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

Request for Comment OSC Rule

January 7, 2000

NOTICE OF PROPOSED RULE AND POLICY
UNDER THE SECURITIES ACT
PROPOSED RULE 91-504
OVER-THE-COUNTER DERIVATIVES
AND
COMPANION POLICY 91-504CP

Introduction

On December 18, 1998, the Commission published the proposed Rule and Companion Policy forcomment at (1998), 21 OSCB 7755. Those versions of the those documents are called the "1998 DraftRule" and "1998 Draft Policy" in this Notice. The proposed Rule and Companion Policy hadpreviously been published for comment on November 1, 1996, at (1996), 19 OSCB 5929. Thoseversions of the those documents are called the "1996 Draft Rule" and "1996 Draft Policy" in thisNotice.

During the comment period on the 1998 Draft Rule and the 1998 Draft Policy, which expired onFebruary 1, 1999, the Commission received 12 submissions from 11 commenters. The names ofcommenters providing the submissions, a summary of their comments and the response of theCommission are contained in Appendix A to this Notice. The Commission thanks all commenters forproviding their comments on the 1998 Draft Rule and 1998 Draft Policy. The 1998 Draft Rule andthe 1998 Draft Policy have been amended to reflect many of the comments, and are being republishedfor further comment. The republished versions of these instruments are called the "Proposed Rule"and "Proposed Policy" in this Notice.

The Commission has considered at length the comments received on the Proposed Rule and has hadnumerous discussions with a number of parties with interests that relate to the Proposed Rule. TheCommission has made some changes to the Proposed Rule in recognition of some of the concernsexpressed.

Substance and Purpose of Proposed Rule

The Proposed Rule deals with the regulation of transactions consisting of over-the-counter ("OTC")derivatives in Ontario and provides complete exemptions from Ontario securities law for sometransactions and provides exemptions from the registration and prospectus requirements of the Act forother transactions. Derivatives products are, generally speaking, instruments the value of which isdependent, wholly or partially, upon the price, level or value of an external benchmark such as asecurity, financial instrument, interest rate, foreign exchange rate, index or commodity price. TheProposed Rule pertains only to the OTC derivatives market, which is a general term given to themarket in which parties contract directly with each other off-exchange and without the interpositionof a clearing corporation. The most common derivatives products used in the OTC market are swaps,options and forwards on a variety of underlying interests.

Purpose of Proposed Policy

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

Summary of Changes to the Proposed Rule

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

For additional background, and a summary of the 1996 Draft Rule, the 1996 Draft Policy, the 1998Draft Rule and the 1998 Draft Policy, reference should be made to the notices that accompanied thepublication of those instruments at (1996) 19 OSCB 5929 and (1998) 21 OSCB 7755.

Section 1.1

Section 1.1 has been amended by the substitution of the names of the courses and examinationscontained in that section. In particular, the "Canadian Futures Examination, Part I and II" is nowcalled the "Futures Licensing Course", and the "Canadian Options Course" is now called the"Options Licensing Course". These changes reflect the changes made in the courses offered by TheCanadian Securities Institute.

In addition, the definition of "exempt transaction" has been amended by the inclusion of a "foreignexchange 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 for OTCderivatives hedging purposes " as an exempt transaction. In addition, paragraph (b) of the definitionnow makes reference to an "interest rate derivative", rather than an "interest rate/foreign exchangederivative". A definition of "foreign exchange derivative" has been added. These changes have beenmade to reflect the decision of the Commission to provide an exemption from the Act to certain foreignexchange derivatives and the resulting necessity to treat foreign exchange and interest rate derivativesseparately in the Proposed Rule. This change has been made as a response to the concern that theregulatory benefits of bringing some foreign exchange derivatives into the Proposed Rule were smallcompared to the compliance costs that such a move might cause in the marketplace. The Commissionnow is satisfied that the Proposed Rule is an appropriate regulatory response to the issue of theapplication of the Act to the OTC derivatives market in Ontario.

Finally, the definition of "OTC derivatives" transaction has been amended by the deletion, inparagraph (a) of the definition, of the requirement that was contained in the 1998 Draft Rule that thematerial economic terms of the relevant contract be customized to the purposes of the parties to theagreement. This change has been made in response to a comment that suggested that the many OTCderivatives transactions are not "customized", but rather are made pursuant to standardized agreementsin which parties negotiate price or rate. The commenter also noted that the removal of thecustomization requirement would make the language of paragraph (a) consistent with the swapagreements exemption in the U.S. Commodity Futures Trading Commission Regulations (Title 17, part35, sec. 35.2).

Sections 2.3 and 2.4

Sections 2.3 and 2.4 have been amended to reflect the new course names referred to above.

Section 2.5

Section 2.5 is new and provides that section 2.3 and 2.4 are not available for the settlement of atransaction consisting of an OTC derivative that is settled by way of the physical delivery of securitiesthat are not freely tradeable. This change was made in response to a comment that noted thepossibility of the use of forward contracts to effect control block distributions in a manner that,arguably, would not be subject to prospectus requirements or hold periods. The Commission agreedwith the comment, and wants to ensure that OTC derivatives transactions are not used to subvertprovisions in the Act that would otherwise restrict the trading of securities.

Section 2.6

Section 2.6 is new and provides an exemption from the underwriting conflict rules of section 224 ofthe Regulation, and its replacement, Multilateral Instrument 33-105 Underwriting Conflicts, for OTCderivatives transactions. The Commission is of the view that the underwriting conflicts regimeapplicable to related and connected issuers of underwriters would not be workable or necessary inthe context of OTC derivatives transactions.

Appendix A

A number of changes have been made to the list of Qualified Parties contained in Appendix A,primarily as a result of comments received by the Commission.

First, references to a "country that is a member of the Basel Accord" have been changed to include "acountry...that has adopted the banking and supervisory rules set out in the Basel Accord". This changeis designed to include financial institutions and other entities from those countries as Qualified Partiesin recognition that the regulatory regime of those countries is sophisticated and credible.

Second, the minimum capital threshold for a number of institutions and entities listed in Appendix Ahas been reduced from $100 million to $25 million. The Commission has made this change to ensurethat the Proposed Rule imposes requirements only on OTC derivatives transactions involving smallinstitutions that may lack sophistication and require the protection provided by the Proposed Rule.

Third, paragraph (q) of subsection (3) of the Proposed Rule has been amended to include mutual fundsor non-redeemable investment funds as Qualified Parties if the portfolio manager of the fund isregistered under the Act or securities legislation elsewhere in Canada as an adviser, other than asecurities adviser. This change is designed to remove the requirement that the "management company"to the mutual fund must have such a registration. The Commission agrees with the commenter whonoted that some portfolio managers are not "management companies".

Fourth, a reference to paragraph (w) of subsection (3) has been added to the description of "managedaccounts" contained in subsection (4) in order to ensure that accounts managed by a person orcompany referred to in that paragraph, namely wholly-owned subsidiaries of certain organizationsdescribed elsewhere in Appendix A, qualified as Qualified Parties.

Summary of Changes to the Proposed Policy

Section 6.3 of the Proposed Policy has been amended to update references that relate to Rule 45-501Prospectus Exempt Distributions.

Section 6.4 of the Proposed Policy has been amended to update references from "Form 20" to "Form45-501F1".

Comments

Interested parties are invited to make written submissions with respect to the Proposed Rule andCompanion Policy. Submissions received by February 7, 2000 will be considered.

Submissions should be made to:

John Stevenson, Secretary

Ontario Securities Commission

20 Queen Street West

Suite 800, Box 55

Toronto, Ontario M5H 3S8

A diskette containing an electronic copy of the submissions (in DOS or Windows format, preferablyWordPerfect) should also be submitted. As the Act requires that a summary of written commentsreceived during the comment period be published, confidentiality of submissions received cannot bemaintained.

Questions may be referred to:

Randee Pavalow

Manager, Market Regulation

Ontario Securities Commission

(416) 593-8257

Tracey Stern

Legal Counsel, Market Regulation

Ontario Securities Commission

(416) 593-8167

Text of Proposed Rule and Proposed Policy

The text of each of the Proposed Rule and Proposed Policy, together with footnotes that are not partof the Proposed Rule or Proposed Policy but have been included to provide background andexplanation.

DATED: January 7 , 2000

ONTARIO SECURITIES COMMISSION RULE 91-504

OVER-THE-COUNTER DERIVATIVES

APPENDIX A

SUMMARY OF COMMENTS RECEIVED

ONTARIO DRAFT RULE 91-504 AND ONTARIO DRAFT POLICY 91-504CP

AND

RESPONSE OF THE ONTARIO SECURITIES COMMISSION

1. INTRODUCTION

On December 18, 1998, the Commission published draft Rule 91-504 and draft Companion Policy 91-504 for comment at (1998), 21 OSCB 7755. Those versions of the those documents are called the"1998 Draft Rule" and "1998 Draft Policy" in this Appendix. The proposed Rule and CompanionPolicy had previously been published for comment on November 1, 1996, at (1996), 19 OSCB 5929.Those versions of the those documents are called the "1996 Draft Rule" and "1996 Draft Policy" inthis Appendix.

