FRNT Financial Inc.
Headnote
Application to the Ontario Securities Commission for a decision to exempt from the dealer registration requirement and the prospectus requirement, in sections 25(1) and 53(1) of the Securities Act (Ontario), in connection with certain trades in over-the-counter (OTC) derivatives with "permitted counterparties", consisting exclusively of persons or companies who are "permitted clients" as defined in Section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations -- Relief sought in Ontario as interim response to the regulatory treatment of certain OTC derivatives in Canada -- Relief subject to sunset condition that is (i) the date that is four years after the date of the decision; and (ii) the coming into force in the jurisdiction of legislation or a rule that specifically governs dealer, adviser or other registration requirements applicable to market participants in connection with OTC derivative transactions.
Applicable Legislative Provisions
Securities Act, R.S.O. 1990, c. S.5, as am., ss. 25(1), 53(1), 74(1).
National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, s. 1.1 ("permitted client").
OSC Rule 13-502 Fees, Part 6 -- Derivatives Participation Fees.
October 10, 2024
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO (the Jurisdiction) AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF FRNT FINANCIAL INC. (the Filer)
DECISION
Background
Previous Decision
The Filer made an application (the Previous Application) to and obtained from the Ontario Securities Commission (OSC), as the principal regulator for the Previous Application, a decision, In the Matter of FRNT Financial Inc. dated October 13, 2020 (the Previous Decision), providing relief from the dealer registration requirement and the prospectus requirement that may otherwise be applicable to a trade in or a distribution of an OTC Derivative made by either the Filer to a Permitted Counterparty (as defined below) or a Permitted Counterparty to the Filer, subject to certain terms and conditions. The Previous Decision provided that the relief would terminate on the date that is the earlier of: (i) the date that is four years after the date of the Previous Decision (being October 13, 2020); and (ii) the coming into force in the Jurisdiction of legislation or a rule that specifically governs dealer, adviser or other registration requirements applicable to market participants in connection with OTC Derivative transactions.
New Decision
The principal regulator in the Jurisdiction has received an application (the Application) from the Filer for a decision under the securities legislation of the Jurisdiction (the Legislation) to revoke the Previous Decision and provide that the dealer registration requirement and the prospectus requirement in the Legislation that may otherwise be applicable to a trade in or distribution of an OTC Derivative transaction (as defined below) made by either:
(a) the Filer to a Permitted Counterparty; or
(b) a Permitted Counterparty to the Filer,
shall not apply to the Filer or the Permitted Counterparties, as the case may be (the Requested Relief), subject to certain terms and conditions.
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the OSC is the principal regulator for this Application; and
(b) the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System is intended to be relied upon in New Brunswick (to the extent that Local Rule 91-501 does not apply), Newfoundland and Labrador, Prince Edward Island, the Northwest Territories, Yukon and Nunavut (the Passport Jurisdictions and, together with Ontario, the Jurisdictions).
Interpretation
Unless otherwise defined herein, terms in this decision have the respective meanings given to them in National Instrument 14-101 Definitions.
The terms OTC Derivative and Underlying Interest are defined in the Appendix to this decision.
The term "Permitted Counterparty" means a person or company that is a "permitted client", as that term is defined in section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103).
Representations
This decision is based on the following facts represented by the Filer:
The Filer
1. The Filer is a company incorporated under the Canada Business Corporations Act. The head office of the Filer is located in Toronto, Ontario.
2. The Filer is a public company whose shares are listed on the TSX Venture Exchange. The largest shareholders are the founders Stephane Ouellette (42.25%) and Adam Rabie (7.71%), officers of the Filer.
3. The Filer provides technology to institutional investors and dealers to enable them to negotiate and record transactions in OTC Derivatives.
4. The Filer intermediates bilateral OTC Derivative transactions between institutional clients and financial institutions providing liquidity and specifically, acts as a counterparty to the transactions it facilitates on its platform.
