Jefferies International Limited et al.
Headnote
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Application for revocation of a previous decision dated July 28, 2017, In the Matter of Jefferies International Limited, Jefferies Financial Services, Inc. and Jefferies Derivative Products, LLC -- Previous decision had exempted the applicants from the dealer registration and the prospectus requirement, in sections 25(1) and 53(1) of the Securities Act, for certain trades in over-the-counter (OTC) derivatives that are made by the filers with a "permitted counterparty" -- Permitted counterparties consist exclusively of persons or companies who are non-individual "permitted clients" as defined in Section 1.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations -- New Decision provides exemptions on the same terms and conditions except that: (i) the exemptions apply to the merged entity of two of the Filers and (ii) the "sunset date" date of July 28, 2021 is extended.
Applicable Legislative Provisions
Securities Act, R.S.O. 1990, c. S.5, as am., ss. 25(1), 53(1) and 74.
National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, s. 1.1 ("permitted client").
July 27, 2021
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 JEFFERIES INTERNATIONAL LIMITED, JEFFERIES FINANCIAL SERVICES, INC., JEFFERIES FINANCIAL PRODUCTS, LLC (the Filers)
DECISION
Background
Previous Decision
Jefferies International Limited, Jefferies Financial Services, Inc., and Jefferies Financial Products, LLC (the "Previous Filers") made an application (the "Previous Application") to the Ontario Securities Commission (the "Commission") and obtained from the Commission, as the principal regulator for the Previous Application, a decision dated July 28, 2017, In the Matter of Jefferies International Limited, Jefferies Financial Services, Inc. and Jefferies Financial Products, LLC (the "Previous Decision").
The Previous Decision provided that the dealer registration requirement and the prospectus requirement in the securities legislation of the jurisdiction of the principal regulator (the "Legislation") that may otherwise be applicable to a trade in or a distribution of an OTC Derivative (as defined below) made by either;
(i) a Previous Filer to a "Permitted Counterparty" (as defined below), or
(ii) a Permitted Counterparty to a Previous Filer,
shall not apply to the Previous Filers or the Permitted Counterparty, as the case may be, subject to certain terms and conditions (the "Previous Requested Relief").
The Previous Decision stated that under the Process for Exemptive Relief Applications in Multiple Jurisdictions:
(a) the Commission was the principal regulator for the Previous Application; and
(b) the Previous Filers had provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System ("MI 11-102") was intended to be relied upon in Newfoundland and Labrador, Northwest Territories, Prince Edward Island, New Brunswick (to the extent Local Rule 91-501 Derivatives does not apply), Yukon and Nunavut (the "Previous Passport Jurisdictions").
The Previous Decision provided that the Previous Requested 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 July 28, 2021) (the "Pending Expiry Date"); and (ii) the coming into force in the jurisdiction of legislation or a rule that specifically governs the conduct of OTC Derivatives transactions.
New Decision
The principal regulator has now received an application (the "Application") from Jefferies International Limited, Jefferies Financial Services, Inc. and Jefferies Financial Products, LLC (collectively, the "Filers") for: (a) revocation of the Previous Decision, and (b) issuance of a new replacement decision, on substantially the same terms as the Previous Decision, except that the new decision being sought would extend the Pending Expiry Date.
Under this Application, the Filers have applied to the Commission, as the principal regulator for the Application, for a decision under the Legislation 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 made by either;
(i) a Filer to a Permitted Counterparty, or
(ii) a Permitted Counterparty to a Filer,
shall not apply to the Filers or the Permitted Counterparty, as the case may be (the "Requested Relief").
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions:
(a) the Commission is the principal regulator for the Application; and
(b) the Filers have provided notice that section 4.7(1) of MI 11-102 is intended to be relied upon in Newfoundland and Labrador, New Brunswick (to the extent Local Rule 91-501 Derivatives does not apply), Northwest Territories, Nunavut, Prince Edward Island and Yukon (the "Passport Jurisdictions").
Interpretation
Terms defined in National Instrument 14-101 Definitions or MI 11-102 have the same meanings if used in this decision, unless otherwise defined.
The terms OTC Derivative and Underlying Interest are defined in the appendix (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 [Definition of terms used throughout this Instrument] of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations ("NI 31-103").
The term Home Jurisdiction means the jurisdiction in which each Filer's head office is located, specifically for:
(a) Jefferies International Limited, London, United Kingdom;
(b) Jefferies Financial Services, Inc., New York, United States of America; and
(c) Jefferies Financial Products, LLC, New York, United States of America.
