More than six years after the C$35 billion meltdown of Canada’s non-bank-sponsored asset-backed commercial paper (Non-Bank ABCP) market, the Canadian Securities Administrators (CSA) have proposed certain changes to the rules governing the prospectus-exempt distribution of short-term securitized products (New Proposals). The New Proposals are much less extensive than the comprehensive changes originally proposed by the CSA in 2011 (2011 Proposals), which would have broadly regulated “securitized products” as a distinct product class. The CSA has substantially refined its initial approach to now focus on the way asset-backed commercial paper (ABCP) issued by a bankruptcy-remote special purpose entity (Conduit) may be distributed and traded without a prospectus.
Under the New Proposals, ABCP backed by traditional or conventional assets, i.e., bonds, loans, leases, mortgages, receivables and royalties, (Traditional ABCP) may be distributed broadly and without resale restrictions, subject to compliance with customized disclosure, liquidity and rating requirements. Otherwise, ABCP will need to be distributed under a full-blown prospectus or based on otherwise available private placement exemptions, such as sales made only to “accredited investors” or based on a minimum investment of C$150,000 (Exempt Private Placements). Exempt Private Placements are generally subject to cumbersome resale restrictions and trade reporting requirements.
The New Proposals are intended to address certain investor protection and systemic risk concerns raised by ABCP, with a particular focus on the types of complex products involved in the meltdown of the Non-Bank ABCP market. The CSA’s conclusion in this regard is that, with the exception of Non-Bank ABCP, securitization activity in Canada does not raise systemic risk or different investor protection concerns that warrant the comprehensive regulatory intervention contemplated by the product-specific rules included in the 2011 Proposals.
EXISTING COMMERCIAL PAPER REGIME
Currently, highly rated promissory notes or commercial paper can be issued and traded on a prospectus-exempt basis in reliance on the prospectus exemption under section 2.35 of National Instrument 45-106 (Commercial Paper Exemption). To qualify under the Commercial Paper Exemption the debt securities must:
- mature no more than a year from date of issue;
- not be convertible or exchangeable into or accompanied by a right to purchase another security other than qualifying commercial paper; and
- have at least one rating at or above, and no rating below, DBRS Limited (DBRS) R-1 (low), Standard & Poor’s Rating Services (Canada) (S&P) A-1(low), Moody’s Canada Inc. (Moody’s) P-1, or Fitch Inc. (Fitch) F1.
Securities distributed under the Commercial Paper Exemption can be issued to any investor, are not subject to resale restrictions and do not need to be reported to securities regulators. By contrast, Exempt Private Placements generally place limitations on who can purchase the securities, impose resale restrictions and need to be reported to securities regulators under Exempt Distribution Reports.
Currently, issuers of ABCP can use the Commercial Paper Exemption. If the New Proposals are implemented, the Commercial Paper Exemption will no longer be available for ABCP. In its place, a new, ABCP-specific exemption will be made available – but only for Traditional ABCP that is distributed in compliance with a new disclosure regime and that otherwise meets specified conditions. All other ABCP will be subject to ordinary prospectus requirements or to the requirements applicable to Exempt Private Placements.
The New Proposals would, among other things:
- eliminate the possibility that “securitized products,” including ABCP, could be traded in reliance on the Commercial Paper Exemption;
- create a new prospectus exemption (Short-Term Securitized Products Exemption) permitting prospectus-exempt sales and resales of Traditional ABCP that is not convertible or exchangeable into another security, other than Traditional ABCP, provided that:
- the Traditional ABCP is rated by at least two of DBRS (R-1 (high) (sf)), Fitch (F1+ sf), Moody’s (P-1(sf)) and S&P (A-1 (high) (sf)), and none of those rating agencies have announced that their ratings are under review where the result could reasonably be that it would not meet such minimum required ratings;
- the Traditional ABCP has the highest priority of any outstanding class of short-term securitized product issued by the Conduit;
- the Traditional ABCP is backed by one or more “global-style” liquidity facilities that meet specified rating, commercial and regulatory criteria and that would be sufficient to cover the value of underlying financial assets and credit enhancements to enable the Conduit to pay principal and interest owing under the Traditional ABCP; and
- an information memorandum is prepared for use by the Conduit in compliance with the requirements set out in the New Proposals, including an undertaking to provide monthly and timely change disclosure in accordance with prescribed forms and requirements – such initial and ongoing disclosure to be provided or made “reasonably available” to investors on the basis and at the times specified in the New Proposals; and
- restrict all other ABCP, including if backed by credit derivatives or other highly structured or leveraged credit products, from being sold without a prospectus or as an Exempt Private Placement.
