Canadian Structured Finance Law : Canadian Structured Finance Law: Securitization/OTC Derivatives Blog by Stikeman Elliot Lawyers & Attorneys

Michael Rumball

To any reader of military history the following adage is very familiar: the military always prepares to fight the last war. One could say that this adage applies equally well to the SEC proposals. The more one plows through them the more one is struck by how its formulation of the problems, and thus the solutions proposed, have been dictated by the specific character of the 2007-09 RMBS collapse. For instance, it is received wisdom that at the root of the collapse was the deteriorating underwriting standards of originators. The SEC appears to believe that this deterioration might have been revealed earlier had there been adequate asset-level disclosure. Accordingly, it proposes to make mandatory in any public issue and for all asset classes (other than credit cards, for which certain groupings are contemplated) certain very specific disclosure points.

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Alix d’Anglejan-Chatillon

AMF Staff issued a notice last week further extending the term of the temporary exemption provided under its February 1, 2009 blanket decision No. 2009-PDG-0007 (the Blanket Order). The Blanket Order provides relief from the derivatives dealer and adviser registration requirements and the derivatives qualification rules under the Derivatives Act (Quebec) for specified derivatives activities carried out solely with “accredited investors” (as defined under National Instrument 45-106 Prospectus and Registration Exemptions). The original exemption had been extended to September 28, 2010 in a March 26, 2010 AMF Staff notice. Last week's notice further extends the Blanket Order for an indefinite term and states Staff's intention to publish any amendments to the relief "at an appropriate time".

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Nova Scotia's Securities Transfer Act, which gained Royal Assent back in May, has now been proclaimed into law. According to Minister of Service Nova Scotia and Municipal Relations Ramona Jennex, the legislation "brings greater legal certainties around the holding, transferring and pledging of securities."

By our count, that leaves PEI and the Yukon as the only Canadian jurisdictions left without any similar legislation. For links the legislation of the respective provinces and territories, see our Resources page.

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Michael Rumball

A number of the SEC Proposals on Asset-Backed Securities have attracted much criticism but perhaps none more so than the proposed requirement for issuers to file on EDGAR, as part of an ABS offering, a waterfall computer program of the contractual cash flow provisions of the securities being offered.  If enacted, it is not unreasonable to posit that this single aspect of the proposals might be sufficient to drive issuers out of the public market.

The proposed rule’s policy objective is to provide to potential investors the wherewithal to conduct their own evaluation of the securities so that they can make an informed decision on whether to participate in the offering without undue dependence on the opinions of credit rating agencies.  The underlying premise here appears to be that investors’ lack of understanding of complicated securitization structures resulted in poor investment decisions in the past.

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Michael Rumball

The market meltdown of 2007-2008 was a complex event and the causes will be debated for many years.  Nevertheless, one of the early frontrunners for the title of “the root cause” is the “originate-to-distribute model”.  In order to satisfy investors’ seemingly insatiable appetite for ABS or ABS derived securities in the years leading up to the meltdown, sponsors and originators needed vast amounts of assets.  As opposed to the existing model of established originators using securitizations as a means to finance their traditional lending, loans were originated for the sole purpose of providing fuel for the securitization machine.  In order to keep the machine running at capacity, assets further and further down the credit spectrum were sought out resulting in the calamities with which we are by now very familiar.

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Citing the need to increase transparency and reduce counterparty and operational risk, the European Commission today released new proposals to regulate the OTC derivatives market. Among other things, the proposals would require trades in OTC derivatives in the EU to be reported to central data centres (trade repositories) accessible to regulators. A new European Securities and Markets Authority would be responsible for registering and monitoring trade repositories, while standard OTC derivatives would have to be cleared through central counterparties. The EC expects the proposals to be promulgated by the end of 2011.

For more information, see the EC Press Release and the accompanying Impact Assessment.

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Margaret Grottenthaler

Those of you who know me personally know I like to read – A LOT. So, as usual, I spent my summer on the beach, book in hand. I did have good intentions to read the US financial reform legislation, but it just didn’t seem to go as well with a G&T as the novels I took to the cottage. I’ll get back to the recommended derivatives reads next month, but I thought I would share my three favourites from the more than 20 novels I read this summer (and no, I didn’t read any of those girl with the tattoo novels – those are SO last summer).  

