• Regulators advise that trades in Canadian “bail-inable” debt securities by persons in the business of trading in securities should be conducted through registered dealers in compliance with usual investor protection requirements, or in reliance on the “international dealer” exemption.
  • Canadian financial institutions subject to “bail-in” regime and market participants to assess compliance and other considerations as bail-inable issuances begin to take place.

Background

On August 23, 2018, the Canadian Securities Administrators (CSA) published CSA Staff Notice 46-309 Bail-in Debt, a few weeks before the implementation of the Canadian “bail-in” bank recapitalization regime which very recently came fully into force.

The Canadian bail-in regime has been developed pursuant to international standards agreed to in response to the global financial crisis of 2008. In accordance with such standards, a number of jurisdictions (including the United States and member states in the European Union) have mandated their systemically important banks to maintain prescribed levels of “total loss absorbing capacity” (TLAC) to ensure that holders of bank debt and other regulatory capital instruments would adequately bear the risk of losses. Such jurisdictions have also enhanced governmental authority to deal expeditiously with troubled lenders.

As described in more detail below, a significant proportion of the senior debt securities that will be issued by the largest Canadian lenders in the future will be “bail-inable”. This means that applicable regulatory authorities will be entitled to order the conversion of such debt securities into core equity capital to recapitalize a failing institution, thus reducing the probability of a government-funded bailout for institutions that would be considered “too big to fail”.

CSA staff position

The Staff Notice cautions that CSA staff may take regulatory action (including through the issuance of cease-trade orders) if it becomes aware of trades in bail-inable debt securities that are made by market participants in the business of trading in securities, other than trades made by or through duly registered dealers or in reliance on the “international dealer” exemption under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103). Trades in unsubordinated debt securities issued or guaranteed by most Canadian financial institutions are currently exempted from generally all dealer registration and related requirements of Canadian securities laws, pursuant to the provisions of NI 31-103 applicable to “specified debt” – a category which also comprises certain debt securities issued or guaranteed by states, governments and supranational institutions and that is seen as presenting limited investment risk.

Although bail-inable debt securities still constitute senior-ranking indebtedness, the view of the CSA is that such securities present different characteristics compared to senior debt instruments traditionally issued by Canadian financial institutions and not subject to bail-in. As such, the CSA consider that if a trade in bail-inable debt securities is made by or through a market participant in the business of trading in securities, such participant should be duly registered and comply with regulatory investor protection requirements (including “know-your-client”, “know-your-product” and suitability requirements) in connection with such trades – subject to the availability of the international dealer exemption for foreign securities dealers.

Scope of bail-in regime

Key Canadian federal regulations implementing the bail-in regime[1] came into force on September 23, 2018, and apply to banks which have been identified as “domestic systemically important” banks (often referred to as D-SIBs) by the Office of the Superintendent of Financial Institutions (OSFI).

More specifically, future unsubordinated unsecured debt issued by D-SIBs that has an original term to maturity of over 400 days and that has been assigned a CUSIP, ISIN or similar identification number will be bail-inable, subject to important exceptions. Those exceptions pertain notably to prescribed types of covered bonds, structured notes, financial contracts and derivative instruments. Moreover, the regime will not apply retroactively. As such, senior debt securities of D-SIBs outstanding as of September 23, 2018 did not become bail-inable.

At this time, the D-SIBs comprise the six largest Canadian banks: Canadian Imperial Bank of Commerce, Bank of Montreal, National Bank of Canada, The Bank of Nova Scotia, Royal Bank of Canada and The Toronto-Dominion Bank. Separately, the Autorité des marchés financiers in Québec has designated the Desjardins cooperative financial group as a domestic systemically important financial institution. Recent legislative changes in Québec, coupled with the future adoption of implementing regulations, are expected to submit Desjardins to a bail-in framework similar to the one designed federally for D-SIBs.

Regulatory considerations and compliance practices

As a result of the Staff Notice, it would be prudent for market participants that will trade in Canadian bail-inable debt securities with parties in a Canadian jurisdiction to ensure that such trades will be effected in accordance with the terms and conditions of their registration category under NI 31-103, or in compliance with the international dealer exemption in the case of foreign securities dealers – consistent with the requirements that currently apply to most trades in corporate debt, including subordinated debt securities of Canadian financial institutions.

Similarly, for Canadian financial institutions that will be issuing their bail-inable debt securities in the primary market, it would be prudent to ensure that agreements with dealer syndicates, as applicable, provide that the offering and sale of such securities will not be conducted in violation of the guidelines under the Staff Notice. In certain cases, limited adjustments to offering and dealer documentation may be suitable.

In keeping with the “business trigger” framework for dealer registration requirements under Canadian securities laws, the Staff Notice does not target trades in bail-inable debt securities made solely by or through persons or entities not in the business of trading in securities. Consequently, financial institutions subject to the Canadian bail-in regime would not – solely as a result of the Staff Notice – be hindered in completing occasional or project specific direct issuances of senior debt securities to institutional investors without an intermediating dealer.

Concurrent publication of Staff Notice 81-331

The Staff Notice was issued as part of a broader announcement relating to the bail-in regime, and CSA Staff Notice 81-331 Investment Funds Investing in Bail-in Debt was issued concurrently. Staff Notice 81-331 was notably intended to clarify on what basis bail-in debt could be considered an eligible investment for money market funds.