Rule Consolidation Project – Phase 2

1. Background

One of the initial CIRO priorities is to consolidate the IDPC Rules and MFD Rules into one set of rules, the CIRO Dealer and Consolidated (DC) Rules, applicable to both investment dealers and mutual fund dealers.

The primary objectives of the consolidation work are:

• to achieve greater rule harmonization to:
  • ensure like dealer activities will be regulated in a like manner,
  • minimize regulatory arbitrage between investment dealers and mutual fund dealers,
• where practical and appropriate, adopt less prescriptive, more principles-based rule requirements to facilitate rules that are scalable and proportionate to the different types and sizes of dealer and their respective business models, and
• improve access to and clarity of the rules applicable to all CIRO Dealer Members.

Taking these objectives into consideration, the following decisions have been made relating to the structure and content of the DC Rules:

The second phase of the rule consolidation project focuses on DC Rule Series 5000 and 7000 and select sections within Series 3000:

2. Phase 2 Proposed DC Rules

To provide details of the Phase 2 Proposed DC Rules, the following documents have been included as appendices to this Bulletin:

• a clean copy of the Phase 2 Proposed DC Rules is included as Appendix 1
• a blackline comparison of the Phase 2 Proposed DC Rules to the equivalent IDPC Rules is included as Appendix 2
• a table of concordance comparing the Phase 2 Proposed DC Rules to any existing equivalent requirements in the IDPC Rules, MFD rules and National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations is included as Appendix 3.

In the next section of this Bulletin, we summarize the key elements of the Phase 2 Proposed DC Rules, which in most cases are the adoption of existing rule provisions from the existing IDPC Rules.

The Phase 2 Proposed DC Rules require specific requirements depending on the type of activities conducted by Dealer Members. Mutual fund dealers are only permitted to carry out activities as prescribed under securities legislation.

2.1 Margin Requirements

The following provisions have been adopted/introduced within Phase 2 Proposed DC Rules related to margin requirements:

• adopt the margin requirements in IDPC Series 5000 with non-material modifications which harmonize the margin rates between investment dealers and mutual fund dealers for all investment products,
• adopt MFD Rule 3.2.1 that prohibits mutual fund dealers from allowing clients to purchase securities on margin, but allows the advancement of redemption funds to clients under certain conditions,
• clarify that the margin requirements apply to:
  • proprietary inventory and client positions/accounts at investment dealers, and
  • proprietary inventory positions/accounts at mutual fund dealers,
• introduce a foreign exchange concentration margin charge for mutual fund dealers,
• apply defined terms introduced in Phase 1, where applicable, and
• introduce the corresponding French language defined term to each English language defined term (and vice versa) to make it easier to access the corresponding term in the other language.

Client account margin requirements have been restricted to investment dealers by adopting modified client account margin and loan value definitions and adopting provisions prohibiting mutual fund dealers from extending margin to clients. The details of the adopted rules and any modifications are described below.

2.1.1 Margin requirements – application and definitions (DC Rule 5100)

We adopted the existing IDPC Rule provisions relating to the application and definitions of margin requirements with the following modifications:

• added “investing” to Dealer Member activities that have market and credit risk requirements to clarify the margin requirements apply to inventory positions arising from Dealer Members investing their excess capital (DC Rule clause 5110(1)(ii)),
• adopted and modified MFD Rule 3.2.1 that does not allow clients of mutual fund dealers to purchase securities on margin but allows mutual fund dealers to advance funds to clients in connection with redemption proceeds under certain conditions. The condition that a mutual fund dealer must be a Level 2, 3 or 4 was modified to require the mutual fund dealer to have a minimum capital of $50,000 based on the minimum requirements for a Level 2 in MFD Rule 3.1.1. This may require further modification in future phases when rules related to minimum capital and Level categories are reviewed (DC Rule subsection 5111(5)),
• for a provision that only applies to investment dealers, replaced “Form 1” with the term “Investment Dealer Form 1” to align with the definition introduced in Phase 1 (DC Rule subsection 5114(2)),
• included reference to both Investment Dealer Form 1 and Mutual Fund Dealer Form 1 where a term is not defined in the rules but defined in one of the Forms (DC Rule subsection 5130(1)),
• introduce the corresponding French language defined term to each English language defined term (and vice versa) to make it easier to access the corresponding term in the other language (DC Rule subsection 5130(2)),
• modified the definition of “client account margin” and “loan value” to refer only to Investment Dealer Members (DC Rule subsection 5130(2)), and
• replaced reference to Form 1, Schedule 11 in the definition of “net long(short) foreign exchange position” with the calculation formula (DC Rule subsection 5130(9)).

