Skip to main content

Finance Minister Dwight Duncan (R) delivers the 2010 Ontario provincial budget as Ontario Premier Dalton McGuinty looks on in Toronto March 25, 2010.Mike Cassese/Reuters

The Ontario government is introducing broad new rules to police the $12-trillion Canadian derivatives market - an opaque corner of the financial world that played a key role in the global financial meltdown.

The move follows similar efforts by Europe and the United States to haul derivatives out of the shadows and avoid a repeat of the global banking crisis triggered by the collapse of Wall Street brokerage firm Lehman Brothers.

But Ontario is pre-empting similar initiatives already under way on multiple fronts in this country, including one led by the Bank of Canada, to make the largely unregulated domestic market safer and more transparent. Bankers and other regulators expressed surprise that the McGuinty government plans to move unilaterally.

"They are trying to jump the gun a little bit," said a senior banker. "They are desperate to have this be an Ontario solution."

A senior government official denied suggestions that Ontario is going it alone. Officials have every intention, he said, of working in concert with the Bank of Canada and other groups, including provincial securities regulators.

"What this legislation is about is setting up the framework. As soon as globally we know where everything is going to land, we can hit the go button."

Under proposed legislation to be unveiled on Thursday as part of the fall economic statement, Ontario's securities watchdog would have broad new powers over the trading of derivatives in the province, according to sources familiar with the plan.

The Ontario Securities Commission would supervise bankers who trade derivatives by requiring them to register with the regulator. The commission would also push ahead with the creation of an open market similar to a stock exchange for trading credit default swaps and other instruments now bought and sold privately between banks.

Finance Minister Dwight Duncan will table the 110-page omnibus bill as part of his economic statement, one he is using to buttress Canada's reputation as a safe banking haven.

"This helps the province maintain regulatory leadership and international competitiveness," the official said.

Derivatives contracts are instruments that call for money to change hands at a future date, with the amount to be determined by such factors as interest rates, stock prices or currency values. Financial institutions typically use swaps and other instruments to hedge various types of risk they face from fluctuations in currency exchange rates and interest rates. One of the most common types of credit derivatives, for instance, lets a bank buy protection against a borrower defaulting on a loan.

Derivatives activity mushroomed in a world that was largely unregulated, as most rules were designed for securities such as stocks and bonds. Since these instruments aren't themselves securities, they fell into a grey area.

After the financial crisis in 2008 showed that derivatives had the potential to be a weak link in the system, global financial regulators began pushing for tighter controls on the trades and on the traders.

An investment banker questioned why the Ontario government is proposing to hand oversight for derivatives to the securities regulator, which is responsible for protecting individual "mom and pop" investors. The regulation of derivatives is concerned with systemic risk to the economy, he said, not about protecting the small investor.

He added that the Ontario government appears to be stepping into a vacuum created by banking regulators trying to figure out their own plan to monitor derivatives and a proposed national securities regulator that is opposed by several provinces.

To ensure that trades are more open and sound, Canada and other G20 members have committed to move large chunks of derivatives trading onto exchanges. Currently, many derivatives trades are done privately between banks.

The G20 has also committed to trying to strengthen the system by demanding that more derivatives trades be done through financially powerful middlemen known as central clearinghouses. That's designed to ensure that the failure of one bank, like a Lehman Brothers, can't ripple through to other banks.

In Canada, the central bank is working with major banks to try to develop that system.