Canada’s C$30-billion market for “asset-backed commercial paper” will soon be regulated by Canada’s securities regulators (CSA) for the first time. The new rules published by the CSA (New Rules) are much less extensive than the CSA’s initial 2011 proposals, which contemplated the comprehensive regulation of securitized products, and are milder than the CSA’s more targeted 2014 rewrite (2014 Proposals).
As of May 5, 2015, issuers of a “securitized product” that is a negotiable promissory note or commercial paper maturing not more than one year from the issue date (ABCP) will no longer be able to sell such securities in reliance on the broad prospectus exemption available generally for commercial paper. Instead, a newly created prospectus exemption (ABCP Exemption) will permit a special purpose issuer (Conduit) to sell its ABCP if it:
- Restricts its underlying asset pools to bonds, loans, leases, mortgages, receivables, royalties and related security interests
- Obtains high credit ratings for the ABCP from at least two designated rating organizations
- Provides for “global-style” liquidity support for the ABCP from one or more rated and regulated or approved deposit-taking institutions
- Provides or makes available:
- An information memorandum to disclose its structure and operations and other specified information
- Monthly disclosure reports focused on the underlying asset pools and transactions
- Timely disclosure reports, when, among other things, events occur that adversely affect the payment of interest or principal under the ABCP.
Otherwise, issuances of ABCP will be treated for securities law purposes like all other asset-backed securities, requiring the use of a full-blown prospectus or needing to be distributed under one or more otherwise available private placement exemptions (such as sales made only to “accredited investors” or based on a minimum investment of C$150,000). In the latter case, the Conduit would be required to comply with related trade filing requirements and resale restrictions that are not well-suited to the ABCP market. The ABCP Exemption will avoid such resale and trade reporting requirements.
The implementation of the New Rules marks the end of the CSA’s initial consideration of issues arising in connection with securitized products, stemming from the global financial crisis. In the end, the CSA determined that a narrow regulatory response, focused on the causes of the “non-bank sponsored ABCP” market meltdown, will be sufficient. In doing so, the CSA considered but ultimately rejected a more pervasive reaction, determining not to:
- Impose expansive new disclosure and certification requirements for securitized products generally
- Require the identification of the principal obligors or the originators of assets
- Create a new regime of statutory or contractually equivalent rights against issuers, sponsors of securitized products and underwriters in respect of misrepresentations in mandated disclosure
- Prescribe structural features, such as minimum levels of credit risk retention by the originators and sponsors of the securitized assets.
The New Rules are incorporated into the general instrument governing most exempt trades of securities in Canada (NI 45-106). The New Rules, together with certain other changes to Canada’s exempt trading regime (discussed in Blakes Bulletin: Still Exempt? Important Changes to the Private Placement Regime being published contemporaneously with this bulletin), will become effective on May 5, 2015.
Requirements to Use the ABCP Exemption
To qualify for the ABCP Exemption, distributions of ABCP must not be convertible or exchangeable into or accompanied by a right to purchase another security other than a permitted short-term securitized product and must satisfy the following requirements.
The ABCP Exemption is only available in respect of a “short-term securitized product”, which is a security that:
- Provides a holder with a direct or indirect ownership or security interest in one or more asset pools
- Entitles a holder to payments of principal or interest primarily obtained from the cash flows or liquidation proceeds from asset pools or from the proceeds of a new issue of securitized products
- Is a negotiable promissory note or commercial paper governed by a trust indenture or similar agreement
- Matures not more than one year from its issue date.
The Conduit issuing such a short-term securitized product must be:
- Created to acquire a direct or indirect ownership or security interest in an asset pool in connection with such issuing activity
- Structured so that it is reasonable to expect that in any bankruptcy or insolvency proceeding:
- None of the assets in which the Conduit has an ownership interest will be consolidated with the assets of a third party who transferred or participated in the transfer of assets to the Conduit prior to the satisfaction of all securitized products backed by such transferred assets
- The Conduit’s security interest in any asset will have priority over the claims of other persons.
The ABCP Exemption requires the Conduit to commit that any cash-flow generating assets in which it acquires a direct or indirect ownership or security interest will consist only of bonds, loans, leases, mortgages, receivables and royalties, and any real or personal property securing or forming part of such assets.
The ABCP Exemption requires that each exempted short-term securitized product:
- Be rated by at least two designated rating organizations (or their designated affiliates)
- Have one such rating at DBRS R-1(high)(sf), Fitch F1+sf, Moody’s P-1(sf) or S&P A-1(High)(sf) (Canada national scale) or A-1+(sf) (global scale)
- Have no such rating below DBRS R-1(low)(sf), Fitch F2sf, Moody’s P-2(sf), S&P A-1(Low)(sf) (Canada national scale) or A-2(sf) (global scale).
