any of them, or

(b) a matter referred to in paragraph (a), or an agreement or instrument that has as its underlyinginterest a matter referred to in paragraph (a), or some relationship between, or combinationof, any of them;

"Options Licensing Course" means a course prepared and conducted by The Canadian SecuritiesInstitute and so named by that Institute as of the date on which this Rule comes into force, everypredecessor to that course, and every successor to that course that does not narrow the scope ofthe significant subject matter of the course;

"OTC derivative" means an option, a forward contract, or a contract for differences of a typecommonly considered to be a derivative, in which

(a) the agreement relating to the option, forward contract or contract for differences is not part ofa 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 materialconsideration 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, stockexchange or futures exchange and cleared by a clearing corporation;

"OTC derivatives dealer" means a person or company registered under the Act as a dealer in thecategory of broker or investment dealer or under the CFA as a dealer in the category of futurescommission merchant;

"OTC derivatives hedging" means the entering into of a transaction, or a series of transactions, theintended effect of which, or the intended cumulative effect of which, is to offset or reduce a risk towhich a person or company is, or can reasonably expect to be, exposed, and which transaction orseries of transactions

(a) involves an OTC derivative, or a series of OTC derivatives, for which there is a high degreeof negative correlation between changes in the value of the position or positions being hedgedand changes in the value of the instrument or instruments with which the position or positionsare hedged, and

(b) is intended to no more than offset the effect of changes in value in the position or positionsbeing hedged;

"qualified party" means, for any transaction

(a) a company, person or entity described in Appendix A, or

(b) a commercial user for that transaction;

"related specified commodity" means a specified commodity that is part or all of an underlyinginterest of a specified commodity derivative that is used by a commercial user to hedge its exposureto a risk resulting from its use of another specified commodity in its business;

"Risk Disclosure Statement for OTC Derivatives" means the statement attached to this Rule asAppendix B; and

"specified commodity" means

(a) whether in the original or a processed state, an agricultural product, forest product, productof the sea, mineral, metal, hydrocarbon fuel product or precious stone or other gem,

(b) a pollutant emission level,

(c) electricity,

(d) a liability from an insurance contract, and

(e) a matter designated by the Commission as a specified commodity, if that designation has notbeen revoked; and

"specified commodity derivative" means an OTC derivative of which an underlying interest is

(a) a specified commodity, or

(b) another OTC derivative of which the underlying interest is a specified commodity.

PART 2 APPLICATION OF THE ACT

2.1 Non-Application of the Act - The Act does not apply to an exempt transaction.

2.2 Application of Provisions of the Act - Subject to section 2.1, sections 25 and 53 of the Act applyto a transaction consisting of an OTC derivative that does not constitute a trade in a security as if,and to the same extent as those sections would apply if, the transaction did constitute a trade in asecurity.

2.3 Registration Provisions - Despite section 2.2, section 25 of the Act does not apply to a transactionconsisting of an OTC derivative if

(a) each party to the transaction is either

(i) a qualified party for that transaction; or

(ii) a person or company

(A) that enters into the transaction with or through an OTC derivatives dealer, ifeach person acting as a representative of the OTC derivatives dealer for thattransaction has successfully completed the Chartered Financial AnalystProgram, or each of the Futures Licensing Course, the Options LicensingCourse and the Canadian Securities Course, and

(B) that has been provided with a copy of the Risk Disclosure Statement for OTCDerivatives by the OTC derivatives dealer; or

(b) in the case of a transaction that does not constitute a trade in a security, the transaction wouldhave been exempt from section 25 of the Act if the transaction did constitute a trade insecurities.

