New Light on Shadow Banking: The FSB's New Report on Rehypothecation of Client Assets

 Margaret Grottenthaler

The Financial Stability Board has been considering the possible harmonization of rules relating to rehypothecation of client assets in securities financing transactions (such as securities loans, repo and margin loans) for several years. On January 25, 2017, it released a report entitled Transforming Shadow Banking into Resilient Market-based Finance, which summarizes the findings of its Rehypothecation and Re-use Experts Group.

Regulatory Approaches to Shadow Banking

Those of you who want to know more about how this aspect of so-called “shadow banking” works will find the new report very informative. Specifically, it explains:

  • What rehypothecation is;
  • Why it is important to the efficient functioning of lending markets;
  • What systemic risks it poses;
  • How those risks are currently addressed by regulation and market practice; and
  • The possibilities for harmonizing regulatory approaches.
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Investment funds lawyers co-author Canada chapter in asset management publication

Stikeman Elliott lawyers Alix d’Anglejan-Chatillon and Jeffrey Elliott have contributed the chapter on Canada The Asset Management Review. This publication provides a business-focused overview and analysis of regulation and market developments in asset management across 33 jurisdictions worldwide. This article was first published in The Asset Management Review, 4th edition (published in September 2015 – editor Paul Dickson) by Law Business Research Ltd., London.  www.lbresearch.com

Yukon's Securities Transfer Act now in force

Yukon recently proclaimed the Securities Transfer Act and related amendments to the Personal Property Security Act (related to security interests in investment property) into force effective May 1, 2015 (Yukon Gazette, February 15, 2015). This leaves PEI as the only province or territory without a Securities Transfer Act or a perfection by control regime for investment property.

Contracting with Corporate Class Funds (or a Sofa)

Margaret Grottenthaler -

Can your sofa enter into a contract? Of course not! Can a class of shares enter into a contract?  Of course not! Both your sofa and the shares are property, not persons. Only an entity with legal personality can enter into contracts. However, it isn’t unusual in the context of ISDA Agreements, for example, for fund managers to name a particular corporate class of shares as the counterparty. At times there isn’t even a clue in the agreement as to the name of the corporation that has issued the shares.

But if you are contracting with such an entity, make no mistake – your counterparty is the corporate entity. Practically speaking these fund structures work by allocating assets and liabilities on a class by class basis, with liabilities being allocated by including limited recourse provisions in material contracts. In other words, your counterparty is the corporation, but you (and others contracting with the corporation with respect to that fund) agree to limit recourse to the assets allocated to a particular class of shares. It is these limited recourse provisions that protect the shareholders of one class and creditors contracting with respect to that class from being exposed to the liabilities of the corporation contracted with respect to another class. Without them, that siloing does not exist.

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IIROC proposes adjusting margin requirements for agency lending agreements

The Investment Industry Regulatory Organization of Canada yesterday proposed amendments to Dealer Member Form 1 intended to address concerns that current rules do not set out specific margin requirements for agency cash and security borrowing and lending arrangements, as well as the fact that current rules do not have the same margin requirements for arrangements with acceptable counterparties versus regulated entity counterparties.

The concerns are especially relevant considering the recent trend involving dealers entering into borrowing and lending arrangements with custodians that act as agents for counterparties. According to IIROC, the risk of such agreements is equivalent to comparable "principal" arrangements. However, since Dealer Member Form 1 does not cover these types of agency agreements, dealers are currently required to provide additional margin in these cases. 

To address these concerns, the amendments are designed to ensure that agency arrangements are treated for margin purposes in the same way as equivalent principal arrangements between dealers and custodians. As such, the counterparty credit risk classification of the custodian would determine the level of margin required. Custodians that are active in the security borrowing and lending business are typically financial institutions that meet the definition of "acceptable institutions" and are considered low credit risk clients.

Proposals to amend the margin requirements were first published last year, and yesterday's release takes into account comments received from stakeholders. IIROC is accepting comments on its revised proposal until May 27, 2015. For more information, see IIROC Notice 15-0053.