During the comment period on the 1998 Draft Rule and the 1998 Draft Policy, which expired onFebruary 1, 1999, the Commission received 12 submissions from 11 commenters. The commentersproviding the submissions can be grouped as follows:

Law Firms and Lawyers 3

- Osler, Hoskin & Harcourt ("Oslers") (2 letters)

- Timothy Baron ("Mr. Baron")

- Stikeman, Elliott ("Stikeman")

Trade Associations 4

- The Investment Funds Institute of Canada ("IFIC")

- Canadian Bankers Association ("CBA")

- International Swaps and Derivatives

Association, Inc. ("ISDA")

- The Canadian Securities Institute ("CSI")

Investment Manager 1

- Friedberg Mercantile Group ("Friedberg")

Investment Dealers 2

- CIBC Wood Gundy ("CIBC WG")

- RBC Dominion Securities Inc. ("RBC DS")

Other 1

- The Toronto Stock Exchange ("TSE") __

TOTAL 11

Copies of the comment letters may be viewed at the office of Micromedia, 20 Victoria Street, Toronto,Ontario (416) 312-5211 or (800) 387-2689.

The following is a summary of the comments received, together with the Commission's responses and,where applicable, the changes in response to the comments that are contained in the proposed Rule(the "Proposed Rule") and proposed Companion Policy (the "Proposed Policy") being published withthis notice.

2. GENERAL COMMENTS

A number of commenters restated comments made in connection with the earlier versions of theProposed Rule. Those commenters questioned the need for the Proposed Rule, the jurisdiction of theCommission to enact it, the effect of the Proposed Rule on the OTC derivatives market in Ontario, theexclusion or inclusion of certain parties as "Qualified Parties" and the applicability of the exemptionsto the retail market. Many of the issues were discussed in the Notice published with the 1998 DraftInstrument (the "1998 Notice") and reference should be made to the "1998 Notice" for a more thoroughdiscussion of a number of those comments and the Commission's responses. The Commission hasattempted to avoid repeating at length the discussions contained in the 1998 Notice.

Other commentators referred to the manner in which the Proposed Rule interacts with the requirementsof the Securities Act (Ontario) (the "Act"), the Regulations to the Act (the "Regulation") and certainrules.

Need for Regulation

The CBA restated its position that no rule for the OTC derivatives market is appropriate or necessary.The CBA does not believe that the Commissions's stated objectives are appropriate in currentcircumstances and even if they are, it does not believe that these objectives are met by the terms of theProposed Rule. In the CBA's opinion, there is no significant uncertainty in the market and no investorprotection problem that needs to be addressed.

ISDA stated that Commission staff did not provide examples as to why regulation in this area wasnecessary and only offered "vague references referring to the jurisdictional scope of the Commission,while reiterating the broad concept of a perceived need for protecting individual retail derivativecounterparties". ISDA stated that the Proposed Rule will confuse regulators and participants in theglobal derivatives business.

CIBC WG indicated that it concurred with the comments made by the CBA and stated that the desireof the Commission to clarify the relationship of the Act to OTC derivatives may be a "laudableobjective", but was only achieved to a very limited degree by the Proposed Rule. CIBC WGcommented that the only clarification that the industry is seeking is "whether and, if so, which OTCderivatives transactions constitute trades in securities under the Act". CIBC WG stated that this wasan issue that the Proposed Rule avoids entirely and which therefore remains unresolved. CIBC WGstated that there was no material investor protection needs in respect of OTC derivatives transactions.Transactions are either entered into by sophisticated investors, or are easily understood by"unsophisticated" investors.

Response:

The Commission continues to be of the view that the Proposed Rule is appropriate andaddresses a need in some sectors of the marketplace for regulatory certainty, and alsoimplements a non-intrusive and useful regime for investor protection.

Effect of the Proposed Rule on the Ontario OTC Derivatives Market

The CBA stated that any regulatory mechanism imposed will impose significant burdens on Ontariomarket participants. The burdens of mandated fixed disclosure procedures, employee education anddealer processing requirements will create inefficiencies and onerous administrative difficulties andwill affect the competitiveness of Canadian dealers and end-users in an international marketplace.The imposition of costs associated with obtaining legal, accounting and other advice may causecounterparties to avoid entering into OTC derivatives transactions in Ontario. The CBA also statedthat it was unaware of any other domestic market (including, specifically, the United States) in whichthis type of regulation has been imposed. The CBA stated that it would be disappointed if OntarioOTC derivatives market participants conducted transactions in other jurisdictions outside the provincein order to avoid potential legal costs and unnecessary regulatory burdens.

ISDA stated that the additional compliance burden imposed on OTC derivatives providers by theProposed Rule is unwarranted and will handicap Canadian institutions in the global derivativesmarket. In ISDA's opinion, the Proposed Rule will adversely impact on OTC derivatives providersand increase the costs to OTC derivative end-users.

Response:

The Commission does not believe that the Proposed Rule will have a damaging effect on theOTC derivatives market in Ontario, and notes, as it did in the 1998 Notice, that the primarypurpose of the Proposed Rule is merely to provide exemptions to a large number oftransactions.

The Commission notes that the Alberta Securities Commission, in an order dated July 29,1999, exempted certain OTC derivatives transactions from the Securities Act (Alberta). TheBritish Columbia Securities Commission issued three blanket orders and a companion policy,dated November 24, 1999, to exempt certain types of OTC derivative transactions from theSecurities Act (British Columbia) (the "B.C. Act") and to enable certain parties to enter intoOTC derivatives transactions without being subject to the registration and prospectusrequirements of the B.C. Act. The Commission intends to pursue efforts to harmonise theapproaches of the Canadian securities regulatory authorities to the regulation of thesetransactions.

Constitutional Issues

The CBA restated its position that the OTC derivatives activities of banks are an integral part of thebusiness of banks and banking and are wholly within federal, not provincial, jurisdiction. The CBAstated that the derivatives activities of Canadian banks are already heavily supervised and adequatelyregulated.

CIBC WG stated that the Commission has stepped outside the bounds of its constitutional authority byfirst asserting authority over all OTC derivatives in order to then provide exemptions which narrowthe application of the Proposed Rule to non-Qualified Parties. CIBC WG indicated that it saw theapproach and structure of the Proposed Rule as being more than a "convenient drafting technique" butin fact resulted in the Commission venturing beyond the bounds of its constitutional authority.

ISDA referred to questions raised by "other commentators" that have raised questions as to theconstitutional basis for the Proposed Rule, its appropriateness under the Commission's rule-makingpower and similar issues concerning the Commission's jurisdiction.

Response:

The Commission has not changed its views concerning this issue since the 1998 Notice. TheProposed Rule has been carefully tailored to focus on investor protection in the retail marketand is therefore designed to protect those least able to protect themselves. It is not aimed atensuring the financial soundness of financial institutions, the subject matter and primaryconcern of federal legislation pertaining to derivatives.

Extra-Territorial Effect of the Proposed Rule

Mr. Baron referred to section 3.1 of the 1998 Draft Policy, which had been added to the ProposedPolicy to attempt to alleviate concerns over the territorial effect of the Proposed Rule. Mr. Baronstated that this section does not provide the same certainty that it would if it were in the Proposed Ruleand recommended that this section be included in the Proposed Rule.

Response:

As noted, section 3.1 was added to the 1998 Draft Policy to clarify the Commission's viewsof its administrative practice concerning the territorial scope of the Proposed Rule. Thatsection outlines that principles analogous to those enunciated in the Interpretation Notereplacing OSC Policy 1.5 in respect of OTC derivatives transactions.

Section 3.1 is properly contained in the Proposed Policy, not the Proposed Rule, because itrepresents only a statement of the administrative position of the Commission in respect of the"manner in which a provision of this Act, the regulations or the rules in interpreted or appliedby the Commission of the Director", as stated in section 143.8(1)(b) of the Act.

CIBC WG suggested that the Commission's position on the territorial scope of the Proposed Rule mayrequire further clarification. CIBC WG stated that the administrative position discussed by theCommission in the proposed policy raises two issues. First, it was noted that the stated administrativeposition suggests that an OTC derivative transaction between a non-Ontario and an Ontario party thatconstitutes a trade in security under traditional tests will not be subject to any provisions of the Act,regardless of connecting factors. It was suggested that this would put foreign institutions at anadvantage in comparison to Canadian institutions who are only exempt from sections 25 and 53 of theAct, but not the remaining provisions of the Act if the transaction is a trade in securities. Second,CIBC WG stated that with regard to investor protection, it would interpret the Proposed Rule asrequiring that if an Ontario party that is not a Qualified Party is entering into an OTC derivativestransaction with a foreign person or company, the entire transaction will be subject to the ProposedRule with the result that the foreign person or company will have to be a Qualified Party under theProposed Rule. CIBC WG stated that it was unclear why a non-Ontario person or company wouldneed to be a Qualified Party to meet the investor protection concerns of the Commission.