2.4 Prospectus Exemption - Despite section 2.2, section 53 of the Act does not apply to a transactionconsisting of an OTC derivative if

(a) each party to the transaction is either

(i) a qualified party for that transaction; or

(ii) a person or company

(A) that enters into the transaction with or through an OTC derivatives dealer, if eachperson acting as a representative of the OTC derivatives dealer for that transactionhas successfully completed the Chartered Financial Analyst Program, or each ofthe Futures Licensing Course, the Options Licensing Course and the CanadianSecurities Course, and

(B) that has been provided with a copy of the Risk Disclosure Statement for OTCDerivatives by the OTC derivatives dealer; or

(b) in the case of a transaction that does not constitute a trade in a security, the transaction wouldhave been exempt from section 53 of the Act if the transaction did constitute a trade insecurities.

2.5 Freely Tradeable Securities - Section 2.3 and 2.4 are not available for the settlement of atransaction consisting of an OTC derivative if settlement is made by way of the physical delivery ofsecurities that are not freely tradeable.

2.6 Exemption from Underwriting Conflicts Rules - Section 224 of the Regulation and MultilateralInstrument 33-105 Underwriting Conflicts do not apply to an OTC derivatives transaction.

PART 3 DESIGNATION OF SPECIFIED COMMODITIES

3.1 Designation - The Commission may designate any matter as a specified commodity, subject to theterms or restrictions that may be contained in the designation, if

(a) an OTC derivative of which the matter is an underlying interest may be used by a person orcompany for OTC derivatives hedging purposes; and

(b) the matter is not included in paragraph (a) or (b) of the definition of "foreign exchangederivative" or "interest rate derivative".

3.2 Revocation of Designation - The Commission may revoke a designation given under section 3.1if the continuation of the designation

(a) may adversely expose persons or companies to unfair, improper or fraudulent practices; or

(b) may be prejudicial to the public interest.

PART 4 EXEMPTION

4.1 Exemption - The Director may grant an exemption to this Rule, in whole or in part, subject to suchconditions or restrictions as may be imposed in the exemption.

PART 5 EFFECTIVE DATE

5.1 Effective Date - This Rule comes into force on December 1, 2000.

OVER-THE-COUNTER DERIVATIVES

APPENDIX A

QUALIFIED PARTIES

Interpretation

(1) The terms "subsidiary" and "holding body corporate" used in paragraphs (w), (x) and (y) of subsection(3) of this Appendix have the same meaning as they have in the Business Corporations Act.

(2) All requirements contained in this Appendix that are based on the amounts shown on the balancesheet of an entity apply to the consolidated balance sheet of the entity.

Qualified Parties Acting as Principal

(3) The following are qualified parties for all OTC derivatives transactions, if acting as principal:

Banks

(a) a bank listed in Schedule I, II or III to the Bank Act (Canada);

(b) the Business Development Bank of Canada incorporated under the Business Development Bank ofCanada Act (Canada);

(c) a bank subject to the regulatory regime of a country that is a member of the Basel Accord, or that hasadopted the banking and supervisory rules set out in the Basel Accord, if the bank has a minimum paidup capital and surplus, as shown on its last audited balance sheet, in excess of $25 million or itsequivalent in another currency;

Credit Unions and Caisses Populaires

(d) a credit union central, federation of caisses populaires, credit union or regional caisse populaire,located, in each case, in Canada;

Loan and Trust Companies

(e) a loan corporation or trust corporation registered under the Loan and Trust Corporations Act or underthe Trust and Loan Companies Act (Canada), or under comparable legislation in any other provinceor territory of Canada;

(f) a loan company or trust company subject to the regulatory regime of a country that is a member ofthe Basel Accord, or that has adopted the banking and supervisory rules set out in the Basel Accord,if the loan company or trust company has a minimum paid up capital and surplus, as shown on its lastaudited balance sheet, in excess of $25 million or its equivalent in another currency;

Insurance Companies

(g) an insurance company licensed to do business in Canada or a province or territory of Canada;

(h) an insurance company subject to the regulatory regime of a country that is a member of the BaselAccord, or that has adopted the banking and supervisory rules set out in the Basel Accord, if theinsurance company has a minimum paid up capital and surplus, as shown on its last audited balancesheet, in excess of $25 million or its equivalent in another currency;

