On April 20, 2016, the Canadian federal government introduced Bill C-15, which is legislation that provides for, among other things, a bank recapitalization or “bail-in” regime for domestic systemically important banks (“D-SIBs”).

BAIL-IN

For those unfamiliar with this feature of financial services regulatory reform, the basic concept of bail-in is that certain stakeholders of a bank that finds itself in the remote circumstance of being in severe distress will be required to support the viability of such a bank by mandatory conversion of their respective instruments into the common equity of the bank. This mandatory conversion would occur upon a regulatory determination that triggering such conversions will absorb losses and that, together with such other measures as regulators may determine to be necessary, such conversions will be sufficient to re-establish the viability of such a bank. This legislative mechanic is intended to avoid (or minimize) the likelihood of a “bail-out” of such a bank by taxpayers. The bail-in regime is largely expected (but not specified as such in the proposed legislation) to apply at least in the first instance to certain unsecured senior debt instruments with a term of greater than 400 days issued by D-SIBs to institutional investors after the legislation comes into force (and after required regulations are also implemented).[1] A bail-in regime for senior debt would augment the existing conversion rules in the Non-Viable Contingent Capital (NVCC) regime applicable to regulatory capital instruments issued by Canadian banks by way of subordinated debt and preferred equity, which has been in place in Canada for all Canadian banks for three years. Both the existing NVCC regime for non-common regulatory capital and the proposed bail-in regime presumably for certain senior debt obligations of D-SIBs, represents Canada’s implementation of global regulatory changes being adopted with varying characteristics in a number of jurisdictions in the post-financial crisis environment.

Pursuant to the proposed legislation, certain D-SIB stakeholders (the scope of which remains to be defined) will be required to absorb losses prior to taxpayers being exposed to losses following a triggering of same by regulators. The prior government had issued a consultation paper (the “Consultation Paper”) outlining the details of a proposed “bail-in” regime (which we described in further detail in our prior legal update Department of Finance Releases Proposal for Canadian Bail-In Regime). The federal government thereafter confirmed its intention to proceed with a bail-in regime in both the 2015 budget and, following the change in government, the March 2016 budget.

The bail-in regime in the proposed legislation is merely, at this point, a framework. As is common practice for such legislative introductions, most of the details are not in the legislation and are reserved for regulations that will follow.

D-SIB

Bill C-15 proposes to amend the Bank Act, providing OSFI with the power to designate D-SIBs pursuant to a prescribed process that will result in public disclosure of all such designations. The Superintendent may, by order, designate a bank as a D-SIB, unless the Minister of Finance is of the opinion that it is not in the public interest to do so. The Superintendent may also revoke a D-SIB designation. The Bank Act amendments provide that the Superintendent must, for each D-SIB, set the amount of capital, composed of prescribed shares and liabilities, that constitute the D-SIB’s minimum capacity to absorb losses. OSFI has previously issued an advisory designating the six largest domestic Canadian banks as D-SIBs.

CDIC

The tabled legislation provides that, if the Superintendent of the Office of the Superintendent of Financial Institutions (“OSFI”) is of the opinion that a D-SIB has ceased, or is about to cease, to be viable, and that its viability cannot be restored through the exercise of the Superintendent’s powers, then the federal government can appoint the Canada Deposit Insurance Corporation (“CDIC”) as receiver of the bank and direct CDIC to convert certain shares and liabilities of the bank into common shares of the bank or any of its affiliates. The shares and liabilities that will be subject to the conversion power are not specified in the legislation, and will be classified by the regulations. The conversion authority will only apply to shares and liabilities issued or originated on or after the date that the regulations come into force unless, on or after that date, the shares or liabilities are amended or, in the case of liabilities, their term is extended. The proposed legislation also provides for additional amendments to the Canada Deposit Insurance Corporations Act (the “CDIC Act”) that broaden CDIC’s bank resolution authority with respect to D-SIBs, and in particular CDIC’s powers to temporarily take control of a D-SIB. In addition, the legislation expands circumstances in which restrictions, such as a stay preventing termination of agreements (subject to the limitations discussed below concerning eligible financial contracts), will be imposed following a CDIC receivership or conversion order, including that an agreement may not be terminated by reason of (i) the “deteriorated financial condition” of the bank or any of its affiliates, providers of credit support or guarantors (rather than only the bank’s insolvency), (ii) a non-monetary default by the bank or an affiliate before the order was made, or (iii) a monetary default, before the order was made, that is remedied within 60 days.