Response:

With respect to CIBC WG's first comment, the Commission notes that the purpose of section3.1 of the Proposed Policy is to provide a framework for market participants to determinewhether a transaction will be considered by the Commission to be an "Ontario transaction",or whether the transaction would be considered to be outside of Ontario and not thereforesubject to Ontario securities law. As CIBC WG has noted, the implication of this may be thata transaction involving Ontario parties could be more likely to be considered an Ontariotransaction, and therefore possibly subject to the Proposed Rule, than a transaction involvingsome non-Ontario parties. With respect to CIBC WG's second comment, a transactionbetween an non-Ontario party and an Ontario party that is not a Qualified Party may be subjectto the Proposed Rule, meaning that the Ontario party will have to be provided with a riskdisclosure statement and the transaction will have to involve a dealer.

Scope of Authority

CIBC WG stated that it disagreed with the view of the Commission concerning the ability of theCommission to regulate derivatives that were not securities under paragraph 35 of subsection 143(1)of the Act. CIBC WG stated that that paragraph should be interpreted "in a manner consistent with theexisting structure and content of the Act", with the result that the Commission's authority to regulatederivatives should be restricted to regulating derivatives that are securities.

Response:

The Commission remains of the view that it has authority under the Act to regulatederivatives, whether or not they are securities.

Structure of the Proposed Rule

The CBA stated that the Proposed Rule will create further confusion and uncertainty for marketparticipants and stated that the proposed structure is complex and creates technical and definitionalproblems.

CIBC WG stated that the Proposed Rule should be directed only at OTC derivative transactions thatconstitute trades in securities. CIBC WG stated that in the Proposed Rule, the "Commission blithelysweeps all but a limited category of OTC derivative transactions under the applications of sections25 and 53 of the Act, without regard to whether or not they constitute trades in securities....". CIBCWG also felt that it was much more appropriate in light of its view on the authority of the Commissionto regulate derivatives to confine any application of the Proposed Rule to derivatives that constitutedtrades in securities.

Response:

The Commission remains of the view that the Proposed Rule is structured in an appropriateway and makes reference to the discussion on that issue in the 1998 Notice. The Commissionnotes that it believes that the difficulties of defining which OTC derivatives transactionsconstitute trades in securities, given the vagaries of the definition of "security" in the Act andthe case law on the subject, are such that basing the Proposed Rule on such a distinctionwould be unsatisfactory and arbitrary.

TSE Comments on General Approach to OTC Derivatives

The TSE stated that it is supportive of the overall objective of the Proposed Rule and Policy.However, the Proposed Rule raises a number of issues.

The TSE is the opinion of the TSE that the Proposed Rule is broader in that it encompasses tradingin OTC derivatives by retail investors as well as sophisticated clients. The Exchange recommendedthat the exemptions from the registration and prospectus requirements of the Act not be extendedbeyond sophisticated investors so that the OTC market is only accessible to retail investors if donethrough a registered dealer providing a prospectus. The TSE stated that the proliferation of variousforms of stock and option plans for employees and shareholders of listed companies has createdopportunities for greater retail involvement in derivatives.

In the TSE's opinion, investing in derivatives involves certain inherent and unique risks, which resultsin the need for particular attention to be paid to the protection of the interests of non-sophisticatedinvestors. With respect to exchange-traded derivatives, because of their standardization, a genericrisk disclosure statement would be appropriate and dealers receive extensive training in coursesoffered by the CSI. However, because OTC derivatives are customized, there are unique risksinvolved with them that would render them unsuitable for retail clients. In the TSE's opinion, ageneric risk disclosure statement does not provide adequate protection for retail investors who maynot fully appreciate the differences between an OTC derivative and exchange-traded derivative thathave the same underlying interest.

The TSE submitted that there should be a level playing field between OTC derivative products andexchange-traded derivative products. Exchange traded derivatives are subject to significant regulatoryoversight whereas the Proposed Rule provides little or no restriction on OTC derivatives. The TSEsubmitted that the Commission should make it a priority to introduce an expedited review process forexchange-traded derivatives coincident with the implementation of the Proposed Rule.

Response:

As stated in the 1998 Notice, the Commission does not propose to impose additionalrequirements on OTC derivatives transaction effected in the retail market. The Commissionis of the view that the investor protection measures imposed by the Proposed Rule areadequate in this regard. The Commission is not considering an introduction of an expeditedreview process for exchange-traded derivatives at this time.

Involvement of an OTC Derivatives Dealer

The CBA expressed concern that the Proposed Rule may require the sharing of confidentialinformation with dealers. For banks to comply with the investor protection measures of the ProposedRule, in particular the requirement to involve a dealer/registered representative in the process, thebank may be asked to disclose confidential client information to the dealer. In addition, there will bean additional cost in imposing the administrative burden of obtaining client authorization. The CBArecommended the deletion of the dealer requirement, and that consideration be given to a requirementfor an enhanced disclosure statement.

Response:

The Commission does not believe that the sharing of confidential information is a majorproblem with the Proposed Rule. The OTC derivatives dealer that becomes involved in atransaction will have to be supplied with substantially the same information as any dealerinvolved in any securities transaction.

It is Mr. Baron's view that the requirement to interpose a dealer between a counterparty and a non-Qualified Party will cause delay and increase the cost of the transaction for the non-Qualified Partydisproportionately to the potential benefit to the non-Qualified Party. The requirement will force thenon-Qualified Party to bear the costs of the dealer complying with the "know your client"requirements. In addition, Qualified Parties may be forced to disclose proprietary trading structuresand explain them to dealers, who compete to provide the same types of products in the market.Finally, OTC derivative transactions often need to be agreed to quickly and are consummated overthe phone, precluding taking the time to involve a dealer.

It is Mr. Baron's view that the effect of subclauses 2.3(a)(ii)(A) and 2.4(a)(ii)(A) will be to precludesmaller banks and other entities from being competitive in the OTC derivatives market due to theincreased costs of transactions. A dealer should not be interposed, but rather the Qualified Partyshould be required to deliver a form of risk disclosure statement to the non-Qualified Party directly.

Response:

As stated above, the Commission continues to believe that the involvement of a dealer in atransaction not involving a non-Qualified Party is appropriate.

Oslers commented that the involvement of an OTC derivatives dealer (likely controlled by a bank)in a transaction involving the bank and a non-qualified party raises a number of issues under the Actand Regulation. Oslers suggested several scenarios that raised specific issues.

Conflicts of Interest

An individual holding a large block of securities wishes to pledge it as security for a loan. The bankwill lend up to 80-90% of the value of the stock if the individual purchases a put option from the bankenabling the individual to put the stock pledged to the bank at 90% of its current trading price at thematurity of the loan. The put option is effected through a cash-settled OTC derivatives transaction.

If the individual is not a Qualified Party, the put option must be entered through a dealer. Given thedefinition of option in Rule 14-501⁽¹⁾, it is possible to conclude that the option is a security for thepurposes of the Act and the sale of the option will therefore be a distribution by the bank to theindividual. If the bank controls the dealer, the bank will be considered to be a "connected issuer" forthe purposes of Part XIII of the Regulation. The dealer may be considered to be an underwriter inconnection with the distribution if it is marketing the product on behalf of the bank or receivescompensation in connection with the services provided. Oslers requested clarification on thefollowing:

(i) whether section 224(1)(a) of the Regulation (the independent underwriter provisions)is intended to apply; and

(ii) if so, how the disclosure of information required by items 5, 30 and 31 of Form 12will be made to the individual.

Oslers argued that sections 225 and 226 of the Regulation require that disclosure of the relationshipbetween the bank and the dealer be made to the individual, so the application of section 224 of theRegulation seems to be unnecessary.

Response:

The Commission has added section 2.6 to the Proposed Rule to exempt OTC derivativestransactions from the operation of the conflict of interest provisions cited by Oslers and thesuccessor to those provisions, proposed Multilateral Instrument 33-105 UnderwritingConflicts. The Commission is of the view that these conflict of interest regimes would not beworkable or necessary in the context of OTC derivatives transactions.

Limitations on Networking

Oslers asked whether an arrangement between the bank and dealer, such as the arrangement describedabove, will be considered a "networking arrangement" and subject to the requirements of section 229of the Regulation.

Response:

Whether such an arrangement would constitute a networking arrangement should beconsidered on a case-by-case basis. The Commission does not believe that it is appropriateto provide complete exemptions from the networking provisions of the Regulation in respectof OTC derivative transactions, as there may be relationships that raise the policy issuesaddressed by section 229 of the Regulation.

Application of the Act to Certain OTC Derivatives Transactions

Oslers described two scenarios that illustrate issues relating to how the Act would apply to certainOTC derivatives transactions.

OTC Call Option Transactions

A purchaser of a call option written by a reporting issuer exercises the option and pays the strikeprice. The reporting issuer satisfies its obligations by delivery of the shares newly issued out of itstreasury. The distribution of shares by the reporting issuer is made pursuant to subclause 72(1)(f)(iii)of the Act. The resale by the purchaser of those shares will be subject to subsection 72(5). However,if the option had been issued pursuant to exemptions contained in clauses 72(1)(a), (b), (c) or (d), themore onerous resale restrictions contained in section 6.4 of Rule 45-501 would apply. Is this theCommission's intention?

