Futures segregation and portability customer protection regime guidance

GN-3200-22-002
Type: Rules Notice> Guidance Note
Rule connection:
IIROC Rules
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Executive Summary

This guidance provides further clarification of the IIROC rule requirements related to the futures segregation and portability customer protection regime for:

  • porting disclosure documents in section 3261 of the IIROC Rules,
  • books and records in section 3814,
  • daily reconciliation requirements in subsection 4424(7), and
  • margin requirements in subsection 5790(2).
Table of contents
  1. Background

  1. Seg and Port regime

Principle 14 of Principles for Financial Market Infrastructures (PFMIs) published by the Bank for International Settlements and the International Organization of Securities Commissions requires a futures market central clearing counterparty (CCP) to establish “rules and procedures to enable the segregation and portability of positions of a participant’s customers and the collateral provided to the CCP with respect to those positions.” The Canadian Derivatives Clearing Corporation (CDCC) has a futures segregation and portability (Seg and Port) customer protection regime to comply with these international standards.

Portability is the ability to transfer client positions and related collateral from a clearing participant that is in default to a different clearing participant. Porting is the process of performing this transfer. CCPs have developed different porting models to meet the portability requirements in the PFMIs.

  1. Central clearing counterparty

We refer to CDCC as the specific CCP in this guidance, since CDCC is the only CCP in Canada, at this time, with a Seg and Port regime. Also, CDCC is currently the only CCP with a gross customer margin model that would qualify as a domestic gross customer margin model (GCM model) under the IIROC Rules. This guidance would also apply if a Dealer Member (Dealer) becomes a clearing member of another CCP offering a futures segregation and portability regime similar to CDCC.

  1. Futures porting disclosure document

Section 3261 of the IIROC Rules requires Dealers to provide clients with a porting disclosure document, for client accounts subject to a futures segregation and portability regime, that includes the benefits, risks and requirements for porting, including the conditions for porting positions to a replacement clearing member. While there is flexibility as to the form and format of the disclosure, in all cases the information must be in writing, in plain language and contain all of the required elements.

A sample disclosure document is included in Appendix A which combined with CDCC’s GCM Factsheet, may be used by Dealers as the porting disclosure document for CDCC’s Seg and Port regime. Dealer Members may supplement this disclosure on the basis of their professional judgement and the nature of the relationship with their client. For example, the Dealer may supplement the disclosure where the Dealer has an introducing/carrying arrangement for futures trading. Any supplemental disclosures must not be contrary to the IIROC or CDCC rules. CDCC has drafted a Factsheet for the CDCC Gross Client Margin (GCM) Regime which provides the details on the porting process and risks. This Factsheet should be provided to clients with the porting disclosure document to give clients a complete understanding of the benefits, risks and requirements for porting.

Pursuant to subsection 3261(2) Dealers are required to obtain acknowledgement from the client that they have received and understood the porting disclosure document. Such an acknowledgment must be explicit and subject to Dealer recordkeeping obligation in section 1405(2).

  1. What information should be included in the porting disclosure document provided to clients?

The scope of the disclosure is that clients should have a good understanding of the porting process at the CCP, including the clients’ own responsibilities. A comprehensive porting disclosure document should include information explaining to the client:

  • the clearing process,
  • how porting can benefit the client in the event of a Dealer default,
  • what the CCP porting process is and associated pre-requisites for porting,
  • the impacts of the CCP’s collateral pool structure,
  • what the client’s responsibilities are, and
  • the additional risks that may prevent porting.
  1. Clearing process

    The porting disclosure document should explain the clearing process for futures contracts at the CCP, including the GCM model. The Dealer’s obligation to provide the CCP with client position information, on a daily basis, and client contact information, in the event of insolvency, as required in subsection 3261(3) should also be included. The clearing process explanation should include information on how the CCP deals with client positions in the event of a Dealer default. For example, the CCP may have the authority to liquidate the client’s futures contract positions, but may allow the client to port their positions under certain conditions. Documentation provided by the CCP which outlines the clearing process (such as the default management process, account and collateral pool structure, porting requirements etc.) should either be attached to or embedded within the porting disclosure document.
  2. How porting can benefit the client in the event of a Dealer default