5. The Filer is not currently registered under the securities legislation of any jurisdiction in Canada, and as a result of the Previous Decision, is currently relying on an exemption from the dealer registration requirement in the Legislation that may otherwise be applicable to a trade in or distribution of an OTC Derivatives transaction.
6. The Filer is not in default of securities, commodity futures or derivatives legislation in any jurisdiction in Canada.
Conduct of OTC Derivatives Transactions
7. The Filer enters into bilateral OTC Derivative transactions with counterparties located in all provinces and territories of Canada that consist exclusively of persons or companies that are Permitted Counterparties. The Filer understands that the Permitted Counterparties are entering into the OTC Derivative transactions for hedging or investment purposes. The Underlying Interest of the OTC Derivatives that are entered into consist of one of the following: a commodity; an interest rate; a currency, including fiat and cryptocurrency; a foreign exchange rate; a security; an economic indicator, an index; a basket; a benchmark; another variable; another OTC Derivative; or some relationship between, or combination of, one or more of the foregoing.
8. While a Permitted Counterparty may deposit margin or collateral with the Filer in respect of its obligations under an OTC Derivative transaction, the Filer itself does not offer or provide credit or margin to any of its Permitted Counterparties for purposes of an OTC Derivative transaction.
9. The Filer seeks the Requested Relief as an interim solution, pending the development of a uniform registration framework with respect to OTC Derivative transactions in all provinces and territories of Canada. The Filer acknowledges that registration and prospectus requirements may be triggered for the Filer in connection with the derivative contracts under any such uniform framework to be developed for the regulation of OTC Derivative transactions.
Regulation of OTC Derivative Transactions in Canada
10. There remains some uncertainty respecting the regulation of OTC Derivative transactions as "securities" in the provinces and territories of Canada other than Québec.
11. In each of Prince Edward Island, the Northwest Territories, Nunavut and Yukon, OTC Derivative transactions are regulated as securities on the basis that the definition of the term "security" in the securities legislation of each of these jurisdictions includes an express reference to this term including a "derivative".
12. In Alberta, British Columbia, Manitoba, Ontario, New Brunswick, Nova Scotia and Saskatchewan, the term "security" no longer includes an express reference to a "futures contract". Following the introduction of a new framework and terminology for the regulation of derivatives, Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia, and Saskatchewan securities legislation now each include a definition of "derivative".
13. In each of Manitoba, Newfoundland and Labrador, and Ontario, it is not always certain whether, or in what circumstances, OTC Derivative transactions are "securities" because the definition of the term "security" in the securities legislation of each of these jurisdictions is a non-exhaustive definition that makes no express reference to a "futures contract" or a "derivative".
14. In October 2009, staff of the OSC published OSC Staff Notice 91-702 Offerings of Contracts for Difference and Foreign Exchange Contracts to Investors in Ontario (OSC Notice 91-702). OSC Notice 91-702 states that OSC staff take the view that contracts for differences, foreign exchange contracts and similar OTC Derivative products, when offered to investors in Ontario, engage the purposes of the Securities Act (Ontario) (OSA) and constitute "investment contracts" and "securities" for the purposes of Ontario securities law. However, OSC Notice 91-702 also states that it is not intended to address direct or intermediated trading between institutions. OSC Notice 91-702 does not provide any additional guidance on the extent to which OTC Derivative transactions between the Filer and a Permitted Counterparty may be subject to Ontario securities law.
15. In Québec, OTC Derivative transactions are subject to the Derivatives Act (Québec), which sets out a comprehensive scheme for the regulation of derivative transactions that is distinct from Québec's securities regulatory requirements.
16. In each of Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia and Saskatchewan (the Blanket Order Jurisdictions) and Québec (collectively, the OTC Exemption Jurisdictions), OTC Derivative transactions are generally not subject to securities or derivative regulatory requirements, pursuant to applicable exemptions (the OTC Derivative Exemptions), when they are negotiated, bi-lateral contracts that are entered into between sophisticated non-retail parties, referred to as "Qualified Parties" in the Blanket Order Jurisdictions and "accredited counterparties" in Québec.