The ABCP Exemption will not be disallowed solely as a result of an applicable credit rating being under review, which had been contemplated by the 2014 Proposals.
ABCP distributed in reliance on the ABCP Exemption may not, in the event of a bankruptcy, insolvency or winding up of the Conduit, be subordinate in priority of claim to the asset pool backing such ABCP relative to the claims of any outstanding series or class of short-term securitized products issued by the Conduit in respect of such asset pool. This means the ABCP Exemption will be available for a Conduit that distributes more than one series or class of short-term securitized products. However, this only applies if the exempt series or class ranks equally with other series or classes backed by the same underlying asset pool.
The ABCP Exemption requires that ABCP be backed by one or more “global-style” liquidity facilities that satisfy the following conditions:
- The liquidity provider must :
- Be a deposit-taking institution
- Be regulated or approved to carry on business in Canada by the Office of the Superintendent of Financial Institutions (Canada) or a government department or regulatory authority of Canada or of a province that has responsibility for regulating deposit-taking institutions
- Have a specified minimum rating from each designated rating organization (or its designated affiliate) that is rating the ABCP
- The related liquidity agreements entered into by the Conduit must obligate the liquidity providers to provide funds to the Conduit sufficient to enable the Conduit to satisfy its principal and interest obligations as the ABCP matures, except that funding would not be required if the Conduit becomes subject to bankruptcy or certain insolvency proceedings and the total of the funding required need not exceed the value of the non-defaulted assets in the asset pool plus any credit enhancement to which the liquidity arrangement relates.
These provisions have been relaxed from those in the 2014 Proposals so that they will allow a liquidity provider to be a deposit-taking institution that is approved to carry on business in Canada (whether or not regulated) by OSFI or a government department or regulatory authority of Canada, or of a jurisdiction of Canada responsible for regulating deposit-taking institutions.
The ABCP Exemption requires that the Conduit must comply with certain initial, continuous and timely disclosure requirements, including the following:
- Use of an Information Memorandum. – The Conduit must prepare and provide or “make reasonably available” to the purchaser and the securities regulator an information memorandum that satisfies detailed form and disclosure requirements. Among other things, an information memorandum must set out certain information regarding the Conduit’s structure, operations and its sponsors. It must also include a representation that the information memorandum does not contain a misrepresentation regarding the Conduit, its structure, or its operations. Importantly, the identities of large obligors and asset originators need not be disclosed, as had been contemplated in the 2014 Proposals. Further, the scope of the information memorandum has been narrowed somewhat to focus on program-level disclosure, with information relating to specific asset transactions and asset pools moved into the monthly disclosure report.
- Monthly Disclosure Report. – For so long as a short-term securitized product of the relevant class remains outstanding, the Conduit must prepare and provide or “make reasonably available” to each holder and the securities regulator a monthly disclosure report that satisfies detailed form and disclosure requirements. Among other things, each monthly disclosure report will need to set out prescribed information regarding underlying asset transactions, asset pools and their performance. The report must be made available within 50 days of the end of the relevant month (rather than 30 days, as had been proposed). The content of the monthly disclosure report has been revised and streamlined from the version set out in the 2014 Proposals.
- Timely Disclosure Monthly Disclosure Report. – For so long as a short-term securitized product of the relevant class remains outstanding, the Conduit must prepare and provide or “make reasonably available” to each holder and the securities regulator prescribed timely disclosure of certain significant events relating to the Conduit’s credit rating and the payment of principal and interest. Disclosure must be made no later than the second business day after the Conduit becomes aware of the event.
The CSA has offered guidance that the requirement to make disclosure “reasonably available” to investors and securities regulators may be satisfied by making disclosure on a website in certain circumstances.
Other Prospectus Exemptions
Securitized products that do not meet the requirements for the ABCP Exemption set out above, including ABCP backed by credit derivatives or other highly structured or leveraged credit products, will be required to be sold with a prospectus or under an available prospectus exemption. In addition, the accredited investor and minimum amount prospectus exemptions will continue to be available for short-term securitized products (e.g., where a Conduit wishes to avoid the ongoing disclosure obligations mandated by the New Rules).
The New Rules will also amend two prescribed forms of report of exempt distribution under NI 45-106 to add a new industry classification for a securitized products issuer. This amendment is intended to allow the CSA to collect information regarding distributions of securitized products made under other prospectus exemptions, including the accredited investor exemption and the minimum amount investment exemption.
Subject to the necessary approvals, the New Rules will come into force on May 5, 2015. Compliance with certain aspects of the reporting requirements of the ABCP Exemption will not be required until November 5, 2015.
The New Rules reflect a distinctly Canadian approach to the regulation of ABCP. It will be interesting to see whether ABCP market participants will choose to comply with the enhanced requirements of the New Rules or to comply with other available prospectus exemptions.