The Ontario Personal Property Security Act (PPSA) currently does not allow cash collateral to be perfected by “control.” In addition, subsection 30(7) of the PPSA provides for a statutory priority by stating that a security interest in an “account” (which is defined in a way that would include deposit accounts) is subordinate to the interest of a person who is the beneficiary of a deemed trust arising under the Employment Standards Act, 2000, the Pension Benefits Act or the Pooled Registered Pension Plans Act, 2015. Moreover, as a result of the Sun Indalex case, the statutory priority could cover unfunded liabilities in defined benefit pans.
Because of the above-referenced PPSA provisions and the Sun Indalex case, the Canadian practise in dealing with cash collateral for derivatives is to either use the ISDA English law Transfer Annex CSA or use the New York Form of CSA amended to provide for title transfer of cash (rather than a grant of security interest). This approach has not yet been tested in courts but provides a good basis to address the risk posed by the unhelpful PPSA provisions and case law.
The Government of Ontario established the Business Law Advisory Council (the Council) in 2016 to review Ontario’s corporate and commercial legislation and to provide recommendations to reform that legislation. In the Fall 2016 Report of the Council, the Council is making a number of recommendations including the following:
- Perfection by “control” – PPSA should be amended to enable security interests in cash collateral to be perfected by “control,” thereby assuring secured parties a first-priority security interest in such collateral.
- Pension priority maintained with one exception – To address concerns expressed by stakeholders representing pension beneficiaries, PPSA should be amended to further preserve the s. 30(7) priority for all deposit accounts other than those that function as “financial collateral” for “eligible financial contracts” as defined in regulations to the Bankruptcy and Insolvency Act, which include most forms of OTC derivatives.
- Deposit accounts exempt if serve as financial collateral – The result would be that security interests in all deposit accounts except those that function as financial collateral would still be subject to the deemed trusts under s. 30(7). Only deposit accounts that serve as financial collateral would enjoy priority over the s. 30(7) deemed trusts.
The Council’s report also notes that the need for reform of the cash collateral regime took on greater urgency in September 2016 when OSFI’s Guideline E-22 (Margin Requirements for Non-Centrally Cleared Derivatives) took effect for the largest and most systemically important financial institutions. The report notes that although the margin need not be in the form of cash, it is expected that as sources of other forms of collateral (such as high-grade marketable securities) are exhausted due to increased demand, cash will become an increasingly important alternative. With this backdrop in mind, the proposed amendments, if enacted, would bring a welcome change for swap counterparties entering into OTC derivatives in Ontario.