On December 17, 2012, Canada Mortgage and Housing Corporation (CMHC) published the Canadian Registered Covered Bond Programs Guide (the Guide), which sets out the expectations of CMHC in respect of its administration of a framework for the issuance of covered bonds by Canadian financial institutions. Publication of the Guide follows the enactment of federal legislation that establishes a legal framework for covered bond programs in Canada.  The legislation is intended to make the market for Canadian covered bonds more robust and increase financial stability.  Covered bonds are debt obligations issued by financial institutions that, in the Canadian context, are secured by a cover pool of mortgage loans and other substitute assets held in a special purpose vehicle (the guarantor entity) thereby isolating the collateral from the assets of the financial institution issuer to ensure they are available for covered bond holders in the event of the issuer’s insolvency.

The expectations of CMHC, outlined in the Guide, are that covered bond programs are structured, serviced and issued in accordance with overcollateralization requirements, which are designed to ensure sufficient collateral to satisfy all payments on bonds issued, and that risk management systems are in place to manage credit, collection, market (including interest rate volatility and currency exchange rates) and liquidity risks associated with such collateral.  

The key highlights of the Guide are:

  • The Registry  CMHC will establish and maintain a publicly accessible registry of covered bond programs under the authority of the National Housing Act.  The Registry will contain prescribed information on covered bond programs that have been registered with CMHC. Issuers will also need to apply for registration. Only federal financial institutions (such as banks, insurance companies, loan and trust corporations and credit associations) and (after promolgation of an order-in-council) provincially regulated cooperative credit societies will be entitled to register.  CMHC has the authority to suspend a registered issuer thereby preventing it from issuing further covered bonds.  
  • Requirements for registered covered bond programs   The Guide sets out the requirements to act as a guarantor entity and counterparty of a registered covered bond program.  In addition, the Guide prescribes provisions that must be included in transaction documentation, including required representations and warranties to be given by counterparties and prescribed rights of the guarantor entity.  If bonds are outstanding under a registered program, no fewer than two rating agencies must have current ratings assigned to at least one series or tranche of the outstanding bonds. Transactional documentation must include provision for certain events where a downgrade in rating below a set level or a withdrawal of a rating or a breach of financial soundness tests is triggered (ratings trigger). These events include the replacement of counterparties, the establishment of a cash reserve to meet interest payments and prematurity tests on collateral to ensure there is sufficient cash to fund principal payments under the bonds.  A registered issuer will be required to engage a custodian of assets, a bond trustee to act on behalf of bond holders and a qualified cover pool monitor who will perform an annual review and audit of the covered bond program.  Existing covered bond programs may be registered providing they meet all the Guide’s requirements, including those regarding permitted collateral. Once the Guide is in place and an order-in-council is promolgated federal financial institutions will no longer be permitted to have unregistered covered bond programs.
  • Permitted collateral   The Guide outlines what will be considered permitted collateral for registered covered bond programs.  In accordance with the National Housing Act, permitted collateral includes loans made on security of residential property located in Canada and consisting of not more than four residential units and may include other prescribed assets.  Residential mortgages insured by CMHC and other identified private insurers and high-ratio mortgages in excess of 80% of the property’s value will not be permitted collateral for covered bond programs.  Government of Canada securities or repos may be held as substitute assets so long as such assets do not exceed 10% of the total collateral.  A guarantor entity shall not hold more cash than is necessary to satisfy its payment obligations for a six-month period.  
  • Overcollateralization The Guide requires registered issuers to establish a minimum and maximum level of overcollateralization, which levels shall be measured with reference to the percentage (not exceeding 100%) of the value of permitted collateral, which is represented by the principal amount of all covered bonds outstanding under the program (the Asset Percentage). The minimum Asset Percentages shall be determined by reference to the limits imposed by regulatory authorities. The Asset Percentage must be disclosed in public offering documentation of the covered bond program and must be reported upon monthly.
  • Interest rates and currency risks To monitor a program’s exposure to volatility in interest rates and currency exchange rates, a guarantor entity must perform a prescribed valuation calculation that measures the present value of the permitted collateral held by it relative to the value of the outstanding covered bonds guaranteed by it (the Valuation Calculation).  The Valuation Calculation must be included in the public offering documentation and must form part of the monthly report.
  • Issuer insolvency   In the event of an insolvency or bankruptcy of a registered issuer, the separately held collateral will be available to service the registered covered bond program.  The Guide provides that the holders of covered bonds shall be afforded recourse to all the assets of the guarantor entity and be granted a security interest over the covered bond collateral.  
  • Offering documentation  As part of the application to register a covered bond program and in respect of each issuance of a tranche or series of the bonds under a registered program, the issuer must provide a proforma public offering document unless the offering is being made by private placement.  The public offering document must contain true plain and full disclosure of all material facts concerning the bonds and the program.  As these concepts are well established in Canadian securities law, the Guide states that CMHC expects a registrant to be guided by the disclosure principles applicable to a public offering of securities in Canada.  The offering document will contain details of the issuer, the guarantor entity and each counterparty, the governance and oversight role of the guarantor entity, the minimum and maximum asset percentages, mortgage eligibility criteria, underwriting and servicing policies, events of default, credit enhancements, rating triggers and the requirement for rating agency confirmation.  Where an offering is done by private placement a proforma offering document is not required.
  • Website   Each registered issuer must maintain a user-friendly website for its covered bond programs.
  • Reporting  The Guide requires that the issuer provide monthly reporting on its covered bond programs.  The contents of the report are prescribed and include details of the program as well as details of Asset Percentage, Value Calculations, any occurrences of rating triggers and collateral. In addition, the registered issuer must provide an annual compliance certificate to CMHC that must be published on its website.

A copy of the Guide can be accessed here.