Sophisticated Entities

(i) a person or company that, together with its affiliates,

(i) has entered into one or more transactions involving OTC derivatives with counterparties thatare not its affiliates, if

(A) the transactions had a total gross dollar value of or equivalent to at least $1 billion innotional principal amount; and

(B) any of the contracts relating to one of these transactions was outstanding on any dayduring the previous 15-month period, or

(ii) had total gross marked-to-market positions of or equivalent to at least $100 million aggregatedacross counterparties, with counterparties that are not its affiliates in one or more transactionsinvolving OTC derivatives on any day during the previous 15-month period;

Individuals

(j) an individual who, either alone or jointly with the individual's spouse, has a net worth of at least $5million, or its equivalent in another currency, excluding the value of his or her principal residence;

Governments/Agencies

(k) Her Majesty in right of Canada or any province or territory of Canada and each crown corporation,instrumentality and agency of a Canadian federal, provincial or territorial government;

(l) a national government of a country that is a member of the Basel Accord, or that has adopted thebanking and supervisory rules of the Basel Accord, and each instrumentality and agency of thatgovernment or corporation wholly-owned by that government;

Municipalities

(m) any Canadian municipality with a population in excess of 50,000 and any Canadian provincial orterritorial capital city;

Corporations and other Entities

(n) a company, partnership, unincorporated association or organization or trust, other than an entityreferred to in paragraph (a), (b), (c), (d), (e), (f), (g) or (h), with total revenue or assets in excess of $25million or its equivalent in another currency, as shown on its last financial statement, to be audited onlyif otherwise required;

Pension Plan or Fund

(o) a pension fund that is regulated by either the Office of the Superintendent of Financial Institutions(Canada) or a provincial pension commission, if the pension fund has total net assets, as shown onits last audited balance sheet, in excess of $25 million, provided that, in determining net assets, theliability of a fund for future pension payments shall not be included;

Mutual Funds and Investment Funds

(p) a mutual fund or non-redeemable investment fund if each investor in the fund is a qualified party;

(q) a mutual fund that distributes its securities in Ontario, if the portfolio manager of the fund is registeredas an adviser, other than a securities adviser, under the Act or securities legislation elsewhere inCanada;

(r) a non-redeemable investment fund that distributes its securities in Ontario, if the portfolio managerof the fund is registered as an adviser, other than a securities adviser, under the Act or securitieslegislation elsewhere in Canada;

Brokers/Investment Dealers

(s) a person or company registered under the Act or securities legislation elsewhere in Canada as a brokeror an investment dealer or both;

(t) a person or company registered under the Act as an international dealer if the person or company hastotal assets, as shown on its last audited balance sheet, in excess of $25 million or its equivalent inanother currency;

Futures Commission Merchants

(u) a person or company registered under the CFA as a dealer in the category of futures commissionmerchant, or in an equivalent capacity elsewhere in Canada;

Charities

(v) a registered charity under the Income Tax Act (Canada) with assets not used directly in charitableactivities or administration, as shown on its last audited balance sheet, of at least $5 million or itsequivalent in another currency;

Affiliates

(w) a wholly-owned subsidiary of any of the organizations described in paragraph (a), (b), (c), (d), (e), (f),(g), (h), (j), (n), (o), (s), (t) or (u);

(x) a holding body corporate of which any of the organizations described in paragraph (w) is a wholly-owned subsidiary;

(y) a wholly-owned subsidiary of a holding body corporate described in paragraph (x);

(z) a firm, partnership, joint venture or other form of unincorporated association in which one or more ofthe organizations described in paragraph (w), (x) or (y) have a direct or indirect controlling interest; and

Guaranteed Party

(aa) a party whose obligations in respect of the OTC derivatives transaction for which the determinationis made is fully guaranteed by another qualified party.

