The Government of Canada recently introduced the Budget Implementation Act, 2016 No. 1 (Bill C-15) to implement certain initiatives announced in the March 2016 federal budget, including amendments to the Canada Deposit Insurance Corporation Act (CDIC Act). Among other things, Bill C-15 will give a new authority to the Canada Deposit Insurance Corporation (CDIC) to bail-in certain liabilities of Canada’s domestic systemically important banks (DSIBs) by converting those liabilities into common shares. Bill C-15 will also amend the automatic stay provisions of the CDIC Act to further limit proceedings and actions against a distressed bank once it is subject to a restructuring order under the CDIC Act. For counterparties to eligible financial contracts that rely on the safe harbour from the automatic stay, Bill C-15 will introduce new limitations on those safe harbour protections. This bulletin provides an overview of these new measures, which will have significant implications for banks and their counterparties and creditors.

BACKGROUND TO CDIC ACT RESTRUCTURING PROCEEDINGS

While the bail-in powers contemplated in Bill C-15 are new, the CDIC Act already contains a legislative framework for restructuring a distressed federal deposit-taking institution (referred to herein as a Restructuring Bank). Under the existing CDIC Act regime, a restructuring process commences when the federal government makes one or more orders:

  1. Appointing the CDIC as the receiver of a Restructuring Bank
  2. Directing the incorporation of a bridge institution to assume a Restructuring Bank’s CDIC-insured deposit liabilities
  3. Vesting specified shares and subordinated debt of a Restructuring Bank in the CDIC

Based on these orders, the CDIC may carry out a number of restructuring transactions, including transferring all or part of the assets and liabilities of a Restructuring Bank to a CDIC-owned bridge institution or to an eligible third-party acquiror.

NEW BAIL-IN CONVERSION POWERS AND LOSS ABSORBING CAPACITY REQUIREMENTS

Two significant changes introduced by Bill C-15 are the bail-in power noted above and new loss absorbing capacity requirement. These apply only to DSIBs. Under Bill C-15, the federal government will be able to direct the CDIC to convert a DSIB’s prescribed liabilities and shares into common shares of either the DSIB or one of its affiliates. The categories of liabilities and shares eligible for such conversion, as well as the mechanics of the conversion, will be specified in regulations and CDIC by-laws, which have yet to be published. The federal government will only be able to order a conversion if the CDIC has already been appointed a receiver of the DSIB or all or part of its shares and subordinated debt have already been vested in the CDIC. New regulations and guidelines under the Bank Act will also specify a loss-absorbing capacity requirement for DSIBs based on a combination of regulatory capital and bail-in eligible liabilities. These are significant additions to the CDIC’s powers as a resolution authority and, along with the non-viable contingent capital regime currently in force, follow similar resolution and recovery reforms for financial institutions introduced in other major jurisdictions following the financial crisis.

CHANGES IMPACTING THE AUTOMATIC STAY

Following the making of an order under the CDIC Act, an automatic stay applies to ensure an orderly restructuring of the Restructuring Bank. In general, creditors of the Restructuring Bank may not commence legal proceedings, enforce a judgment, or exercise set-off rights against the Restructuring Bank or its assets (although certain exceptions apply in respect of clearing and settlement systems). The statutory stay also prohibits terminating or amending an agreement with a Restructuring Bank or claiming an accelerated payment under such agreement on the basis that the Restructuring Bank is insolvent or has defaulted in the performance of its obligations before an order is made under the CDIC Act. In addition, an agreement with a Restructuring Bank may not be terminated, amended or accelerated on the basis that the CDIC Act proceedings were instituted in respect of the Restructuring Bank or that the agreement was assigned to a bridge institution.

Bill C-15 amends the application of the automatic stay to agreements with a Restructuring Bank in four significant ways.

  1. While the automatic stay currently prohibits the termination, amendment or acceleration of any agreement with the Restructuring Bank solely on the basis of the insolvency of the Restructuring Bank, Bill C-15 extends that prohibition to include the insolvency of the Restructuring Bank’s affiliates, credit support providers or guarantors.
  2. Bill C-15 introduces a new prohibition on exercising termination, amendment, or acceleration rights based solely on the deteriorated financial condition of the Restructuring Bank, its affiliates, credit support providers or guarantors. Depending on how “deteriorated financial condition” is interpreted, this is a potentially significant expansion of the current prohibition under the CDIC Act, which, as noted above, only applies based on the insolvency of the Restructuring Bank itself.
  3. While the current automatic stay prohibits the exercise of termination, amendment or acceleration rights based on any pre-order default by the Restructuring Bank under the agreement, Bill C-15 draws a distinction between monetary and non-monetary defaults. Where a Restructuring Bank defaults pre-order in the performance of a monetary obligation under an agreement, Bill C-15 provides that the Restructuring Bank will have a 60-day grace period to remedy the monetary default after which the stay will no longer apply. In other words, Bill C-15 introduces a new time-limitation on the automatic stay in the case of monetary defaults.
  4. A party to an agreement with a Restructuring Bank will be prevented from terminating, amending, or accelerating that agreement if one of its affiliates has defaulted under that agreement. This prohibition would only apply where both the Restructuring Bank and the defaulting affiliate are parties to the agreement. It would not prohibit the termination, amendment or acceleration of an agreement based on the default of a third-party guarantor or credit support provider (though affiliated guarantors and credit support providers would trigger the prohibition).