    The porting disclosure document should explain the benefits of porting such as the opportunity for the client to maintain positions without liquidating and re-establishing the positions at another Dealer. If the positions are ported, the client may avoid the adverse impacts of liquidation. For example, the CCP has the ability to liquidate positions that have not been ported and use the cash proceeds within the default management process to cover costs and losses. The amount returned to the client will be dependent on the remaining assets of the insolvent Dealer and subject to any coverage provided by the Canadian Investor Protection Fund (CIPF). As a result, the client may experience delays in receiving their portion of the cash remaining (if any). Without the benefit of porting, the client’s ability to re-establish their positions and collateral may be reduced by these delays and potential losses.
  3. CCP (CDCC) porting process and pre-requisites

    The porting disclosure document should clearly explain the CCP process and pre-requisites for porting. CDCC for instance requires clearing members to inform their clients of the applicable porting requirements and process including informing the client to name a receiving clearing member when a porting event is triggered. The specific CCP porting requirements (such as those set by CDCC) should either be attached to or embedded within the porting disclosure document.
  4. Impacts of CCP’s collateral pool structure

    The porting disclosure document should explain specific risks associated with porting such as the impact of the CCP’s collateral pool structure and collateral management process. For example, under the GCM model (utilized by CDCC), the CCP calculates the margin requirement separately for each client on a daily basis, but the client collateral is commingled in a pooled account. At the time of default, the CCP calculates the collateral to be ported for each client based on an allocation methodology.
    This allocation methodology exposes clients to risks that:
    • the type of collateral and the value of the collateral ported to the replacement dealer may differ from the collateral the client deposited at the default Dealer,
    • the client’s excess collateral may be ported to accounts of other clients that have not deposited sufficient funds to meet their margin requirements, and
    • the collateral ported may not be adequate to cover the margin required by the replacement Dealer, resulting in a requirement for the client to provide additional collateral to the replacement Dealer.
    • If the CCP identifies additional risks to clients that are associated with the CCP’s collateral pool structure and management process, these risks should be included within the porting disclosure document.
  5. Client’s responsibilities to meet certain porting requirements

    Where the CCP’s porting model requires the client’s request and/or positive consent to port positions to another clearing Dealer (replacement Dealer) chosen by the client, there may be a limited period of time to have the consent confirmed. In these instances, clients should have a backup arrangement in place at all times (pre-arrangement) with a replacement Dealer if they wish to port their positions. The porting disclosure document should explain:
    • the purpose and importance of the pre-arrangement,
    • the client’s responsibility for ensuring a pre-arrangement is in place if they wish to port positions, and
    • the risks of not having a pre-arrangement, including the high likelihood that positions will not be ported.
    The porting disclosure document should also highlight other key client responsibilities during the porting process such as:
    • completing the porting request form,
    • communicating with the replacement Dealer,
    • submitting the porting request form to the CCP within the porting period, and
    • any other client expectations included in the CCP porting requirements.
  6. Additional risks that may prevent porting

    The porting disclosure document should also highlight additional risks that may prevent porting. For example, porting may not occur if:
    • the CCP determines porting is not feasible based on market conditions, collateral deficiencies or other reasons,
    • the replacement Dealer does not complete the porting requirements within the porting period,
    • the defaulting Dealer does not provide the information required by the CCP at the time of default and during the porting period, or
    • the positions are not eligible for porting under the CCP’s rules.
  1. What are the expectations where the Dealer has been unable to obtain the client acknowledgement?

Pursuant to the new subsection 3261(1), Dealers are required to provide a porting disclosure document to the client and obtain acknowledgement from the client that they have received and understood such disclosure. The porting disclosure is required for all clients, retail and institutional clients, whose accounts are subject to a futures segregation and portability regime. The client acknowledgment requirement under clause 3261(1)(ii) seeks to ensure client awareness of the disclosure.