Qualified Party Not Acting as Principal

(4) The following are qualified parties, in respect of all OTC derivative transactions:

Managed Accounts

1. Accounts of a person, company, pension fund or pooled fund trust that are fully managed by a portfoliomanager or financial intermediary referred to in paragraphs (a), (d), (e), (g), (s), (t), (u) or (w) ofsubsection (3) or a broker or investment dealer acting as a trustee or agent for the person, company,pension fund or pooled fund trust under section 148 of the Regulation.

Subsequent Failure to Qualify

(5) A party is a qualified party for the purpose of any OTC derivatives transaction if it, he or she is aqualified party at the time it, he or she enters into the transaction.

OVER-THE-COUNTER DERIVATIVES

APPENDIX B

RISK DISCLOSURE STATEMENT FOR OTC DERIVATIVE TRANSACTIONS

This risk disclosure statement sets out general information relevant to entering into transactions inover-the-counter derivative products ("OTC derivatives").

There are many different types of OTC derivatives. OTC derivatives include options, forwards, swaps,swaptions, caps, floors, collars and forward rate agreements and combinations or variations upon thesetransactions. This disclosure statement does not disclose all of the risks and other significant aspects ofentering into these transactions. In light of the risks, you should undertake these transactions only if youunderstand the nature of the product, the contractual relationships into which you are entering and the extentof your exposure to risk. Entering into OTC derivative transactions is not suitable for many investors. Youshould carefully consider whether these transactions are appropriate for you in light of your experience,investment objectives, financial and operational resources, ability to bear risk, understanding of the productsand other relevant circumstances. Your exposure to risk of loss may significantly exceed the amount of anypayment you make.

Over-the-Counter Derivatives

(a) General

You should confirm with the firm with which you deal the terms and conditions of the specific OTCderivative you are entering into and associated obligations (including such things as the circumstances underwhich you may become obligated to make payments or to make or take delivery of the underlying interest,expiration dates and any restrictions on exercise).

You should, as well, familiarize yourself with the terms and conditions of any agreement that you maybe required to enter into with the firm with which you deal so that you fully understand the nature of yourrelationship with the firm with which you deal and your rights and obligations under that agreement.

The value of OTC derivatives may be influenced by a number of inter-related factors. The relationshipamong these factors is complex. Factors that can be expected to affect the value of OTC derivativesinclude: time remaining to expiry (or maturity) of the instrument, the level of interest rates, the credit ratingof the counterparty, the price or level of the underlying interest of the derivative component and the volatilityof the underlying interest of the derivative component.

You should calculate the extent to which the value of the derivative component must increase for yourposition to become profitable, taking into account the imputed cost of the component and all transactioncosts.

You will also be exposed to risks which are specific to the underlying interest of the OTC derivativeand you should familiarize yourself with those risks prior to entering into the transaction.

(b) Effect of Leverage

Transactions in OTC derivatives can carry a high degree of risk. Certain OTC derivatives areleveraged so that a relatively small market movement in the price of the underlying interest will have aproportionately larger impact on your position. This may work against you as well as for you.

(c) Risk Reducing Strategies

Certain strategies intended to reduce the risk of entering into a transaction in OTC derivatives maynot be effective because market conditions may make it impossible to implement the strategy. Strategiesusing combinations of positions may be as risky as taking simple 'long' or 'short' positions.

Hedging transactions may require constant monitoring. A failure to adjust a hedging transaction in lightof changing market conditions can result in the position becoming either unhedged or overhedged and lossescan ensue.

(d) Risk of Options

Purchasers and sellers of options should familiarize themselves with the type of option (i.e. put or call)that they contemplate entering into and the associated risks.

The purchaser of an over-the-counter option may be able to offset or exercise the option or allow theoption position to expire. The exercise of an option results in either a cash settlement or in the purchaseracquiring or delivering the underlying interest. If the purchased option expires worthless you will suffer atotal loss of your investment that will consist of the option premium paid plus transaction costs.