Quebec is first province to propose cash collateral regime

Sterling Dietze  -

As previously reported in our post of November 28, 2014, the Quebec Minister of Finance presented Bill 28 to the National Assembly on November 26, 2014. The proposed legislation includes provisions in respect of cash collateral, and would make Quebec the first Canadian province to propose legislative modifications in order to facilitate cash collateral. The purpose of this post is to provide some background as to the necessity of these new provisions as well as an overview of the specific rules before proceeding to give examples of application.

Background

Historically, it has been a challenge for Canadian entities to offer a first priority security interest on cash to their counterparties. By contrast, in the United States, a debtor may grant a first priority security interest over cash in a deposit account by way of control pursuant to the provisions of Article 9 of the Uniform Commercial Code. The same is not currently the case in Canada for cash not in a securities account. If a secured party is granted a security interest in cash, the traditional view is that valid security under the laws of the jurisdiction of the grantor’s location needs to be obtained, the security needs to be perfected by registration, a search of the relevant register needs to be undertaken and estoppels, subordinations or waivers from competing or prior ranking creditors need to be obtained. This may be a costly and time-consuming exercise and ultimately may not be successful.

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Quebec proposes Cash Collateral Provisions and modifications to Security Agent Provision

Sterling Dietze -  

On November 26, 2014, the Quebec Minister of Finance presented Bill 28 to the National Assembly. The proposed legislation includes provisions in respect of cash collateral as well as modifications to the provision for security in favour of a security agent. Once the bill is adopted, the cash collateral provisions are proposed to come into effect on a later date determined by the Quebec government. The basic conceptual building block for cash collateral is the notion of control similar to that applicable to granting a first priority security over security entitlements. The provisions also compare favorably in important respects to the security-interest regime applicable to deposit accounts under Article 9 of the Uniform Commercial Code. We will be posting, in the next little while, further discussion in respect of the cash collateral provisions.

FSB proposes standards for global securities financing and data collection and aggregation

On November 13, the Financial Stability Board published a consultation report that sets out proposed standards and processes for global securities financing and data collection and aggregation. 

Among other things, the report includes proposals on data elements for repos, securities lending and margin lending, as well as recommendations to ensure consistency among national and regional data collection. 

The FSB is accepting comments on the proposal, including in respect of specific questions asked of stakeholders, until February 12, 2015.

CSA decide not to reduce early warning threshold to 5%

The Canadian Securities Administrators today announced that they will not be moving forward with plans to reduce the early warning reporting threshold from 10% to 5% as previously proposed.

As discussed on our securities blog in March 2013, the CSA last year proposed amendments to the reporting threshold, triggers and related disclosure requirements under Canada’s early warning reporting regime intended to “provide greater transparency about significant holdings of issuers’ securities”. While the most significant change under the 2013 proposal would have been to decrease the reporting threshold from 10% to 5%, the CSA also proposed a number of other significant reforms, including greater transparency through reporting of “equity equivalent derivatives” in order to address issues such as “hidden ownership” and “empty voting”.

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Investment fund modernization: Phase 2 implementation to start in September of 2014

The Canadian Securities Administrators today announced the adoption of final amendments that will implement certain aspects of Phase 2 of the Modernization of Investment Fund Product Regulation Project.  The mandate of Phase 2 involved generally addressing the regulatory gap between non-redeemable investment funds and mutual funds by focusing on imposing certain core operational requirements on publicly offered non-redeemable investment funds that are generally analogous to the requirements applicable to mutual funds.

The final amendments to be adopted as of September 22, 2014 stem from proposed amendments published last year, and will involve the imposition of core investment restrictions for non-redeemable investment funds while also enhancing disclosure requirements regarding securities lending activities by investment funds.  The following is a summary of some of the final amendments that are set to come into force, which we will review in further detail in subsequent posts.  

Notably, the final amendments do not extend to the creation of a more comprehensive alternative funds framework (planned to be effected through an overhaul of National Instrument 81-104 Commodity Pools).  As previously announced by the CSA,  the “alternative funds proposals” have been deferred to allow for further review, along with related restrictions that were proposed with respect to investments in physical commodities, short selling, the use of derivatives and borrowing cash.

