CSA Proposes New Regime For Securitized Products

The Canadian Securities Administrators ("CSA") have published, for a 90‐day comment period (expiring July 1, 2011), proposed new rules that will fundamentally change the existing regulatory framework applicable to the offering of securitized products in Canada. The proposal would impact securitized products offered by prospectus as well as those offered in the exempt market.

Securitization refers to the process by which a special purpose vehicle is used to create securities that entitle holders to payments that are supported by the cash flow from a pool of financial assets held by the special purpose vehicle. In Canada, common types of financial assets include credit card receivables, automobile leases and residential mortgages. Less frequently, the assets may themselves be securitized products, such as residential mortgage‐backed securities, or may be "synthetic assets" created through the use of derivatives.

The CSA proposal follows from an industry‐wide review of securitized products by a variety of international bodies (including the International Organization of Securities Commissions and the United States Securities and Exchange Commission), as well as significant legislation in the United States – the Dodd–Frank Wall Street Reform and Consumer Protection Act (the "Dodd‐Frank Act"). In the United States, the SEC has already implemented a variety of rules implementing certain provisions of the Dodd‐Frank Act relating to enhanced disclosure around securitized products, and others are in the proposal stage.

According to the CSA, there are two main features of the proposed securitized products rules. Specifically, the rules are intended to provide enhanced disclosure for securitized products issued by reporting issuers, and secondly, provide new rules that narrow the class of investors who are permitted to buy securitized products on a prospectus exempt basis, and require that issuers of exempt securitized products meet initial and ongoing disclosure obligations. Certain of the initiatives brought forward in the United States have been incorporated into the CSA proposal, although the CSA have indicated that certain other (potentially more onerous) features of the U.S. regime may or may not ultimately be included in the final CSA position.

With respect to prospectus qualified securitized products, the CSA are proposing a new form requirement (Form 41‐103F1) as a supplement to the existing prospectus disclosure regime. The new prospectus disclosure requirements are proposed to include:

• detailed descriptions of the identities and roles of all parties involved in the securitization transaction;

• disclosure of relationships among the named parties and conflict of interest disclosure with respect to investors;

• disclosure of significant obligors along with applicable financial information or financial statements;

• detailed information regarding the pool assets including selection criteria, material pool characteristics, delinquent and non‐conforming assets, sources of pool cash flow, representations and warranties regarding the pool assets, claims on pool assets, information on pre‐funding or revolving periods, and transaction agreement terms governing modification of pool asset terms;

• static pool information if it would be material to an investor, and if none is provided, the prospectus must explain why disclosure is omitted;

• whether any party is retaining any portion of the assets and whether it has been hedged;

• information about the flow of funds for the securitized product transaction, the distribution frequency and cash maintenance in respect of the product, all fees and expenses, excess cash flow, issuances of additional series or classes by master trusts, any optional or mandatory redemption or termination features, and prepayment, maturity and yield considerations;

• detailed description of material external and internal credit enhancements or support, as well as each derivative instrument used to alter the payment characteristics of the payments on the securitized product; and

• identification of providers of significant credit support and derivative counterparties, and depending on their significance, issuers may be required to include selected financial information or financial statements for those parties.

In addition to significantly enhanced prospectus disclosure requirements, the CSA are proposing a new continuous disclosure regime applicable to securitized products, and in that regard, the CSA have indicated that they are not proposing to "grandfather" any current outstanding securitized products or implement any transition period. Among other things, prescribed reports must be filed within 15 days after each payment date on each series or class of securitized product, and issuers must report significant events. Additionally, the proposed continuous disclosure rules set out servicing standards related to servicing activities, and require that any entity providing any such service to the extent of more than 5% of the pool assets must assess its compliance and prepare a report stating whether or not it has complied with each standard during the reporting issuer's most recently completed year; this service report must beaudited and certified and be provided to the reporting issuer, who in turn must file it with the securities regulatory authorities.

The changes proposed by the CSA with respect to the distribution of securitized products on a prospectus exempt basis are extensive. Of particular note, it is proposed that a number of the most common prospectus exemptions will no longer be available for distribution of securitized products. In their place, it is proposed that a new prospectus exemption will be implemented that will apply only to exempt securitized products. Under the proposal, securitized products will only be available for sale to an "eligible securitized product investor" purchasing as principal; the definition of this permitted investor is largely the same as the definition of 'permitted client' in National Instrument 31‐103 – with the most material distinction from the "accredited investor" exemption being that non‐individual purchasers must meet a $25 million net asset threshold instead of $5 million. In addition to a restricted category of potential investor, issuers will be required to deliver an information memorandum to each purchaser, with different disclosure requirements applying depending on whether the securitized product is short term (less than one year) or not.

In addition to written disclosure requirements, all information memoranda must describe statutory or contractual rights of action for misrepresentation, describe resale restrictions that apply, and contain certificates signed by the issuer's CEO, CFO, promoter and sponsor as to the lack of any misrepresentations. As well, each information memorandum must contain a certificate signed by each underwriter as to no misrepresentation in the document to the best of its knowledge, information and belief. The CSA are proposing that an information memorandum must be posted on a website at the same time or before it is delivered to a purchaser.

In addition to the information memorandum requirement, the CSA are proposing a number of ongoing reporting and continuous disclosure obligations, which are similar to the reporting and continuous disclosure obligations imposed on reporting issuers who distribute securitized products under a prospectus.

With respect to resale, it is proposed that first trades of securitized products distributed under the securitized product exemption be deemed distributions, and as a result the only prospectus exemption that would be available for resale would be the securitized product exemption – which in effect creates a specialized 'closed system' for securitized products. With respect to statutory civil liability and withdrawal rights, the CSA have stated that they believe that investors should have the right to sue the issuer, the sponsor and each underwriter for damages if the information memorandum required by the securitized product exemption contains a misrepresentation. The CSA also believe that the right of action should be available without the investor being required to prove reliance on the misrepresentation. With respect to withdrawal rights, in those jurisdictions where statutory provisions provide an investor with a right to withdraw from the purchase of a security within two days of receipt of a prescribed offering document, staff in those jurisdictions are now considering whether the two day withdrawal right is appropriate in the case of securitized products.

In general, while the CSA have indicated in the notice that there are a number of issues which they are continuing to consider, and they have requested industry comment with respect to 47 questions, the policy position of the CSA is fairly evident from the proposal document. As a result, issuers who are active in the securitized product market should begin considering possible impacts of the CSA proposal on their business.

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