If you are purchasing deep out-of-the-money options you should be aware that the chance of theseoptions becoming profitable ordinarily is remote.

Selling ("writing" or "granting") an option generally entails greater risk than purchasing an option.Although the premium received by the seller is fixed, the seller may sustain a total loss well in excess of thatamount. The seller may be liable for additional margin to maintain the position if the market movesunfavourably. The seller will also be exposed to the risk of the purchaser exercising the option and the sellerwill be obligated to either settle the option in cash or to acquire or deliver the underlying interest. If the selleris 'covered', by holding a corresponding position in the underlying interest, the risk may be reduced. If theoption is not covered, the risk of loss may be unlimited.

(e) Liquidity and Restrictions of Pricing Relationships

OTC derivatives are not traded on an exchange or other organized market and permit precisecustomization to accomplish particular financial and risk management objectives that might otherwise beunachievable. Customization can introduce significant liquidity risk and other risk factors of a complexcharacter. As a result, it may be difficult or impossible to effect transactions or to liquidate or offsetpositions. The customized nature of many derivatives may also add to illiquidity. If you have sold options,an illiquid market may increase the risk of loss, particularly where you do not hold the underlying interest oran equivalent amount of cash.

Normal pricing relationships between the underlying interest and the OTC derivative may not exist.This can occur when, for example, there are market interruptions or circuit breakers in effect. The lack ofavailability of an underlying reference price may make it difficult to judge 'fair' value.

(f) Credit Risk

You should assess the creditworthiness of the firm with which you deal and any other counterparty.Most OTC derivatives transactions are direct obligations of the counterparty.

You should also determine how easily your OTC derivatives position can be assigned in the event ofa bankruptcy or insolvency and at what cost. In the case of OTC derivatives transactions where there aremutual obligations, you should determine whether the netting of payments is supportable under bankruptcyand insolvency legislation.

You should also note that your right to enforce your counterparty's obligations under your agreementmay be compromised if your counterparty receives protection under insolvency legislation in relevantjurisdictions.

You should familiarize yourself with the protections accorded to cash or other property you deposit fordomestic and foreign OTC derivatives transactions, particularly in the event of the insolvency or bankruptcyof the counterparty with whom you deal. The extent to which you recover may be governed by specificlegislation or local rules. In some jurisdictions, property that had been specifically identifiable as your ownwill be pro-rated in the same manner as cash for purposes of distribution in the event of a shortfall.

(g) Commissions and Other Charges

Before you enter into an OTC derivatives transaction, you should obtain a clear explanation of allcommissions, fees and other charges for which you will be liable. These charges will affect your net profit(if any) or increase your loss.

(h) Transactions in Other Jurisdictions

Transactions with institutions in other jurisdictions, including institutions with formal links to thedomestic market, may expose you to additional risk. Those institutions may be subject to regulation that mayoffer different or diminished investor protection.

Before you enter into an OTC derivative transaction, you should enquire about any rules relevant toyour particular transaction. You should ask the firm with which you deal or your legal adviser for detailsabout the types of redress available in both your home jurisdiction and other relevant jurisdictions before youstart to trade.

(i) Currency Risks

The profit or loss in foreign currency denominated OTC derivatives products (whether they are tradedin your own or another jurisdiction) will be affected by fluctuations in currency rates.

(j) Legal Risks

As in any financial transaction, you should ensure that you understand the requirements (includinginvestment restrictions), if any, applicable to you that are established by your regulators or by your board ofdirectors or other governing body. Certain entities may not be permitted to enter into derivatives transactionspursuant to their incorporating documents or governing legislation. You should ensure that counterparty withwhich you deal is empowered to deal with you using derivatives and you should be aware of the legalimplications of default in the jurisdiction in which the counterparty resides.

You should also consider the legal and accounting implications of entering into any OTC derivativetransaction and consulting such advisers as may appropriate to assist you in understanding the risksinvolved.

