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

Douglas J. Klaassen -

For those of us who follow the largely self-inflicted trials and tribulations of the US residential securitization business, the recent White Paper from the American Securitization Forum (Transfer and Assignment of Residential Mortgage Loans in the Secondary Mortgage Market) is an interesting review of a couple of current legal issues associated with U.S. residential mortgage conveyancing that relate directly to the integrity of US securitization structures and foreclosure actions. These mortgage conveyancing practices are being raised daily in US residential foreclosure actions, and certain recent US Court decisions have raised some fundamental questions of concern to the securitization industry. One of these issues (the use of title nominees) is relevant to Canadian mortgage lending and securitization structures, so a short summary here is in order.

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As expected, the government of Ontario has now introduced proposed amendments to the Securities Act (text not yet available) that would allow the Ontario Securities Commission to develop a regulatory framework to govern over-the-counter (OTC) derivatives. According to the government's economic update released this afternoon, the proposed framework would be consistent with the federal government's plan to implement a national securities regulator. 

In addition to tackling OTC derivatives regulation, the proposed amendments would also "provide for regulatory oversight of credit rating agencies and strengthen the oversight of alternative trading systems".

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According to various media outlets, including the Globe and Mail and the Financial Post, the Ontario government is expected to introduce proposals later today relating to the regulation of derivatives. The expected move may raise the question of how Ontario's proposals will fit with those of other jurisdictions. Watch for more details once the proposals are released this afternoon.

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 Michael Rumball

After last week’s relatively optimistic note, its back to grim reality, in this case the Reg AB II proposals relating to the private market.  These would require that, in order for a reseller of a “structured finance product” to sell a security in reliance on Rule 144A or in order for an issuer of a “structured finance product” to sell a security in reliance on Rule 506 of Regulation D (the so called “safe harbors”), the underlying transaction agreement must grant to initial investors and transferees, as applicable, the right to request, both initially and on an ongoing basis, the same information that would have been required had the transaction been registered.

While the SEC acknowledges that this proposal is “significant” it claims it to be nonetheless necessary due to the fact that “the recent financial crisis exposed deficiencies in the information available about CDOs and other privately issued structured finance products”. While one can debate whether the financial crisis exposed deficiencies in the available information or rather deficiencies in the market participants’ sense of judgment, it seems at least to be clear that the crisis had something to do with RMBS and CDOs involving RMBS.  The latter transactions were unique in their capacity to magnify and, indeed, multiply the risks inherent in the RMBS market which, as it turns out, were copious and, as many have argued, unique to that market sector.  Nevertheless, the SEC has seen fit to once again visit the sins of the RMBS sector on the entire ABS market with significant adverse consequences.

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Cora Zeeman

As recently discussed on our securities blog, on October 27, the Canadian Securities Administrators (CSA) issued Staff Notice 51-333 – Environmental Reporting Guidance to provide guidance to reporting issuers on satisfying existing continuous disclosure requirements with respect to environmental concerns. Specifically, Staff Notice 51-333 is intended to assist issuers in determining what information about environmental matters needs to be disclosed by reporting issuers based on the requirements found in National Instrument 51-102 Continuous Disclosure Obligations (NI 51-102), National Instrument 58-101 Disclosure of Corporate Governance Practices (NI 58-101) and National Instrument 52-110 Audit Committees (NI 52-110).

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The bridge institution provisions of the Canada Deposit Insurance Corporation Act (CDIC Act), as they relate to the exemption from the termination, netting and collateral enforcement safe-harbour that otherwise applies in a CDIC receivership of a deposit insured federal institution, came into force on November 1. As we discussed in July, the amendments were part of federal Bill C-9, the Jobs and Economic Growth Act.

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Alix d’Anglejan-Chatillon and Jason Streicher

Omnibus financial legislation introduced by the Quebec government on November 10, 2010 includes technical amendments to Quebec's derivatives legislation, as well as provisions intended to improve the oversight of persons authorized to market a derivative and to strengthen the process of authorization of the marketing of the product.

The technical amendments would include expanding the list of instruments included in the definition of "derivative" under the Derivatives Act (Quebec) (the QDA) to cover contracts for differences (CFDs) specifically. 

Bill 128 would also incorporate more detailed requirements to provisions under the QDA that are not yet in force governing persons qualified under the QDA to create or market a derivative.  These new provisions include requirements that a qualified person maintain a corporate and organizational structure and adequate human, financial and technological resources to enable it to operate effectively and ensure the security and reliability of its transactions and activities.  A qualified person would also be required to have adequate business policies and procedures and appropriate governance practices, including, in particular, with respect to the independence of its directors and the auditing of its financial statements. The amendments also clarify that a qualified person would be required to register as a dealer or offer derivatives to the public through a dealer.

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 Michael Rumball

Finally some good news. It may be recalled that in April the SEC released its proposals for Reg AB II including proposals relating to risk retention.  These proposals generated heated responses from industry participants mostly due to the requirement that securitizers (other than in credit card transactions) retain a 5% interest in each tranche of offered securities (a so-called “vertical slice”).  The stated purpose of this proposal was to realign incentives among market participants in response to the abuses associated with the “originate–to–distribute” transaction model.  It was rightly remarked that several market sectors, most notably auto and equipment finance, never employed this model but did employ alternative risk retention models which performed as expected during the crisis.

