Proposed amendments to the Canada Deposit Insurance Corporation Act(CDIC Act) introduced in Bill C-15 enhance the resolution powers of CDIC and are intended to make Canada a Protocol-Eligible Regime under the ISDA 2015 Universal Stay Protocol. I am happily contemplating updating all of our capital netting opinions in light of the proposed changes, some of which affect the operation of the Act’s eligible financial contracts safe-harbour (EFC exemption). Those of you who read capital netting opinions for pleasure (or because you must in order to keep your jobs) will be most interested in the following features of the Bill.
CDIC Can Make Broader Range of Orders
The CDIC Act restructuring regime allows CDIC to make a broader range of orders under s.39.13 with respect to an insolvent member institution (an Order), including, in the case of domestic systemically important banks, an order to convert its prescribed shares and liabilities to common shares (see the related post by Peter Hamilton here).
Automatic Stay on Termination Arises on Wider Range of Events (s.39.15(1)(e))
The automatic statutory stay on the right to terminate or accelerate contracts arises when an Order is made. The generally operative statutory stay would prevent reliance on the following amended list of events as termination triggers:
- insolvency or deteriorated financial condition of the member or any of affiliates or its credit support providers (Insolvency);
- a pre-proceeding non-monetary default by the member or affiliates (pre-Order non-monetary default);
- a pre-proceeding monetary default by the member or affiliates that is remedied within 60 days of the order being made (pre-Order monetary default); [Previously the stay applied even if the monetary default was not cured.]
- the making of the order or any change of control related to the making of the order (the Order);
- the assignment or assumption of the agreement to or by a bridge institution or third party (Transfer of contract);
- the transfer to a third party of all or part of the assets or liabilities of the federal member institution or any of its affiliates (Transfer of assets); [“What’s all this about a third party”, you ask? See below.]
- a conversion order or a conversion under the terms of the member’s shares or liabilities (Conversion).
For want of a better term, let’s call these events collectively the “Restructuring Events”.
Clearing House Membership (s.39.15(2.1), (7.12))
Clearing houses take note! The right to suspend or terminate membership rights under the rules of an organization is also stayed if triggered by the Restructuring Events. “Clearing houses” enjoy an exception to this stay. They are able to exercise rights under their settlement rules and cease to act as the clearing agency unless, at the time the order is made, CDIC undertakes to them to provide the financial assistance that the institution needs in order to discharge its obligations to the clearing house as they become due. A clearing house is one that has a system designated under section 4 of the Payment Clearing and Settlement Act (e.g. LCH on the basis of SwapClear being designated) or a securities and derivatives clearing house as defined in s.13.1(3) of the PCSA (which is essentially CDS, CDCC and those designated by the Minister of Finance under this section of the PCSA).
Also, limits on relying on the EFC Exemption where the transfer of assets to a bridge institution or third party are contemplated (discussed below), do not apply to a clearing house unless CDIC has given the financial assistance undertaking.
EFC Exemption (s.39.15(7))
The EFC exemption from the automatic stay will remain but is framed in somewhat different terms. The exemption applies to:
- termination or amendment of the contract,
- acceleration of the contract,
- exercise of remedies for a failure to pay [new],
- netting or setoff (or compensation) of an amount payable under or in connection with the contract, and
- dealings with financial collateral
Bridge Institution Stay (s.39.15(7.01), (7.1))
I don’t think there is a statute (except maybe the Income Tax Act) that has as many exemptions to exemptions as this one does. Really, forget Sudoku or the NYT Crossword to keep your brain in shape; just spend time each day trying to understand Division 5 of the CDIC Act. But I digress. So far we have a general stay and the EFC Exemption. Now we deal with the exceptions to the EFC Exemption.
Netting opinion enthusiasts will recall that under the current version of the Act there is a one business day stay in the context of a CDIC Act receivership proceeding where Cabinet has directed CDIC to incorporate a bridge institution. This continues under the amendments, but with some modifications. In that one-day period, a non-defaulting party cannot terminate or accelerate or deal with financial collateral if the default trigger is Insolvency, the Order (if it appoints CDIC as receiver or directs incorporation of the bridge institution) or the Transfer of the EFC. If the default trigger is a pre-Order monetary or non-monetary default, the EFC Exemption remains available. Also, this stay does not preclude netting or set-off. Given that termination is stayed, presumably this refers not to close out netting, but to payment netting or netting of other performance obligations, such as netting collateral delivery obligations.
The one-day stay is extended (under 39.15(7.1)) if, within the one-day period, CDIC undertakes to assign the contract to the bridge institution. Recall that CDIC has an obligation to financially support the bridge institution while it has that designation (e.g. for two years, or before it is sold or mergers with another institution).
Broader Restructuring Stay (s.39.15(7.1), (7.102), (7.2); s.39.152(1))
To facilitate the restructuring process, there is a new stay in s.39.15(7.1). It applies when the Order is made even if the Order does not direct the incorporation of a bridge institution. It prevents termination or acceleration or dealings with financial collateral if those rights are triggered by:
- Transfer of the contract,
- the Order, or
It does not apply:
- if the trigger is a pre-Order monetary or non-monetary default,
- to prevent exercising remedies for a failure to pay (including collateral realization) or netting or set-off in the ordinary course, or
- to prevent any reliance on post proceeding defaults, such as failure to provide credit support.
Third Party Transfers (s.39.15(7.101), (7.102), (7.2); s.39.152(1))
There is a new provision permitting the Cabinet to allow the transfer of substantially all of the assets of the institution to a third party. Cabinet has a discretionary power to lift the (7.1) stay, but only if it considers that “all or substantially all of the [institution’s] assets will be transferred to a third party”. CDIC can override that order lifting the stay if it undertakes to assign the EFC to the third party. If the undertaking is not made, the stay would be lifted assuming Cabinet made this order.
Unless this Cabinet stay power is exercised, the stay imposed under (7.1) continues until an order to wind-up the institution under the WURA is made. The likely scenario is that in any situation where the institution does not itself continue as a viable institution, there will eventually be a WURA proceeding to distribute the proceeds recovered in the CDIC Act proceeding and liquidate any remaining assets.
Assignments of the EFCs to a third party are permitted as long as the third party meets certain conditions including certifying in writing that it has all licenses and registrations it requires, balance sheet assets exceed liabilities, it is able to discharge the contract obligations as they become due and its creditworthiness is at least as good as the institution immediately before the order was made. These criteria generally track those of the Protocol.
As under the existing Act, no cherry-picking is permitted for any transfer of EFCs to a bridge institution or third party. All transactions with the counterparty must be assigned together with related collateral arrangements.
Once contracts are assigned to the bridge institution or third party, the EFCs cannot be terminated unless there is a fresh default by the third party or bridge institution essentially.
If they are not assigned, they can be terminated, but seemingly only if a WURA is eventually made. That might not happen for quite a few years.