(k) Management Risks

You should inform yourself about the risks and ongoing monitoring requirements of the specific OTCderivatives transactions into which you propose to enter.

OTC derivatives are complex instruments that can be difficult to value and to monitor. Before enteringinto a transaction involving OTC derivatives you should ensure that you have supervisory procedures andanalytical systems commensurate with the level of activity you contemplate so that you are able to keeptrack of your OTC derivatives exposure.

(l) Tax Risks

Before entering into a transaction in OTC derivatives you should understand the income taximplications of doing so. Different OTC derivatives transactions may have different income tax implications.The income tax implications of using OTC derivatives are dependent upon the nature of your businessactivities and the transaction in question. You should, therefore, consult your tax adviser to understand therelevant income tax considerations.

COMPANION POLICY 91-504CP TOONTARIO SECURITIES COMMISSION RULE 91-504

OVER-THE-COUNTER DERIVATIVES

TABLE OF CONTENTS

PART TITLE

PART 1 INTRODUCTION

1.1 Purpose

1.2 Definition of "contract for differences"

1.3 Definition of "OTC derivative"

1.4 Definition of "OTC derivatives hedging"

PART 2 ESTABLISHING QUALIFICATION

2.1 Qualified Parties

2.2 Receipt of Risk Disclosure Statement

2.3 Hedging

PART 3 APPLICATION OF ONTARIO SECURITIES LAW

3.1 Territorial Scope of the Rule

3.2 Exemption from the Act

PART 4 USE OF OTHER EXEMPTIONS

4.1 Use of Other Exemptions

PART 5 ISSUES RELATING TO DEALERS

5.1 Universal Registration

5.2 Responsibilities of OTC Derivatives Dealers

PART 6 APPLICATION OF THE ACT

6.1 Effect of Section 2.2 of the Rule

6.2 Circumstances of Mutual Obligation

6.3 Paragraph 5 of Subsection 35(1) and Clause 72(1)(d) of the Act

6.4 Form 45-501F1 Requirements

COMPANION POLICY 91-504CP TO ONTARIO SECURITIES COMMISSION RULE 91-504

OVER-THE-COUNTER DERIVATIVES

PART 1 INTRODUCTION

1.1 Purpose - The purpose of this Policy is to state the Commission's interpretation of

(a) certain provisions of Rule 91-504 Over-the-Counter Derivatives (the "Rule"); and

(b) the applicability of certain aspects of the Act to trades in OTC derivatives.

1.2 Definition of "contract for differences" - The definition of "contract for differences" contained inthe Rule excludes a "spot currency contract". The Commission has decided not to define the term"spot currency contract" and to interpret it to have its normal commercial meaning.

1.3 Definition of "OTC derivative" - The definition of "OTC derivative" contained in the Rule requires,among other things, that the agreement relating to an OTC derivative not be "part of a fungible classof agreements that are standardized as to their material economic terms". The Commission is ofthe view that a master agreement, such as the ISDA form of agreement, and any supplements tothe master agreement, should not be considered to be an agreement that is standardized as to itsmaterial economic terms.

1.4 Definition of "OTC derivatives hedging" - One component of the definition of "OTC derivativeshedging" contained in subsection 1.1 of the Rule is the requirement that hedging transactions musthave a "high degree of negative correlation between changes in the value of the position or positionsbeing hedged and the instrument or instruments with which the position or positions are hedged".The Commission is of the view that there need not be complete congruence between the hedginginstrument or instruments and the position or positions being hedged if it is reasonable to regard theone as a hedging instrument for the other, taking into account the closeness of the relationshipbetween fluctuations in the price of the two.

PART 2 ESTABLISHING QUALIFICATION

2.1 Qualified Parties - The Rule provides exemptions from the Act or specified sections of the Act ifone or both parties to the transaction is a qualified party for the relevant transaction. TheCommission is of the view that a party entering into a transaction with a person or a companyclaiming to be a qualified party for the transaction is entitled to rely upon representations by thatperson or company to the effect that that person or company is a qualified party in thosecircumstances unless the party has reason to believe otherwise. Staff of the Commission willtherefore normally not take any enforcement action in respect of a transaction against a party thathas reasonably relied, in the manner described, on representations of its counterparty.