Where the Dealer has not been able to obtain the client acknowledgement, they must provide evidence of any attempts to obtain such acknowledgement. Dealers are expected to take reasonable steps for obtaining the client acknowledgment, which should not stop at the initial attempt. IIROC considers reasonable steps, to include Dealers making several meaningful attempts to reach the client for obtaining their acknowledgment, including via various communication means. To clarify, the acknowledgment is a one-time requirement, meaning that once the Dealer has obtained the client acknowledgment (this excludes interpretations of implied acknowledgment ), the Dealer does not have to seek such acknowledgment again unless the disclosure has been materially updated. Under the general requirements to maintain records, in section 3804, the Dealer must keep records evidencing that the porting disclosure document has been provided to clients and evidencing the attempts to obtain the client acknowledgement.

  1. What pre-arrangements are Dealers expected to make for clients?

If the client wishes to port their positions, they should have pre-arrangements with a replacement Dealer because it is highly unlikely there will be sufficient time within the limited porting period to open accounts or complete account documentation. As part of the pre-arrangement, the replacement Dealers are expected to complete all necessary account documentation for account opening prior to any default of the client’s primary Dealer. The account should also be operationally ready to accept client positions.

  1. What are the expectations for omnibus arrangements?

The Dealer may offer Canadian futures contract trading to clients through an omnibus clearing arrangement with a clearing member of the CCP. In this case, the Dealer may choose to either:

  • disclose the client position information to the clearing member for inclusion of the clients in the GCM model, or
  • maintain the omnibus account at the clearing member on an undisclosed basis.

If the Dealer and clearing member include the Dealer’s clients in the GCM model, the Dealer would be required to comply with the IIROC rules related to the Seg and Port regime in section 3261 and section 3814.

If the Dealer maintains the omnibus account on an undisclosed basis, the Dealer is responsible for making a pre-arrangement with a replacement Dealer. This pre-arrangement would significantly increase the likelihood of the Dealer being able to port the client positions in the omnibus account, in the event of the clearing member’s default.

  1. Books and Records

Since a CCP (such as CDCC) requires the Dealer to provide client information and futures contract position information under a GCM model, additional books and records are required by the Dealer to identify the clients, positions and collateral subject to the GCM model.

  1. What additional books and records are Dealers required to maintain for the GCM model?

Subsection 3814(3) requires the Dealer to maintain a daily record showing all the positions owned by the client that are declared as GCM positions and the collateral received by the Dealer to support the margin on those positions. Subsection 3814(4) requires the Dealer to maintain a client identification record for accounts subject to the GCM model.

The purpose of these requirements is to:

  • prevent delays or errors in reporting GCM positions to the CCP,
  • reconcile positions and collateral between the CCP and Dealer,
  • improve portability likelihood, and
  • provide timely reporting of GCM positions and collateral to the bankruptcy trustee or the investor protection fund (such as CIPF) in the event of default.
  1. Are separate client accounts required for futures positions subject to the GCM model?

Subsection 3814(3) does not require client futures positions subject to the GCM model to be reported in a separate client account from other futures positions. The Dealer may have challenges determining the portion of collateral that is supporting the margin on the GCM futures positions since clients with both Canadian and foreign futures positions may deposit collateral on a bulk basis. For purposes of determining the collateral associated with the GCM futures positions for the record requirement in subsection 3814(3), the Dealer may choose to:

  • open a separate futures account for the client’s GCM futures contract positions and collateral
  • allocate the collateral in the client’s futures account between the GCM futures contract positions and other futures contract positions based on the margin requirements of the positions

If the Dealer chooses to use the allocation method, the allocation methodology should be clearly documented. The allocated collateral amounts should be reconciled to the total collateral deposited by the client. Since subsection 3814(3) requires a daily record, the allocated collateral amount must be calculated and updated on a daily basis.