Representations
This decision is based on the following facts represented by the Filers:
The Filers
1. Each of the Applicants is an affiliate of the other as a result of their common parent, Jefferies Group LLC ("Jefferies Group").
2. Jefferies International Limited ("JIL") is a financial services firm that has been granted permission to conduct a number of different financial services in the United Kingdom by the Financial Conduct Authority. These services include arranging and dealing in investments as both a principal and an agent in respect of, among other things, securities, contracts for differences, options, futures, rolling spot forex contracts and commodity futures contracts. JIL is therefore qualified to rely on the international dealer exemption (the "IDE") that is available pursuant to section 8.18 of NI 31-103 in Ontario and each of the Passport Jurisdictions. JIL's head office is located in London, United Kingdom.
3. Jefferies Financial Products, LLC ("JFP") is a provisionally registered swap dealer with the CFTC and it is a member of the NFA. JFP carries on the business of trading equity swaps on a principal basis with other institutional counterparties. JFP additionally trades Equity Options with JIL and interest rate swaps with Jefferies Group. All of JFP's derivative transactions are currently conducted as uncleared OTC Derivative transactions. The head office of JFP is located in New York, United States of America.
4. Jefferies Financial Services, Inc. ("JFSI") is a provisionally registered swap dealer with the U.S. Commodity Futures Trading Commission ("CFTC") and it is a member of the National Futures Association (the "NFA"). JFSI carries on the business of trading on a principal basis with market counterparties in interest rate swaps, swaptions (defined in the Appendix), credit default swaps, and foreign exchange products, including, but not limited to, spot, forward, non-deliverable forward, option and swap transactions. Such transactions may be cleared by a derivatives clearing organization or may be uncleared, and are executed either over-the-counter or on a swap execution facility/exchange, as applicable, depending on the transaction. The head office of JFSI is located in New York, United States of America.
5. At the time of application JFP was planning to merge into JFSI, with JFSI as the surviving entity. The merger was completed on July 16, 2021. Following that merger, JFSI's trading business will expand to include the products currently traded by JFP, as well as additional products such as Equity Options or forwards with non-affiliate counterparties. Additionally, following the merger, JFSI intends to register as a security-based swap dealer and as an OTC derivatives dealer with the U.S. Securities and Exchange Commission (the "SEC"). As of the date of this decision, neither JFSI nor JFP is currently registered in any capacity with the SEC. As such, each of JFSI and JFP is unable to rely on the IDE because it is not registered under the securities legislation of its home jurisdiction in a category of registration that permits it to carry on the activities in that jurisdiction that registration as a dealer would permit it to carry on in a local Canadian jurisdiction.
6. The Filers are not currently registered in any capacity in Canada. The Filers do not maintain an office, sales force or physical place of business in Canada.
7. The Filers are not in default of any requirements of securities, commodity futures or derivatives legislation in any jurisdiction of Canada.
8. The Filers are in material compliance with securities, commodity futures and derivatives laws of their Home Jurisdictions.
Proposed Conduct of OTC Derivative Transactions
9. Each Filer proposes to enter into bilateral OTC Derivatives with counterparties located in all provinces and territories of Canada that consist exclusively of persons or companies that are Permitted Counterparties. The Underlying Interest of the OTC Derivatives that are entered into between a Filer and a Permitted Counterparty will consist of one of the following: a commodity; an interest rate; a currency; 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.
10. While a Permitted Counterparty may deposit margin or collateral with the Filers in respect of its obligations under an OTC Derivative transaction, the Filers themselves will not offer or provide credit or margin to any of their Permitted Counterparties for purposes of an OTC Derivative transaction.
11. Each Filer seeks the Requested Relief as an interim, harmonized solution to the uncertainty and fragmentation that currently characterizes the regulation of OTC Derivatives across Canada, pending the development of a uniform framework for the regulation of OTC Derivative transactions in all provinces and territories of Canada. The Filers acknowledge that registration and prospectus requirements may be triggered for the Filers in connection with the derivative contracts under any such uniform framework to be developed for the regulation of OTC Derivative transactions.
Regulatory Uncertainty of the Regulation of OTC Derivative Transactions in Canada
12. There has generally been a considerable amount of uncertainty respecting the regulation of OTC Derivative transactions as "securities" in the provinces and territories of Canada other than Quebec.