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IIROC updates proposed rule regarding oversight of debt securities trading

Last week, IIROC republished a proposed rule that would require reporting of debt transactions. As we discussed last year, IIROC initially released a draft rule in February 2013 to require each IIROC dealer member to report on a post-trade basis all debt market transactions executed by the dealer member, including those executed on an Alternative Trading System (ATS) or through an Inter-Dealer Bond Broker (IDBB). The more recent version of the draft rule, whose purpose is to facilitate the creation of a database of transaction information that would enable IIROC to carry out its responsibilities with respect to surveillance and oversight of OTC debt market trading, includes a number of revisions in response to stakeholder comments.

Changes made to the latest revision include setting out the data elements that must be reported for transactions and extending the deadline to report transactions to IIROC from T+1 at 2:00 a.m. to T+1 at 2:00 p.m. 

Comments on the proposed rule are being accepted until March 10, 2014. For more information, see IIROC Notice 14-0004.

Financial Administration Act (Quebec) amendments to clarify pledging by Quebec Crown in connection with transactions and set-off against it

Catherine Jenner -

Section 16 of the Financial Administration Act (Quebec) (FAA) empowers the Quebec Minister of Finance to enter into certain types of financial contracts. In 2011, the FAA was amended to add new section 16.1 permitting the Minister to pledge securities and security entitlements within the meaning of the Act respecting the transfer of securities and the establishment of security entitlements in connection with a transaction effected under section 16. Now, Bill 58, An Act to again amend various legislative provisions concerning mainly the financial sector, which has just been tabled, will amend section 16.1 to clarify that the pledge includes a “margin deposit, margin or settlement” and, in addition that, compensation (the civil law term for set-off) can be effected against the Quebec Crown in connection with the transaction. What this latter amendment will do is clarify that article 1672 of theCivil Code of Québec, which prohibits claiming compensation against the Quebec Crown, does not prevent netting under a transaction entered into under section 16 of the FAA. Finally, Bill 58 amends section 18 of the FAA to clarify that a close-out amount under a transaction is a charge against the Consolidated Revenue Fund.

Recent developments in the Regulation of Shadow Banking

 Michael Rumball -

Over the summer and fall shadow banking regulation moved forward on several fronts.

First, the SEC proposed rules that would reform the way money market funds operate “in order to make them less susceptible to runs that can harm investors”. In keeping with previous guidance provided by the Financial Stability Board (FSB) and the Financial Stability Oversight Counsel (FSOC), the SEC proposal includes two principal alternatives that may be adopted alone or in combination. One alternative would require a floating net asset value (NAV) for prime institutional money market funds. (Note that government-debt funds are now to be excluded as it has become apparent that there had not been runs on these funds during the crisis). The other alternative would allow for the use of liquidity fees and redemption gates in times of stress.

The public comments on these proposals have been relatively predictable and in line with comments previously made in respect of the FSB and the FSOC proposals. Opposition to both the floating NAV and redemption fee alternatives remains strong. J.P Morgan Asset Management summarizes the views of MMF investors as follows:

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Proposals for the regulation of shadow banking postscript

Michael Rumball  -

Short term investors are extremely risk-adverse. They demand two things at minimum – ready access to and the safety of their principal. When risk unexpectedly emerges they become nervous, always on the verge of a flight to safety. As we have seen, a large enough flight can turn into a stampede which can cause significant collateral damage.

In the 30’s the risk posed by bank runs was finally tamed by the adoption of the financial safety net for bank deposits. This was not adopted for reasons of altruism, that government was somehow responsible for safeguarding the deposits of widows and orphans and should protect them from risk. Rather it was a pragmatic solution to the risk of bank runs which had the potential to damage the general economy.

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CASLA panel considers proposed developments in securities lending

Margaret Grottenthaler -
 

I spoke at the CASLA conference yesterday about the pending regulatory developments in Canada with respect to the early warning regime and changes to National Instrument 81-102 and prepared a short article on these changes.   Previous items in this blog have covered these developments generally, but the paper focuses on the securities lending aspects of the proposed developments. Other materials from the conference will soon be posted on the CASLA website.  This third annual conference organized by the Canadian Securities Lending Association was very well attended and extremely informative

Ontario reaffirms plan to amend PPSA re cash collateral

Margaret Grottenthaler -
 
According to the Ontario budget released today, personal property security legislation will be amended to make it easier for businesses and financial institutions to provide or obtain first‐priority security interests in cash collateral. Sound familiar? That’s what the last budget said. But the budget does recognize that significant progress has been made on the government's proposals, and key aspects will be finalized pursuant to further consultations.

