Canadian Structured Finance Law : Canadian Structured Finance Law: Securitization/OTC Derivatives Blog by Stikeman Elliot Lawyers & Attorneys

Margaret Grottenthaler -

As we discussed last month, the Canadian Securities Administrators Derivatives Committee recently released the latest in a series of eight papers intended to build on the high-level proposals found in Consultation Paper 91-401 regarding the regulation of OTC derivatives. Specifically, Consultation Paper 91-405 considers the scope and characteristics of a proposed end-user exemption to address market participants that generally only trade to hedge commercial risks. According to the paper, this limited segment of end-users, not systemically important to the market, should be exempted from most of the proposed regulations concerning OTC derivatives. The CSA are accepting comments on the consultation paper until June 15, 2012.

Meeting Requirements

The Consultation Paper considers various criteria for determining who should qualify for the end user exemption. According to the CSA's proposal, an end user would include participants that: (i) trade for their own account; (ii) are not financial institutions; and (iii) hedge to mitigate commercial risks related to the operation of their business or a related affiliated entity or series of legal entities within that affiliated group. End users that otherwise meet the criteria for the exemption may still be found ineligible for the exemption, however, if they are deemed to be "Large Derivatives Participants" considered key participants in the market or whose default would represent a systemic risk to the market. An upcoming consultation paper on registration is expected to consider the thresholds for Large Derivatives Participants. The Committee also specifically rejected including certain criteria in determining whether a participant qualifies as an end-user, including those based on: (i) trade volume or notional dollar values of trades; (ii) sector specific exceptions; and (iii) standardized contracts and clearing.

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Margaret Grottenthaler -
 

On April 27, the Financial Stability Board Workstream on Securities Lending and Repos (WS5) under the FSB Shadow Banking Task Force published  an Interim Report documenting WS5’s progress to date.   As someone trying to keep track of regulatory developments in these areas, I found this report to provide a very useful overview of the markets, their relationship with each other and the market issues that these activities raise and which may come in for further regulation in future.  If you are new to this area, I would also recommend it as way to quickly bring yourself up to speed.

The market overview in Part 1 is a very high level description of the functions and participants in four segments of the market, namely securities lending, leveraged investment fund financing and securities borrowing, interdealer repo and repo financing. Some helpful charts describe the interrelationship between these segments of the market, and further detail on each of these segments can be found in Annex 1 of the Report.

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On May 4, the Ontario Securities Commission released a statement regarding a meeting held in Toronto earlier this month and attended by various international regulatory agencies regarding the regulation of OTC derivatives. Various issues surrounding implementation were discussed, including transparency, margin for uncleared derivatives, coordination of clearing mandates, access to data in trade repositories, and cross border clearing house crisis management. Ultimately, the meeting's purpose was to provide a forum for discussion among the regulators as they work toward international harmonization of the regulatory requirements.

In addition to the OSC and Quebec's Autorité des marchés financiers, the meeting included representatives from the Australian Securities and Investments Commission, Brazil's Comissão de Valores Mobiliários, the European Commission and European Securities and Markets Authority, Hong Kong's Securities and Futures Commission, Japan's Financial Services Agency, the Monetary Authority of Singapore, the Swiss Financial Market Supervisory Authority, and the U.S. Commodity Futures Trading Commission and Securities and Exchange Commission.

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Michael Rumball  -

In comparison to the ongoing regulatory onslaught in Europe and the United States, we in Canada appear to have gotten off pretty lightly and may even have felt that this was completely justifiable given our country’s performance and the high performance standards maintained by Canadian assets throughout the financial crisis. Although there is little we enjoy more than a good dose of smugness, if we review the regulatory surge in its international context, we may have second thoughts about what may await us.

In their July 2011 report entitled “Report On Asset Securitization Incentives”, the Joint Forum, consisting of the Basel Committee on Banking Supervision, the International Organization of Securities Commissions and the International Association of Insurance Supervisors, while recognizing the potential benefits of securitization, acknowledged that “reforms are necessary to address the incentive conflicts and misalignments highlighted during the crisis, which distorted risk transfer, increased structural complexity and opacity, and led to extreme leverage in the financial system. If such negative aspects of securitization are limited through rules and supervisory frameworks that better align incentives and promote appropriate disclosures, the foundation should be in place for a sustainable and responsible securitization market”.

