On April 1, 2011, the Canadian Securities Administrators (“CSA”) published proposed new rules for the regulation of securitized products that will fundamentally alter the existing framework in Canada (the “Proposal”). Securitized products, whether offered publicly by prospectus or in the exempt market, will be affected by the Proposal.
According to the CSA, the Proposal aims to both increase disclosure requirements for securitized products, as well as to narrow the class of investors who can buy securitized products in the exempt market. Three principles acted as a guide to the CSA in developing the Proposal, including: 1) providing investors with increased access to information about the securitized products; 2) facilitating transparency in the securitization market in order to reduce systemic risk; and 3) considering the particular features of the Canadian securitization markets, such that rules are proportionate to the risks associated with specific types of securitized products in Canada.
Application – New Definition of Securitized Products
Securitization involves the process whereby a special purpose vehicle (“SPV”) is used to create securitized products which entitle holders to payments supported by cash flows from a pool of financial assets held by the SPV.
The Proposal contains a new broad definition of “securitized product”, which triggers its application. The definition captures: 1) securities whose payments are derived from cash-generating financial assets (ie. loans, leases and receivables); 2) securities backed by assets that are themselves securities (ie. bonds, and other securitized products); and 3) securities whose payments are derived from “synthetic assets” (ie. credit default swaps or other derivatives). Explicitly excluded from the scope of the definition are covered bonds and securities, other than debt securities, issued by a mortgage investment entity. The CSA has stated that covered bonds do not raise the same policy concerns as standard securitized products because they are primarily obligations of the financial institution with the cover or collateral pool serving as a credit enhancement, and that the regulatory analysis of mortgage investment entities is being considered in a separate initiative.
Supplementary Prospectus Disclosure Obligations
The proposed National Instrument 41-103 Supplementary Prospectus Disclosure Requirements for Securitized Products and Form 41-103F1 – Supplementary Information Required in a Securitized Products Prospectus (collectively, the “Proposed Prospectus Disclosure Rule”) subjects securitized products issued by reporting issuers to enhanced disclosure requirements contained within the newly proposed Form 41-103F1, which will apply in addition to the existing prospectus disclosure regime. Form 41-103F1 requires disclosure of:
- Functions and responsibilities of material parties to a transaction, as well as certain relationships among the parties, and transactions within 12 months involving any material conflict of interest with respect to an investor in the securitized product;
- Significant obligors and selected financial information or financial statements with respect to them, depending upon the significance of the obligor to the pool assets;
- Detailed pool assets information;
- Static pool information, if material, and if no information is provided, an explanation for the omission;
- Description of each securitized product distributed;
- Whether material parties are retaining any portion of a tranche, the amount retained, and whether the interest is being hedged;
- Detailed information on the structure of the transaction;
- Material credit enhancements or support, as well as derivative instruments altering payment characteristics of payments on securitized products;
- Information on credit rating of securitized products;
- Descriptions of reports or documents provided to holders of securitized products, or to be filed with a securities regulatory authority; and
- Legal proceedings and regulatory actions in respect of material parties to the transaction.
Proposed Continuous Disclosure and Certification Amendments
The CSA has also proposed new continuous disclosure requirements for securitized products issued by a reporting issuer in the Proposed National Instrument 51-106 – Continuous Disclosure Requirements for Securitized Products (“Proposed CD Rule”). The CSA has made it clear that it does not propose to “grandfather” securitized products that are currently outstanding. Significant features of the Proposed CD Rule, include:
- Payment and performance report (Form 51-106F1) must be filed within 15 days after each payment date on each series or class of securitized products it has issued;
- Timely disclosure of significant events (events enumerated in section 5 of NI 51-106), through filing of Form 51-106F2 or a material change report (NI 51-102);
- If the servicer is providing service relating to more than five percent of the pool assets, an annual servicer report must be prepared, audited and provided to the reporting issuer, stating whether the servicer complied with each servicing standard during the reporting issuer’s most recently-completed financial year. The reporting issuer must then file it with the securities regulatory authorities;
- Annual servicer certificate prepared disclosing extent of servicer’s compliance with applicable servicing agreement must be provided to reporting issuer; and
- Reporting issuer must disclose in their management’s discussion and analysis any non-compliance with the applicable servicing standards or servicing agreement that is disclosed by a servicer.
Additionally, the CSA is proposing amendments to National Instrument 52-109 – Certification of Disclosure in Issuer’s Annual and Interim Filings. The amendments would exempt reporting issuers of securitized products, which are subject to NI 51-106, from reporting requirements under Part 3 of NI 52-109, relating to establishing and maintaining disclosure controls and procedures, as well as internal control over financial reporting. It would also contain modified forms of certificates for these reporting issuers.
Proposed Exempt Distribution Rules
Amendments to National Instrument 45-106 – Prospectus and Registration Exemptions are also proposed, in order to significantly reduce the class of investors which can invest in securitized products on a prospectus-exempt basis, as well as to require disclosure both at issuance and on a continuous basis. The Proposal also contemplates the creation of a modified regime for short-term securitized products that have a maturity of not more than one year from the date of issuance, which is meant to account for their particular features and distribution methods.
Removal of Existing Exemptions and New Exemption
One significant amendment is the removal of a number of existing prospectus exemptions for issuers of securitized products, including: the accredited investor exemption, the private issuer exemption, the offering memorandum exemption, the minimum amount investment exemption, the financial institution or Schedule III bank specified debt exemption and the short-term debt exemption. The Proposal instead adds a new prospectus exemption for distribution of securitized products, entitled the “eligible securitized product investor” exemption (“Securitized Product Exemption”). The definition of “eligible securitized product investor” being essentially similar to the definition of “permitted client” in National Instrument 31-103 – Registration Requirements and Exemptions.
Information Memorandum Requirement
Accompanying the eligible securitized product investor exemption, is the requirement that the issuer deliver an information memorandum to each purchaser both before and at the time of purchase. Depending on whether the securitized product is short-term or not, the disclosure requirements will differ. For securitized products that mature more than one year from the date of issue, the Proposal simply sets out general requirements, aimed at ensuring the information memorandum discloses sufficient information about the securitized product and transaction to enable purchasers to make informed investment decisions. For securitized products that mature not more than one year from the date of issue, Form 45-106F7 – Information Memorandum for Short-Term Securitized Products is the prescribed form for information memorandum. All information memorandums must be posted on a website at the same time or before delivery to the purchaser, and the user must deliver a copy to the securities regulatory authorities.
Non-Reporting Issuers – Periodic and Timely Disclosure
For non-reporting issuers of securitized products under the Securitized Product Exemption, the amendments propose to create periodic and timely disclosure requirements similar to proposed continuous disclosure requirements for reporting issuers under NI 51-106.
Also proposed, is the right of investors to sue the issuer, the sponsor and each underwriter for damages should the information memorandum contain a misrepresentation (without any requirement that the investor prove reliance on the misrepresentation).
Proposed amendments to National Instrument 45-102 – Resale of Securities, would result in the first trade of a securitized product under the eligible securitized product investor exemption to be categorized as a distribution. As a result, a “closed system” for securitized products would be created, whereby the eligible securitized product investor exemption would be the only prospectus exemption available for resale of a securitized product. A prospectus would otherwise be required.
The comment period has been extended from July 1, 2011 to August 31, 2011.