2.2 Receipt of Risk Disclosure Statement - Clauses 2.3(a)(ii)(B) and 2.4(a)(ii)(B) of the Rule requirethe delivery of a risk disclosure statement by the OTC derivatives dealer that is involved with thetransaction as a condition to relying on the respective exemptions contained in those provisions.It is possible that the OTC derivatives dealer will not be a principal in the transaction, and that theprincipal would want to receive comfort that the risk disclosure statement had been received by theappropriate party. The Commission is of the view that the principal may, in those circumstances,rely on representations from the intended recipient of the risk disclosure statement that thestatement was in fact received.

2.3 Hedging - Section 2.1 of the Rule provides that the Act does not apply to an "exempt transaction";this includes, among other things, certain transactions that one of the parties enters into for OTCderivatives hedging purposes. The Commission is of the view that a party entering into an OTCderivatives transaction is entitled to rely, for purposes of establishing that the transaction is an"exempt transaction" under the Rule, upon representations by the other party to the effect that thatparty is entering into the transaction for OTC derivatives hedging purposes within the meaning ofthe Rule unless the party has reason to believe otherwise. Staff of the Commission will thereforenormally not take any enforcement action in respect of a transaction against a party that has relied,in the manner described, on representations of its counterparty.

PART 3 APPLICATION OF ONTARIO SECURITIES LAW

3.1 Territorial Scope of the Rule

(1) Many OTC derivatives transactions have an international component, in which one party maybe located in Ontario and other parties located elsewhere. This raises the issue of whether,or in what circumstances, those transactions should be considered to have taken place inOntario and be therefore subject to the Rule or any other applicable Ontario law.

(2) The Commission is of the view that the persons or companies entering into an OTC derivativetransaction in which some parties are not located in Ontario are entitled to consider theconnecting factors of the transaction with Ontario in order to determine whether thetransaction is subject to the Rule and any other applicable Ontario securities law.

(3) The Commission notes that the investor protection aspects of the Rule are designed for thebenefit of Ontario persons or companies.

(4) The Commission notes that the ISDA master agreements provide that the rights andobligations thereunder are not transferable except in certain prescribed circumstances, suchas default or reorganization. The Commission is of the view that those provisions do not leadto any inference that would make paragraph (3)(c) above inapplicable.

3.2 Exemption from the Act - Section 2.1 of the Rule provides that the Act does not apply to anexempt transaction. This provision is designed to remove exempt transactions entirely from Ontariosecurities law in all respects.

PART 4 USE OF OTHER EXEMPTIONS

4.1 Use of Other Exemptions - A party conducting an OTC derivatives transaction under an exemptionprovided by the Rule is not required to come within the scope of any of the exemptions containedin the Act or the Regulation. However, a party conducting an OTC derivatives transaction that isnot exempt from the prospectus and registration provisions of the Act under the Rule is notprecluded from using an exemption contained in the Act, the Regulation or another rule whenavailable, despite the Rule.

PART 5 ISSUES RELATING TO DEALERS

5.1 Universal Registration

(1) The universal registration regime contained in Part XI of the Regulation operates by removingcertain registration exemptions contained in the Act. However, persons or companies enteringinto OTC derivatives transactions through the exemptions provided in the Rule are not subjectto the universal registration regime because the exemptions contained in the Rule are notremoved by Part XI of the Regulation.

(2) OTC derivatives transactions not effected under exemptions in the Rule will be subject to theapplication of the ordinary registration and universal registrations rules contained in the Act.Therefore, a person or company engaged in effecting OTC derivatives transactions under, forinstance, the $150,000 private placement exemption may be a market intermediary andtherefore required to be registered as a limited market dealer.

