OSC’s priorities provide clues to enforcement

01 OSC statement of priorities

In March, the OSC asked for comment on its priorities for 2017-2018.

Each priority aligns with one of five OSC regulatory goals: investor protection, enforcement, regulation, financial stability and efficiency.

Nine priorities are carried forward from last year, and five are new: investor redress, fintech, reducing regulatory burden, sanction collection and transitioning to the Capital Markets Regulatory Authority.

Rebecca Cowdery, a partner at Borden Ladner Gervais (BLG) in Toronto, notes most of the goals and priorities apply to financial services, not the regulation of reporting issuers. It’s been a growing trend over the last five years, she says.

Indeed, the first priority, under investor protection, is to “publish regulatory reforms to define a best interest standard.” The second is to “define regulatory actions to address embedded commissions.”

Though the regulators are currently consulting on an embedded commissions ban, a new standard to act in the client’s best interest is inevitable, says John Fabello, a partner at Torys in Toronto. Cowdery agrees.

The priority is “a very strong hint that we’re going to get a draft rule published” this year on the best interest standard, Cowdery says, though additional time would be required for comments and a transition period.

Instead of debating the issue further, Fabello suggests registrants focus on discussing limitations and parameters to the best interest standard. For instance, CSA says in its consultation paper on the best interest standard (33-404) that the standard isn’t intended to prohibit firms from charging for their services or to result in the best or highest returns for clients.

Also under investor protection is the priority to empower the Ombudsman for Banking Services and Investments (OBSI) “to secure redress for investors.” That aligns with one of 19 recommendations made by an independent evaluator of OBSI in 2016. OBSI currently has no enforcement powers, so watch for the priority’s outcome, says Cowdery.

One of the success measures for investor protection, she adds, is “pilot projects for behavioural insights testing,” which builds on an OSC staff notice on behavioural research. But how the behavioural insights would be implemented remains to be seen, says Cowdery.

Cowdery is pleased to see that, for the first time, OSC has prioritized reducing regulatory burden, particularly “removing redundant and ineffective disclosure and reporting requirements for investment funds,” as stated in a notice.

Also cited as a priority is reducing ongoing disclosure requirements and streamlining rules for smaller reporting issuers.

Small and medium-sized dealers across the country are especially challenged by the pace of regulatory change, says Fabello. Though business costs are routinely acknowledged by regulators, committing to reduce regulatory burden “rings a little bit hollow when you’re talking about potential significant sea changes, like a best interest standard,” he says. He would like to see more detail provided for the priority.

A positive for Cowdery is the priority to enhance OSC business capabilities—for example, working with the CSA to renew CSA national systems. She says electronic filing systems, like SEDAR, require improvements.

Overall, she calls the priorities “ambitious,” but says the OSC tends to meet its targets.

Fabello says registrants should see the priorities as indications of how limited enforcement resources could be allocated. Further, “Don’t be surprised if [the OSC is] pushing the envelope in investigating something that’s consistent with those priorities.”

02 CSA proposes national instrument for derivatives business conduct

In April, CSA proposed National Instrument 93-101 Derivatives: Business Conduct, and a proposed companion policy, as part of ongoing reform to the derivatives market in the aftermath of the financial crisis.

Though terms in the proposal look familiar at first glance—fair dealing, conflicts, know your client—registrants shouldn’t assume CSA simply lifted NI 31-103 (registration requirements, exemptions and obligations) and changed the references from securities to derivatives, says Julie Mansi, a partner at BLG in Toronto.

For example, the proposal says senior derivatives managers must submit a report, at least once per calendar year, “certifying that their derivatives business unit is in material compliance with this instrument.”

Currently, a chief compliance officer provides an annual report to the board, says Mansi, “but that’s for the purposes of assessing compliance, not certifying that your business unit is in material compliance.” That’s a liability threshold not seen before, she says.

Managers must also ensure that “eligible derivatives parties”—similar to permitted clients in NI 31-103—meet not only required financial thresholds but also have the knowledge and experience to evaluate provided information, as well as the suitability and characteristics of derivatives.

“That’s a unique twist compared to what’s in the securities space currently,” says Mansi, referring to the financial thresholds for permitted clients and best practices for suitability. “CSA has put in more particular language on investor protection concerns.”

Simon Williams, a senior associate at Torys in Toronto, notes the “higher level of disclosure” required to clients, such as reporting daily valuations of trades, as well as reporting monthly transactions.

He highlights the proposal’s restrictions on tied selling and fair terms and pricing. “It’s timely,” he says, noting the headlines about aggressive sales tactics at banks.

Disclosure requirements could mean firms must redesign “onboarding documents or reboot their back offices so reports are generated more frequently,” he says.

The comment period of 150 days allows the proposal to be considered in light of the forthcoming registration rule, Proposed National Instrument 93-102 Derivatives: Registration, expected in early summer, Mansi says. Regardless of registration, the proposal applies to all derivatives market participants.

“Whether or not you are caught within the provincial securities registration regime, these are the expectations of how you will deal with investors going forward,” says Mansi.

Carve-outs are expected for OSFI-regulated financial institutions and IIROC-registered derivatives managers, who can demonstrate substitute compliance.

Mansi says credit unions that aren’t OSFI regulated, or money services businesses that have only FINTRAC obligations, will have to pay special attention since they’re outside the regulated space.

Further, foreign exchange derivatives fall under the proposal. “This is not simply a rule that will speak to interest rate swaps or credit default swaps,” says Mansi. “It’s a very broad derivatives scope.”