17. The corresponding OTC Derivative Exemptions are as follows:
Alberta ASC Blanket Order 91-507 Over-the-Counter Trades in Derivatives British Columbia BC Instrument 91-501 Over-the-Counter Derivatives Manitoba Blanket Order 91-501 Over-the-Counter Trades in Derivatives New Brunswick Local Rule 91-501 Over-the-Counter Trades in Derivatives Nova Scotia Blanket Order 91-501 Over the Counter Trades in Derivatives Saskatchewan General Order 91-908 Over-the-Counter Derivatives Québec Section 7 of the Derivatives Act (Québec)
The Evolving Regulation of OTC Derivative Transactions as Derivatives
18. Each of the OTC Exemption Jurisdictions has sought to address the regulatory uncertainty associated with the regulation of OTC Derivative transactions as securities by regulating them as derivatives rather than securities, whether directly through the adoption of a distinct regulatory framework for derivatives in Québec, or indirectly through amendments to the definition of the term "security" in the securities legislation of the other OTC Exemption Jurisdictions and the granting of the OTC Derivative Exemptions.
19. Between 1994 and 2000, the OSC sought to achieve a similar objective by introducing proposed OSC Rule 91-504 Over-the-Counter Derivatives (the Proposed OSC Rule) for the purpose of establishing a uniform, clearly defined regulatory framework for the conduct of OTC Derivative transactions in Ontario, but the Proposed OSC Rule was returned to the OSC for further consideration by Ontario's Minister of Finance in November 2000.
20. The Final Report of the Ontario Commodity Futures Act Advisory Committee, published in January 2007, concluded that OTC Derivative contracts are not suited to being regulated in accordance with traditional securities regulatory requirements and should therefore be excluded from the scope of securities legislation, because they are used for commercial risk management purposes and not for investment or capital-raising purposes.
21. On April 19, 2018, the Canadian Securities Administrators (CSA) published a Notice and Request for Comment on the Proposed National Instrument 93-102 Derivatives -- Registration, and on September 28, 2024, National Instrument 93-101 Derivatives: Business Conduct (the Business Conduct Rule) took effect.
Reasons for the Requested Relief
22. The Requested Relief would provide the Filer and its Permitted Counterparties, additional certainty with respect to the characterization of OTC Derivative transactions in Canada, by permitting these parties to enter into OTC Derivative transactions in reliance upon exemptions from the dealer registration and prospectus requirements of the Legislation that are comparable to the OTC Derivative Exemptions.
Books, Records and Reporting
23. As a result of the Previous Decision, the Filer is a "market participant" for the purposes of the OSA and will continue to be so as a consequence of this Decision. For the purposes of the OSA, and as a market participant, the Filer is required by subsection 19(1) of the OSA to: (i) keep such books, records and other documents as are necessary for the proper recording of its business transactions and financial affairs, and the transactions that it executes on behalf of others; and (ii) keep such books, records and documents as may otherwise be required under Ontario securities law.
24. For the purposes of its compliance with subsection 19(1) of the OSA, the books and records that the Filer keeps, and will continue to keep, include books and records that:
a) demonstrate the extent of the Filer's compliance with applicable requirements of securities legislation;
b) demonstrate compliance with the policies and procedures of the Filer for establishing a system of controls and supervision sufficient to provide reasonable assurance that the Filer, and each individual acting on its behalf, complies with securities legislation;
c) identify all OTC Derivative transactions conducted on behalf of the Filer and entered into by each of its clients, including the name and address of all parties to the transaction and the terms of those transaction; and
d) set out for each OTC Derivatives transaction entered into by the filer, information corresponding to that which would be required to be included in an exempt distribution report for the transaction, if the transaction were entered into by the Filer in reliance upon the "accredited investor" prospectus exemption in section 2.3 [accredited investor] of National Instrument 45-106 Prospectus Exemptions.
