Canada Gazette

Efficient capital markets require a modern legal framework for financial transactions. This framework must provide issuers, investors and other parties to a transaction with clear rights and obligations. It must also keep up with international standards, advances in business practices, and evolving types of financial instruments.

The use of "eligible financial contract," commonly referred to as derivatives, has become an integral part of the risk management strategy for many Canadian businesses. For example, they are currently used by lenders, commodity companies, and exporters that wish to protect against risk related to credit default, commodity prices, or currency fluctuations. Growth in both exchange-traded and over-the-counter derivatives markets has been strong in recent years.

In this context, Canadian insolvency and financial sector legislation currently permits the termination of an "eligible financial contract" and the netting of financial obligations between the insolvent party and the counterparties under such contracts. In addition, the legislation has recently been amended to allow counterparties to seize financial collateral under eligible financial contracts. These rights are not generally available to counterparties to contracts that do not fall within the definition of "eligible financial contract." Because of these particular rights, determining which contracts qualify under the definition is vitally important to the parties and financial markets.

The definition of "eligible financial contract" was enacted in 1992 and has never been amended. The definition can be found in the Bankruptcy and Insolvency Act, the Companies' Creditors Arrangement Act, the Winding-up and Restructuring Act, the Canada Deposit Insurance Corporation Act, and the Payment Clearing and Settlement Act (by reference to the Winding-up and Restructuring Act).

Three factors are driving the need to revise the definition. First, the financial markets have evolved significantly since 1992 and the definition is no longer in line with current practice. As such, there are inconsistencies in application that are causing difficulties in the market. Second, the United States and the European Union have legislation that contains a modern definition. The legal risks associated with the inconsistencies are reducing the competitiveness of Canadian financial markets, financial institutions and other market participants. Third, the Basel II Capital Accord, which will be applicable to Canadian banks starting on November 1, 2007, has drawn attention to national insolvency regimes. Legal opinions prepared for foreign market players highlight the fact that the Canadian legislation is not competitive vis-à-vis other jurisdictions.

To address this issue, Part 9 of the Budget Implementation Act, 2007, which received Royal Assent on June 22, 2007, introduced amendments to enable the Governor in Council to prescribe the meaning of "eligible financial contract." This will allow the Government to establish a revised definition of "eligible financial contract" and to update it with relative ease as financial market practices evolve.

The proposed revised definition, which is largely based on the current definition, has the benefit of explicitly referring to financial contracts that have become or could become commonly transacted in the markets. In addition, it includes margin loans made by securities intermediaries, as well as a broader "basket clause," that will allow the definition to better keep up with market practice. The revised definition will be consistent with that of the United States and the European Union.

The proposed General Rules would apply to the Bankruptcy and Insolvency Act and the Companies' Creditors Arrangement Act, which are the responsibility of the Minister of Industry. Similar regulations are being proposed in respect of the Winding-up and Restructuring Act, the Canada Deposit Insurance Corporation Act, and the Payment Clearing and Settlement Act.

Maintaining the status quo fails to provide enough legal certainty to Canadian financial market participants. Further, it would put Canada's financial markets at a competitive disadvantage vis-à-vis the United States and the European Union.

Updating the definition by amending the legislation limits the Government's ability to further revise it as financial markets continue to evolve. The original definition has not been amended in over 15 years despite the changing markets.

In light of evolving financial markets and of the upcoming implementation of the Basel II Capital Accord in Canada, the revised definition would provide legal certainty to market participants and ensure that Canadian financial markets remain competitive vis-à-vis other jurisdictions.

The Department of Finance and the Department of Industry have consulted with key stakeholders regarding this proposal. In addition, a number of other market participants have expressed their support for a change. To date, neither department is aware of any opposition to the revised definition.

The proposed General Rules would not result in any alteration to compliance or enforcement. The revised definition of "eligible financial contract" would simply serve as the new basis for determining which contracts are eligible for special treatment in insolvency. Further, as the revised definition would better reflect current market practices, it would be less likely to result in litigation.

Susan Bincoletto
Director General
Marketplace Framework Policy Branch
Industry Canada
Ottawa, Ontario
K1A 0H5
Telephone: 613-952-0211
Fax: 613-948-6393
Email: bincoletto.susan@ic.gc.ca

Notice is hereby given that the Governor in Council, pursuant to subsection 18(1) of the Companies' Creditors Arrangement Act, proposes to make the annexed Eligible Financial Contract General Rules (Companies' Creditors Arrangement Act).

Interested persons may make representations concerning the proposed Rules within 30 days after the date of publication of this notice. All such representations must cite the Canada Gazette, Part I, and the date of publication of this notice, and be addressed to Susan Bincoletto, Director General, Marketplace Framework Policy Branch, Industry Canada, 235 Queen Street, Ottawa, Ontario K1A 0H5 (tel.: 613-952-0211; fax: 613-948-6393; e-mail: bincoletto.susan@ic.gc.ca).

ELIGIBLE FINANCIAL CONTRACT GENERAL RULES (COMPANIES' CREDITORS ARRANGEMENT ACT)

1. The following kinds of financial agreements are prescribed for the purpose of the definition "eligible financial contract" in section 2 of the Companies' Creditors Arrangement Act:

(b) a derivative agreement settled by payment or delivery the price of which is directly dependent on and derived from the value of one or more underlying reference items such as interest rates, indices, currencies, commodities, securities or other ownership interests, credit or guarantee obligations, debt securities, weather, bandwidth, freight, emission rights, real property indices and inflation or other macroeconomic data and includes

(i) a contract for differences or a swap, including a total return swap, price return swap, default swap or basis swap,

(ii) a cap, collar, floor or spread,

(iii) an option, and

(iv) a spot or forward;

(i) borrow or lend securities or commodities,

(ii) clear or settle securities, futures, options or derivatives transactions, or

(iii) act as a depository for securities;

(d) a repurchase, reverse repurchase or buy-sellback agreement with respect to securities or commodities;

(e) a margin loan agreement made by a financial institution or securities intermediary;

(f) an option in respect of an agreement referred to in any of paragraphs (a) to (e);

(g) any other agreement, however structured, that serves a financial purpose equivalent to that of an agreement referred to any of paragraphs (a) to (f);

(i) a master agreement in respect of an agreement referred to in any of paragraphs (a) to (h);

(j) a master agreement in respect of a master agreement referred to in paragraph (i);

(k) a guarantee of, or an indemnity or reimbursement obligation with respect to, the liabilities under an agreement referred to in any of paragraphs (a) to (j); and

(l) an agreement relating to financial collateral, including any form of security or security interest in collateral and a title transfer credit support agreement, with respect to an agreement referred to in any of paragraphs (a) to (k).

2. These Rules come into force on the day on which subsection 104(2) of the Budget Implementation Act, 2007, chapter 29 of the Statutes of Canada, 2007 comes into force.