As previously noted in our structured finance blog post of January 24, the Canadian Securities Administrators have published for comment proposed amendments to National Instrument 45-106 Prospectus and Registration Exemptions. These amendments represent a significant retreat from the more comprehensive set of amendments that were originally proposed by the CSA in 2011. Insofar as both the public and private term markets are concerned, status quo is the happy result. This is a sensible and welcome result and credit to the CSA for taking into consideration the feedback received from the industry consultation on the 2011 proposals.
Given that the only troubling issues in the asset-backed securities market during the financial crisis occurred in the asset-backed commercial paper (ABCP) market (albeit in the non-bank sponsored portion of the market), it is not surprising to see the CSA retain some semblance of heightened regulation over this sector. Consistent with the approach taken in 2011, the CSA have (thankfully) chosen not to impose some of the more substantive (and controversial) requirements on transactions that are being implemented in other jurisdictions (such as mandatory risk retention) but instead have chosen to impose additional requirements (that are largely disclosure-based) on ABCP conduit issuers in order for them to be able to access the prospectus-exempt market.
At first blush, the revised proposals appear to be responsive to much of the commentary received from the industry on the ABCP market in 2011. That being said, there look to be some issues that we expect will draw the interest of (and create some consternation for) ABCP conduit sponsors.
In brief, the main substantive requirements for ABCP to be issued on a prospectus-exempt basis are as follows: (i) the ABCP must be rated by at least two of the specified rating agencies in the highest short-term rating category (which is R-1 (high)(sf) in the case of DBRS); (ii) a “global style” liquidity facility must be provided by a deposit-taking institution that is regulated by OSFI or by another federal or provincial authority that regulates deposit-taking institutions and that has certain specified minimum ratings from two of the specified rating agencies (which is A(low) in the case of DBRS); (iii) the ABCP must be the highest rated “class” issued by the conduit; and (iv) the asset pool of the conduit is limited to a prescribed list of asset types (bond, mortgage, lease, loan, receivable, royalty or a security issued by another conduit that is backed by one of these asset types).
Rating and liquidity requirements
The rating and liquidity requirements are simply codifying the current state of the ABCP market and should not raise any real concern. While ABCP rated less than R-1 (high) was never a large part of the market, it formally ends the possibility of any type of rebirth or renewal of this sector. The reference to “classes” of debt throughout the proposed amendments is an interesting change in terminology. The 2011 proposals repeatedly used the concept of “series” to distinguish between different categories of debt issued by conduits and this is consistent with the commonly used terminology in the conduit market in the sense that series of debt are typically “siloed” or “ring-fenced” from other series and each series is secured by a separate asset pool (or a separate asset interest in a common asset pool). Typically, multiple series of debt wouldn’t rank with or as against one another or have an interest in the same collateral (whereas classes within a series would).
It isn’t clear from these proposed amendments whether the CSA is trying to distinguish between classes of debt within the same series or whether they are using the concepts of “series” (as used by the market) and “class” interchangeably. Consequently, in some cases the purpose of the amendments is uncertain and will hopefully be clarified.
Prescribed list of assets
The use of a prescribed list of assets to determine what may form part of an asset pool of a conduit is somewhat unfortunate. While it may on its face appear to be sufficiently broad to cover the lion’s share of asset classes that are presently securitized in the Canadian market, this prescriptive approach could stifle innovation in the future as new asset classes or financial products develop or evolve.
While we understand the concern over riskier assets such as highly leveraged credit default swaps, which introduce a significant degree of market risk (over and above the credit risk), query whether the other substantive requirements that are being codified (including multiple ratings and global style liquidity) aren’t sufficient to police this issue (anecdotal evidence would suggest this is the case). At a minimum, the preferred approach would be to create a broader definition of financial assets that would permit new asset classes to fit within its parameters and to prescribe certain assets that are prohibited rather than prescribe what is permissible.
The greatest area of concern raised by the proposed amendments relates to the substance of the disclosures that are required in the prescribed form of information memorandum (IM), the form of monthly report and the timely disclosure report. The IM is required to disclose, among other things, the identity of persons originating assets in an asset pool of the conduit. Anonymity has long been a hallmark of the ABCP conduit market and something that has been important to many originators; this may lead some (of those that are left) to withdraw from the ABCP market.
The IM is also required to disclose certain matters that are typically determined (and will vary) from transaction to transaction depending upon the quality and characteristics of the particular originator and its assets (such as investment guidelines and underwriting criteria (typically embodied in transaction-specific eligibility criteria), the amount and nature of credit enhancements, portfolio performance tests, a description of the terms of each material agreement and the basic structure and cash flows of each transaction). Given that these matters are transaction-specific and will change periodically this type of information would seem to be more appropriately dealt with in the monthly disclosure reports.
In addition to the required content in the IM, the conduits are also required to provide monthly disclosure reports containing transaction-specific disclosure. These are intended to provide information with respect to new transactions entered into by the conduit as well as an update to information previously disclosed in the IM or prior monthly disclosure reports. As with the form of IM, the level of detail required (including specific disclosure with respect to originators and their assets) is significant and in some cases goes beyond what is currently provided in the market. Whether or not these requirements will deter either sponsors from maintaining a conduit or originators from selling to conduits (for confidentiality and competitive reasons) will be subject to debate.
In addition to the IM and the monthly report, conduits are also required to provide a timely disclosure report within two days of becoming aware of any change to the information provided in the most recently required monthly disclosure report or any event that the conduit would reasonably expect to significantly affect either a payment on the securitized product or the performance of the assets in the asset pool. Given that sponsors already require a minimum of 30 days (or perhaps longer) to compile monthly portfolio reports from their sellers in order to prepare the conduit’s monthly report, it is unlikely that this type of information can be disseminated more effectively or efficiently than through the monthly reporting process. Nonetheless, this reporting requirement would appear to put a greater onus on the conduits to report information that isn’t entirely within their control (at least not on a timely basis).
Given the vast amount of regulatory change and the turbulent economic conditions in recent years, the ABCP market in Canada isn’t nearly as robust as it used to be. Hopefully these proposals won’t inflict greater damage or render it extinct.