2.1.2 Margin requirements for debt securities and mortgages (DC Rule 5200)

We adopted the existing IDPC Rule provisions relating to margin requirements for debt securities and mortgages with no changes.

2.1.3 Margin requirements for equity securities and index products (DC Rule 5300)

We adopted the existing IDPC Rule provisions relating to margin requirements for equity securities and index products with the following non-material modifications:

• removal of unnecessary capitalization (DC Rule subsection 5310(1)), and
• inclusion of the phrase “listed on an acceptable exchange” for listed rights and warrants for consistency with the DC Rule subsection 5130(4) definition of “Canada and United States listed equity securities eligible for margin” (DC Rule subsection 5350(1)).

2.1.4 Margin requirements for other investment products (DC Rule 5400)

We adopted existing IDPC Rule provisions relating to margin requirements for other investment products with the following modifications:

• revisions to terminology relating to swap counterparty margin requirements for other counterparties (DC Rule clause 5442(1)(iii))
• revisions to terminology relating to foreign exchange exposures to other counterparties (DC Rule clause 5468(1)(ii))
• inclusion of a foreign exchange concentration charge calculation for mutual fund dealers based on adjusted allowable working capital in Mutual Fund Dealer Form 1 (DC Rule subsection 5469(2)).

2.1.5 Margin requirements for underwriting commitments and when issued trading (DC Rule 5500)

We adopted the existing IDPC Rule provisions relating to margin requirements for underwriting commitments and when issued trading with no modifications.

2.1.6 Margin requirements for offset strategies involving debt and equity securities and related instruments (DC Rule 5600)

We adopted the existing IDPC Rule provisions relating to margin requirements for offset strategies involving debt and equity securities and related instruments with non-material modifications to formatting and numbering.

2.1.7 Margin requirements for offset strategies involving derivative products (DC Rule 5700)

We adopted existing IDPC Rule provisions relating to margin requirements for offset strategies involving derivatives with the following modifications:

• removed the “exchange-traded option” header from sections related to “basket, participation unit and futures combinations” and “cross index offsets and the optional use of the Standard Portfolio Analysis methodology” as these offsets do not include exchange traded options (DC Rule subsection 5701(2))
• added ability for Dealer Members to apply the short iron condor spread offset to inventory accounts, for consistency with other option offset rules (DC Rule subsection 5740(1))
• corrected language for margin requirements on long and short tripo combinations to replace “index basket” with the defined term, “qualifying basket of index securities” (DC Rule subclauses 5754(2)(i)(c) and 5755(2)(i)(c))

2.1.8 Account related agreements (DC Rule 5800)

We adopted existing IDPC Rule provisions relating to account related agreements with the following modifications:

• clarified that the guaranteed client’s account statements should be provided at least quarterly (DC Rule clauses 5820(1)(iv) and (v))
• replaced “Form 1” where applicable with the term “Investment Dealer Form 1” to align with the definition introduced in Phase 1 (DC Rule subclause 5821(1)(i)(d), subsections 5840(2) and 5850(1))

The defined terms Executives and Directors are specific to Investment Dealer Members. These terms are used in section 5821 related to restrictions on shareholder account guarantees and section 5822 related to restrictions on clients providing account guarantees. We did not make any modifications to include partners, directors and officers of mutual fund dealers in the restrictions for account guarantees. Since mutual fund dealers are restricted from offering margin to clients, the account guarantees would not be applicable. The restrictions on guarantees and loans to clients by Approved Persons (as defined in proposed Phase 1) and restrictions on guarantees and loans by mutual fund dealers will be addressed in futures phases.