CHANGES TO SAFE HARBOUR FOR ELIGIBLE FINANCIAL CONTRACTS

Bill C-15 would significantly change the rights of counterparties who have entered into “eligible financial contracts” (EFCs) with a Restructuring Bank. EFCs include, among other arrangements, derivative agreements, agreements to borrow or lend securities or commodities, securities or commodities repurchase, reverse repurchase or buy-sellback agreements, certain margin loans and related guarantees and security agreements.

The CDIC Act provides a safe harbour, which exempts EFCs from the automatic stay.

Under the CDIC Act as amended by Bill C-15, a counterparty to an EFC may, despite the automatic stay, take the following actions in accordance with the provisions of the EFC:

  1. Terminate or amend the EFC
  2. Accelerate payment under the EFC
  3. Exercise remedies for a failure to pay under the EFC
  4. Net or set off an amount payable under the EFC
  5. Deal with financial collateral, including by selling, foreclosing on, or setting off against financial collateral, or applying the proceeds or value of financial collateral

Under the current CDIC Act, the ability of counterparties to rely on this EFC safe harbour is suspended in order to preserve eligible financial contracts pending certain resolution actions by the CDIC. Specifically, if an order is made under the CDIC Act to incorporate a CDIC-owned bridge institution, the EFC safe harbour is suspended from the coming into force of that order until 5 p.m. (EDT) on the following business day. This temporary suspension of the EFC safe harbour becomes permanent if the CDIC undertakes to guarantee the Restructuring Bank’s payment obligations under the EFC or if the obligations of the EFC are assumed by the bridge institution. The CDIC is required to provide the financial assistance that the bridge institution needs to perform the assumed obligations under the EFC.

Bill C-15 amends these limitations on the EFC safe harbour in two significant ways.

Currently, if the federal government makes an order under the CDIC Act to incorporate a bridge institution, a counterparty to an EFC may not terminate or amend the EFC, accelerate a payment under the EFC, or deal with financial collateral based on the insolvency of the Restructuring Bank, the making of an order under the CDIC Act or the assignment of an EFC to the bridge institution. Mirroring some of the changes noted above in the context of the automatic stay, Bill C-15 would prohibit reliance on the EFC safe harbour based not only on the insolvency of the Restructuring Bank (as the current CDIC Act provides), but also based on (i) the insolvency of the Restructuring Bank’s affiliates or any guarantors and credit support providers under the EFC or (ii) the deteriorated financial condition of the Restructuring Bank, its affiliates, or any of its guarantors or credit support providers under the EFC. Among other things, these changes would limit the ability of counterparties to rely on the safe harbour to exercise certain cross-default rights under EFCs with the Restructured Bank. However, the changes in Bill C-15 do not go as far as reforms contemplated in other jurisdictions where financial institutions are being required to obtain contractual recognition and consent to such resolution stays from their counterparties regardless of the governing law of the underlying contract. We would note that the safe harbour is still fully preserved and permits exercises of remedies arising due to a failure to pay in respect of the EFC.

Further, under Bill C-15, the EFC safe harbour will be suspended not only where an EFC is assumed by a bridge institution but also when it is assumed by a third-party acquiror that meets the eligibility criteria specified in the CDIC Act. In particular, a counterparty to an EFC would not be permitted to terminate or amend the EFC, accelerate a payment under the EFC, or deal with financial collateral based on grounds similar to those described above if substantially all of the assets of the Restructuring Bank are being transferred to a third-party acquiror and the third-party acquiror assumes the EFC. The stay also applies if the CDIC undertakes to assign the EFC to the third-party acquiror.

Unlike a bridge institution, an eligible third-party acquiror that assumes the Restructuring Bank’s obligations under an EFC will not necessarily have the financial backing of the CDIC to discharge such obligations. Therefore, CDIC would be permitted to assign EFCs to a third-party acquiror only if the third-party meets certain conditions to be specified in the CDIC by-laws, which have not yet been published. In addition, the third party will need to certify that it meets all of the following requirements:

  1. It maintains all material licences and registrations required for the continued operation of its business and is in good standing in respect thereof
  2. It has, on its balance sheet, assets that exceed its liabilities
  3. It is able to discharge its obligations in respect of the assigned EFCs as they become due
  4. Its creditworthiness is at least as good as the Restructuring Bank’s creditworthiness was immediately before the relevant CDIC Act order was made

CLEARING AND SETTLEMENT SYSTEMS

Bill C-15 clarifies that the automatic stay under the CDIC Act will not prevent a clearing house of a settlement system designated under the Payment Clearing and Settlement Act or a securities and derivatives clearing house subject to that Act from taking any action in respect of the Restructuring Bank under its settlement rules. However, such clearing house may not discontinue acting as a clearing house in respect of a Restructuring Bank if the CDIC undertakes to provide the financial assistance that the Restructuring Bank needs in order to discharge its obligations to the clearing house as they become due.

Bill C-15 also clarifies that the automatic stay under the CDIC Act will not prevent a member of the Canadian Payments Association (CPA) from acting or ceasing to act as a clearing agent for the Restructuring Bank in accordance with the CPA governing legislation and rules, unless CDIC provides an undertaking of the type described above in respect of the Restructuring Bank.

COMING INTO FORCE

Bill C-15 is currently at first reading stage in the House of Commons. Once enacted, the provisions outlined above will come into force on a date to be fixed by the federal government.