  1. How should the daily record be reconciled?

Subsection 4424(7) requires that Dealers reconcile their records daily with the CCP and depository records. The Dealer must reconcile their daily records of client positions to the CCP’s record of positions each day to identify and correct any discrepancies. The Dealer may setup accounts at the CCP under different account types depending on the account structure offered by the CCP such as:

  • omnibus accounts where positions for multiple clients are held within one account at the CCP
  • individual accounts where an account at the CCP is setup for a specific client

Where the clients positions are held in an omnibus account at the CCP, the Dealer submits a data file to the CCP to identify positions by individual customer so that the CCP may calculate the gross customer margin. The Dealer should reconcile the daily record to the data file and the CPP’s records of positions for the omnibus account each day.

Where the Dealer has setup individual accounts for clients at the CCP and these accounts are subject to GCM, the client positions should be individually reconciled on an account by account basis between the daily record and the CCP record. The account on the Dealer’s records should be reconciled to the corresponding account at the CCP each day.

  1. What information is expected to be included in the client identification record under subsection 3814(4)?

The main purpose of the client identification record is to assist the CCP with identifying clients during the porting process. The CCP rules may require the Dealer to provide a client identification record to the CCP at the time of a Dealer insolvency and/or on an ad-hoc basis at the request of the CCP. The CCP uses the client identification information to confirm the identity of clients who are requesting porting of their positions. Each client identification record should contain the following:

  • the account identifier at the CCP (e.g. CDCC SOLA Account ID)
  • the account number,
  • the client name,
  • the client address,
  • the client contact information (email, phone number) and
  • where the client is a non-individual, a primary and secondary (if applicable) contact name .

The Dealer should refer to the CCP’s rules and system requirements to identify any other specific client identification information to be included in the client identification record.

  1. Margin requirements

Subsection 5790(2) allows a grace period for the collection of futures contract margin for a client that is an acceptable institution (AI), acceptable counterparty (AC) or regulated entity (RE) when determining the margin deficiency to include in the risk adjusted capital calculation. The conditions for excluding the margin deficiency from the risk adjusted capital calculation under subsection 5790(2) require the Dealer to promptly call for margin and receive the required margin by the end of the next trading day after the deficiency occurs.

  1. How does the grace period for collection of futures contract margin work?

The following examples illustrate how the grace period is applied:

Example 1:

Client XYZ is an AI, AC or RE.

Trade date (October 31)

  • Margin deficiency for client XYZ is $1,000

Trade date +1 (November 1)

  • Dealer makes margin call for $1,000 and receives $1,000 from client XYZ

Result: No margin for Client XYZ is included in the risk adjusted capital calculation as of October 31, since sufficient margin collateral to cover the $1,000 margin deficiency as of October 31 was collected by the end of the next trading day (November 1).

Example 2:

Client DEF is an AI, AC or RE.

Trade date (October 31)

  • Margin deficiency for client DEF is $2,000

Trade date +1 (November 1)

  • Dealer makes margin call but does not receive $2,000 from Client DEF

Result: No margin collateral was collected to cover the $2,000 margin deficiency as of October 31 by the end of the next trading day. The Dealer must provide the $2,000 margin deficiency amount for Client DEF in its calculation of risk adjusted capital as of October 31.

  1. Effective date

The Guidance is effective upon the implementation of CDCC’s GCM model rule amendments on March 31, 2023. If the implementation of CDCC’s GCM model rule amendments is extended beyond March 31, 2023, the implementation of the Guidance will be extended accordingly.

  1. IIROC Rules

This Guidance Note discusses the following rules:

IIROC Rule 3200 - specifically section 3261

IIROC Rule 3800 - specifically subsections 3814(3) and 3814(4)

IIROC Rule 4400 – specifically subsection 4424(7)

IIROC Rule 5700 – specifically subsection 5790(2)

Form 1, Notes and Instructions to Schedules 4 and 5 – specifically Schedule 4, Note (11) and Schedule 5, Note 4

  1. Related Documents

This Guidance Note is related to the following Notice 22-0191.