Response:

The Commission recognizes that market participants are free to take advantage of whateverexemption is applicable to a given transaction. The Commission understands that there arecircumstances in which two available exemptions could lead to different resale restrictions.

OTC Forward Transaction

A control block shareholder ("X") enters into a forward transaction with Y. X agrees to sell sharesof ABC Co. to Y for an amount of cash in 90 days. Both are Qualified Parties and therefore, exemptfrom the prospectus requirements pursuant to section 2.4 of the Proposed Rule. It is arguable that notrade occurs at the maturity of the forward. As the trade is exempt from the prospectus requirements,it may be argued that the ABC Co. shares acquired upon settlement are not subject to any first traderestrictions. Oslers requests clarification regarding the manner in which the OSC will analyze thistype of transaction.

Response:

The Commission has added section 2.5 to the Proposed Rule to ensure that the exemptionsprovided by the Proposed Rule are not available for the settlement of a transaction consistingof an OTC derivative that is settled by the physical delivery of securities that are not freelytradeable. This restriction would eliminate the use of forward contracts or other OTCderivatives to subvert provisions in the Act that would otherwise restrict the trading ofsecurities.

Identification of Qualified Parties

The CBA stated that the cost burdens imposed by the Proposed Rule entail requiring banks tocategorize OTC derivatives business as whether the client is a Qualified Party and obtainrepresentations that certain transactions are being conducted for hedging or speculative/investmentpurposes. Obtaining and tracking these representations on an on-going basis was stated to beextremely onerous, and resulting in the generation of significant legal fees and compliance costs.

CIBC WG submitted that it would be administratively very difficult to identify Qualified Parties inconnection with transactions undertaken by CIBC at a branch level. It was noted that registeredrepresentatives of CIBC WG are present at only six of over 1400 CIBC branches. To meet therequirement of the Proposed Rule, clients would have to be directed by the branch to a registeredrepresentative of CIBC WG or other registered dealer in a separate location but who likely will haveno existing business relationship with the client and little appreciation of the client's specific businesscircumstances and financing needs. It was submitted that these requirements, and the additional costsof administering these requirements, are excessive in light of the simple derivative products, such ascurrency forwards, that are typically offered to these types of clients.

CIBC WG also noted that banks are currently, or soon will be, allowing clients to purchase currencyforwards through internet based trading platforms. CIBC WG indicated that the requirement tointerpose a dealer in the transaction would be expensive and inconvenient, or would cause orderentries to be rejected. CIBC WG suggested that, in lieu of requiring the participation of a registereddealer, a risk disclosure statement delivered to the client clearly point out the advantages andadditional costs of entering into the transaction through a dealer.

Response:

The Commission believes that it is appropriate that less sophisticated investors be identifiedand protected in respect of OTC derivatives transactions. This obviously will entail theimplementation of procedures necessary to identify such investors. The Commission expectsthat appropriate procedures will be put in place. Also, the Commission continues to believethat the involvement of a dealer in a transaction involving a non-Qualified Party isappropriate.

However, the Commission also notes that it has amended the definition of "exempt definition"to exclude certain foreign exchange derivatives from the Act.

2. SPECIFIC REQUESTS FOR COMMENTS

In the 1998 Notice, the Commission requested comment on whether definitions such as "contract fordifferences", "forward contracts" and "options" should be undefined in the Proposed Rule or beallowed to be interpreted in accordance with ordinary usage.

The CBA stated that it had no specific recommendations on the issue. However, the CBA stated thatit does believe that either approach will cause problems and create uncertainties in the market.

CIBC WG submitted that the terms would be better defined than undefined.

Response:

The Commission has decided to leave definitions of the terms in the Proposed Rule.

3. COMMENTS ON SPECIFIC PROVISIONS OF THE 1998 DRAFT RULE AND 1998DRAFT POLICY

Part 1 - Definitions

The CSI provided an update on the status of the CSI's derivatives-related courses, which have beenchanged since the earlier versions of the Proposed Rule were published for comment. The CSIrecommended that references in the definitions section of the Proposed Rule to "Canadian FuturesExamination Parts I and II", "Canadian Options Course" and "Canadian Securities Course" should bereplaced with references to with "Derivatives Fundamentals Course", "Options Licensing Course" and"Futures Licensing Course".

Response:

The Commission has changed the names of the courses listed in the Proposed Rule to reflectthe new names of the courses offered by The Canadian Securities Institute.

Section 1.1 - definition of "interest rate/foreign exchange derivative"

The CBA stated that it strongly believed that forward foreign exchange transactions should beexcluded on the same basis as spot transactions. Forward transactions are no more complex, both arenormally confirmed electronically and there is often no documentation. The documentationrequirements contained in the Proposed Rule for forward foreign exchange transactions will changethe way these contracts are traded and would be difficult and expensive for the banks to administer.In addition, dealers are not normally involved in the foreign exchange business, thus their judgementson suitability are inappropriate.

Response:

The Commission has amended the Proposed Rule to provide that "foreign exchangederivatives" will be "exempt transactions" if one party to the transaction is a qualified partyfor that transaction, or each party to the transaction is a person or company entering into thetransaction for OTC derivatives hedging purposes. In these circumstances, the foreignexchange derivative would be entirely exempt from the operation of the Act. The Commissionis of the view that this change addresses the concerns of the commenters, while maintainingthe Commission's jurisdiction over "bucket shop" operations.

Section 1.1 - Definition of "qualified party"

Comments on the specific parties included in the list of Qualified Parties are included in thediscussion of "Appendix A" in this Appendix.

Section 2.2

CIBC WG submitted that section 2.2 was ineffective to accomplish its stated purpose. Section 2.2 ofthe Proposed Rule provides that section 53 of the Act applies to transactions consisting of an OTCderivatives transaction that does not constitute a trade in a security as if the transaction did constitutea trade in a security. CIBC argued that section 53 of the Act by its terms applied only to distributionsof securities. Therefore section 2.2 cannot work.

Response:

The Commission disagrees with the interpretation of CIBC WG, and believes that section 2.2of the Proposed Rule does effectively accomplish its purpose.

Definition of "OTC derivatives"

CIBC WG stated that the definition of "OTC derivative" was sufficiently broad to include many kindsof contracts that should not be subject to the Proposed Rule. As an example, CIBC WG referred topre-approved mortgages, which are effectively a sale by a financial institution of a forward rateagreement and a call on interest rates. This problem would have to be dealt with by having financialinstitutions obtain representations on hedging from clients in order to ensure that such transactionswould be exempt from the Proposed Rule. CIBC WG stated that these problems would be alleviatedif the Proposed Rule was confined to OTC derivative transactions that constitute trade in securities.

Response:

The Commission is aware of the definitional difficulties of defining many of the termscontained in the Proposed Rule but believes that the definitions contained in the ProposedRule are workable and does not propose to make further changes. It is not intended that thedefinition of OTC derivative will catch transactions that are not commonly considered to bederivatives, such as pre-approved mortgages. The Commission will consider amending theCompanion Policy from time to time if necessary to clarify particular problematicambiguities.

Section 2.3

The CSI recommended that

(a) subclause 2.3(a)(ii)(A) to be changed to state "...has successfully completed theChartered Financial Analysts Course, or the Derivatives Fundamentals Course"; and

(b) subclause 2.4(a)(ii)(A) to be changed to state "...has successfully completed theChartered Financial Analysts Course, or the Derivatives Fundamentals Course".

In the view of the CSI, the licensing requirements should be limited to the Derivatives FundamentalsCourse (the "DFC") because OTC derivatives are taught exclusively in the DFC. The CSI estimatesthat 20-40% of the DFC's examination relates to OTC derivatives. In addition, all registeredrepresentatives employed by member firms must have completed the Canadian Securities Course, andtherefore a separate reference to that course is unnecessary. The Options Licensing Course andFutures Licensing Course are designed to provide registered representatives with knowledge onexchange traded futures and options. The DFC is a prerequisite for both.

Response:

The Commission has amended the Proposed Rule to require that representatives of OTCderivatives dealers must have either the Chartered Financial Analysts Course, or all of theFutures Licensing Course ("FLC"), the Options Licensing Course ("OLC") and the CanadianSecurities Course in order to satisfy the requirements of the Proposed Rule. Commissionwants to ensure the highest standard of proficiency possible in these circumstances. The FLC,OLC and the DFC, are considered to be successor courses to Canadian Futures Examination,Parts I and II and the Canadian Options Course.

Appendix A - List of Qualified Parties

Foreign Entities

Mr. Baron contended that Appendix A should not refer to foreign parties as Qualified Parties for anumber of reasons. First, the Commission has stated that it is not concerned with the protection offoreign parties. Consequently, it should be irrelevant if there is any nexus with Ontario and thereshould be no need to determine the status of a foreign party as a Qualified Party. Second, a foreignparty may attempt to void an unfavourable transaction in reliance of section 133 of the Act on the basisthat it is not a Qualified Party, did not receive a disclosure statement and should have received aprospectus from the Ontario party.

