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

Peter Hamilton -

On May 11, 2011, the Department of Finance issued a consultation paper dealing with covered bonds. This consultation paper contemplates the adoption of covered bonds legislation and seeks comments with respect to the content of that legislation. The enactment of covered bonds legislation would implement a proposal made by the federal government in the 2010 budget and would respond to requests made by many of the Canadian banks for such legislation. The Consultation Paper is open for comments until June 10, 2011.

A covered bond is a bond issued by an issuer (for our purposes a Canadian bank) and collateralized by a pool of assets that meet certain eligibility criteria. In Europe, this collateralization is often accomplished by designating certain assets as being allocated to a collateral pool. Legislation then provides that the holders of the covered bonds issued in relation to the designated pool have a priority claim upon the assets in the designated pool. In Canada, the assets are actually transferred to an SPV which, in turn, guarantees the covered bonds. The priority afforded by the Canadian structure is the result of the application of ordinary legal principles (much the same principles as are relied upon in the context of a securitization) and not specific legislation. In fact, there are currently no existing legislative or regulatory provisions or other regulatory guidance specifically dealing with covered bonds in Canada other than a letter issued by the Office of the Superintendent of Financial Institutions on June 27, 2007. This letter provided that covered bonds must not, at the time of issuance, make up more than four per cent of the total assets of the bank or other deposit taking institution. OSFI also stated at the time that it expected that the pledging policies of banks and other deposit-taking institutions would be amended to address the issuance of covered bonds. Since covered bonds are in substance a form of secured borrowing, it certainly makes sense that they would be addressed in the pledging policy.

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On May 17, the European Union's Economic and Financial Affairs Council (Ecofin) released a draft proposal intended to increase transparency and ensure coordination on short selling and credit default swaps. Among other things, Ecofin's proposal would create a two-tier disclosure regime for significant net short positions. Specifically, private disclosure to a regulator would be mandated when a person's short position in a company reached 0.2% of issued share capital, while public disclosure would be triggered on reaching a 0.5% threshold.

Short sales, meanwhile, would only be permitted in situations where a person had borrowed the relevant shares, entered into an agreement to borrow the shares or made other arrangements to ensure that settlement could be effected. While similar restrictions are included with respect to sovereign debt, the proposal generally exempts transactions that serve to hedge a long position in debt instruments. The restrictions could also be temporarily suspended where the liquidity of sovereign debt fell below a specific threshold.

Negotiations are now expected to get underway with the European Parliament, which released its own proposal in March, in order to finalize the regulations.

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Michael Rumball -

As reported earlier, the SEC has included in 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.

As formulated, these proposals could create significant contingent closing risk for issuers leaving them with no practical options but to assume the worst by preparing the necessary disclosure.  Given the enhanced disclosure requirements of Reg AB II, this could be a very difficult proposition, especially for issuers who have traditionally accessed the private market because they are unable to satisfy all public market requirements.  These provisions could be especially problematic for ABCP issuers. It is hard to imagine how an issuer of ABCP would set about complying with many of the requirements of Reg AB II, such as asset level disclosure and waterfall computer programs, in respect of each originator.

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The Department of Finance issued a consultation paper on May 11, 2011 outlining the major elements of the proposed legislative covered bonds framework and seeking comments by June 10, 2011. As our readers know, unlike some European jurisdictions, Canada does not have a specific legislative framework to address covered bond technology and principles including such items as guarantor asset segregation, protection in insolvency, priority among creditors and related matters.
 

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 Michael Rumball -

On March 29, 2011, the SEC together with a number of other federal regulators and agencies proposed rules relating to risk retention for securitizations which had been mandated by the Dodd-Frank Act in order to “provide a sponsor with an incentive to monitor and control the quality of the assets being securitized and help align the interests of the sponsor with those of investors in the ABS”.

The proposed rules, if adopted, will affect nearly every type of ABS transaction, including both registered and private offerings, and will also capture a wider variety of securities than have been regulated under Reg AB due to the expanded definition of asset-backed securities adopted by the Dodd-Frank Act.

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As we discussed in our securities blog posts of February 25 and March 18, IIROC has requested comments on proposed amendments to the UMIR that would, among other things, repeal short sale price restrictions currently applicable on Canadian markets. The comment period for the proposed amendments is quickly drawing to a close and ends on May 26, 2011. IIROC's proposals would see the repeal of the tick test and introduce the requirement that all short sales be marked as such. However, orders from accounts meeting specific requirements (including certain arbitrage and institutional accounts) would qualify for a "short-marking exempt" designation.

Of particular interest in the notice are IIROC's comments regarding the disclosure of short sale activity. Specifically, in response to the IOSCO principle stating that short selling should be subject to a reporting regime that provides timely information to the market or market authorities, IIROC confirms that it recognizes the problems associated with current short position reporting. IIROC communicates its intention, therefore, to produce and publicly release, semi-monthly, short sale summaries based on aggregated trading data across all marketplaces regulated by IIROC for orders that are marked as short sales, to be implemented following the implementation of the proposed amendments. The nature and scope of this disclosure remains to be seen.

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P. Jason Kroft   -
 
In previous blog entries, we introduced the CSA’s proposed information memoranda requirements that are part of the recent securitization proposals. As noted previously, a condition of the securitized product exemptions (permitting prospectus and registration exempt issuance to eligible securitized product investors) is the delivery of an information memorandum to the purchaser at the same time or before the purchase of the securitized instrument. The CSA proposals differentiate between short-term and longer term securitized products. This blog entry will focus on short-term securitized products only.

Unlike the disclosure requirements for products of greater than one year in duration, the CSA provides prescribed form requirements for short-term securitized products, which terms are contained in proposed Form 45-106F7 and, according to the CSA, were developed following a review of existing ABCP information memoranda, the information the Bank of Canada expects when reviewing whether to accept ABCP issued by an ABCP program as eligible collateral for its standing liquidity facility and comment letters from market participants as part of the October 2008 ABCP Concept Proposals. We would urge ABCP conduit sponsors and administrators in particular to consider the following requirements and read the provisions of proposed Form 45-106F7 carefully. We believe that the information memorandum requirements for short term securitized products require in many cases substantially more disclosure than what ABCP conduits currently provide to their investors and these requirements may raise considerable practical and operational challenges for ABCP conduit sponsors and administrators (among others). 

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 Michael Rumball -

Pursuant to Reg AB II, the Dodd-Frank Act and the rules implementing that Act (the “U.S. Proposals”), U.S. authorities have proposed the most far-reaching substantive and procedural regulations ever applied to the ABS market.  In Canada, the CSA have chosen not to propose similar rules at this time but have instead focused almost entirely upon enhanced disclosure; in essence merely bringing Canadian ABS regulations to the standard existing under Reg AB prior to the U.S. Proposals. The implicit rationale for taking this approach is reflected in the third of the general principles which the CSA have indicated have guided them in developing the proposed rules:

“The rules should take into account the particular features of the Canadian securitization markets. In particular, rules should be proportionate to the risks associated with particular types of securitized products available in Canada, and should not unduly restrict investor access to securitized products. Canada experienced significant turmoil in the ABCP market in August 2007. However, for a number of reasons, the Canadian securitization market did not experience a sub-prime mortgage securitization bubble.”

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