I think we can read into that that the government generally accepts the approach of the OBA’s Personal Property Security Law sub-committee proposing a perfection by control regime for cash, but that there are some details to work out. We all know the devil is in the details though!

CSA propose amendments to early warning reporting regime to enhance disclosure

Amanda Linett and Ruth Elnekave -

The Canadian Securities Administrators (CSA) have published for comment proposed amendments to the reporting threshold, triggers and related disclosure requirements under Canada’s early warning reporting (EWR) regime intended to “provide greater transparency about significant holdings of issuers’ securities”.  These amendments could affect the conduct of certain equity derivative transactions and related hedging activities.

Currently, under the EWR regime, prescribed disclosure is required by any investor that acquires beneficial ownership of or the power to exercise control or direction over 10% or more of any class of a public company’s voting or equity securities. Additional reporting is required on each incremental acquisition of 2% as well as a change in a material fact contained in an earlier report. Certain eligible institutional investors (EIIs) can take advantage of relaxed timing requirements for early warning reporting under the alternative monthly reporting (AMR) regime.

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SCC Decision in Re Indalex not good news for cash collateral arrangements

Margaret Grottenthaler -

Swaps market participants accepting cash collateral from an entity subject to Ontario provincial pension benefits legislation will want to consider the implications of this decision on their priority. Unfortunately and somewhat surprisingly, the Supreme Court of Canada did not overturn a key part of the Ontario Court of Appeal’s decision. Four of seven judges agreed that the deemed trust under the Pension Benefits Act (Ontario) (PBA) and, consequently, the statutory priority conferred on that trust under the Personal Property Security Act (PPSA) applied to the statutory liabilities of an employer to fund certain deficiency payments that arise during the wind-up of a pension plan. The secured creditor with an assignment of the DIP financing ultimately prevailed in its appeal on the basis of other arguments and was found to take priority over the deemed trust, but it did not prevail on this fundamental issue regarding the liabilities covered by the deemed trust. 

In our blog post on the Court of Appeal decision we addressed whether the decision had a negative effect on credit support provided for derivatives transactions and other securities financing transactions, such as securities loans, repo and margin loans. As stated in that post, there is potential for the deemed trust to take priority over cash collateral accounts where Ontario law alone governs priority, because the PPSA gives the deemed trust priority with respect to “accounts”, and cash collateral arrangements are characterized as “accounts”. The priority and deemed trust applies not only to wind-up deficiencies, but also other amounts the employer owes to the pension fund (e.g. delinquent current service costs and remittances on behalf of employees). As a practical matter, the other liabilities subject to the deemed trust tend to be in a less significant amount and, consequently, they get paid from the assets readily available to the insolvency representative if they are in arrears. The wind-up deficiency amount, however, can be extremely large with respect to defined benefit plans, and essentially unascertainable until wind-up occurs. This is what makes the decision particularly concerning. There is no legal requirement to share the pain of the deemed trust among secured creditors, so the most readily accessible assets tend to fund the liability. The deemed trust beneficiaries may be looking further afield, however, when it comes to the deficiency liability and a nice healthy pool of cash collateral may look very attractive. Swap providers may not have the same influence in insolvency proceedings as the employer’s lending syndicate to force the employer into bankruptcy (where the deemed trust is clearly subordinated to secured creditors). I’ll first briefly review the parts of the decision that are relevant to the cash collateral issue. I will then tell you why I think it might affect priority for cash collateral (but not securities collateral) and offer some recommendations for dealing with this issue.

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Proposals for the regulation of shadow banking

Michael Rumball  -

Much of the blame for the recent financial crisis has been attributed to the shadow banking system. This paper explores the development of that system, its role in the financial crisis and the subsequent proposals for its regulation. Click here for the full text of the article.