5.2 Responsibilities of OTC Derivatives Dealers

(1) Clauses 2.3(a)(ii)(A) and 2.4(a)(ii)(A) require as a condition to the exemptions provided inthose sections that a person or company entering into the transaction must do so with orthrough an OTC derivatives dealer. The Commission is of the view that this requirement issatisfied

(a) if an OTC derivatives dealer acts as principal in the transaction, or

(b) if the OTC derivatives dealer is not acting as principal in the transaction, the OTCderivatives dealer has taken the steps required by dealers under section 1.5 of Rule31-505 Conditions of Registration for that transaction.

PART6 APPLICATION OF THE ACT

6.1 Effect of Section 2.2 of the Rule - The Rule is structured so that it is unnecessary to determinewhether a given OTC derivatives transaction involves a trade in a security. Section 2.2 of the Ruleis a technical provision designed to achieve this purpose; this section causes OTC derivativestransactions that are not exempt transactions or trades in securities to be subject to sections 25 and53 of the Act. This puts those transactions on the same footing in respect of the registration andprospectus provisions of the Act as OTC derivative transactions that are trades in securities. Thesetransactions, however, are subject to provisions of the Act other than the prospectus and registrationprovisions only if they are trades in a security.

6.2 Circumstances of Mutual Obligation - In an OTC derivatives transaction, both parties may beissuing securities. The Commission is of the view that each party to the transaction needs to ensureeither that the Act does not apply to that transaction or that appropriate exemptions are available,either under the Rule or the Act.

6.3 Paragraph 5 of Subsection 35(1) and Clause 72(1)(d) of the Act - Under section 3.1 of Rule 45-501 Prospectus Exempt Distributions, the exemptions contained in paragraph 5 of subsection 35(1)and clause 72(1)(d) of the Act are available where the "aggregate acquisition cost" to a purchaserof a security is not less than $150,000. The Commission is of the view that those exemptions areavailable for OTC derivatives transactions only if an amount of at least $150,000 is paid as premiumat the time that the OTC derivative position is created. Pursuant to section 3.2 of Rule 45-501, thatpayment must be satisfied by the payment of cash or other immediately available funds or theincurring or assumption of a liability, or any combination thereof. These payments or commitmentsmust be in consideration for the security being issued, rather than constituting part of the paymentof the purchase price of the underlying interest. These exemptions would not be available,therefore, for transactions entered into "at-the-money" where no premium is paid, as is typically thecase for swaps and forwards, regardless of the notional amount of the OTC derivative. Theseexemptions should not be interpreted as being available where only the notional amount of thetransaction, or the value of the underlying interest, equals or exceeds $150,000.

6.4 Form 45-501F1 Requirements

(1) A transaction effected pursuant to the exemptive relief provided by the Rule does not triggerForm 45-501F1 filing requirements or the payment of any fee.

(2) Any OTC derivative transaction effected in reliance upon a paragraph of section 72 of the Actenumerated in subsection 72(3) triggers the requirement of the filing of a Form 45-501F1 andpayment of the requisite filing fee under Rule 45-501. At the effective date of this Policy, Rule45-501 provides, in effect, that the fee payable in respect of a Form 45-501F1 filing is thegreater of $100 and 0.02 per cent of the aggregate gross proceeds to be realized in Ontariofrom the distribution of the securities, other than special warrants, to which the Form 45-501F1relates.

(3) The Commission is of the view that the "aggregate gross proceeds to be realized in Ontariofrom the distribution of the securities" will be, in the case of an OTC derivative, theconsideration paid for the instrument, such as the amount of premium paid for an option. The"aggregate gross proceeds to be realized" is not the amount, notional or otherwise, of theunderlying interest.

(4) In the case of "at-the-money" swaps and forwards, no proceeds are realized from thedistribution of the securities, and, therefore, the fee payable in respect of any Form 45-501F1filed in respect of transactions of this nature is $100 at the effective date of this Policy.