The Office of the Superintendent of Financial Institutions (OSFI) recently published Draft Guideline B-5: Asset Securitization (Draft Guideline), which sets out an updated regulatory framework for the securitization activities of federally regulated insurers, including foreign insurer branches and mortgage insurers (Insurers). The Draft Guideline will replace the existing OSFI Guideline B-5 published in November 2004, and the related OSFI Advisory: Securitization – Expected Practices (Advisory) published in October 2008.
OSFI notes that the existing Guideline B-5 and Advisory applicable to Insurers do not adequately address the impact of the financial crisis and the ensuing updates to the Basel securitization framework. OSFI has issued the Draft Guideline to remedy these deficiencies. The Draft Guideline largely aligns the regulatory framework for the securitization activities of Insurers with the operational and qualitative requirements applicable to the securitization activities of banks and federal trust and loan companies, as currently reflected in OSFI’s Basel III-compliant Capital Adequacy Requirements (CAR) Guideline, Chapter 7. Insurers can anticipate that OSFI may further amend its guidance in the future to address changes to the Basel securitization framework under the final set of Basel III reforms released in December 2017.
The Draft Guideline sets out OSFI’s general expectations with respect to securitization transactions by Insurers and supplements OSFI’s capital guidelines for Insurers (that is, LICAT, MCT or MICAT) by specifying the capital treatment for securitization exposures. OSFI intends to release the final version of the Draft Guideline in January 2019.
This bulletin summarizes certain key requirements of the Draft Guideline.
CRITERIA FOR EXCLUDING SECURITIZED EXPOSURES FROM CAPITAL REQUIREMENTS
The Draft Guideline sets out a comprehensive list of requirements that an originating Insurer must satisfy in order exclude securitized exposures from capital requirements.
The originating Insurer must be sufficiently removed from a securitization special-purpose vehicle (SPV) that it has set up, and OSFI’s requirements in this respect have not materially changed. Where these requirements are not satisfied, the originating Insurer is required to hold capital against all debt instruments issued by the SPV to third parties.
The Draft Guideline also sets out a number of operational requirements that must be satisfied before an originating Insurer may exclude securitized exposures from the calculation of required capital. These requirements are analogous to the requirements currently set out in OSFI’s CAR Guideline. The operational requirements for traditional (non-synthetic) securitizations are as follows:
- Significant credit risk associated with the securitization must be transferred to third parties. The originating Insurer must establish policies and procedures to ensure that the amount of risk retained and transferred is assessed on an ongoing basis.
- The capital requirement for exposures retained by the originating Insurer following the issuance must be no greater than 30 per cent of the capital requirement applicable to assets supporting all tranches of the securitization structure.
- The originating Insurer may not maintain effective or indirect control over the transferred exposures and the assets must be legally isolated from the Insurer beyond the reach of its creditors. This must be supported by a legal opinion acceptable to OSFI.
- The securities issued may not be obligations of the original Insurer.
- The entity to which the risk is transferred must be an SPV and the holders of beneficial interests in the SPV must have the right to pledge or exchange those rights without restriction.
- Any clean-up calls must satisfy the requirements set out in the Draft Guideline.
- The securitization may not contain clauses that: (a) require the originating Insurer to systematically alter the underlying exposures such that the pool’s weighted average credit quality is improved (unless this is achieved by selling assets to independent and unaffiliated third parties at market prices); (b) allow for increases in a retained first loss position or credit enhancement provided by the originating insurer after the transaction’s inception; or (c) increase the yield payable to parties other than the originating Insurer, such as investors and third-party providers of credit enhancements, in response to a deterioration in the credit quality of the underlying pool.
- There are no termination options or triggers except for eligible clean-up calls or due to specific changes in tax and regulation.
The Draft Guideline includes a separate set of operational requirements for synthetic securitizations.
The Draft Guideline sets out certain expectations in respect of the capital treatment of securitized assets where the terms of the securitization include clean-up calls, payment collection activities, and servicer activities to be performed by the Insurer. These requirements are included in the current Guideline B-5 and have not significantly changed in the Draft Guideline.
