Schedule 9 of Form 1, concentration of securities

GN-4100-21-004
Type: Rules Notice> Guidance Note
Rule connection:
IIROC Rules
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Executive Summary

Effective Date: December 31, 2021

This Guidance Note provides guidance on:

  • the purpose of Schedule 9 of Form 1, concentration of securities (Schedule 9)
  • concentration exposures
  • capital charges
  • how to determine the exposure (amount loaned) in a security
  • what securities are tested for concentration
  • what adjustments exist to reduce the exposure in a security
  • how to treat the value of trades with qualifying institutional clients
  • reporting to IIROC.

This Guidance Note includes a sample calculation attached as Appendix A.

As indicated in Notice 21-0028, published on February 18, 2021, the applicable securities regulatory authorities approved amendments to Schedule 9 (Amendments) that will bring debt securities with a normal margin rate of 10% or less (debt securities margined at <=10%) into the existing securities concentration test. The Amendments introduce separate, but related, tests for debt securities margined at <=10% (Debt Security Test) and current Schedule 9 positions (General Security Test).

There are certain differences between the Debt Security Test methodology and the General Security Test, including those noted below in sections 2, 3, 4, 5, and 6 of this guidance note.

The Amendments are scheduled to become effective September 1, 2022.

 

Table of contents
  1. What is the purpose of Schedule 9?

A capital charge applies for any concentration by the firm exceeding a specified threshold for any single security or group of related securities of the same issuer (security or issuer) carried by a Dealer Member (Dealer) in inventory, purchased or sold by clients on margin or carried in overdue cash or delivery against payment (DAP) and receipt against payment (RAP) accounts. Schedule 9 also includes concentrations in precious metal positions. Any references below to security or issuer exposures may also apply to precious metal position exposures.

Schedule 9 attempts to address the unlikely situation where the security in which a Dealer and its clients have a high exposure, substantially decreases (long positions) or increases (short positions) in value in a relative short period of time. Schedule 9 is not designed to inhibit the Dealer from making a business decision to take a certain amount of risk; it is designed to preserve a minimum level of residual capital such that a Dealer that takes on high exposure to a single security or group of related securities of the same issuer might liquidate or buy-in, as the case may be, such positions without cost to the firm as a going concern.

  1. How does Schedule 9 define exposure?

A concentration exposure is the incremental exposure to a particular security captured for concentration testing, which is the market value of the security less any margin already provided on that position. For short positions, the exposure is the market value of the security. In client accounts, an additional computation is made to include any excess margin in the account as protection, reducing the amount of exposure to the member as a result of the possibility of the security in question declining in value by an amount significantly greater than the margin provision.

For debt securities margined at <=10%, the Amendments allow short exposures to be calculated in the same manner as long exposures.

  1. What is the capital charge for a concentration in securities?

The Dealer must aggregate these exposures by security across inventory and client accounts. Where the exposure exceeds 2/3 of the Dealer’s risk adjusted capital (RAC) before securities concentration charge and minimum capital as most recently calculated, a capital charge of an amount equal to 150% of the excess of the exposure over the threshold is levied, unless the over exposure is eliminated within five business days of when it first occurs.  Otherwise, 150% of the excess amount is required to preserve a minimum amount of RAC.

Exposures in related, or “non-arm’s length securities” and non-marginable securities of an issuer held in a cash account are measured against a reduced threshold of 1/3 of the Dealer’s RAC before securities concentration charge and minimum capital as most recently calculated.

If the Dealer has already incurred a concentration charge on any one security, or if the total amount being loaned (as computed pursuant to the notes and instructions to Schedule 9) on any one security for all client and inventory accounts exceeds an amount equal to 1/2 of the Dealer’s RAC before securities concentration charge and minimum capital as most recently calculated, additional exposures on any other security are measured against a reduced concentration threshold of 1/2 RAC. Exposures in related, or “non-arm’s length securities” and non-marginable securities of an issuer held in a cash account are always measured against a concentration threshold of 1/3 RAC.

Concentration charges are only applied against  the largest five issuer positions and precious metal positions in which there is a calculated exposure. Once effective, the Amendments will change this requirement and concentration charges will be applied against the largest three exposures originating from the General Security Test and the largest three exposures originating from the Debt Security Test.

  1. How does a Dealer determine exposure (amount loaned) in a security for the purpose of Schedule 9?

For the purpose of the concentration calculation, the Dealer will only consider the greater exposure determined in separate calculations made for all long security positions and short security positions for any single security or group of related securities of an issuer carried by a firm in inventory, purchased or sold by clients on margin or carried in overdue cash or DAP and RAP accounts (see attached example in Appendix A).