The requirements related to financing agreements, such as cash and securities loan agreements and repurchase and reverse repurchase agreements, apply to both investment dealers and mutual fund dealers. Although margin requirements for financing transactions are set out in the Investment Dealer Form 1, any mutual fund dealers engaging in such financing activities would be subject to these margin requirements until the Mutual Fund Dealer Form 1 and Investment Dealer Form 1 are harmonized in future phases.

For example, where a mutual fund dealer engages in financing activities and is not party to a written agreement that contains the minimum terms set out in 5840(3) or 5850(2), the margin penalties in Investment Dealer Form 1 apply.

2.1.9 Agreement related margin requirements (DC Rule 5900)

We adopted existing IDPC Rule provisions relating to agreement related margin requirements with the following modifications:

• replaced “Form 1” with the term “Investment Dealer Form 1” to align with the definition introduced in Phase 1 (DC Rule subsections 5901(1), 5903(1) and 5903(2))
• introduced the corresponding French language defined term of “fixed rate” (and vice versa) to make it easier to access the corresponding term in the other language (DC Rule subsection 5902(1)).

The term risk margin requirements in DC Rule 5900 apply to both investment dealers and mutual fund dealers engaging in financing activities that would be subject to term risk. Both investment dealers and mutual fund dealers that engage in financing activities are also subject to the general margin requirements in Investment Dealer Form 1.

2.2 Debt Markets and IDBBs

The IDPC Rules contain regulatory requirements relating to debt markets, debt market transaction reporting and IDBBs in Series 7000. There are no equivalent regulatory requirements set out within the MFD Rules. Accordingly, we have adopted these rule provisions and included them as DC Rule Series 7000. These requirements have no application in the case of the activities of mutual fund dealers dealing in mutual funds but will impact mutual fund dealers dealing in debt securities as described below.

2.2.1 Debt markets (DC Rule 7100)

We propose to extend the debt securities trading and settlement practice obligations to mutual fund dealers dealing in debt securities to ensure like activities will be regulated in a like manner and minimize regulatory arbitrage between investment dealers and mutual fund dealers. (DC Rule 7100)

Most importantly, mutual fund dealers dealing in debt securities would have to establish, maintain and apply specific policies and procedures.

2.2.2 Transaction reporting for debt securities and IDBBs (DC Rules 7200 and 7300)

We are not proposing to extend transaction reporting for debt securities and IDBBs requirements to mutual fund dealers at this time. We have included a question later in this Bulletin asking for your views on whether transaction reporting for debt securities should be extended to mutual fund dealers.

We are proposing clarifying changes to the debt reporting requirements to reflect the current practice of reporting entities dealing in debt securities. (DC Rule subsection 7203(6))

These changes reflect current practice and are not intended to result in any material changes in the application of requirements to investment dealers dealing in debt securities or reporting entities subject to the reporting requirements in Rule 7200.

We have also introduced the corresponding French language defined term to each English language defined term (and vice versa) in Rules 7200 and 7300 to make it easier to access the corresponding term in the other language. (DC Rule subsections 7202(1) and 7302(1))

2.3 Trading

The IDPC Rules contain trading requirements relating to best execution (Part C of Rule 3100), client identifiers (Part D of Rule 3100) and client priority (section 3503). There are no equivalent regulatory requirements set out within the MFD Rules. Accordingly, we have adopted the rule provisions relating to best execution, client identifiers and client priority from the existing IDPC Rules. These requirements have no application in the case of the activities of mutual fund dealers dealing in mutual funds.