COMPENSATION

Bill C-15 does provide that if a designated person is in an inferior financial position following the conversion than such person would have been in following a winding-up then that person is entitled to compensation. This situation could arise, for example, when a debt-holder has its debt converted to common equity and loses the priority it would have otherwise had to common shareholders in a winding-up of a bank.

EFCs

Eligible financial contracts (“EFCs”) substantially corresponds to what is generally viewed, in business terms, as derivatives instruments, securities lending or repurchase transactions.

Subject to certain exceptions, the CDIC Act contains safe harbours providing for the enforceability of termination and close out netting rights, including dealing with financial collateral, under EFCs, despite the automatic stay from termination of contracts that would otherwise apply upon the making of a CDIC receivership or similar order. Currently, in the case of a CDIC receivership where an order to incorporate a bridge institution is made, the EFC safe harbour is not available for one business day (the “Bridge Institution Stay”) where the termination and close-out netting is being taken by reason only of (i) the insolvency of the bank, (ii) the making of the order appointing CDIC as receiver or incorporating the bridge institution or (iii) the assigning of the EFC to a bridge institution (collectively, the “StayedReasons for Terminating”).

Bill C-15 amends these existing EFC safe harbour provisions mainly in three ways. First, Bill C-15 provides that the Bridge Institution Stay still applies to stay (i) the termination or amendment of the EFC, (ii) the accelerated payment or forfeiture of the term under the EFC, and (iii) any dealings with financial collateral (other than two specified actions described below) (collectively, the “Stayed Actions”) in circumstances in which a bridge institution order is made. It also expands the Stayed Reasons for Terminating under the Bridge Institution Stay to include the “deteriorated financial condition” of the bank, its affiliates or its credit support provider or guarantors under an EFC in addition to the bank’s insolvency. However, Bill C-15 clarifies that the following actions are not subject to the Bridge Institution Stay: (a) the exercise of remedies for a failure to pay an amount payable under an EFC, and (b) the netting and setting off of an amount payable under the EFC. Therefore, in such circumstances, if a bank has failed to pay under the EFC, the non-defaulting party could exercise its remedies, even where an order to incorporate a bridge institution is made.

Second, Bill C-15 amends the EFC safe harbour provisions under the CDIC Act to provide that, in the case where no bridge institution is created, or if one is created and the CDIC assigns the EFC to it prior to the expiry of the one business day stay mentioned above, the Stayed Actions could not be taken by reason only of the following reasons:

  • the insolvency or deteriorated financial condition of the bank, its affiliates or its credit support provider or guarantors,
  • the bank’s EFCs being assigned to or assumed by a bridge institution or a third party,
  • an order appointing CDIC as receiver or similar order or any change of control or ownership of the bank or any of its affiliates, or
  • a conversion of the bank’s shares or liabilities in accordance with their terms or as a result of an order.

The federal government may order the end of this stay at a prescribed effective time if all or substantially all of the assets of the bank will be transferred to a third party, except with respect to EFCs that CDIC undertakes to transfer to a third party before the prescribed effective time.

Third, Bill C-15 amends the EFC provisions to provide that the Stayed Actions do not apply to EFCs that are cleared unless the CDIC has given an undertaking to provide financial assistance that the bank needs in order to discharge the bank’s obligations to the clearing house as they become due.

TIMING

The draft legislation provides no timetable for the implementation of the proposed bail-in regime. Bill C‑15 provides that it will come into force on a date to be determined.