Mr. Baron therefore recommended that the criteria for foreign parties to become Qualified Partiesshould be eliminated and that a provision be included that states that the Proposed Rule does not applyto foreign parties.

Response:

The Commission has determined to leave foreign entities in Appendix A. This may be helpfulin the case of transactions involving offices of foreign entities that may be located in Ontario.

Basel Accord

Friedberg noted that the IDA has changed its definition of Basel Accord Countries to include thosecountries who are not initial signatories to the Accord but have adopted the banking and supervisoryrules set out in the Basel Accord. These countries include Australia, New Zealand and Hong Kong.Friedberg suggested that paragraphs 3(c), (f) and (h) of the list of Qualified Parties in the ProposedRule be changed to reflect this change.

Response:

The Commission agrees with the comment concerning the Basel Accord countries and hasamended the paragraphs described above to include countries that have adopted the bankingand supervisory rules of the Basel Accord.

Portfolio Manager

IFIC noted that the definition of mutual fund in paragraph (q) of the List of Qualified Parties currentlyincludes only those mutual funds where "the management company of the fund is registered under theAct or securities legislation elsewhere in Canada as an adviser, other than as a securities adviser."IFIC recommended that this provision be amended to refer to a registered portfolio manager, so thata mutual fund whose portfolio adviser was a registered portfolio manager would be a Qualified Party.

Response:

The CSA agrees with the comment and has amended paragraph (q) to include "a fund thatdistributes its securities in Ontario, if the portfolio manager of the fund is registered under theAct as an adviser, other than a securities adviser" in Ontario or under the securitieslegislation of any other jurisdiction.

$100 Million Threshold

The CBA stated that the $100 million threshold for a Qualified Party is too high and should belowered to either a balance sheet amount of $25 million or a capital amount of $5 million. The CBArecommended lowering the dollar threshold to $25 million in assets.

In the opinion of RBC DS, the high threshold for corporations is inconsistent with the low thresholdof $5 million in assets set for individuals. In addition, the high threshold is inconsistent with therequirements set for financial institutions, where all trust and loan corporations incorporated inCanada and credit unions and caisses populaires are considered to be "qualified" regardless of size.

RBC DS is concerned that the requirement that a corporation have assets in excess of $100 millionto be a Qualified Party would greatly impact its clients. It noted that Royal Bank has a large numberof small and medium enterprises clients across Canada, none of which hold $100 million, and asubstantial number engaged in OTC derivatives transactions.

Response:

The Commission has lowered the threshold to $25 million generally. Specifically withrespect to corporations, the threshold has been changed to $25 million in revenue. Therequirements for financial institutions have been left unchanged; this approach is consistentwith the exemptions provided in the Act by clause 72(1)(a).

Wholly-Owned Corporations

Oslers suggested that the Proposed Rule include in the list of Qualified Parties, a corporation or otherentity controlled by an individual who has a net worth of at least $5 million, and a corporation whollyowned by a pension fund.

Response:

The Commission agrees to include subsidiaries wholly owned by a pension fund andsubsidiaries wholly owned by an individual with net worth of at least $5 million as qualifiedparties.

Threshold/Hedging

RBC DS noted that the determination of whether a transaction is a hedge might differ for accountingpurposes and under the Proposed Rule.

Response:

The Proposed Rule does not require the "hedging" classification to be determined by theclassification of the transaction for accounting purposes.

RBC DS was also concerned that the judgement calls that it makes today (that a transaction is enteredinto for "hedging purposes") may prove to be incorrect in the future. RBC DS stated that it saw onlya portion of client activity and that clients are under no obligation to disclose their derivativepositions taken with other financial institutions.

Finally, RBC DS stated that the Proposed Rule opens it up to litigation by clients or their disgruntledshareholders over the hedging of risk positions that should have been left unhedged. No paper recordsare kept supporting RBC DS' belief that a client is entering into a transaction for hedging purposes.It relies on the expertise of its salespeople. It is RBC DS' view that the Proposed Rule would requirethem to keep paper records in support of its understanding that a client is entering into a transactionfor the purpose of hedging.

RBC DS disagreed with the notion that to obtain evidence of a client's intention, it would need onlya representation from the client stating that the transaction is for hedging purposes. It is RBC DS' viewthat to obtain representations, it would need to allocate time and resources to obtain the representation

In summary, it was RBC DS' opinion that the Proposed Rule will add to the costs of providing OTCderivative services to clients, will be a burden on clients who are not Qualified Parties and mayadversely affect the relationship with those clients. RBC DS suggests that its concerns can beaddressed by lowering the total asset requirement for corporations to a level that is consistent withthe threshold set for individuals. This will impact a smaller number of clients and permit reducedmonitoring.

Response:

The Commission disagrees with this suggestion and has not amended the list in this respect.The $5 million requirement corresponds to the requirement for individuals to be permittedclients of international advisers registered as advisers, contained in paragraph III.1(k) ofOntario Securities Commission Policy 4.8, which will be replaced with Rule 35-502International Advisers.

Managed Accounts

Oslers commented that an account of a person, company, pension fund or pooled fund trust that is fullymanaged by a person referred to in paragraph (w) of paragraph 2 of the appendix should be includedas a qualified party.

Response:

The Commission agrees with this comment, and has added a reference to paragraph (w) ofparagraph 3 of Appendix A in respect of managed accounts.

D. COMMENTS ON THE PROVISIONS OF THE 1998 DRAFT POLICY

Comment on Section 6.1 of the 1998 Draft Policy

Mr. Baron cited the Commission's statement in section 6.1 of the 1998 Draft Policy that "the ProposedRule is structured as it is in order to eliminate the need to determine whether an OTC derivativestransaction is or is not a trade in a security". He stated that the language in section 6.1 of the 1998Draft Policy is contrary to this statement, as it provides that OTC derivatives transactions are subjectto the provisions of the Act, other than registration and prospectus provisions, only if they are tradesin securities. Therefore, a participant still has to determine if the OTC derivative transaction is atrade in a security for the purposes of the application of the rest of the Act. Mr. Baron requestedfurther clarity in this regard.

CIBC WG stated that the Proposed Rule would possibly be useful only if it clarifies which OTCderivatives transactions constitute trades in securities. CIBC WG states that the Proposed Rule onlyaccomplishes this goal in relation to the exemptions provided under sections 25 and 53 of the Act, andstates that the "Rule will be of little benefit to the OTC derivatives industry" unless it confronts theissue of the application of other areas of the Act to OTC derivatives transactions.

Response:

The determination of whether those instruments will be subject to the Act will depend onwhether or not they are securities. Moreover, the determination of what other provisions ofthe Act apply will often be fact-specific, depending upon the structuring of the particularinstrument. As a result, the Commission is not following this suggestion. The purpose of theProposed Rule and the Proposed Policy is only to deal with exemptions from the prospectusand registration provisions of the Act. These instruments do not deal with the application ofother provisions of the Act to OTC derivatives.

Comment on Section 2.1 of the 1998 Draft Policy

Oslers requested that the Commission clarify whether it intended, with the adoption of Rule 14-501,that participants in the OTC derivatives market file trade reports (Form 20) and pay fees in connectionwith cash-settled OTC option transactions where the underlying interest is a security. If necessary,the Commission should provide blanket relief from the reporting and fee payment requirements of theAct. This relief would only extend until such time as the Proposed Rule comes into force.

Response:

The Commission of course cannot in the Proposed Rule provide relief that deals with a timeperiod before the Proposed Rule is in force, and so has made no changes to the Proposed Rulein respect of this comment. The Proposed Rule does not change the application of Rule 14-501 or the fee schedule.

