On August 31 the comment period in respect of the Canadian Securities Administrators’ Proposed Securitized Product Rules ended. About 30 comment letters were submitted. Over the next couple of weeks I will briefly canvass the comments received on the prospectus disclosure rules and the exempt market rules. Following is a brief discussion of the more general comments.
While almost all commentators concurred with the general principles enunciated by the CSA, a few concluded from the distinct nature of the traditional Canadian securitization market (no originate-to-distribute model; good asset performance) and the nature of the financial crisis that it experienced (liquidity only), that any new rules should leave traditional ABS alone and concentrate solely on those transactions which in fact at the root of the financial turmoil of the past few years. These were identified as those transations utilizing originate-to-distribute model and those involving synthetic securities. Although this view has much to recommend it, it does not seem likely that the CSA will abandon the omnibus approach which they have taken. They will probably feel that they have already provided sufficient recognition of the distinct nature of the Canadian market by refraining from applying the more intrusive Dodd-Frank and Reg AB II proposals, an approach otherwise all but uniformly praised by commentators.
The entry point for the application of the Proposals is the definition of securitized product. Given the importance of this definition it is perhaps surprising that comparatively little attention was paid to it by most commentators. Those who did comment on it did little but indicate that they believed the definition to be too broad and cite a few examples of instruments that should not be caught. These included NHA MBS, Canada Mortgage Bonds, over-the-counter derivatives, corporate loans secured by pools of assets, innovative Tier 1 capital structures and structured notes. Apart from our own submission, very little analysis was provided to the CSA to allow it to structure a principle-based definition. And we do not believe that the solution lies in merely listing the above as exceptions as, unless the definition itself is refined significantly, there will be too many classes of securities on the margins or in the “grey” zone. As illustrated in our submission, there are a number of other types of securities that could unexpectedly be caught by the definition and specifically listing included or excluded securities may not be an effective solution as such lists may result in further interpretive difficulties.
The extreme breadth of the definition will create a trap for the unwary issuer which may only become apparent upon receipt of a comment letter or, more problematically, a claim from an investor in a private transaction who later, being discontented with the outcome of his investment, is casting about for grounds for reimbursement. Indeed any proposed issuance of securities in the “grey” zone will need to be approached cautiously under the proposed definition. If the issuance is to be by way of prospectus, the new rules are tailored almost entirely to fit traditional ABS and a “grey” zone issuer would be hard-pressed to understand what specific disclosure is required in respect of its issuance. It would be much worse, however, if the issuance is to be conducted in the exempt market since the issuer would be caught between the rock of not complying, and thereby potentially opening itself up to liability for non-compliance, and the hard place of complying, and thereby voluntarily taking on unwarranted liability by operation of the new disclosure and certification requirements. The uncertainty surrounding the applicability of the definition of securitized product could virtually eliminate all issuances of these “grey” zone securities as it would be difficult to obtain a legal opinion which would give sufficient comfort on the applicability of and compliance with securities laws. It is therefore incumbent upon the CSA to strive for much greater clarity in this area and we believe that they should submit a new proposal on this point for comment.