Foreign-based trading facilities in Ontario: A regulatory review

Introduction

In an increasingly global world, marketplaces are digitized and compete for international participants. Facilitation of access to foreign marketplaces is becoming an increasingly global endeavour. Both foreign marketplaces and Canadian market participants alike want facilities in place that provide efficient markets and access to capital and liquidity.

However, not all foreign marketplaces are made equal. Unwrapping access to Ontario participants by foreign marketplaces, which in some cases may not be subject to the same high standards of investor protection, means the Ontario Securities Commission (the OSC) and other securities regulators are tasked with balancing (A) access to foreign marketplaces so that investor choice is maintained, with (B) regulation and oversight of foreign marketplaces such that the high standards of investor protection and market integrity are upheld.

The regulatory framework: A brief overview

The regulatory landscape is complicated and multi-faceted. Foreign exchanges are faced with significant regulatory requirements. Despite some overlap, there are different classifications of, and requirements imposed on, different categories of foreign marketplaces. Foreign marketplaces include, among others: foreign alternative trading systems (Foreign ATSs), foreign multilateral trading facilities (Foreign MTFs), foreign derivatives exchanges and swap execution facilities (Foreign SEFs) and foreign-based stock exchanges (Foreign Exchanges). Despite similarities and some overlap in the regulatory approach to each, discrete differences surrounding Foreign Exchanges, Foreign ATSs, Foreign SEFs and Foreign MTFs remain. The focus of this article is on Foreign Exchanges.

Broadly, when determining whether a Foreign Exchange is carrying on business in Ontario, the test does not rest solely on the physical location of the Foreign Exchange. The OSC considers that an exchange located outside Ontario is “carrying on business as an exchange” in Ontario if it provides Ontario participants with direct access to the exchange.

There is a dual-track regulatory approach that governs exemptive relief for Foreign Exchanges aiming to provide Ontario residents with direct access to foreign marketplaces. In order to carry on business as an exchange in Ontario, a Foreign Exchange must either: (i) obtain a recognition order under section 21 of the Securities Act (Ontario) (the Act); or (ii) obtain an exemption order from recognition under section 147 of the Act.

The Application

Whether applying for recognition or an exemption, the application process can be lengthy and onerous. The applicant must submit a detailed application covering aspects of its history, business and regulatory structure. It must further address how it meets certain specified criteria. After the application has been submitted, the OSC provides comments. Once the OSC commentary period is complete, and the application and order have been finalized, both are published and open to public comment for a period of 30 days.

(i) Applying for a Recognition Order

In order to obtain a recognition order, an applicant must provide robust disclosure that includes a description of the applicant’s operations and how it meets certain criteria prescribed by the OSC. The application process for a Foreign Exchange is the same as the one used for the recognition of a domestic-based stock exchange. Numerous filings are required, including of financial information and certain policies and reports. Based on its review of the prescribed criteria, any recognition order issued by the OSC may be subject to certain terms and conditions.

(ii) Applying for an Exemption Order

In considering applications for exemption orders under Section 147 of the Act, the OSC recognizes that most Foreign Exchanges are already subject to a regulatory regime in their home jurisdiction. However, since the governing regulatory regime and level of investor protection in an applicant’s home jurisdiction may materially differ from that of Ontario, the applicant must demonstrate that it meets the same criteria required of a domestic exchange (at the time of its application). Such criteria may be slightly tailored to meet the particularities of the Foreign Exchange such as the products traded on the exchange, or its regulatory environment.

Once the applicant has established that it has met the necessary criteria and that it is subject to an appropriate regulatory regime, the Foreign Exchange will not be subject to many of the ongoing requirements applied to domestic exchanges.

In making a recommendation to exempt a Foreign Exchange, the OSC may impose certain terms and conditions which will vary depending on specific circumstance. Such terms and conditions may include certain notice obligations, operational reporting obligations and financial reporting obligations.

Enforcement

Applications filed with the OSC must contain candid, accurate and complete information. Such applications must also disclose if an applicant is in breach at the time of the application. After a recognition order or exemption order has been issued, it is critical that the Foreign Exchange strictly comply with such order’s terms and conditions. A successful applicant must also fastidiously adhere to regular reporting requirements.

Any breach by a Foreign Exchange of a recognition order or exemption order is a contravention of Ontario securities laws and can entail disgorgement of profits and hefty penalties, which can further portend reputational damage.

Key takeaways

Desired access to Ontario’s robust and mature capital markets by foreign marketplaces is a sign of the times. Regulatory requirements imposed on such foreign marketplaces seeking to carry on business in Ontario are onerous and significant. Failure to adhere to such obligations can carry heavy consequences. Navigating the regulatory landscape, from submission of the initial application to ongoing operational requirements after an order has been obtained, can be racked with complexity. Careful consideration that foreign marketplaces are above board at every step of the process is of critical importance.