Canadian Securities Administrators Propose New Securitized Products Rules
The Canadian Securities Administrators (CSA) published a comprehensive set of proposed new rules with respect to securitized products in April 2011 (2011 Proposals), but in a notice dated January 23, 2014 the CSA indicated that they do not intend to proceed with the aspects of the 2011 Proposals relating to: (a) prospectus and continuous disclosure requirements; (b) restricting the prospectus-exempt distribution of securitized products to a class of highly-sophisticated investors; and (c) the prospectus-exempt distribution of securitized products with a maturity of one year or more. The rationale given by the CSA for this change of direction was based on their conclusion that Canadian securitization activity currently does not raise systemic risk or investor protection concerns that warrant the type of comprehensive regulatory intervention contemplated by the 2011 Proposals.
Instead, the CSA has published for a second comment period a more targeted set of proposed amendments (Revised Proposals) that incorporate and modify certain aspects of the 2011 Proposals relating to the prospectus-exempt distribution of short-term securitized products (i.e. having a maturity of less than one year), primarily asset backed commercial paper (ABCP). Any comments on the Revised Proposals must be provided in writing by April 23, 2014. Citing the ABCP market disruption of 2007, the CSA premises the new approach on their belief that ABCP raises greater investor protection and systemic risk concerns than other types of commercial paper by virtue of its complexity, the frequent maturity mismatch between the underlying assets and the ABCP, and the systemic risk introduced by the maturity and liquidity transformations inherent in ABCP structures. The Revised Proposals would amend National Instrument 45-106 by making the following exemptions unavailable for the distribution of ABCP: (a) the short-term debt prospectus exemption; (b) the private issuer prospectus exemption; (c) the family, close friends and close business associates exemptions; (d) the founder, control person and family exemption; and (e) the offering memorandum exemption.
New Prospectus Exemption
A new prospectus exemption for short-term securitized products would be introduced under the Revised Proposals requiring that the short-term securitized product satisfy a number of conditions including:
Two credit ratings. A conduit that issues ABCP would be required to have credit ratings from at least two designated rating organizations (the existing short term debt exemption requires only one such rating). Each credit rating must be at or above a prescribed minimum level, which is higher than the minimum level proposed for other types of commercial paper. The exemption would be unavailable for ABCP if any of the issuing conduit’s credit ratings are under review by the relevant designated rating organization and it would be reasonable for the conduit to expect that the review would result in the credit rating being withdrawn or downgraded below the prescribed minimum level.
Prescribed liquidity support. Proposed liquidity support requirements with respect to short-term securitized products include:
- a "global-style" liquidity facility so that the liquidity provider is required to provide funding to pay in full maturing ABCP in all circumstances other than the bankruptcy or insolvency of the conduit or default of the underlying assets;
- the liquidity provider be a deposit-taking institution that is regulated by OSFI or a similar provincial regulatory authority; and
- the liquidity provider have long-term credit ratings that are at or above a prescribed minimum level from at least two designated rating organizations.
Permitted assets. A conduit relying on the exemption would have to contractually agree that its asset pool would consist only of traditional asset classes such as bonds, leases, mortgages, loans, royalties and receivables. The conduit could also hold securities of other conduits subject to the same asset class restrictions. If an asset pool includes credit derivatives or highly structured or leveraged credit products, short-term securitized products could still be issued in reliance on other prospectus exemptions such as the accredited investor exemption or the $150,000 minimum investment exemption. However, such exemptions would include resale conditions and may require the filing of an exempt distribution report (the current form of exempt distribution report would be amended to add securitization conduits as an industry classification).
Mandatory information memorandum. A conduit issuing ABCP would be required to prepare and make available to investors an information memorandum in a prescribed form prior to the investor purchasing the ABCP. Information required to be disclosed by the conduit in its information memorandum would include, among other things, the names of material sellers and servicers. See "Information Memorandum" below.
Contractual obligation to provide continuous disclosure. A conduit would be required to contractually agree with investors to provide a prescribed monthly disclosure report, to be prepared and made available within 30 days of month end, and a timely disclosure report which would be required in the event of either a change to the information in the most recent monthly disclosure report, or an event occurring that would reasonably be expected to materially affect either payments on that class of ABCP or performance of the assets in the asset pool. See "Continuous Disclosure" below.
Risk retention and incentive and interest alignment disclosure. Disclosure would be required in the monthly disclosure report about whether and how an ABCP structure aligns incentives of the securitization transaction parties with the interests of the investor.
Investor and regulator access to disclosure. The information memorandum, monthly disclosure reports and timely disclosure reports must be made reasonably available to investors and securities regulators (which may be satisfied by a conduit posting such documents on a website maintained by or on its behalf). In recognition that ABCP transactions occur in the exempt market, there would be no requirement that these disclosure documents be filed with securities regulators. However, conduits would be required to undertake to deliver the monthly disclosure reports and timely disclosure reports to securities regulators on request.
Significant Party Disclosure. One of the key disclosure requirements for the form of information memorandum in the Revised Proposals (Form 45-106F7) is disclosure of the identity of each "significant party" to a securitization transaction. The definition of "significant party" in Form 45-106F7 includes "principal obligors" and each person that performs or will perform certain activities if that role is "material". Such activities include: (a) organizing or initiating the transfer of a material portion of an asset pool to the conduit, (b) originating assets in an asset pool of the conduit, and (c) collecting payments generated by one or more assets in an asset pool of the conduit. "Principal obligor" is defined in Form 45-106F7 as an obligor of assets in an asset pool if the assets in respect of which the person is an obligor generate one-third or more of the aggregate cash flow generated by all assets in an asset pool of a conduit.