However, we propose to extend the best execution, client identifiers, and client priority requirements to mutual fund dealers dealing in exchange traded funds (ETFs) to ensure like activities will be regulated in a like manner and minimize regulatory arbitrage between investment dealers and mutual fund dealers. (DC Rule sections 3119 through 3129, 3140, and 3503)

Most importantly, mutual fund dealers dealing in ETFs would have to establish, maintain, and apply policies and procedures that specifically address achieving best execution for client orders and transactions. Mutual fund dealers would also need to ensure compliance with client order identification requirements and give priority to client orders or transactions over all other orders.

We have also introduced the corresponding French language defined term to each English language defined term (and vice versa) relating to best execution to make it easier to access the corresponding term in the other language. (DC Rule subsection 3119(1))

2.4 Adoption of rules pending implementation

In order to ensure that the proposed consolidated rules remain consistent over time with the existing and proposed IDPC Rules and MFD Rules, we have incorporated the following “business as usual” rule amendment proposals within the Phase 2 Proposed DC Rules:

• Amendments to facilitate the industry’s move to T+1 settlement – These amendments will be effective May 27, 2024. From these amendments we have adopted modifications to IDPC Rule sections 5560, 5561 and 5562 to shorten the timeline for the posting of client account margin to the first settlement day after the trade date.
• Proposed amendments to introduce margin requirements for structured products – From this proposal we have incorporated the proposed definitions in section 5130 and the proposed margin requirements in sections 5455 and 5456.
• Proposed amendments to CIRO’s derivatives-related requirements – From this proposal we have incorporated the proposed revised and updated version of the best execution requirements set out in Part C of Rule 3100.

3. Impacts of the Proposed DC Rules

3.1 Impact assessment approach

As the Rule Consolidation Project is being pursued in five phases, and the combined impact of the project can only be assessed once development of all five phases have been completed, it would be misleading for us to assess the impact of each phase in isolation from the other phases or to make an assessment of the combined impact of all five project phases until all phases have been developed.

To provide you with some impact information in the interim, we will identify the impacts specific to each project phase, as each project phase is published for public comment and provide an overall Rule Consolidation Project impact assessment once all five phases have been developed.

3.2 Specific impacts of Phase 2 Proposed DC Rules

There is minimum impact to investment dealers as the existing requirements will be adopted into the DC Rules with minimal modifications. Mutual fund dealers will be impacted as follows:

• changes to margin rates for certain inventory positions which generally result in lower margin requirements,
• potential additional margin due to foreign exchange margin requirements on foreign currency exposures,
• application of requirements for financing agreements and margin to mutual fund dealer activity in cash and securities loans, repurchase and reverse repurchase agreements,
• application of the best execution obligation to mutual fund dealer activity in ETFs, which may oblige mutual fund dealers to update their client disclosure, compliance systems, and policies and procedures, and
• application of trading and settlement practice obligations to mutual fund dealer activity in debt securities, which may oblige mutual fund dealers to update their client disclosure, compliance systems, and policies and procedures.

We have assessed the impact of the changes being introduced as part of the Phase 2 Proposed DC Rules as having an overall positive impact on investors, Dealer Members and CIRO staff. While there could be some negative impacts to mutual fund dealers, we concluded these impacts were outweighed by the positive impacts the Phase 2 Proposed DC Rules would have. A complete impact analysis of the Phase 2 Proposed DC Rules is attached as Appendix 4.

3.3 Regional impacts

We have identified no regional impacts associated with the Phase 2 Proposed DC Rules.

4. Alternatives to rule consolidation considered

We didn’t consider any alternatives to rule consolidation, such as maintaining separate rules for investment dealer members and mutual fund dealer members as, based on the feedback provided in response to CSA Position Paper 25-404, New Self Regulatory Organization Framework, we determined that there is general cross-stakeholder support for rule consolidation.