ONTARIO SECURITIES COMMISSION RULE 91-504

OVER-THE-COUNTER DERIVATIVES

TABLE OF CONTENTS

PART TITLE PAGE

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

APPENDIX A - QUALIFIED PARTIES

APPENDIX B - RISK DISCLOSURE STATEMENT FOR OTC DERIVATIVETRANSACTIONS

ONTARIO SECURITIES RULE 91-504

OVER-THE-COUNTER DERIVATIVES

PART 1 DEFINITIONS⁽²⁾

1.1 Definitions - In this Rule

"Canadian Securities Course" means a course prepared and conducted byThe Canadian Securities Institute and so named by that Institute as of thedate on which this Rule comes into force, every predecessor to that course,and every successor to that course that does not narrow the scope of thesignificant subject matter of the course;

"commercial user" means a person or company that enters into a specifiedcommodity derivative transaction, if

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

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

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

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

(iii) a specified commodity derivative, the underlying interest ofwhich 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⁽³⁾, aforward contract, a spot currency contract or a conventional floating ratedebt security, that provides for

(a) an exchange of principal amounts, or

(b) the obligation or right to make or receive a cash payment based uponthe value, level or price, or on relative changes or movements of thevalue, level or price of, an underlying interest;

"conventional floating rate debt security" means an evidence ofindebtedness of which the interest obligations are based upon a benchmarkcommonly 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 thattransaction, or

(ii) each party to the transaction is a person or company enteringinto the transaction for OTC 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 OTCderivatives hedging purposes, or

"foreign exchange derivative" means an OTC derivative of which theunderlying interest consists entirely of

(a) Canadian or foreign currency or a foreign exchange rate, or somerelationship between, or combination of, any of them, or

(b) a matter referred to in paragraph (a), or an agreement or instrument thathas as its underlying interest a matter referred to in paragraph (a), orsome relationship between, or combination of, any of them;

"forward contract" means an agreement, not entered into or traded on orthrough an organized market, stock exchange or futures exchange andcleared by a clearing corporation⁽⁴⁾, to do one or more of the following onterms or at a price established by or determinable by reference to theagreement and at or by a time established by or determinable by referenceto 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 orcompany or combination of persons or companies referred to inparagraph (c) of the definition of "distribution" in the Act,

(d) the securities are not subject to any cease trade order imposed by aCanadian securities regulatory authority,

(e) all hold periods imposed by Canadian securities legislation before thesecurities can be traded without a prospectus or in reliance on aprospectus exemption have expired, and

(f) any period of time for which the issuer has to have been a reportingissuer before the securities can be traded without a prospectus or inreliance on a prospectus exemption has passed;

"futures exchange" means an association or organization operated toprovide the facilities necessary for the trading of commodity futures";

"Futures Licensing Course" means a course prepared and conducted by TheCanadian Securities Institute and so named by that Institute as of the date onwhich this Rule comes into force, every predecessor to that course, andevery successor to that course that does not narrow the scope of thesignificant subject matter of the course;

"interest rate derivative" means an OTC derivative of which the underlyinginterest consists entirely of

(a) an interest rate, or an evidence of indebtedness of an entity other thana corporation that is not exchangeable for or convertible into anothersecurity, or some relationship between, or combination of, any of them,or

"Options Licensing Course" means a course prepared and conducted by TheCanadian Securities Institute and so named by that Institute as of the date onwhich this Rule comes into force, every predecessor to that course, andevery successor to that course that does not narrow the scope of thesignificant subject matter of the course;

"OTC derivative" means an option, a forward contract, or a contract fordifferences of a type commonly considered to be a derivative, in which

(a) the agreement relating to the option, forward contract or contract fordifferences is not part of a fungible class of agreements that arestandardized as to their material economic terms,

(b) the creditworthiness of a party having an obligation under theagreement would be a material consideration in entering into ordetermining the terms of the agreement, and

(c) the agreement is not entered into or traded on or through an organizedmarket, stock exchange or futures exchange and cleared by a clearingcorporation;

"OTC derivatives dealer" means a person or company registered under theAct as a dealer in the category of broker or investment dealer or under theCFA⁽⁵⁾ as a dealer in the category of futures commission merchant;

"OTC derivatives hedging" means the entering into of a transaction, or aseries of transactions, the intended effect of which, or the intendedcumulative effect of which, is to offset or reduce a risk to which a personor company is, or can reasonably expect to be, exposed, and whichtransaction or series of transactions

(a) involves an OTC derivative, or a series of OTC derivatives, for whichthere is a high degree of negative correlation between changes in thevalue of the position or positions being hedged and changes in thevalue of the instrument or instruments with which the position orpositions are hedged, and

(b) is intended to no more than offset the effect of changes in value in theposition or positions being 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 orall of an underlying interest of a specified commodity derivative that is usedby a commercial user to hedge its exposure to a risk resulting from its useof another specified commodity in its business;

"Risk Disclosure Statement for OTC Derivatives" means the statementattached to this Rule as Appendix B; and

"specified commodity" means

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

(b) a pollutant emission level,

(d) a liability from an insurance contract, and

(e) a matter designated by the Commission as a specified commodity, ifthat designation has not been revoked; and

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

(a) a specified commodity, or

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

PART 2 APPLICATION OF THE ACT

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

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

2.3 Registration Provisions - Despite section 2.2, section 25 of the Act doesnot apply to a transaction consisting 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 OTCderivatives dealer, if each person acting as a representative of theOTC derivatives dealer for that transaction has successfully completedthe Chartered Financial Analysts Course, or each of the FuturesLicensing Course, the Options Licensing Course and the CanadianSecurities Course, and

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

(b) in the case of a transaction that does not constitute a trade in a security,the transaction would have been exempt from section 25 of the Act ifthe transaction did constitute a trade in securities.

2.4 Prospectus Exemption - Despite section 2.2, section 53 of the Act does notapply to a transaction consisting 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

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

(b) in the case of a transaction that does not constitute a trade in a security,the transaction would have been exempt from section 53 of the Act ifthe transaction did constitute a trade in securities.

2.5 Freely Tradeable Securities - Section 2.3 and 2.4 are not available for thesettlement of a transaction consisting of an OTC derivative if settlement ismade by way of the physical delivery of securities that are not freelytradeable.

2.6 Exemption from Underwriting Conflicts Rules - Section 224 of theRegulation and Multilateral Instrument 33-105 Underwriting Conflicts donot apply to an OTC derivatives transaction.

PART 3 DESIGNATION OF SPECIFIED COMMODITIES

3.1 Designation - The Commission may designate any matter as a specifiedcommodity, subject to the terms or restrictions that may be contained in thedesignation, if

(a) an OTC derivative of which the matter is an underlying interest may beused by a person or company for OTC derivatives hedging purposes;and

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

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

(a) may adversely expose persons or companies to unfair, improper orfraudulent 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 wholeor in part, subject to such conditions or restrictions as may be imposed inthe exemption.

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 meaningas they have in the Business Corporations Act.

(2) All requirements contained in this Appendix that are based on the amountsshown on the balance sheet of an entity apply to the consolidated balancesheet 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 or II to the Bank Act (Canada);

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

(c) a bank subject to the regulatory regime of a country that is a member of theBasel Accord, or that has adopted the banking and supervisory rules set outin the Basel Accord, if the bank has a minimum paid up 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 orregional caisse populaire, located, in each case, in Canada;

Loan and Trust Companies

(e) a loan corporation or trust corporation registered under the Loan and TrustCorporations Act or under the Trust and Loan Companies Act (Canada),or under comparable legislation in any other province or territory ofCanada;

(f) a loan company or trust company subject to the regulatory regime of acountry that is a member of the Basel Accord, or that has adopted thebanking and supervisory rules set out in the Basel Accord, if the loancompany or trust company has a minimum paid up capital and surplus, asshown on its last audited balance sheet, in excess of $25 million or itsequivalent in another currency;

Insurance Companies

(g) an insurance company licensed to do business in Canada or a province orterritory of Canada if the insurance company has a minimum paid up capitaland surplus, as shown on its last audited balance sheet, in excess of $25million or its equivalent in another currency;

(h) an insurance company subject to the regulatory regime of a country that isa member of the Basel Accord, or that has adopted the banking andsupervisory rules set out in the Basel Accord, if the insurance company hasa 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

(i) has entered into one or more transactions involving OTC derivativeswith counterparties that are not its affiliates, if

(A) the transactions had a total gross dollar value of or equivalentto at least $1 billion in notional principal amount; and

(B) any of the contracts relating to one of these transactions wasoutstanding on any day during the previous 15-month period,or

(ii) had total gross marked-to-market positions of or equivalent to at least$100 million aggregated across counterparties, with counterparties thatare not its affiliates in one or more transactions involving OTCderivatives on any day during the previous 15-month period;

Individuals

(j) an individual who has a net worth of at least $5 million, or its equivalentin 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 andeach 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 the banking and supervisory rules of the Basel Accord,and each instrumentality and agency of that government or corporationwholly-owned by that government;

Municipalities

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

Corporations and other Entities

(n) a company, partnership, unincorporated association or organization or trust,other than an entity referred to in paragraph (a), (b), (c), (d), (e), (f), (g) or(h), with total revenue, as shown on its last audited financial statements, inexcess of $25 million or its equivalent in another currency;

Pension Plan or Fund

(o) a pension fund that is regulated by either the Office of the Superintendent ofFinancial Institutions (Canada) or a provincial pension commission, if thepension fund has total net assets, as shown on its 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 thefund is a qualified party;

(q) a mutual fund that distributes its securities in Ontario, if the portfoliomanager of the fund is registered as an adviser, other than a securitiesadviser, under the Act or securities legislation elsewhere in Canada;

(r) a non-redeemable investment fund that distributes its securities in Ontario,if the portfolio manager of the fund is registered as an adviser, other thana securities adviser, under the Act or securities legislation elsewhere inCanada;

Brokers/Investment Dealers

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

(t) a person or company registered under the Act as an international dealer ifthe person or company has total assets, as shown on its last audited balancesheet, in excess of $25 million or its equivalent in another currency;

Futures Commission Merchants

(u) a person or company registered under the CFA as a dealer in the categoryof futures commission merchant, or in an equivalent capacity elsewhere inCanada;

Charities

(v) a registered charity under the Income Tax Act (Canada) with assets not useddirectly in charitable activities or administration, as shown on its lastaudited balance sheet, of at least $5 million or its equivalent in anothercurrency;

Affiliates

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

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

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

(z) a firm, partnership, joint venture or other form of unincorporatedassociation in which one or more of the organizations described inparagraph (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 forwhich the determination is made is fully guaranteed by another qualifiedparty.