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On October 22nd, 2010, the government of British Columbia released draft cap and trade regulations for public consultation. The proposed regulations establish the rules for emissions trading and offset projects in the province and are part of the province's commitment to the Western Climate Initiative. The public consultation period is open until December 6, 2010.

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Margaret Grottenthaler

If you were waiting to hear what the English Court of Appeal had to say about the lower court decision in Marine Trade S.A. v. Pioneer Freight Futures Co. Ltd. you’ll be disappointed, as the appeal was dismissed by consent of the parties on October 22, 2010.  Given the reasonableness of the lower court decision, however, that’s just fine by me.  If you missed it when it was decided in October 2009 (or maybe you can’t remember if you read it), here’s a short description of the decision.

Marine Trade and Pioneer were parties to a Forward Freight Agreement master agreement (under which they entered into numerous cash settled CFDs based on a published freight rate index).  The parties were both buyer and seller under the various CFDs. The FAA agreements incorporate terms from the ISDA Master and the case is in large part about the rights to suspend and net payments under section 2 of the ISDA Master.

The monthly settlement amounts due in January 2009 were about US$7m owing by Pioneer to Marine Trade and US $12m owing by Marine Trade to Pioneer.

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Michael Rumball

The second SEC release in response to the requirements of the Dodd Frank Act deals with the requirement of issuers to perform a review of the assets underlying an ABS and to disclose the nature of the review.  It too may have a dampening effect on private placements into the U.S.

One interesting aspect of this release is the apparent willingness of the SEC to interpret the statute narrowly when given the opportunity, in this case, the Act’s requirement that the SEC issue rules “relating to the registration statement”.  The SEC seized upon this to conclude that these rules were meant to apply to registered offerings only and not to unregistered offerings.

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The Canadian Securities Administrators yesterday published a consultation paper on over-the-counter derivatives regulation in Canada intended to address "some of the deficiencies that have become apparent in the OTC derivatives market". Specifically, the consultation paper provides background on the need for regulation and provides a number of specific proposals. Among other things, the report recommends and requests comments on:

• mandatory central clearing of OTC derivatives that are determined to be appropriate for clearing and capable of being cleared, such as standardized derivatives. This is the approach taken by the Dodd-Frank Act;
   
• amending provincial securities legislation to mandate the reporting of all derivatives trades by Canadian counterparties to a trade repository. The report makes no recommendation regarding a specific time requirement for reporting but states that real-time reporting will ultimately be required;
   
• in the near term, having provincial regulators obtain regulatory authority to mandate electronic trading of OTC derivative products. The report states, however, that further study will be necessary to determine "the eventual scope of a regulatory mandate";
   
• in accordance with the recommendations of the Basel II Accord, imposing capital requirements proportionate to the risks that an entity assumes;
   
• establishing exemptions for defined categories of end-users that use OTC derivatives to hedge a variety of risks. The report states, however, that it would not be appropriate to provide an exemption for speculative derivative trades or an exemption to financial entities; and
   
• having provincial regulators obtain authority to conduct surveillance on OTC derivatives markets, develop robust market conduct standards and obtain authority to investigate and enforce against abusive practices.

The report also states that further analysis is required before making a recommendation regarding the segregation of capital in the OTC derivatives context.

The Committee, which also set out a number of specific questions pertaining to its recommendations, is accepting comments on the consultation paper until January 14, 2011. According to the Committee, it will move forward by continuing to develop legislative proposals and beginning to draft proposed rules.

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On October 21, Chairman Gary Gensler of the U.S. Commodity Futures Trading Commission gave a speech to the Institute of International Bankers in which he discussed the regulation of swaps. Specifically, Mr. Gensler described the recent amendments to the Commodity Exchange Act (care of s. 722(d) of the Dodd-Frank Act) to extend the CFTC's jurisdiction to all international activities that "have a direct and significant connection with activities in, or effect on, commerce of the United States" or that "contravene such rules or regulations as the Commission may prescribe or promulgate as are necessary or appropriate to prevent the evasion of any provision". As Mr. Gensler characterized the amendments, "if your bank is doing business here in the U.S., offering swaps to U.S. counterparties, you may want to take a close look at the statute."

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On September 27, the Board of Directors of the FDIC approved a final rule (the Rule) that governs the rights of the FDIC, as conservator or receiver of a failed insured depository institution (a Bank), over financial assets previously transferred by such Bank in connection with a securitization or a participation transaction (a Transaction).
 
The FDIC, as conservator or receiver of a Bank, has the statutory authority to repudiate contracts to which such Bank is a party, where it deems the contract to be burdensome and such repudiation would aid in the orderly administration of the Bank’s affairs. In 2000, the FDIC adopted a safe harbour, which provided that the FDIC would not try to reclaim loans transferred in connection with a Transaction so long as an accounting sale had occurred. However, following changes to the sale accounting rules by the Financial Accounting Standards Board in November 2009 (the Old Accounting Standards), most Transactions no longer met the off-balance sheet standards for sale accounting and as a result no longer qualified for the safe harbour. The Rule extends a transition period (the Transition Period), initially put in place in November 2009, which effectively grandfathers safe harbour treatment of all Transactions in process before the end of 2010, that, among other things comply with the Old Accounting Standards. In addition, the Rule imposes further conditions for a safe harbour for Transactions issued after the Transition Period.

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