The definition of "significant party", as well as several other items in Form 45-106F7, provide that disclosure is only required of "material" information. The instructions to Form 45-106F7 provide that information is "material" if knowledge of it could reasonably be expected to affect a reasonable investor’s decision whether to buy, sell or hold a short-term securitized product. This materiality description is similar to the description of materiality in the form requirements for management’s discussion and analysis and annual information forms.
Eligible Assets. Form 45-106F7 requires disclosure of the material investment guidelines and underwriting criteria applied or to be applied to the assets that will form the conduit’s asset pool, including those regarding: (a) the types of assets that a conduit may acquire; (b) concentration or correlation limits, including limits in respect of industry classification, geographic regions and obligors; (c) the credit quality of assets that will form the asset pool of the conduit; and (d) the originators or intermediaries from which assets may be obtained. The due diligence or verification procedures that will be applied to the assets that will form each asset pool of the conduit are also to be described.
Material Agreements. Form 45-106F7 requires a description of the terms of each material agreement to which a significant party is a party, except to the extent previously disclosed in an information memorandum or a monthly disclosure report for the conduit. Disclosure is specifically required on any material contractual provisions designed to protect a holder of ABCP from material deterioration in respect of either or both of: (a) the performance of an asset pool, and (b) the credit quality or performance of a significant party.
Asset Pool. If on or prior to the date of the information memorandum the conduit has acquired an asset pool, Form 45-106F7 requires inclusion in the information memorandum, or as an annex thereto, of certain asset level information regarding the asset pool, such as: (a) a diagram disclosing the aggregate composition of the conduit’s asset pool broken down to disclose: (i) each asset type, expressed as a dollar amount and a percentage of the total asset pool; (ii) the industry of the originator of the assets, expressed as a dollar amount and a percentage of the total asset pool; and (iii) the amount of assets obtained from each originator, expressed as a percentage of the total asset pool; and (b) the identity of each principal obligor and the percentage of the asset pool in respect of which the person is the principal obligor.
No Misrepresentation. Form 45-106F7 provides that each information memorandum is to state that "This information memorandum does not contain a misrepresentation". However, the Revised Proposals do not introduce any additional statutory rights of action for a misrepresentation in an information memorandum beyond those that may already exist under the laws of an applicable jurisdiction.
In an attempt to increase and standardize ongoing disclosure to investors and regulators, the Revised Proposals require conduits to prepare both a monthly disclosure report (MDR) and a timely disclosure report (TDR). The prescribed requirements for the MDR are set out in Form 45-106F8, which is to be current as at each month end and is to be prepared and made available to investors within 30 days of each month end. The TDR is to be delivered to investors within two days upon the conduit becoming aware of material changes to information that was included in the most recently delivered MDR or upon the occurrence of an event that could reasonably be expected to "significantly" affect either (a) the payments on the short term securitized product; or (b) the performance of the assets in the asset pool. The Revised Proposals require that the conduit contractually agree with its investors by way of an undertaking or other agreement that it will provide such continuous disclosure reports for so long as the particular securitized product being sold remains outstanding.
Monthly Disclosure Report
As noted above, the prescribed form and content of the MDR is set out in Form 45-106F8, and requires the conduit to disclose, among other things, (a) the identity of each significant party to the securitization transaction; (b) structure diagrams of the securitization transaction or series of securitization transactions in which the conduit acquires an interest in an asset pool in connection with issuing ABCP and the related cash flows; (c) composition of the asset pool including a breakdown of: (i) each asset type, (ii) industry of the originator; (iii) identity of principal obligor, (iv) concentration risks, (v) use of hedging arrangements; and (vi) a description of any securities of other conduits owned by the conduit and the securitization program issuing them; (d) changes to the asset pool from the prior period; (e) program compliance and termination events, including the insolvency or bankruptcy of the conduit and material amortization or program events of default, and draws on liquidity facilities; (f) a summary of each securitization transaction entered into by the conduit, including: (i) number of obligors; (ii) number of originators and the industry in which each of the originators primarily does business; (iii) a description of assets; (iv) available credit enhancement; and (v) alignment of interest and conflicts of interest of the significant parties to such transaction, including: (A) whether any significant party has been required by law or undertaking to retain an economic interest in the credit risk of the assets and (B) if no economic interest was retained, the reasons why no risk was retained.
Timely Disclosure Report
The CSA has proposed that conduits provide "material information" to investors by delivery of a TDR relating to a change from information that was included in the most recently provided MDR or an event that the conduit would reasonably be expected to "significantly" effect either (a) the payment on the short term securitized product; or (b) the performance of the assets in the asset pool. As with Form 45-106F7, information is "material" if knowledge of it could reasonably be expected to affect a reasonable investor’s decision whether to buy, sell or hold a short term securitized product.
The Revised Proposals do not provide a prescribed form for the TDR. However, the Revised Proposals do provide that the TDR must describe the nature and substance of the change or event including how the change or event effects any payment on the short-term securitized product and the investment performance of the conduit’s asset pool.