Qualified Party Not Acting as Principal

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

Managed Accounts

1. Accounts of a person, company, pension fund or pooled fund trust that arefully managed by a portfolio manager or financial intermediary referred toin paragraphs (a), (d), (e), (g), (s), (t), (u) or (w) of subsection (3) or abroker or investment dealer acting as a trustee or agent for the person,company, pension fund or pooled fund trust under section 148 of theRegulation.

Subsequent Failure to Qualify

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

OVER-THE-COUNTER DERIVATIVES

APPENDIX B

RISK DISCLOSURE STATEMENT FOR OTC DERIVATIVE TRANSACTIONS

This risk disclosure statement sets out general information relevant toentering into transactions in over-the-counter derivative products ("OTC derivatives").

There are many different types of OTC derivatives. OTC derivativesinclude options, forwards, swaps, swaptions, caps, floors, collars and forward rateagreements and combinations or variations upon these transactions. This disclosure statementdoes not disclose all of the risks and other significant aspects of entering into thesetransactions. 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 enteringand the extent of your exposure to risk. Entering into OTC derivative transactions is notsuitable for many investors. You should carefully consider whether these transactions areappropriate for you in light of your experience, investment objectives, financial andoperational resources, ability to bear risk, understanding of the products and other relevantcircumstances. 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 andconditions of the specific OTC derivative you are entering into and associated obligations(including such things as the circumstances under which you may become obligated to makepayments or to make or take delivery of the underlying interest, expiration dates and anyrestrictions on exercise).

You should, as well, familiarize yourself with the terms and conditions ofany agreement that you may be required to enter into with the firm with which you deal so thatyou fully understand the nature of your relationship with the firm with which you deal and yourrights and obligations under that agreement.

The value of OTC derivatives may be influenced by a number of inter-related factors. The relationship among these factors is complex. Factors that can be expectedto affect the value of OTC derivatives include: time remaining to expiry (or maturity) of theinstrument, the level of interest rates, the credit rating of the counterparty, the price or levelof the underlying interest of the derivative component and the volatility of the underlyinginterest of the derivative component.

You should calculate the extent to which the value of the derivativecomponent must increase for your position to become profitable, taking into account theimputed cost of the component and all transaction costs.

You will also be exposed to risks which are specific to the underlyinginterest of the OTC derivative and you should familiarize yourself with those risks prior toentering into the transaction.

(b) Effect of Leverage

Transactions in OTC derivatives can carry a high degree of risk. CertainOTC derivatives are leveraged so that a relatively small market movement in the price of theunderlying interest will have a proportionately larger impact on your position. This may workagainst you as well as for you.

Certain strategies intended to reduce the risk of entering into a transactionin OTC derivatives may not be effective because market conditions may make it impossibleto implement the strategy. Strategies using combinations of positions may be as risky as takingsimple 'long' or 'short' positions.

Hedging transactions may require constant monitoring. A failure to adjusta hedging transaction in light of changing market conditions can result in the position becomingeither unhedged or overhedged and losses can ensue.

(d) Risk of Options

Purchasers and sellers of options should familiarize themselves with thetype 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 orexercise the option or allow the option position to expire. The exercise of an option resultsin either a cash settlement or in the purchaser acquiring or delivering the underlying interest.If the purchased option expires worthless you will suffer a total loss of your investment thatwill consist of the option premium paid plus transaction costs.

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

Selling ("writing" or "granting") an option generally entails greater risk thanpurchasing an option. Although the premium received by the seller is fixed, the seller maysustain a total loss well in excess of that amount. The seller may be liable for additionalmargin to maintain the position if the market moves unfavourably. The seller will also beexposed to the risk of the purchaser exercising the option and the seller will be obligated toeither settle the option in cash or to acquire or deliver the underlying interest. If the seller is'covered', by holding a corresponding position in the underlying interest, the risk may bereduced. If the option 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 marketand permit precise customization to accomplish particular financial and risk managementobjectives that might otherwise be unachievable. Customization can introduce significantliquidity risk and other risk factors of a complex character. As a result, it may be difficult orimpossible to effect transactions or to liquidate or offset positions. The customized nature ofmany derivatives may also add to illiquidity. If you have sold options, an illiquid market mayincrease the risk of loss, particularly where you do not hold the underlying interest or anequivalent amount of cash.

Normal pricing relationships between the underlying interest and the OTCderivative may not exist. This can occur when, for example, there are market interruptions orcircuit breakers in effect. The lack of availability of an underlying reference price may makeit difficult to judge 'fair' value.

(f) Credit Risk

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

You should also determine how easily your OTC derivatives position canbe assigned in the event of a bankruptcy or insolvency and at what cost. In the case of OTCderivatives transactions where there are mutual obligations, you should determine whether thenetting of payments is supportable under bankruptcy and insolvency legislation.

You should also note that your right to enforce your counterparty'sobligations under your agreement may be compromised if your counterparty receivesprotection under insolvency legislation in relevant jurisdictions.

You should familiarize yourself with the protections accorded to cash orother property you deposit for domestic and foreign OTC derivatives transactions, particularlyin the event of the insolvency or bankruptcy of the counterparty with whom you deal. Theextent to which you recover may be governed by specific legislation or local rules. In somejurisdictions, property that had been specifically identifiable as your own will be pro-ratedin 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 aclear explanation of all commissions, 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 institutionswith formal links to the domestic market, may expose you to additional risk. Those institutionsmay be subject to regulation that may offer different or diminished investor protection.

Before you enter into an OTC derivative transaction, you should enquireabout any rules relevant to your particular transaction. You should ask the firm with whichyou deal or your legal adviser for details about the types of redress available in both yourhome jurisdiction and other relevant jurisdictions before you start to trade.

(i) Currency Risks

The profit or loss in foreign currency denominated OTC derivativesproducts (whether they are traded in your own or another jurisdiction) will be affected byfluctuations in currency rates.

(j) Legal Risks

As in any financial transaction, you should ensure that you understand therequirements (including investment restrictions), if any, applicable to you that are establishedby your regulators or by your board of directors or other governing body. Certain entities maynot be permitted to enter into derivatives transactions pursuant to their incorporatingdocuments or governing legislation. You should ensure that counterparty with which you dealis 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 enteringinto any OTC derivative transaction and consulting such advisers as may appropriate to assistyou in understanding the risks involved.

(k) Management Risks

You should inform yourself about the risks and ongoing monitoringrequirements of the specific OTC derivatives transactions into which you propose to enter.

OTC derivatives are complex instruments that can be difficult to value andto monitor. Before entering into a transaction involving OTC derivatives you should ensurethat you have supervisory procedures and analytical systems commensurate with the level ofactivity you contemplate so that you are able to keep track of your OTC derivatives exposure.

(l) Tax Risks

Before entering into a transaction in OTC derivatives you should understandthe income tax implications of doing so. Different OTC derivatives transactions may havedifferent income tax implications. The income tax implications of using OTC derivatives aredependent upon the nature of your business activities and the transaction in question. Youshould, therefore, consult your tax adviser to understand the relevant income taxconsiderations.

COMPANION POLICY 91-504CP TO

ONTARIO SECURITIES RULE 91-504

OVER-THE-COUNTER DERIVATIVES

PART 1 INTRODUCTION

1.1 Purpose

1.2 Definition of "OTC derivative"

1.3 Definition of "OTC derivatives hedging"

1.4 Interpretation of Definitions

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 Clause72(1)(d) of the Act

6.4 Form 20 Requirements

COMPANION POLICY 91-504 TO

ONTARIO SECURITIES RULE 91-504

OVER-THE-COUNTER DERIVATIVES

PART 1 INTRODUCTION

1.1 Purpose - The purpose of this Policy is to state the Commission'sinterpretation 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 OTCderivatives.

1.2 Definition of "OTC derivative" - The definition of "OTC derivative"contained in the Rule requires, among other things, that the agreement relatingto an OTC derivative not be "part of a fungible class of agreements that arestandardized as to their material economic terms". The Commission is of theview that a master agreement, such as the ISDA form of agreement, and anysupplements to the master agreement, should not be considered to be anagreement that is standardized as to its material economic terms.

1.3 Definition of "OTC derivatives hedging" - One component of the definitionof "OTC derivatives hedging" contained in subsection 1.1 of the Rule is therequirement that hedging transactions must have a "high degree of negativecorrelation between changes in the value of the position or positions beinghedged and the instrument or instruments with which the position or positionsare hedged". The Commission is of the view that there need not be completecongruence between the hedging instrument or instruments and the position orpositions being hedged if it is reasonable to regard the one as a hedginginstrument 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 specifiedsections of the Act if one or both parties to the transaction is a qualified partyfor the relevant transaction. The Commission is of the view that a partyentering into a transaction with a person or a company claiming to be aqualified party for the transaction is entitled to rely upon representations bythat person or company to the effect that that person or company is a qualifiedparty in those circumstances unless the party has reason to believe otherwise.Staff of the Commission will therefore normally not take any enforcementaction in respect of a transaction against a party that has reasonably relied, inthe manner described, on representations of its counterparty.