Structured finance regulatory resources available

If you're looking for quick access to standard industry documentation, like IIROC's securities loan agreements or SIFMA's standard forms, make sure you bookmark our blog's Resources page. Links to provincial securities transfer legislation and other resources are also provided.

Many industry associations also maintain resource libraries. For example, CASLA's resources page provides information on such topics as IIROC regulatory updates, Dodd Frank developments and potential effect on the Canadian market, and insights from CASLA's recent roundtable held to discuss the effects of the eurozone crisis and regulatory trends.

ISDA supports OBA proposal on cash collateral priority

Margaret Grottenthaler -
 
Last week, the International Swaps and Derivatives Association released a letter it submitted to the Ontario government in support of the Ontario Bar Association's proposal to provide an automatic first priority ranking to financial institutions that have a security interest in cash in financial accounts perfected by control. As I noted in my post of February 14, the OBA proposal would give secured parties holding cash collateral the same degree of legal certainty as to their priority against other creditors that the Securities Transfer Act, 2006 provides to holders of securities as collateral.

In its letter, the ISDA stated that there is no legal assurance of priority in a registration regime. According to the ISDA, however, the certainty and predictability resulting from the proposed changes would "significantly contribute to financial stability in the derivatives markets" in which market participants take part and "enhance their ability to compete in these markets on a more cost-efficient basis." Ontario's Ministry of Consumer Services is accepting input on the issue until May 17.

FSB WG Reports on role of sec lending and repo in shadow banking markets

Margaret Grottenthaler -
 

On April 27, the Financial Stability Board Workstream on Securities Lending and Repos (WS5) under the FSB Shadow Banking Task Force published  an Interim Report documenting WS5’s progress to date.   As someone trying to keep track of regulatory developments in these areas, I found this report to provide a very useful overview of the markets, their relationship with each other and the market issues that these activities raise and which may come in for further regulation in future.  If you are new to this area, I would also recommend it as way to quickly bring yourself up to speed.

The market overview in Part 1 is a very high level description of the functions and participants in four segments of the market, namely securities lending, leveraged investment fund financing and securities borrowing, interdealer repo and repo financing. Some helpful charts describe the interrelationship between these segments of the market, and further detail on each of these segments can be found in Annex 1 of the Report.

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Ontario Government Announces Intention to Amend Cash Collateral Law

Margaret Grottenthaler -
 
The Ontario Government released its 2012 budget this afternoon and, in doing so, stated its intention to amend the cash collateral provisions of the Personal Property Securities Act to facilitate the granting of first priority security interests in cash. These changes will not be in this budget bill, but hopefully will be introduced as a bill in the fall.

Specifically, the Government, according to its budget summary, intends to:

propose legislative changes...to Ontario’s personal property security legislation, to make it easier for businesses and financial institutions to provide or obtain a first-priority security interest in cash collateral. If enacted, these changes would support a competitive Ontario business climate, help meet Canada’s international financial reform commitments and mitigate financial system risk related to over-the-counter derivatives.

Presumably this budget statement is intended to clearly convey to the market the government’s commitment to making these important changes. As I discussed in a post last month, the Ontario Personal Property Security Law Sub-Committee of the Ontario Bar Association’s Business Law Section released a proposal earlier this year to amend the PPSA to deal more effectively with cash collateral. While the exact nature of the Government's amendments remain to be seen, the OBA subcommittee's recommended changes will be influential in developing the particular solution to give secured parties holding cash collateral the same degree of legal certainty as to their priority against other creditors that the Securities Transfer Act, 2006 provides to holders of securities as collateral.

OBA submission on cash collateral finalized

Margaret Grottenthaler -
 
As I discussed in my post of January 4, the Ontario Personal Property Security Law Sub-Committee of the Ontario Bar Association’s Business Law Section has been working on a draft proposal over the last year to amend Ontario's personal property security legislation to deal more effectively with cash collateral. The OBA subcommittee's submission has now been finalized. The OBA highlights that the recommended changes will give secured parties holding cash collateral the same degree of legal certainty as to their priority against other creditors that the Securities Transfer Act, 2006 provides to holders of securities as collateral.

Hopefully the government will accept the recommendations and put these changes on the spring legislative agenda.

