Derivative Structures

Derivative instruments work is generally understood to incorporate both the private and public derivative markets. On the private side, legal work will cover preparation of documentation for negotiation and assisting in the development of a wide range of products including interest rate, basis and cross-currency swaps; equity index and commodity swaps and forwards; over-the-counter options on government bonds (domestic and foreign), commodities, equity indices and other underlying interests; warrant products; caps, collars, floors, swaptions; forward rate agreements; foreign exchange contracts; and structured notes and hybrid securities. On the public side of the derivatives market activities will include, in addition to the work noted above, a presentation of issuers or agents in public derivative product offerings and preparation of documentation for and assisting in the development of a variety of different financings involving the use of derivative products, including asset and inventory securitizations and oil, gold, and other commodity monetization programs.

Income Tax Characterization of Derivatives

In March 2020, the Supreme Court of Canada in its decision in MacDonald v. Canada re-affirmed the existing test for determining whether a derivative contract entered into by a taxpayer constituted a hedging transaction for Canadian income tax purposes. According to a Stikeman Elliott LLP client bulletin, the decision is useful as it “consolidates several principles relating to the income tax characterization of derivatives that were previously found in a number of different cases, rendered by courts of different levels, into one judgment of the SCC.”1

Although MacDonald does not break new ground, it “provides a helpful framework for the income tax characterization of derivative contracts.” The report concludes: “While some issues still remain, such as the degree of linkage required to establish the existence of a hedging transaction and the relevance of a taxpayer’s intention for entering into a derivative contract, the SCC’s decision is useful addition in the body of jurisprudence involving the Canadian income tax treatment of derivative contracts.”

Margin Requirements for Non-Centrally Cleared Derivatives

In July 2016, the Canadian Securities Administrators (CSA) proposed a new framework for minimum margin requirements for non-centrally cleared derivatives. The proposals are part of an ongoing effort to make the over-the-counter (OTC) derivatives market more secure and transparent. According to a McCarthy Tétrault LLP client bulletin, the proposed framework is “largely consistent” with standards developed by the Basel Committee on Banking Supervision, the International Organization for Securities Commissions, and the Office of the Superintendent of Financial Institutions.2

The margin requirements apply to all OTC derivatives not cleared through a central counterparty where the counterparty to the derivatives are “covered entities.” Such entities are financial institutions whose outstanding derivatives exceed C$12 billion calculated on an aggregate month-end average. Covered entities whose initial margin on outstanding derivatives exceeds C$75 billion must exchange initial margin and variation margins. The proposal provides a formula for calculating these values. Initial margin may not be repledged or reused, except on a one-off basis to fund back-to-back hedges.

Assets exchanged as margin should be highly liquid and non-volatile in times of financial stress. They should not be dependent on the creditworthiness of the counterparty providing the collateral or on the value of the derivatives that are the consideration for the exchange. Their quoted prices should be reasonably accessible to the public.

Amendments to OTC Derivatives Trade Reporting Rules

Amendments to OTC trade reporting rules came into force throughout Canada on July 29, 2016. The amendments require local counterparties to obtain legal entity identifiers (LEI), which are part of a global system used to identify counterparties to financial transactions.

“This amendment addresses an anomaly in the existing rules which require a reporting party to report the LEI of its counterparty, but the reporting party has no ability to obtain this LEI on behalf of its counterparty,” says a McCarthy Tétrault LLP bulletin. “Now that there will be an obligation placed on all local counterparties to obtain an LEI, this should assist reporting parties in satisfying their obligation to report the LEI of counterparties.”3

The rules also reduce the scope of public disclosure. The existing rules require that certain information be publicly disseminated, other than for inter-affiliate transaction. The amendments now limit the disclosure requirements to the following transactions: interest rate swaps based on CDOR, USD LIBOR, EURIBOR, and GBP LIBOR; credit derivatives on all indices; and equity derivatives on all indices. Transactions involving the exchange of more than one currency or resulting from a bilateral or multilateral compression exercise are also excluded.

“By limiting the asset classes of transactions to be disclosed, along with the imposition of rounding and capping conventions, the amendments attempt to balance the benefits of post trade transparency with the potential harm that may be caused from inadvertently disclosing a counterparty’s identity.” Parties required to disseminate must do so within 48 hours after the transaction’s timestamp.

  1. Amirault, Kate, and Jonathan W. Willson. “The Income Tax Characterization of Derivatives: The Supreme Court of Canada Weighs In.” Stikeman Elliott. April 6, 2020.
  2. Fouin, Laure, Candace Pallone, and Sonia J. Struthers. “Derivatives Update: CSA Propose Margin and Collateral Requirements for Non-Centrally Cleared Derivatives.” McCarthy Tétrault LLP. August 31, 2016.
  3. Pallone, Candace, and Barry J. Ryan. “Anticipated Amendments to OTC Derivatives Trade Reporting Rules in Ontario, Manitoba and Quebec Adopted.” McCarthy Tétrault LLP. May 31, 2016.



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