  1. Determining the exposure in respect of long positions

The Dealer will determine the exposure in the security as follows:

  • the loan value of long securities in margin accounts on settlement date,
  • the weighted market value (calculated pursuant to the weighted market value calculation set out in Schedule 4, Note 8, Cash Accounts Instruction (a)) and/or loan value (calculated pursuant to the loan value calculation set out in Schedule 4, Note 8, Cash Accounts Instruction (b)) of long securities in a regular settlement cash account when any portion of the account is outstanding after settlement date,
  • the market value (calculated pursuant to the market value calculation set out in Schedule 4, Note 8, DAP and RAP Accounts Instruction (a)) and/or loan value (calculated pursuant to the loan value calculation set out in Schedule 4, Note 8, DAP and RAP Accounts Instruction (b)) of long securities in a delivery against payment cash account when such securities are outstanding after settlement date,
  • the loan value (calculated pursuant to the Notes and Instructions to Schedule 2) of net long inventory positions on trade date, and
  • the loan value of new issues carried in inventory twenty (20) business days after new issue settlement date.
  1. Determining the exposure in respect of short positions

The Dealer will determine the exposure in the security as follows:

  • the market value of short positions in margin accounts on settlement date,
  • the market value of short positions in a regular settlement cash account when any portion of the account is outstanding after settlement date,
  • the market value of short positions in a delivery against payment account when any portion of the account is outstanding after settlement date, and
  • the market value of net short inventory securities on trade date.

As note above in section 2, for debt securities margined at <=10%, the Amendments allow short exposures to be calculated in the same manner as long exposures.

  1. Are all securities captured for testing by Schedule 9?

The securities that must be considered for the concentration test include:

  • all long and short positions in equity and convertible securities of an issuer,
  • long and short precious metal positions including all certificates and bullion of the particular precious metal (gold, platinum or silver),
  • all long and short positions in debt or other securities, other than debt securities margined at <=10%.

The Amendments will capture debt securities margined at <=10%, effective September 1, 2022.

Security positions that qualify for margin offsets may be netted.

  1. What adjustments exist to reduce the exposure in a security?

The Dealer may deduct from individual client exposure of the total exposure in a security:

  • any excess margin in the client's account
  • in the case of margin accounts, 25% of the market value of long positions in any:
    • non-marginable securities in the account
    • securities with a margin rate of 100% in the account
  • provided such securities are carried in readily saleable quantities only
  • in the case of cash accounts, 25% of the market value of long positions in any securities whose market value weighting is 0.000 (pursuant to Schedule 4, Note 8, Cash Accounts Instruction (a)) in the account, provided such securities are carried in readily saleable quantities only.

The Amendments include a general adjustment allowing the exclusion of security positions that are financed by limited recourse loans that meet the industry standard wording set out in the Limited Recourse Call Loan Agreement. Additional adjustments specific to the Debt Security Test will apply, including netting allowances, and risk-weighting adjustment factors for determining the amount loaned.

  1. Treatment of account guarantees

Any security or precious metal positions in the client’s (the Guarantor) account, which are used to reduce the margin required in another account pursuant to the terms of a guarantee agreement, must be included in calculating the amount loaned on each security for the purposes of the Guarantor’s account.

  1. Are the value of trades with financial institutions and other Dealer included in the concentration calculation?

  1. Balances with Acceptable Institutions (AIs), Acceptable Counterparties (ACs) or Regulated Entities (REs)

Balances with AIs, ACs, or REs, which are outstanding ten business days past settlement date and are (i) not confirmed for clearing through an acceptable clearing corporation, or (ii) not confirmed by the AI, AC or Regulated Entity, must be included in the concentration calculation in the same manner as DAP cash accounts.

  1. Trades of financial institution counterparties that have been confirmed by an AI

For any accounts of parties which are not AIs, ACs or REs, trades less than ten days past regular settlement date do not have to be included in the calculation of potential concentrations if they have been confirmed on or before settlement date by a settlement agent which qualifies as an AI.

  1. Must the Dealer report concentration over exposures to IIROC?

Where there is an over exposure in a security and the concentration charge as referred to above would produce either a capital deficiency or a violation of the Early Warning Rule, the Dealer must report the over concentration situation to IIROC on the date the over exposure first occurs.

Section 4111 of the IIROC Rules requires Dealers to maintain at all times risk adjusted capital greater than zero as calculated in accordance with Form 1. Dealers are reminded that, at a minimum, they are required to calculate their capital position on a weekly basis and retain evidence of such calculation. The calculation should give due consideration to the monitoring of potential concentration of securities on an ongoing basis.

  1. Applicable Rules

IIROC Rules this Guidance Note relates to:

  • Rule 4100,
  • Rule 5300,
  • section 5430,
  • Schedule 2 of Form 1,
  • Schedule 4 of Form 1, and
  • Schedule 9 of Form 1.
  1. Previous Guidance Note

This Guidance Note replaces C-68 - Concentration of Securities (December 23, 1993).

  1. Related documents

This Guidance Note was published under NNotice 21-0190 - IIROC Rules, Form 1 and Guidance.

  1. Appendices

Appendix A – Sample calculation.