Draft cash collateral proposal for Ontario PPSA and background paper

Margaret Grottenthaler -
 

The cash collateral working group drafting subcommittee of the Ontario Personal Property Security Law Sub-Committee of the Ontario Bar Association’s Business Law Section has prepared a draft proposal to amend Ontario personal property security law to deal more effectively with cash collateral. Over the past year the working group circulated a number of draft proposals and this final proposal reflects input from many committee members and others. The proposal is to be considered by the PPSL Committee later this month and if approved (which hopefully it will be) will serve as the basis for a formal submission of the Business Law Section of the OBA to the Ontario Ministry of Consumer Services (with a copy to the Ministry of Finance) early in this year. If the proposal is acceptable to the government, it is hoped that it could be put before the legislature shortly thereafter. Comments on the draft proposal are welcome.  For more information, see the background paper on the proposals.

Quebec cash collateral update

Sterling Dietze -

The Quebec National Assembly passed, on November 30, 2011, an Act to amend various legislative provisions mainly concerning the financial sector. As part of that Act, amendments were made to the Derivatives Act (Quebec) in respect of the use of set-off related to cash posted as credit support. We discussed the proposed amendments in a prior post. The provisions are now in force.

Is cash collateral king again in Quebec?

Sterling H. Dietze -

It is currently a challenge in Canada for Canadian entities in the derivatives, securities lending and repurchase space to offer a first priority security interest on cash to their counterparties. The Quebec government recently introduced an amendment to the Derivatives Act (Quebec) (the QDA) that, if passed as tabled, will restore confidence in the use of absolute transfer of cash and the related use of contractual set-off or compensation when dealing with cash as credit support for these types of transactions from Quebec counterparties. The amendments also specifically address cash collateral provided to a derivatives clearing agency by its members. We give some background to this issue and then outline the application of the proposed rule.

Background

Cash as credit support for obligations of counterparties to derivatives, securities lending and repurchase transactions has become more and more prevalent over the past numbers of years. ISDA has reported that 80% of collateral for derivatives contracts is in the form of cash. The use of cash collateral will increase in importance as more and more derivatives transactions are cleared by central counterparties.

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Quebec introduces amendments regarding cash collateral

On November 10, 2011, the Quebec Minister for Finance introduced an amendment to Bill 7 presently before the Committee on Public Finance of the National Assembly which contemplates an amendment to the Derivatives Act (Quebec). The intent of the proposed rule is to give more clarity and certainty to the effectiveness of a contractual right of set-off in respect of cash given as credit support in connection with agreements including derivatives, securities lending and repurchase agreements (as well as under related master agreements) and dealings between a derivatives clear agency and its members. A more in-depth note will follow next week.

CSA Staff concerned with U.S. exempt market dealers carrying out brokerage activities

The Canadian Securities Administrators released a staff notice today communicating their concern regarding firms that carry out brokerage activities registering as exempt market dealers. The notice describes such firms as being primarily U.S.-based broker-dealers that are members of FINRA.

According to CSA staff, the EMD category of registration was not intended for firms that conduct brokerage activities (trading securities listed on an exchange in foreign or Canadian markets), and the notice states that permitting such activity would result in differing levels of regulatory oversight between EMDs and those firms subject to IIROC requirements and supervision.

In light of their concerns, the CSA will instead "consider" registering these broker-dealers in the restricted dealer category with terms and conditions, including a requirement that such broker-dealers only deal with permitted clients. Such registrations would also be temporary while the CSA engage in a consultation process to ensure that "appropriate regulatory requirements" apply to all firms undertaking brokerage activities. According to the notice, the consultations will "likely" result in changes to the registration rules.

For more information, see CSA Staff Notice 31-327.

Does Re Indalex affect credit support priorities for derivatives and securities financing transactions?