25. In respect of the OTC Derivative transactions, the Filer complies with any applicable OTC Derivatives-specific trade reporting rules and instruments in effect in the provinces and territories of Canada, including the following:
a) The derivatives trade reporting rules (including, OSC Rule 91-507 Derivatives: Trade Reporting);
b) The fee rule (OSC Rule 13-502 Fees), specifically Part 6 "Derivatives Participation Fees";
c) The derivatives business conduct rule (National Instrument 93-101 Derivatives: Business Conduct);
d) The mandatory clearing rule (National Instrument 94-101 Mandatory Central Counterparty Clearing of Derivatives); and
e) The segregation and portability rule (National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions.
26. The Filer does not and will not operate a "marketplace" as that term is defined in National Instrument 21-101 Marketplace Operation and in Ontario, subsection 1(1) of the OSA.
27. The Filer will ensure that it is in compliance with the securities laws in all jurisdictions in which it operates.
Decision
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator is that the Requested Relief is granted, provided that:
a) the counterparty to any OTC Derivative transaction that is entered into by the Filer is a Permitted Counterparty;
b) in the case of any trade entered into by the Filer with a Permitted Counterparty, the Filer does not offer or provide any credit or margin to the Permitted Counterparty, although the Filer and a Permitted Counterparty may exchange collateral under an OTC Derivatives transaction;
c) The Filer complies with the filing and fee payment requirements under Part 6 of OSC Rule 13-502 Fees; and
d) the Requested Relief shall terminate on the date that is the earlier of:
(i) the date that is four years after the date of this decision; and
(ii) the coming into force in the Jurisdiction of legislation or a rule that specifically governs dealer, adviser, or other registration requirements applicable to market participants in connection with OTC Derivative transactions.
OSC File #: 2024/0547
APPENDIX
DEFINITIONS
Clearing Corporation means an association or organization through which Options or futures contracts are cleared and settled.
Contract for Differences means an agreement, other than an Option, a Forward Contract, a spot currency contract, or a conventional floating rate debt security, that provides for:
(a) an exchange of principal amounts; or
(b) the obligation or right to make or receive a cash payment based upon the value, level or price, or on relative changes or movements of the value, level or price of, an Underlying Interest.
Forward Contract means an agreement, not entered into or traded on or through an organized market, stock exchange or futures exchange and cleared by a Clearing Corporation, to do one or more of the following on terms or at a price established by or determinable by reference to the agreement and at or by a time established by or determinable by reference to the agreement:
(a) make or take delivery of the Underlying Interest of the agreement; or
(b) settle in cash instead of delivery.
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 price determinable by reference to the agreement at or by a time established by the agreement:
(a) receive an amount of cash determinable by reference to a specified quantity of the Underlying Interest of the Option.
(b) purchase a specified quantity of the Underlying Interest of the Option.
(c) sell a specified quantity of the Underlying Interest of the Option.
OTC Derivative means one or more of, or any combination of, an Option, a Forward Contract, a Contract for Differences, or any instrument of a type commonly considered to be a derivative, in which:
(a) the agreement relating to, and the material economic terms of, the Option, Forward Contract, Contract for Differences or other instrument have been customized to the purposes of the parties to the agreement and the agreement is not part of a fungible class of agreements that are standardized as to their material economic terms;
(b) the creditworthiness of a party having an obligation under the agreement would be a material consideration in entering into or determining the terms of the agreement; and
(c) the agreement is not entered into or traded on or through an organized market, stock exchange or futures exchange.
Underlying Interest means, for a derivative, the commodity, interest rate, currency, foreign exchange rate, security, economic indicator, index, basket, benchmark or other variable, or another derivative, and, if applicable, any relationship between, or combination of, any of the foregoing, from or on which the market price, value or payment obligations of the derivative are derived or based.