On April 26, 2012 the Canadian government introduced legislation which provides a framework for the issuance of covered bonds by Canadian financial institutions. The framework is intended to make the market for Canadian covered bonds more robust and increase financial stability by helping lenders find new sources of funding. It implements the measures introduced by the federal government in its budget on March 29, 2012 and follows through on the government’s 2010 commitment to introduce covered bond legislation and a public consultation on covered bonds undertaken by the government last year. Covered bonds are debt obligations issued by financial institutions which, in the Canadian context, are secured by a cover pool of insured and uninsured mortgage loans and other substitute assets held in a special purpose vehicle 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 an insolvency of the issuer.
The key highlights of the framework are:
- the establishment of a publicly accessible registry maintained by the Canadian Mortgage and Housing Corporation (CMHC) containing details of any registered programs. Issuers will need to apply for registration to issue and for their covered bond programs and applications will be required to include certain prescribed information (essentially a detailed description of the program and any additional information that in CMHC’s opinion is required).
- CMHC will have discretion as to whether it will register a particular issuer or covered bond program and to establish conditions or restrictions applicable to registered issuers and registered programs. CMHC will also have the authority to suspend the right of a registered issuer to issue further covered bonds under a registered program and to impose cost-recovery based fees for administering the framework.
- registered issuers will be permitted to withdraw from the framework when they have no covered bonds outstanding under a registered program.
- only federal financial institutions (such as banks, insurance companies and loan and trust corporations) and provincially regulated co-operative credit societies will be entitled to register under the legislative framework. Corresponding amendments have been proposed to the federal legislation governing such issuers prohibiting them from issuing covered bonds outside of the framework.
- permitted collateral will include 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 will no longer be allowed as collateral for covered bond programs. Government of Canada securities and other assets yet to be prescribed (to a limit of 10% of the collateral) may also be held as covered bond collateral.
- in the event of an insolvency or bankruptcy of a registered issuer, the framework confirms that the separately held collateral will be available to service its registered covered bond program and that the transfer of the collateral to the special purpose vehicle for the registered program cannot be attacked.
Impact of the framework
The proposed legislation is very much a broad based framework and can be expected to be complemented by guidance from CMHC and potentially regulations made by the Minister of Finance.
The framework does not impose a maximum level of overcollateralization for registered programs as was alluded to in the consultation process or impose valuation or monitoring requirements. However, it is possible that CMHC guidelines will address these issues. The issuance limit of 4% of adjusted assets of the issuer imposed by the Office of the Superintendent of Financial Institutions (OSFI) on federal financial institutions is not affected by the legislation but again may be the subject of CMHC guidance or left with OSFI to determine.
The major shift of the legislation from current practice is to prohibit the inclusion of insured mortgages as acceptable collateral for Canadian covered bond programs and to prohibit the issuance of covered bonds outside of the framework. Those current issuers with insured collateral in their programs will be required to reconstitute their cover pools for issues of covered bonds after the legislation is adopted and comes into force (expected in a matter of months).
In addition, the implementation of a legislative regime for the issuance of covered bonds will expand the group of investors outside Canada and the United States that may invest in covered bonds of Canadian issuers, particularly in Europe, where certain investors are limited to investing in covered bonds which are covered by specific covered bond legislation. However, full expansion of the scope of investors in the European Economic Area (EEA) will require amendment to European legislation covering mutual funds and regulated financial institutions to provide the same advantages to issuers outside of the Eurpoean Union to those provided to EEA issuers.
The proposed legislation also places CMHC under the purview of OSFI.
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