13. In each of Alberta, British Columbia, the Northwest Territories, Nunavut, Prince Edward Island 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 a "futures contract" or a "derivative".
14. In Manitoba, Ontario, New Brunswick, Newfoundland and Labrador, Nova Scotia and Saskatchewan, OTC Derivative transactions are regulated as derivatives; however, in Manitoba, Ontario and Newfoundland and Labrador, certain OTC Derivative transactions also meet the definition of "security".
15. In October 2009, staff of the Ontario Securities Commission (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) (the "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 to the Filers on the extent to which OTC Derivative transactions between a Filer and a Permitted Counterparty may be subject to Ontario securities law.
16. In Quebec, OTC Derivative transactions are subject to the Derivatives Act (Quebec), which sets out a comprehensive scheme for the regulation of derivative transactions that is distinct from Quebec's securities regulatory requirements.
17. In each of Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia and Saskatchewan (the "Blanket Order Jurisdictions") and Quebec (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 Quebec.
18. 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 Derivatives
Nova Scotia
Blanket Order 91-501 Over the Counter Trades in Derivatives
Saskatchewan
General Order 91-908 Over-the-Counter Derivatives
Quebec
Section 7 of the Quebec Derivatives Act
The Evolving Regulation of OTC Derivative Transactions as Derivatives
19. 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 Quebec, or indirectly through amendments to the definition of the term "security" in the securities legislation of the OTC Exemption Jurisdictions and the granting of the OTC Derivative Exemptions.
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. Ontario has now established a framework for regulating the trading of derivatives in Ontario (the "Ontario Derivatives Framework") through amendments to the OSA that were made by the Helping Ontario Families and Managing Responsibility Act, 2010 (Ontario).
22. The amendments to the OSA establishing the Ontario Derivatives Framework will not become effective until the date on which they are proclaimed in force. These amendments are not expected to be proclaimed in force until an ongoing public consultation on the regulation of OTC Derivatives has been completed. On April 19, 2018, the Canadian Securities Administrators (the "CSA") published a Notice and Request for Comment on the Proposed National Instrument 93-102 Derivatives: Registration, and on June 14, 2018, the CSA published a Notice and Second Request for Comment on the Proposed National Instrument 93-101 Derivatives: Business Conduct, which, together, are intended to implement a comprehensive regime for the regulation of persons or companies that are in the business of trading or advising on derivatives.
Reasons for the Requested Relief
23. The Requested Relief would substantially address, for each Filer and its Permitted Counterparties, the regulatory uncertainty and fragmentation that is currently associated with the regulation of OTC Derivative transactions in Canada, by permitting the Filers to enter into OTC Derivative transactions in reliance upon exemptions from the dealer registration and prospectus requirements of the securities legislation of each of the Passport Jurisdictions that are comparable to the OTC Derivative Exemptions.
Books and Records
24. Each Filer will become a "market participant" for the purposes of the OSA if the Requested Relief is granted. For the purposes of the OSA, and as a market participant, each 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.
25. For the purposes of its compliance with subsection 19(1) of the OSA, the books and records that each Filer will keep will include books and records that:
(a) demonstrate the extent of the Filers' compliance with applicable requirements of securities legislation;
(b) demonstrate compliance with the policies and procedures of the Filers for establishing a system of controls and supervision sufficient to provide reasonable assurance that the Filers, and each individual acting on their behalf, complies with securities legislation; and
(c) identify all OTC Derivatives transactions entered into by the Filers and each of their clients, including the name and address of all parties to the transaction and its terms.
26. To the extent necessary and in respect of the OTC Derivative transactions, the Filers will comply with the derivatives trade reporting rules and instruments in effect in the provinces and territories of Canada.
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 Filers is a Permitted Counterparty;
(b) in the case of any trade entered into by the Filers and a Permitted Counterparty, the Filers do not offer or provide any credit or margin to the Permitted Counterparty; and
(c) 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 which specifically governs dealer, adviser or other registration requirements applicable to market participants in connection with OTC Derivative transactions.
In addition, it is the decision of the principal regulator that the Previous Decision is revoked.
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.
"Equity Option" means an Option where the Underlying Interest of the Option is a security, an index, a basket of securities or a basket of indices, or any combination thereof.
"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.
"Swaption" means a right, but not the obligation, to enter into a swap transaction, usually an interest rate swap transaction, on the exercise date. The buyer of the swaptions gains the right to cause the issuer to enter into the swap transaction. The rates under the swap transaction are determined on the trade date of the swaption.
"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.