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Canadian Securities Administrators Propose Rules and Amendments Relating to Securitized Products

On April 1, 2011, the Canadian Securities Administrators (CSA) issued a notice and request for comments in connection with a proposed framework for the regulation of securitized products in Canada (Proposal). The Proposal consists of the following: two proposed national instruments, one governing prospectus disclosure and the other governing continuous disclosure for reporting issuers of securitized products; related amendments to existing national instruments with respect to certification of disclosure in annual and interim filings, prospectus and registration exemptions, and resale of securities; and consequential amendments to other national instruments relating to prospectus disclosure requirements and continuous disclosure obligations.

The Proposal is intended to improve investor protection and to be consistent with international developments in the area of securitized products regulation where considered appropriate to do so. In developing the Proposal, the CSA was guided by the following three principles: (i) providing investors with greater access to the information necessary to understand securitized products, to make informed investment decisions, and to value the securities at the time of investment and on an ongoing basis in a manner that promotes market efficiency; (ii) facilitating transparency in the securitization market in an effort to reduce systemic risk; and (iii) accounting for the particular features of the Canadian securitization market.

Application

The Proposal applies to issuers of "securitized products," a term broadly defined in the Proposal to capture securities where the payments are dependent on cash-generating financial assets that collateralize the securities. Securitized products encompass "asset-backed securities," as such term is currently defined in National Instrument 51-102 – Continuous Disclosure Obligations (NI 51-102), securities backed by other securities (including other securitized products), and securities where payments are derived from synthetic assets, such as credit default swaps or other derivatives. Specifically excluded from the definition of securitized products are covered bonds and securities, other than debt securities, issued by a mortgage investment entity.

Enhanced Prospectus Disclosure

Under the Proposal, and in addition to the general prospectus requirements, an issuer that distributes a securitized product pursuant to a prospectus must include the supplemental disclosure contained in proposed Form 41-103F1 – Supplementary Information Required in a Securitized Products Prospectus. The proposed form requires enhanced disclosure in a number of areas, including: the functions and responsibilities performed by each party with a material role in the transaction, whether any such party is retaining an interest in the securitized product and, if so, whether such interest is being hedged; selected financial information or financial statements of significant obligors depending on their significance to the pool assets; detailed information regarding the pool assets; static pool information, if material; and the structure of the transaction, including flow of funds, redemption and prepayment considerations, and credit enhancement.

Continuous Disclosure for Reporting Issuers

Proposed National Instrument 51-106 – Continuous Disclosure Requirements for Securitized Products (NI 51-106) sets out the continuous disclosure obligations for a reporting issuer that has issued a securitized product that is outstanding. The CSA has indicated that it does not intend to implement any "grandfathering" provisions in respect of securitized products outstanding when NI 51-106 comes into force.

Among the proposed continuous disclosure obligations in NI 51-106 are the following: a payment and performance report to be filed within 15 days after each payment date in respect of an outstanding series or class; report of the occurrence of a significant event, which may be satisfied by the filing of a material change report under NI 51-102 provided that it meets certain criteria; annual servicer report prepared by the servicer addressing compliance with the servicing standards appended to NI 51-106 and accompanied by a report of an audit firm expressing an opinion on the servicer’s assessment of compliance with such servicing standards as well as an annual certificate of the servicer addressing compliance with the related servicing agreement, in each case filed by the issuer; and disclosure in the issuer’s management’s discussion and analysis of non-compliance by the servicer with the servicing standards or the servicing agreement.

The Proposal also includes amendments to National Instrument 52-109 – Certification of Disclosure in Issuer’s Annual and Interim Filings (NI 52-109). The proposed amendments create a new category of issuer (securitized product issuer) that is exempt from the requirements in Part 3 of NI 52-109 (establishment and maintenance of disclosure controls and procedures and internal control over financial reporting), and includes new forms of certificates for securitized product issuers.

Narrowed Prospectus Exemptions

The Proposal contains significant amendments to National Instrument 45-106 – Prospectus and Registration Exemptions (NI 45-106) and National Instrument 45-102 – Resale of Securities (NI 45-102), the effects of which include a narrowed scope of investors that may purchase securitized products on a prospectus-exempt basis, a "closed system" for securitized products, and the requirement to deliver an information memorandum for all exempt distributions of securitized products.

Several of the commonly used prospectus exemptions, namely, the accredited investor, private issuer, offering memorandum, minimum-amount investment, financial institution, and short-term debt exemptions, are unavailable to issuers of securitized products under the Proposal. Instead, issuers of securitized products must rely on the proposed eligible securitized product investor exemption in order to distribute securitized products on a prospectus-exempt basis. The definition of "eligible securitized product investor" contained in the Proposal is very similar to the definition of "permitted client" in National Instrument 31-103 – Registration Requirements and Exemptions. Related amendments to NI 45-102 provide that the first trade of a securitized product distributed pursuant to the above-noted exemption is a distribution. Accordingly, unless specific discretionary exemptive relief is obtained, the first trade of a securitized product by eligible securitized product investors may only be made in reliance on the eligible securitized product investor exemption, or if such trade is qualified by a prospectus.

Pursuant to the Proposal, an issuer that distributes a securitized product pursuant to the eligible securitized product investor exemption must deliver an information memorandum to the purchaser thereof at the same time or prior to the purchase of the securitized product. The Proposal contains a prescribed form for information memoranda in respect of securitized products with maturities not more than one year from their date of issue and sets out general requirements for securitized products with longer maturities. The Proposal also affords investors the right to sue the issuer, the issuer’s directors and officers, the sponsor and each underwriter for a misrepresentation contained in the information memorandum. This right of action would be available to the investor without being required to demonstrate reliance on the misrepresentation.

The proposed amendments to NI 45-106 also create periodic disclosure obligations for issuers of securitized products that are not reporting issuers. For issuers of securitized products with maturities of more than one year, these disclosure obligations are similar to those obligations created by NI 51-106 and include the following: a payment and performance report to be delivered to the securities regulatory authority and posted on a website within 15 days after each payment date in respect of an outstanding series or class; and a report of the occurrence of a significant event to be delivered to the securities regulatory authority, posted on a website and delivered to each holder of the related securitized product within two business days following the occurrence of the significant event. Similar obligations exist for issuers of a securitized product that matures within one year of its date of issue.

Next Steps and Ongoing Review

The notice and request for comments issued by the CSA on April 1, 2011 invites written comments on the Proposal and responses to the questions contained therein no later than July 1, 2011. We would be pleased to discuss with you any comments or concerns you may have with respect to the Proposal.