  1. Appendices

Appendix A – Sample Futures Porting Disclosure Document


 

Appendix A

Futures Porting Disclosure Document
This disclosure document (including the attached Canadian Derivatives Clearing Corporation (CDCC) Fact Sheet) provides information on the benefits, risks and requirements for transferring your futures positions and collateral, when cleared via a central clearing counterparty (CCP), to another Canadian Investment Dealer that is a CCP clearing member (Replacement Clearing Member) in the event of our default (referred to as porting). This disclosure is not exhaustive of all the risks and other aspects of CCP clearing member default and porting. We encourage you to ask questions and seek information for you to understand how porting can benefit you and steps you need to take, before and during the porting process.

Protection of futures and deposits
The protections for money or other property you deposit as collateral for domestic and foreign futures transactions, and your ability to maintain open futures positions may vary in the event of our insolvency or bankruptcy. The extent to which you may recover your money or property may be governed by specific legislation or local rules, including the rules of the CCP that clear and settle your futures and futures options. You should understand the protections provided by the CCP in order to evaluate the level of protection that may be available to you on our default. It is important that you review the relevant disclosures by the CCP in this respect.

Futures clearing in Canada
CDCC acts as the CCP for exchange-traded derivative products in Canada. As a CDCC clearing member, we provide clients with access to clearing of Canadian exchange traded futures and futures options. CDCC has a mechanism in place to port client futures and futures options and associated collateral to a Replacement Clearing Member1 in the event of our default.

Porting futures positions to a Replacement Clearing Member
There are a number of conditions which must be satisfied before your futures positions and associated collateral can be ported by CDCC to a Replacement Clearing Member. These conditions are set by CDCC and include obtaining your consent to transfer your futures positions and associated collateral at the time of default. You will also need a Replacement Clearing Member to agree to accept the futures positions and associated collateral. You are strongly encouraged to make arrangements with a Replacement Clearing Member in advance, at your discretion. If you have not appointed a Replacement Clearing Member prior to our default, then porting is highly unlikely to occur given the limited porting period.

Termination of contracts
If you want to port your futures positions and associated collateral, you will need to comply with CDCC’s porting conditions and requirements within a specific period of time after our default. Otherwise, CDCC may take action to manage their risks, including liquidating the futures positions. You may need to make a claim to the insolvency trustee or Canadian Investor Protection Fund (CIPF) for any remaining proceeds of the liquidated positions and any excess collateral you have on deposit with us. Any claims to the CIPF are subject to their coverage limits.

CDCC Fact Sheet
The attached CDCC Fact Sheet provides additional important information on actions you need to take if you wish to increase the likelihood of porting your futures positions and associated collateral to a Replacement Clearing Member in the event of our default. The CDCC Fact Sheet also provides information on account structures, protections, benefits and risks (including the risks associated with facilitating porting). It is highly unlikely that you could port positions and associated collateral if you have not met the conditions outlined in the CDCC Fact Sheet.

Client information provided to CDCC
Under the CDCC rules, we are obligated to provide CDCC with information and reports related to your futures positions for the calculation of margin. We may also provide your contact information to CDCC, in the event of our default, to facilitate any porting requirements.

  • 1The CDCC Factsheet uses the term ‘Receiving Clearing Member’ to refer to the ‘Replacement Clearing Member’.

MFDA and IIROC have consolidated

As of January 1, 2023 the MFDA and IIROC have come together as New Self-Regulatory Organization of Canada (New SRO).

New SRO has assumed the regulatory responsibilities of the MFDA and IIROC.

We have set up an interim website for updates and information related to the New SRO including:

  • Executive Management
  • Governance
  • New SRO Rules
  • Member Application
  • Investor Office and the Investor Advisory Panel
  • Information concerning mutual fund dealers registered in Québec
  • Complaints
  • Careers

Enforcement proceedings, membership lists, continuing education, investor education resources and any other information not set out above continue to reside on www.mfda.ca and www.iiroc.ca.