DERIVATIVES UPDATE
AUGUST 1999
Participants concerned about market impact
OTC derivatives now ‘securities’
in Alberta, but most deals exempt
After market participants expressed serious concerns about extension of the Alberta Securities
Act to cover over-the-counter derivatives, the province’s Securities Commission has issued
an order to exempt most transactions from the act’s scope. Participants are hopeful that
similar action will be taken in British Columbia, which recently made the same move.
Alberta had extended the application of its act to OTC derivatives on June 1, with B.C.
taking a similar step on the 29th. When market participants learned of the Alberta move,
many of them seriously questioned their ability to do OTC derivatives transactions in the
normally active Alberta market. After a week of consultation with participants and their
advisers, the Securities Commission issued the exemption order, retroactive to June 1. It
basically exempts all OTC derivatives transactions and commodity contracts transactions
between sophisticated parties.
ALBERTA AMENDMENTS
Bringing OTC derivatives within the scope of the Alberta Act was accomplished through
the repeal of the existing “futures contract” definition and the expansion of the definition of
“trade” to include the entering into of a futures contract. The term “futures contract” now
reads:
(h.01) “futures contract” means any obligation to make or take future delivery of
(i)
a commodity,
(ii)
a security,
(iii)
cash if the amount of cash is derived from, or by reference to, a variable,
including:
(A)
a price or quote for a commodity or security,
(B)
an interest rate,
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(C)
a currency exchange rate, or
(D)
an index or benchmark,
but does not include an obligation or a class of obligations that is designated not to be a
futures contract pursuant to an order made under section 9.1 . . .
This definition is now broad enough to include not only forward commodity sales
agreements, but also most, if not all, physically and financially settled OTC derivative
products, whether or not they would otherwise be considered “securities” under traditional
tests. Futures contracts that are not exchange traded are “securities”, as defined in the Act.
In addition, the definition of “trade” was amended to include the entering into of a futures
contract. In the result, parties entering into an OTC derivative transaction or forward
commodity sales agreement are effecting a trade in a security and, unless exempted, are
subject to the registration and prospectus requirements of the Act.
Unfortunately, the amendments were not accompanied with any registration or prospectus
exemptions in respect of OTC derivative transactions or forward commodity sales
agreements. Initially, the Alberta Commission indicated that it intended to wait until Ontario
had finalized its draft rule and policy before issuing any exemptions. Given that the
traditional statutory exemptions have limited application in the OTC derivative/forward
commodity sales context, this approach raised significant concerns among many nonAlberta market participants that they could do business in the Alberta market and among
many Alberta participants that they would have access to the hedging products they needed.
(The situation in Ontario is different, because until the Ontario Commission issues its draft
order there is no regulation of an OTC derivatives transaction if it does not meet the
traditional definition of a security.)
The Commission understood the concerns and on August 3 issued an interim order
exempting OTC derivatives contracts and commodity contracts between what are essentially
sophisticated parties from the scope of the Act. It was not the Commission’s goal to develop
the perfect solution for the regulation of the OTC derivatives market, but simply to come up
with an adequate interim measure pending development of a more considered rule and
policy.
THE EXEMPTION ORDER
The Order defines two classes of contracts, “OTC derivatives” and “commodity contracts”.
“OTC derivatives” is widely defined, essentially including any option, forward contract,
contract for differences or other instrument based on a wide variety of underlying variables.
“Commodity contracts” are physically settled contracts for future delivery of a commodity,
including those with an option for cash settlement. These types of contracts (and, in
additional contracts for the sale or exchange of a commodity that only provide for physical
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settlement) are exempt from the Act if they are between “Qualified Parties”, for the most
part, acting as principal in the transactions.
“Qualified Parties” include

financial institutions

governments and government agencies

securities dealers and brokers

certain mutual funds and pension funds

municipalities with more than 50,000 in population

entities with total assets of more than $25 million

individuals with net assets of more than $5 million (excluding personal residence)

persons or companies that together with their affiliates meet certain financial
thresholds with respect to their derivatives or commodities business

parties related to certain qualified parties
Importantly, commercial users are also qualified parties. A commercial user is a person or
company that sells, buys, trades, produces, markets, brokers or otherwise uses in its business
a commodity and as a consequence enters into an OTC derivative transaction or commodity
contract. A commodity includes a “currency” so given a generous interpretation this
exemption may be wide enough to cover all interest rate and FX transactions entered into
for hedging purposes. It would have been preferable if a clearer hedging exemption had
been included.
The Order also makes it clear that a party is a Qualified Party if it was so at the time it
entered into the transaction or contract. Although the Order does not expressly state that a
party is entitled to rely on a representation of its counterparty as to its status as a Qualified
Party, we recommend that parties obtain such representations. The following example
should suffice, although parties may wish a more tailored representation depending on the
particular counterparty they are dealing with:
“Party [A][B] represents that it is a Qualified Party within the meaning of paragraph 9.1 of
Alberta Securities Commission Order Doc.#394043.”
If the representation is included in a schedule, it should be drafted as a continuing
representation.
IMPLICATIONS IN B.C.
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The amendments to the British Columbia Securities Act are similar to those in the Alberta act.
The definition of “futures contract” is the same and as in Alberta the definition of “trade”
has been amended to include entering into a futures contract. The B.C. Commission has the
power under section 3.1 to make orders exemption an obligation or class of obligation from
the definition of “futures contract” if to do so would not be prejudical to the public interest.
Unless exempted pursuant to the traditional statutory exemptions or an exemption order
from the B.C. Commission is obtained, B.C. resident counterparties and potentially those
dealing with them are required to be registered dealers under the Act and to have issued a
prospectus in respect of any OTC derivative transaction or forward commodity sales
agreement.
Failure to comply with such requirements may constitute an offence under the Act, expose
counterparties (and possibly their directors, officers and employees involved in such
transactions) to statutory penalties and other remedies and sanctions, and potentially render
the transaction void by reason of such non-compliance.
Given the potential consequences of non-compliance, counterparties involved in the B.C
derivatives market would be well-advised to consider obtaining an interim order from the
Commission providing for appropriate exemptive relief from the requirements of the Act.
Hopefully the B.C. Commission will follow the lead of the Alberta Commission in making a
retroactive blanket exemption. Let’s hope that no other jurisdiction will enact similar
amendments before a properly considered exemption order is ready to go.