2.2 Receipt of Risk Disclosure Statement - Clauses 2.3(a)(ii)(B) and2.4(a)(ii)(B) of the Rule require the delivery of a risk disclosure statement bythe OTC derivatives dealer that is involved with the transaction as a conditionto relying on the respective exemptions contained in those provisions. It ispossible that the OTC derivatives dealer will not be a principal in thetransaction, and that the principal would want to receive comfort that the riskdisclosure statement had been received by the appropriate party. TheCommission is of the view that the principal may, in those circumstances, relyon representations from the intended recipient of the risk disclosure statementthat the statement 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 transactionsthat one of the parties enters into for OTC derivatives hedging purposes. TheCommission is of the view that a party entering into an OTC derivativestransaction is entitled to rely, for purposes of establishing that the transactionis an "exempt transaction" under the Rule, upon representations by the otherparty to the effect that that party is entering into the transaction for OTCderivatives hedging purposes within the meaning of the Rule unless the partyhas reason to believe otherwise. Staff of the Commission will thereforenormally not take any enforcement action in respect of a transaction against aparty that has relied, in the manner described, on representations of itscounterparty.

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 may be located in Ontario and other parties locatedelsewhere. This raises the issue of whether, or in what circumstances,those transactions should be considered to have taken place in Ontarioand be therefore subject to the Rule or any other applicable Ontariolaw.

(2) The Commission is of the view that the persons or companies enteringinto an OTC derivative transaction in which some parties are notlocated in Ontario are entitled to consider the connecting factors of thetransaction with Ontario in order to determine whether the transactionis subject to the Rule and any other applicable Ontario securities law.

(3) The Commission notes that the investor protection aspects of the Ruleare designed for the benefit of Ontario persons or companies.

(4) The Commission notes that the ISDA master agreements provide thatthe rights and obligations thereunder are not transferable except incertain prescribed circumstances, such as default or reorganization.The Commission is of the view that those provisions do not lead to anyinference that would make paragraph (3)(c) above inapplicable.

3.2 Exemption from the Act - Section 2.1 of the Rule provides that the Act doesnot apply to an exempt transaction. This provision is designed to removeexempt transactions entirely from Ontario securities law in all respects.

PART 4 USE OF OTHER EXEMPTIONS

4.1 Use of Other Exemptions - A party conducting an OTC derivativestransaction under an exemption provided by the Rule is not required to comewithin the scope of any of the exemptions contained in the Act or theRegulation. However, a party conducting an OTC derivatives transaction thatis not exempt from the prospectus and registration provisions of the Act underthe Rule is not precluded from using an exemption contained in the Act, theRegulation or another rule when available, despite the Rule.

PART 5 ISSUES RELATING TO DEALERS

5.1 Universal Registration

(1) The universal registration regime contained in Part XI of theRegulation operates by removing certain registration exemptionscontained in the Act. However, persons or companies entering intoOTC derivatives transactions through the exemptions provided in theRule are not subject to the universal registration regime because theexemptions contained in the Rule are not removed by Part XI of theRegulation.

(2) OTC derivatives transactions not effected under exemptions in theRule will be subject to the application of the ordinary registration anduniversal registrations rules contained in the Act. Therefore, a personor company engaged in effecting OTC derivatives transactions under,for instance, the $150,000 private placement exemption may be amarket intermediary and therefore required to be registered as alimited 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 theexemptions provided in those sections that a person or companyentering into the transaction must do so with or through an OTCderivatives dealer. The Commission is of the view that thisrequirement is satisfied

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

(b) if the OTC derivatives dealer is not acting as principal in thetransaction, the OTC derivatives dealer has taken the stepsrequired by dealers under section 1.5 of Rule 31-505Conditions of Registration for that transaction.

PART 6 APPLICATION OF THE ACT

6.1 Effect of Section 2.2 of the Rule - The Rule is structured so that it isunnecessary to determine whether a given OTC derivatives transactioninvolves a trade in a security. Section 2.2 of the Rule is a technical provisiondesigned to achieve this purpose; this section causes OTC derivativestransactions that are not exempt transactions or trades in securities to besubject to sections 25 and 53 of the Act. This puts those transactions on thesame footing in respect of the registration and prospectus provisions of the Actas OTC derivative transactions that are trades in securities. Thesetransactions, however, are subject to provisions of the Act other than theprospectus and registration provisions only if they are trades in a security.

6.2 Circumstances of Mutual Obligation - In an OTC derivatives transaction,both parties may be issuing securities. The Commission is of the view thateach party to the transaction needs to ensure either that the Act does not applyto that transaction or that appropriate exemptions are available, either underthe Rule or the Act.

6.3 Paragraph 5 of Subsection 35(1) and Clause 72(1)(d) of the Act - Undersection 3.1 of Rule 45-501 Prospectus Exempt Distributions, the exemptionscontained in paragraph 5 of subsection 35(1) and clause 72(1)(d) of the Actare available where the "aggregate acquisition cost" to a purchaser of asecurity is not less than $150,000. The Commission is of the view that thoseexemptions are available for OTC derivatives transactions only if an amountof at least $150,000 is paid as premium at the time that the OTC derivativeposition is created. Pursuant to section 3.2 of Rule 45-501, that payment mustbe satisfied by the payment of cash or other immediately available funds or theincurring or assumption of a liability, or any combination thereof. Thesepayments or commitments must be in consideration for the security beingissued, rather than constituting part of the payment of the purchase price of theunderlying interest. These exemptions would not be available, therefore, fortransactions entered into "at-the-money" where no premium is paid, as istypically the case for swaps and forwards, regardless of the notional amountof the OTC derivative. These exemptions should not be interpreted as beingavailable where only the notional amount of the transaction, or the value of theunderlying interest, equals or exceeds $150,000.

6.4 Form 20 Requirements

(1) A transaction effected pursuant to the exemptive relief provided by theRule does not trigger Form 45-501F1 filing requirements or thepayment of any fee.

(2) Any OTC derivative transaction effected in reliance upon a paragraphof section 72 of the Act enumerated in subsection 72(3) triggers therequirement of the filing of a Form 45-501F1 and payment of therequisite filing fee under Rule 45-501. At the effective date of thisPolicy, Rule 45-501 provides, in effect, that the fee payable in respectof a Form 45-501F1 filing is the greater of $100 and 0.02 per cent ofthe aggregate gross proceeds to be realized in Ontario from thedistribution of the securities, other than special warrants, to which theForm 45-501F1 relates.

(3) The Commission is of the view that the "aggregate gross proceeds tobe realized in Ontario from the distribution of the securities" will be,in the case of an OTC derivative, the consideration paid for theinstrument, such as the amount of premium paid for an option. The"aggregate gross proceeds to be realized" is not the amount, notionalor otherwise, of the underlying interest.

(4) In the case of "at-the-money" swaps and forwards, no proceeds arerealized from the distribution of the securities, and, therefore, the feepayable in respect of any Form 45-501F1 filed in respect oftransactions of this nature is $100 at the effective date of this Policy.

1. In Rule 14-501, "option" means an agreement that provides the holder with the right,but not the obligation, to do one or more of the following on terms or at a priceestablished by or determinable by reference to the agreement at or by a timeestablished by the agreement:

1. Receive an amount of cash determinable by reference to a specified quantity of the underlyinginterest of the option.

2. Purchase a specified quantity of the underlying interest of the option.

3. Sell a specified quantity of the underlying interest of the option.

2. A general definition rule has been adopted as Rule 14-501 Definitions. It contains definitions ofcertain terms used in more than one rule. Rule 14-501 also provides, among other things, that termsused in a rule and defined in section 1 of the Securities Act or subsection 1(2) of the Regulation willhave the respective meaning given to them in the Securities Act or regulation, as appropriate.

3. The term "option" is defined in Rule 14-501. The definition is "an agreement that provides the holderwith the right, but not the obligation, to do one or more of the following on terms or at a pricedeterminable by reference to the agreement at or by a time established by the agreement:

1. Receive an amount of cash determinable by reference to a specified quantity of theunderlying interest of the option.

2. Purchase a specified quantity of the underlying interest of the option.

3. Sell a specified quantity of the underlying interest of the option."

The term "underlying interest" is also defined in Rule 14-501. The definition is "for a derivative, thesecurity, commodity, financial instrument, currency, interest rate, foreign exchanges rate, economicindicator, index, basket, agreement or reit, and, if applicable, the relationship between any of theforegoing, from or on which the market price, value or payment obligations of the derivative arederived or based".

4. The term "clearing corporation" is defined in Rule 14-501. The definition is "an association ororganization through which options or futures contracts are cleared and settled".

5. The term "CFA" is defined in Rule 14-501. The definition is "the Commodity Futures Act".