Canadian covered bond legislation consultation paper released

Authors: Eric Reither, Andrew Fleming, Peter Noble Publication | May 12, 2011

Following the Canadian Government's announcement in its 2010 budget of its intention to introduce a legislative framework for covered bonds, the Department of Finance yesterday released its much anticipated consultation paper on the proposed framework.


In the consultation paper, the Government reiterates its objective of ensuring financial institutions have access to covered bonds as a funding source. It also acknowledges the increased importance of covered bonds to Canadian banks in recent years with issuances by Canadian financial institutions having increased to over $30 billion since the first covered bonds were issued by a Canadian bank in 2007. Further, the Government recognizes that the stability of financial institutions and the financial sector can be enhanced by providing funding options that are robust under stress and that a legislative framework for covered bonds will benefit Canadians.

The framework

The proposed Canadian covered bond framework will:


  • authorize or establish a covered bond registrar to oversee the covered bond framework;
  • empower the covered bond registrar to suspend an issuer from issuing additional covered bonds;


  • implement a voluntary process for registration under a regime established by the covered bond registrar;
  • limit the protections of the legislative framework to programs registered by a registered issuer;
  • limit participation to federally regulated financial institutions (FRFIs). Non-FRFIs will be able to benefit from the framework by selling eligible assets to a FRFI aggregator;
  • allow existing covered bond programs to be registered and benefit from the protections in the framework (provided they meet the requirements of the framework such as being established by an FRFI);
  • permit a registered issuer to withdraw a program from the legislative framework if it has no covered bonds outstanding and to withdraw its registration if it has no registered programs outstanding;


  • require the covered bond registrar to make public certain information on registered programs;
  • set minimum disclosure requirements for programs and their cover pools based on current Canadian practices and standardize the manner for disclosure of such information;

Structural Requirements

  • require registered covered bond programs to use a special-purpose vehicle (SPV) to segregate cover pool assets from the issuer;
  • impose requirements with respect to the demand loan mechanism common in existing Canadian programs, including with respect to the amount of the demand loan, the times at which it is valued relative to the asset coverage test and the times at which it may, must or is deemed to be called with a view to striking a balance between the rights of creditors of the issuer and covered bondholders. The demand loan is a feature unique to Canadian covered bond programs which, among other things, allows for quicker access to the market;
  • impose record keeping requirements with respect to the transfer of assets and delivery of information to the SPV for perfection of its claim over cover pool assets;
  • permit issuers to act as swap counterparties and service providers provided that, consistent with current practice for Canadian programs, back-up counterparties and service providers are put in place at a particular trigger such as a ratings downgrade;
  • provide the registrar with the authority to set minimum standards for swap collateral;

Cover Pool Assets

  • provide covered bondholders with a legislative priority of claim over the cover pool assets;
  • protect service providers to the covered bond programs in the event of an insolvency of the SPV;
    limit cover pool assets to loans made on the security of a residential property located in Canada to avoid increased complexity in the covered bond framework;
  • provide for the percentage of substitute assets that may be included in a cover pool and the minimum standards for such substitute assets;
  • establish a maximum level of overcollateralization (presumably by reference to the asset percentage) to standardize the current Canadian practice of requiring the issuer to consent to an asset percentage in excess of generally 90%, which results in approximately 110% collateralization in respect of the outstanding covered bonds;
  • impose a consistent approach to valuing assets in the cover pool and the frequency (monthly) with which the asset coverage and amortization tests are applied;
  • standardize the frequency and content of  cover pool audits, based on current Canadian practices; and

Covered Bonds

  • not limit the note features of the covered bonds themselves (although covered bonds will not be eligible for Canada Deposit Insurance Corporation Act insurance applicable to other bank deposits). To date Canadian covered bonds have not generally purported to be eligible deposits for such insurance.

Closing thoughts

This is an exciting time for Canadian covered bond issuers and investors. With the incumbent party elected to a majority government, the potential for quick implementation of covered bond legislation is high.

The proposed framework endorses many of the current practices employed by Canadian banks in their existing programs, including the use of an SPV structure and disclosure with respect to the cover pool and program to allow investors to assess the merits of the investment. Further, it presents an approach that relies on market discipline rather than regulatory constraints to achieve its objectives of promoting financial sector stability and high standards that are consistent with international best practices while limiting unnecessary costs to maintain the efficiencies which have helped to make covered bonds and ever more popular funding source for Canadian financial institutions.

The consultation period sets out a number of areas for input from the public during the consultation period which is open until June 10, 2011.  

About covered bonds

Covered Bonds are bonds with full recourse to the issuer, but also with recourse to a pool of assets (the cover pool), generally residential mortgages, that secures or "covers" the bond in the event the originator becomes insolvent. The recourse to the issuer combined with the cover pool of assets generally results in the bonds being assigned AAA credit ratings.

In an effort to ensure the cover pool is sufficient to satisfy the outstanding indebtedness in the event of a default on the part of the  issuer an asset coverage test is employed to measure the level of over collateralization required to be maintained in the cover pool. The cover pool is dynamic and the issuer is required to replenish the cover pool as necessary to meet the asset coverage test requirements which gives no credit to non-performing assets.

Royal Bank of Canada was the first Canadian financial institution to launch a covered bond program followed by Bank of Montreal, Bank of Nova Scotia, CIBC, The Toronto Dominion Bank, National Bank of Canada and Caisse Centrale Desjardins du Québec. Ogilvy Renault LLP has acted for Royal Bank of Canada in connection with the establishment and renewals of its program, its European, Canadian, U.S. and Swiss issuances and for the arrangers and dealers in connection with the establishment and renewal of and first issuance under The Toronto Dominion Bank's covered bond programme. Ogilvy Renault LLP also provides advice to service providers in connection with other covered bond programs of Canadian issuers.

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Eric Reither

Eric Reither

Andrew Fleming

Andrew Fleming

Peter Noble

Peter Noble