The New Proposals are much narrower and less invasive than the 2011 Proposals. For example, after considering 31 comment letters and other analysis related to the 2011 Proposals, the CSA determined not to:
- impose expansive new disclosure and certification requirements for term securitized products with maturities of more than one year;
- restrict prospectus exempt distributions of securitized products to highly sophisticated investors that satisfy the contemplated “Eligible Securitized Products Investor Exemption;”
- mandate particular structural features for securitized products, such as requiring minimum levels of credit risk retention by the originators and sponsors of the securitized assets (although the New Proposals do contemplate that risk retention disclosure will be required for short-term securitized products relying on the new, ABCP-specific prospectus exemption);
- require detailed loan/asset level disclosure, in addition to current portfolio level disclosures, in a prospectus for securitized products; or
- create a new regime of statutory or contractually equivalent rights against issuers, sponsors of securitized products and underwriters in respect of misrepresentations in an information memorandum or statutory rights in respect of misrepresentations in mandated continuous disclosure for securitized products in the exempt market.
A UNIQUE CANADIAN APPROACH
In the New Proposals, the CSA recognized several practical points that differentiate Canada’s market from the U.S. and other foreign markets where additional substantive requirements like minimum risk retention requirements are under consideration. For example, the CSA focused on the nature of the securitized products prevalent in Canada, the typical underlying assets backing those products and the basic business motivations for Canada’s securitizers and concluded that the problems experienced elsewhere due to a misalignment of incentives among originators of financial assets and securitization promoters were not prevalent in Canada’s market for securitized products. The CSA also noted that their post-financial crisis framework for regulating credit rating organizations and the adoption of product-based suitability and due diligence requirements applicable to securities dealers through Investment Industry Regulatory Organization of Canada address investor protection concerns in this context.
EXPANDED DISCLOSURE REQUIREMENTS
The requirement for use of a prescribed form of information memorandum in order to rely on the Short-Term Securitized Products Exemption represents a significant regulatory expansion, although may not represent a dramatic departure from the best disclosure practices that have evolved in the ABCP market since the Non-Bank ABCP meltdown. Among other things, the CSA notes that the new disclosure regime for eligible Traditional ABCP is intended to accord with the disclosure required by the Bank of Canada for ABCP to be eligible as collateral under its Standing Liquidity Facility. Key disclosures called for under the New Proposals include disclosure of a Conduit’s concentration and correlation limits, credit quality of assets requirements, credit enhancements, liquidity support and the priority of an investor’s claims over the Conduit’s assets.
The requirement for Conduits to undertake continuous and timely disclosure goes beyond current market practice in the commercial paper context, but seems focused in a practical way on updating material disclosures made in the prescribed form of information memorandum.
Mandated disclosures will not be required to be filed with securities regulators unless specifically requested, but must be made “reasonably available” (e.g., over the Internet) to investors and securities regulators.
Even though the CSA is no longer contemplating the introduction of additional statutory rights of action in the context of securitized products, it is important to note that the liability provisions of existing securities laws could in some circumstances apply in respect of new disclosure required in connection with the Short-Term Securitized Products Exemption. Those participating in issuances of Traditional ABCP should carefully consider the potential for liability arising in connection with these additional disclosure documents.
The CSA is soliciting comments on the New Proposals. The comment period ends April 23, 2014.