The Draft Guideline also outlines OSFI’s position on implicit support provided by an Insurer to a securitization, consistent with OSFI’s CAR Guideline. Implicit support refers to an insurer providing support to a securitization in excess of its predetermined contractual obligation. Some examples of implicit support include the purchasing deteriorating credit exposures, purchasing assets from the underlying pool at above-market prices, increasing the originator-provided first loss position, and achieving the same results indirectly via other lending arrangements. When an Insurer provides implicit support, it cannot exclude securitized assets from its calculation of regulatory capital, must make public that it has provided non-contractual support, and disclose publicly the capital impact of providing such support.
Additionally, if OSFI determines that an Insurer has provided implicit support in a securitization, the Insurer will be ineligible to exclude the securitized assets from the calculation of the required capital for the longer of two years, or until all notes issued benefiting from the implicit support have matured. If OSFI finds that an insurer has provided implicit support on more than one occasion, the Insurer will be ineligible to exclude any of its securitized assets from the calculation of required capital for a minimum of five years. These punitive measures are new under the Draft Guideline.
REQUIRED CAPITAL FOR SECURITIZATION EXPOSURES
The Draft Guideline sets out a framework for calculating an Insurer’s regulatory capital requirements for an Insurer’s credit exposure to a securitization (securitization exposure). Insurers are required to hold regulatory capital against all of their securitization exposures, including those arising from investments in asset-backed securities, the provision of credit risk mitigation to a securitization transaction, retention of a subordinated tranche, and extension of a liquidity facility or credit enhancement.
The regulatory capital requirement for a securitization exposure is generally calculated by multiplying the exposure amount of the securitization (the sum of the on- and off- balance sheet amounts of the exposure, subject to certain deductions) by a credit risk factor set out in the OSFI capital guideline applicable to the federal insurer (that is, LICAT, MCT or MICAT). However, certain securitization exposures listed in the Draft Guideline are deemed to fall within the highest-risk category of securitization exposures provided for in the applicable OSFI capital guideline. Certain exceptions also apply to mortgage insurers.
OSFI’s capital guidelines assign a credit risk factor to a securitization exposure based on external assessments in a number of circumstances. The Draft Guideline sets out a list of operational requirements that an Insurer must satisfy in order to be able to rely on external credit assessments for securitization exposures. These operational requirements are largely aligned with the analogous requirements in OSFI’s CAR Guideline.
The Draft Guideline also permits an Insurer to infer a credit rating for an unrated securitization exposure if the exposure ranks equally with, or senior to, an externally rated reference exposure, subject to satisfying a number of requirements.
SOUND BUSINESS PRACTICES
The Draft Guideline sets out expectations regarding Insurers’ practices relating to securitizations. In particular, the Draft Guideline introduces new due diligence requirements that are more onerous than the expectations set out in the existing Guideline B-5. In particular, the Draft Guideline will require Insurers to have the information described below for each securitization exposure; otherwise, the exposure would be classified within the highest risk category for capital purposes:
- The Insurer should, on an ongoing basis, have a comprehensive understanding of the risk characteristics of its individual securitization exposures and the underlying pools.
- The Insurer should be able to access performance information on the underlying pools on an ongoing basis in a timely manner. For resecuritizations, insurers should have information not only on the underlying securitization tranches but also on the characteristics and performance of the pools underlying the securitization tranches.
- The Insurer should have a thorough understanding of all structural features of a securitization transaction that would materially impact the performance of the Insurer’s exposures to the transaction, such as the contractual waterfall and related triggers, credit enhancements, liquidity enhancements, market value triggers, and deal-specific definitions of default.
The industry has until October 12, 2018 to provide comments on the Draft Guideline. OSFI will publish a non-attributed summary of the comments it receives, together with OSFI’s responses, on its website when the final version of Guideline B-5 is released.