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Kevin Fine is Director of the Derivatives Branch at the Ontario Securities Commission (OSC). The Investor Office recently sat down with Kevin to discuss his background, what derivatives are and the role of the Derivatives Branch.
Prior to working at the OSC, I worked for the legal department and capital markets group at one of the major banks for many years where I provided legal support for the derivatives desks of the bank all over the world.
I came to the OSC, along with Deb Foubert, on a secondment. The OSC needed assistance from a couple of the banks to draft new derivatives legislation as an amendment to the Securities Act. The legislation was passed in 2010, and in 2011, I stayed on as Director of the Derivatives Branch.
What is a derivative?
A derivative is a contract whose market price or value is derived from an underlying reference or asset.
When we give our education seminars, we give standard examples like interest rate swaps, credit default swaps, commodity swaps, and equity swaps. But we also like to give the ‘sofa example’. When you go to a furniture store and buy a sofa but don’t pay right away, you’re agreeing to pay a certain amount at a time in the future. That’s technically a derivative contract – though not one that is covered under the Securities Act.
But that’s mostly what it is: an instrument related to fluctuations or changes in pricing in the future. Corporations can fix the prices for commodities that they use or future payments they are owed or owe. They would do this if they are worried about fluctuations, for example, in the US or Canadian dollar exchange rates.
The movie The Big Short has some great tutorials in regards to some of the more complicated derivatives and how these types of products absolutely contributed to the international financial meltdown of 2008. If someone is trying to get a better sense of what these products are, I think the movie is a fun place to start.
On the role of the Derivatives Branch…
We do a variety of things related to derivatives. Our first job was to create the regulatory framework and rules the G-20 mandated post financial crisis to lower systemic risks. We have lawyers, risk managers, and a group that take care of our data governance and data collection. We draft the rules regulating derivatives, and process exemption requests for the rules that are in place.
We are also, in conjunction with the Compliance & Registrant Regulation (CRR) Branch, doing audits of our earliest rule in place: the trade reporting rule. We are in the process of doing audits on Canadian banks, which is a first for a Canadian securities commission and an important piece in ensuring that we are getting the most accurate data and that the banks are complying with the rules.
On the data side, we currently have over one billion data points and we receive approximately 4 to 6 million records a week. In order to process all of this information efficiently and accurately we are working on expanding our capabilities and automating the loading of the data that comes into the system. This will put us in a position to expand the capabilities of the system and eventually bring in other data sets so that we can better monitor and surveil from both a systemic risk and enforcement point of view.
On his current priorities…
We are about to release a business conduct rule that will apply to derivatives dealers including banks. We recently finalized a Segregation and Portability Rule which is our version of an investor protection rule. If you are participating in the derivatives markets as an end user, not as a dealer, and you provide collateral for a cleared transaction, this rule will provide certain protections. This rule will go into force by summer of 2017.
We are also working on a rule to deal with the electronic trading of derivative products. Those platforms have the potential to change the way the market works.
Any final thoughts?
One of my main messages is that derivatives are not inherently bad. Warren Buffett’s famous quote about them being ‘weapons of mass destruction’ really did a disservice to the hedging products. In general, basic hedging of your obligations is good for business. It’s encouraged by accounting practices and it’s absolutely legitimate. The problem lies within excessive risk-taking, poor credit and risk management and market misconduct. All of those factors can introduce significant risk to our financial system. Our objective is to make the derivatives market safer for all market participants.