Margaret Grottenthaler -

The Ontario Court of Appeal decision in Re Indalex released on April 7 is certainly the talk of the town in secured financing circles. Unless overturned, it will almost certainly have a significant negative impact on the availability of asset backed loans for entities with defined benefit pension plans given that it conferred priority over secured creditors (including the creditor subordinated to the rights of the super-priority DIP lender) for unfunded employer liabilities to the company’s defined benefit pension plans. As many appreciate, this liability is potentially a huge whack of dough for some companies. But does it have the same negative effect on credit support provided for derivatives transactions and other securities financing transactions, such as securities loans, repo and margin loans? I’m going to refer only to derivatives in this note, but similar comments apply to the collateral for securities financing arrangements. If you’re holding your breath, you can relax a bit because there are reasons why the decision is not likely to have the same impact on the typical collateral arrangement for derivatives transactions as it will have in the commercial finance context. It is problematic though with respect to cash collateral.

The Decision

If you haven’t yet read 20 law firm newsletters on this case, here’s a short description focusing on the aspects potentially relevant to derivatives markets and leaving out some of the details and my more colourful thoughts about the court’s analysis. You have to buy me lunch if you want those!

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Comment period on IIROC short sale proposals coming to an end

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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My new year's wish list

P. Jason Kroft

It has long been a Kroft family tradition to spend a relatively significant amount of time discussing and documenting new year's resolutions (and it is also a long-standing tradition of discarding or ignoring the resolutions not long after January 2nd of each year). Each year at around this time I'll sit down to carefully draft my plans for the year in an attempt to chart out my year's goals, plans and objectives. The plans are, by design, ambitious, considered and comprehensive. As my final blog submission for the year, I thought I would share with our readers some of my own goals for next year in the hopes that they may entertain and potentially inspire.

In 2011, I would like to own a Bugatti sports car like Jay-Z, have one million Facebook friends and appear during an episode of HBO's 'Entourage'. I'd like to finally obtain that work/life balance that I've read about and find that the Loonie is well above par during my spring break trip to Miami. I'm hoping for sunny and dry summer months, peace and prosperity for my clients, contacts and friends and interesting and challenging work assignments. 

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U.S. legislation to add withholding tax to certain swap transactions

Jonathan Willson and Roanne C. Bratz

The Hiring Incentives to Restore Employment Act (or HIRE Act) has now come into effect in the United States and it will likely be relevant to Canadian participants in the OTC derivatives and securities lending areas. 

By way of background, the HIRE Act added a new U.S. withholding tax provision for certain equity-related swaps, sale-repurchase transactions and securities lending transactions. The HIRE Act applies to dividend equivalent payments made on or after September 14, 2010.  Dividend equivalent payments include payments that are contingent on, or determined by reference to, U.S.-source dividends in sale-repurchase and securities lending transactions, including certain equity swap transactions where a non-U.S. counterparty buys or sells the underlying U.S. security from or to its counterparty.  After March 18, 2012, cross-border dividend equivalent payments made under all equity swap transactions will be treated as U.S.-source dividend income, unless the U.S. Department of the Treasury issues regulations exempting any particular equity–related swap from its application.  As a result, any U.S. source dividend equivalent payment received or paid by Canadian parties, for example, generally will be subject to U.S. withholding tax even if there is no U.S. counterparty to the transaction.  The withholding tax is imposed on the “gross amount” of any dividend-equivalent payment used in computing any net amount paid to the non-U.S. counterparty in connection with the transaction.  The U.S. withholding tax generally will be imposed at a 30% rate, unless the applicable withholding rate is reduced under the terms of an income tax treaty and proper documentary evidence is timely provided to the appropriate counterparty.

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Nova Scotia proclaims Securities Transfer Act

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.

Proposed changes to NI 81-102 relevant for derivatives and securities lending

P. Jason Kroft and Sarah Horan

On June 25, 2010, the Canadian Securities Administrators (CSA) published for comment proposed amendments to National Instrument 81-102 Mutual Funds (NI 81-102) and related instruments, which set out the regulatory framework for mutual funds under Canadian securities legislation. Certain of the proposed amendments are relevant for derivatives and securities lending, the salient aspects of which are described below.

The proposed amendments seek to codify frequently granted exemptive relief from the requirements under NI 81-102, create additional operational requirements for money market funds and generally update the instrument to reflect changes in the Canadian marketplace and the evolution of regulatory approaches to mutual funds in other major markets. Included among the amendments are several changes relating to the use of short-selling and specified derivatives by mutual funds.

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