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Legal Update: Canadian Registered Covered Bond Programs Guide

On December 17, 2012, Canada Mortgage and Housing Corporation (CMHC) published the Canadian Registered Covered Bond Programs Guide (Program Guide) implementing the legislative framework established by Part I.1 of the National Housing Act (Canada) (Legislative Framework). The Program Guide elaborates on the role and powers of CMHC as administrator of the Legislative Framework and sets out the conditions and restrictions applicable to registered covered bond issuers and registered covered bond programs.

Investor Protection

A key element of the Legislative Framework is the protection afforded to the transfer of cover pool assets from the registered issuer to the guarantor and the guarantor’s ability to deal with such assets in the event of the insolvency of the registered issuer. This protection is supported in the Program Guide through the prescription of various default risk mitigants, such as limitations on cure periods for payment defaults and ratings triggers for the replacement of the account bank at which the guarantor’s accounts are held. The Program Guide also specifies a number of circumstances which must be included as events of default under a registered covered bond program and certain of the actions that must be taken following the occurrence and continuance of any such event.

Covered Bonds Registry

One of CMHC’s primary responsibilities as administrator of the Legislative Framework is to establish and maintain a publicly-accessible registry of covered bond issuers and programs. Eligible issuers (including federally-regulated financial institutions and, following the order of the Governor in Council, provincial cooperative credit societies) can apply to CMHC for registration as a covered bond issuer by providing CMHC with the prescribed information and materials, including an undertaking not to issue covered bonds other than pursuant to a registered covered bond program. Registered issuers can then apply for registration of one or more covered bond programs. It is within the power of CMHC as administrator of the Legislative Framework to reject applications, to suspend registered issuers and to deregister programs (provided that no covered bonds are outstanding under such program) and issuers (provided that no covered bonds of such issuer are outstanding under any registered program).

Program Requirements

In order to be registered, covered bond programs must meet the requirements provided for in the Legislative Framework and the Program Guide, which include (i) restrictions on the type of entity that can serve as the guarantor, (ii) criteria to be satisfied by all counterparties to registered covered bond program transaction documents, (iii) a requirement for a custodian to hold data and documents in respect of the cover pool, and (iv) matters that must be subject to a ratings trigger.

Cover Pool Assets

Assets held by the guarantor as collateral for the covered bonds may not include mortgages or other secured residential loans that (i) are insured by CMHC or other prescribed insurers, or (ii) have a loan-to-value ratio that exceeds 80%. The guarantor may hold substitute assets consisting of Government of Canada securities and repos of such securities, provided that the value of such substitute assets may not exceed 10% of the total value of the cover pool. The Program Guide further restricts cover pool assets by limiting cash held by the guarantor at any time to the amount necessary to meet the guarantor’s payment obligations for the next six months, subject to certain exceptions. Registered issuers must also establish a minimum and maximum level of overcollateralization with the requirement that such levels to be disclosed in the issuer’s offering documents and in the registry.

The Program Guide also requires that the guarantor engage in certain risk-monitoring and risk-mitigation practices, including (i) measurement of the present value of the cover pool assets as compared to the outstanding covered bonds, and (ii) hedging of its interest rate and currency exchange risks. Further, the Program Guide prescribes methodology to be employed for the asset coverage and amortization tests as well as the specified procedures to be carried out by the cover pool monitor.

Disclosure and Reporting

The Program Guide sets out a number of disclosure and reporting obligations for registered covered bond issuers. Underlying these obligations is the principle that investors should have access to all material information with respect to the registered issuer and the relevant series of covered bonds in order to make an informed investment decision with respect to buying, selling or holding such covered bonds. Registered covered bond issuers will be required to maintain a website where investors can access, among other things, public offering documents, material transaction documents, monthly reports on the cover pool assets and static cover pool data that users may download and analyze.

While the disclosure requirements in the Program Guide for public offering documents under registered covered bond programs are generally guided by Canadian securities law principles of full, true and plain disclosure of all material facts concerning a registered covered bond issuer and a program, the Program Guide also sets forth minimum specific disclosure requirements for such offering documents. In some cases, these minimum standards enhance the level of disclosure found in public offering documents of existing non-registered covered bond programs, in particular with respect to statistics relating to the cover pool assets.

In addition to the information provided to CMHC at the time of application for registration of an issuer or a program and the disclosure to be published on a registered issuer’s program website, the Program Guide imposes ongoing obligations on registered issuers, including notification to CMHC of certain matters. Such obligations include: delivery of annual compliance certificates and notification of an issuance of covered bonds, changes to the program or terms and conditions of the covered bonds, and breaches and defaults under the transaction documents.

Next Steps

We would be pleased to discuss with you any questions or comments that you may have with respect to the Program Guide and the Legislative Framework.