5. Questions

While comment is requested on all aspects of the Phase 2 Proposed DC Rules, comment is specifically requested on the following questions:

6. Policy Development Process

6.1 Regulatory Purpose

We took the public interest into consideration when developing the Proposed DC Rules and we believe the proposals achieve their intended objectives to ensure like dealer activities will be regulated in a like manner while minimizing regulatory arbitrage between investment dealers and mutual fund dealers.

We also believe the Proposed DC Rules will foster public confidence in capital markets by ensuring all CIRO Dealer Members will be held to standards of conduct that foster fair, equitable and ethical business standards and practices.

6.2 Regulatory Process

The Board of Directors of CIRO (Board) has determined the Phase 2 Proposed DC Rules to be in the public interest and on November 15, 2023 approved them for public comment.

We consulted with the following CIRO advisory committees on this matter:

• Conduct, Compliance and Legal Advisory Section (CCLS)
• Fixed Income Advisory Committee (FIAC)
• Market Regulation Advisory Committee (MRAC)
• Financial and Operations Advisory Section (FOAS) Capital Formula Subcommittee
• Ad-hoc Mutual Fund Dealer Member Financial Advisory Working Group

After considering the comments received in response to this Request for Comments together with any comments of the CSA, CIRO staff may recommend revisions to the Phase 2 Proposed DC Rules. If the revisions and comments received are not material in nature, the Board has authorized the President to approve the revisions on CIRO’s behalf and the revised Proposed DC Rules will be subject to approval by the CSA. If the revisions or comments are material, CIRO staff will submit the Proposed DC Rules, including any revisions, to the Board for approval for republication or implementation, as applicable.

7. Appendices

Appendix 1 – Proposed DC Rules – Phase 2 (clean)

Appendix 2 – Proposed DC Rules – Phase 2 (blackline)

Appendix 3 – Table of concordance

Appendix 4 – Impact Analysis of the Phase 2 Proposed DC Rules

Appendix 4 – Impact Analysis of the Phase 2 Proposed DC Rules

Impact Assessment Table

In the impact assessment table below, we list:

• the major policy elements of the Phase 2 Proposed DC Rules,
• a description of the intended policy benefits of each element, and
• an assessment of its impact on clients, investment dealer members (Investment Dealers), mutual fund dealer members (Mutual Fund Dealers), and CIRO itself.

Conclusions

We concluded that, if approved, the Phase 2 Proposed DC Rules would result in reduced potential for regulatory arbitrage by harmonizing:

• inventory margin rates for Mutual Fund Dealers and Investment Dealers,
• application of foreign exchange margin requirements to any Dealer Member with foreign exchange exposure,
• application of best execution obligation for any Dealer Member dealing in exchange traded funds (ETFs), including Mutual Fund Dealers, and
• application of best execution and trading and settlement practice obligations for any Dealer Member dealing in debt securities, including Mutual Fund Dealers.

We have assessed the impact of the changes being introduced as part of the Phase 2 Proposed DC Rules as having an overall positive impact on clients, Dealer Members and CIRO staff. While there could be some negative impacts to Mutual Fund Dealers, we concluded these impacts were outweighed by the overall positive impacts the Phase 2 Proposed DC Rules would have.

Cost Estimate 

We do not know the dollar magnitude of the collective impacts of the Phase 2 Proposed DC Rules, and we cannot determine it without detailed stakeholder feedback. For example, the harmonization of margin rates for Investment Dealers and Mutual Fund Dealers may require Mutual Fund Dealers to revise their margining process and systems to support the Phase 2 Proposed DC Rules. However, it is expected that most Mutual Fund Dealers will not be impacted as they do not invest in the same breadth of instruments as Investment Dealers. The Phase 2 Proposed DC Rules are not expected to have any significant incremental costs to Dealer Members and clients.