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Last week, Bank of Canada Governor Mark Carney designated the Canadian Derivatives Clearing Service (CDCS), operated by the Canadian Derivatives Clearing Corporation (CDCC), as subject to oversight under Part I of the Payment Clearing and Settlement Act. The designation is effective April 30, 2012. According to the TMX Group, of which the CDCC is part, the designation "reflects the importance of CDCC's fixed income central counterparty facility to the efficient, secure and reliable operation of a Canadian dollar core funding market."

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Doug Klaassen  and Mark McElheran -

On April 26, 2012, the federal government introduced the Jobs, Growth and Long-Term Prosperity Act, the legislation to implement the March 29, 2012 federal budget. Buried in this legislation (over 420 pages!) are significant changes to both the Canada Mortgage and Housing Corporation (CMHC) and the law in respect of Canadian covered bonds that will have direct and material effects on our mortgage and securitization markets.  Industry participants who initially asked for covered bond legislation must surely be regretting it.

CMHC is now (finally) under adult supervision. As a federal Crown corporation with over $540 billion of outstanding guarantees on Canadian housing (an amount equal to the entire Canadian federal debt), CMHC will now report to the Office of the Superintendent of Financial Institutions, instead of the Minister responsible for Human Resources and Skills Development Canada (believe it or not!). With CMHC approaching its current statutory guarantee cap of $600 billion (which has been raised 4 times in 8 years), something had to give.

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Michael Rumball  -

Over the past few months, while waiting for further regulatory developments in the securitization space, I have engaged in a self-taught course in finance and economics. Along with the plethora of tell-all’s detailing the main players in and the course of the late great financial crisis, or the “Great Recession” as it seems to be called in some sectors, among the titles perused were The Origin of Financial Crises (Cooper), Zombie Banks (Onarin), How Markets Fail(Cassidy),  Extreme Money (Das), The Black Swan (Taleb), The Myth of the Rational Market (Fox), Fault Lines (Rajan), This Time Is Different (Reinhart & Rogoff), Endgame (Mauldin and Tepper) and Freefall (Stiglitz). While this has (predictably) failed to result in the development of any sort of expertise on my part, the main conclusion that I managed to draw from this reading is that there was no single cause of the financial crisis; rather it resulted from the interaction of a multitude of interconnected factors the significance of which is yet to be fully understood. Nevertheless, I will venture a few observations:

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The Canadian Securities Administrators (CSA) last week released Consultation Paper 91-405 Derivatives: End-User Exemption, the latest in a series of eight papers intended to build on the high-level proposals found in Consultation Paper 91-401 released in November 2010.

As is suggested by its title, the paper considers an end-user exemption to OTC derivatives regulation. Ultimately, an end-user exemption is intended to avoid discouraging the use of OTC derivatives by market participants that are not in the business of derivatives trading but that trade in OTC derivatives to mitigate commercial risks related to their business. As such, according to the CSA, an end-user exemption must address this specific segment of the market without undermining the broad objective of increased regulation of OTC derivatives contracts.

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Margaret Grottenthaler -
 
The Ontario Government released its 2012 budget this afternoon and, in doing so, stated its intention to amend the cash collateral provisions of the Personal Property Securities Act to facilitate the granting of first priority security interests in cash. These changes will not be in this budget bill, but hopefully will be introduced as a bill in the fall.

Specifically, the Government, according to its budget summary, intends to:

propose legislative changes...to Ontario’s personal property security legislation, to make it easier for businesses and financial institutions to provide or obtain a first-priority security interest in cash collateral. If enacted, these changes would support a competitive Ontario business climate, help meet Canada’s international financial reform commitments and mitigate financial system risk related to over-the-counter derivatives.

Presumably this budget statement is intended to clearly convey to the market the government’s commitment to making these important changes. As I discussed in a post last month, the Ontario Personal Property Security Law Sub-Committee of the Ontario Bar Association’s Business Law Section released a proposal earlier this year to amend the PPSA to deal more effectively with cash collateral. While the exact nature of the Government's amendments remain to be seen, the OBA subcommittee's recommended changes will be influential in developing the particular solution to give secured parties holding cash collateral the same degree of legal certainty as to their priority against other creditors that the Securities Transfer Act, 2006 provides to holders of securities as collateral.

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