The Passage by Justin Cronin. Yes, I know this is a book about vampires, but it was good. Really. Well written, compelling, fun – well as fun as a book about mass plague wiping out all life in North America can be. Bet they make a movie of this.

The Raw Shark Texts by Steven Hall (2007). One of the most inventive novels I’ve read in eons. There is a 50 page flip book in the middle with an approaching shark. Need I say more? Yet in case you think that sounds pretentious, it’s a great story with all kinds of allusions to films, other writers etc. That actually sounds pretentious too, but it’s not. Bound for moviedom as well I’m sure. 

The Thousand Autumns of Jacob de Zoet by David Mitchell. This author is a genius and this book is great. It’s set in 1799 in a Japanese Dutch trading post which in and of itself is interesting. Love story, coming of age story, adventure story (yes, there are samurai). 

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The TMX Group Inc. issued a paper last week providing its perspective on issues deriving from the financial crisis and discussing how the core competencies of a combined regulated exchange and clearing house are designed to meet G-20 objectives respecting improving over-the-counter (OTC) derivatives markets. While the paper focuses primarily on the TMX Group's competencies applicable to OTC and exchange-traded derivatives, it does provide an interesting viewpoint on how Canada should respond to prevent similar crises from recurring.

According to the TMX,

[t]he financial crisis was global, and international organizations are adopting recommendations and commitments to address key global issues. However, legislators, regulators and supervisors are provincial and national, and it will be these authorities, working with market operators and market participants who will be responsible for both the implementation and the success of these measures.

Specifically, the paper recommends to Canadian regulators that they utilize domestic facilities with international linkages to provide regulatory oversight of OTC markets, such as trading, clearing, data warehousing and regulatory services. According to the TMX, such a regulatory scheme would satisfy the G-20 requirements of strengthening prudential oversight, improving risk management, increasing transparency, promoting market integrity, protecting against market abuse, mitigating systemic risk and reinforcing international cooperation.

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Michael D. Rumball

Since the Securities and Exchange Commission issued a request for comments on its proposed rules on asset backed securities on April 7, market participants have weighed in with their comments.  Here are some of the things that ABS market dealers, investors, lawyers, accountants and originators have been saying (paraphrased of course).

1. The proposed asset-level disclosure requirements are inappropriate for many asset classes, such as auto loans and leases, and may deter securitizations and eliminate market access for some issuers.

2. The waterfall computer requirement takes two distinct aspects of securitization – monthly distribution reports and ABS modeling – and requires issuers to provide a single program that can do both.  Programs do not exist that would meet the proposal’s specifications and developing that sort of model would add a substantial burden to issuers.

3. The “one size fits all” risk retention proposal, which would require a 5% “vertical slice” of all issued securities to be retained, is not appropriate for many asset classes, such as auto loans and leases.

4. The proposal to require an issuer relying on one of the safe harbours for private placements to provide, upon request from an investor, the same information that would be required as if the products were issued in a registered transaction would significantly adversely affect this market.

In future postings we will return to a more detailed look at each of these issues and various other aspects of the SEC release and the elicited comments.

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On August 31, the Investment Industry Regulatory Organization of Canada (IIROC) released findings and recommendations deriving from its 2009 compliance review of principal protected notes (PPNs). The review, based on a representative sample of dealers, considered, among other things, the adequacy of the selling firm's knowledge of the product and the firm's training for sales personnel and whether appropriate point of sale disclosure was provided to investors.

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On August 30, the U.S. Commodity Futures Trading Commission (CFTC) released final rules respecting off-exchange retail foreign currency transactions. The rules, which include requirements regarding registration, disclosure, recordkeeping, financial reporting, minimum capital and other operational standards, among other things, take effect on October 18.

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Last week, the U.S. Securities and Exchange Commission (SEC) released a report cautioning nationally recognized credit rating agencies about "deceptive ratings conduct and the importance of sufficient internal controls over the policies, procedures, and methodologies the firms use to determine credit ratings." The report stems from an investigation into whether Moody's Investor Service, Inc. violated federal registration or antifraud provisions. The SEC also stated in the report that it will utilize new provisions in the Dodd-Frank Act "for enforcement actions alleging otherwise extraterritorial fraudulent misconduct that involves significant steps or foreseeable effects within the United States."

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