On February 4, 2011, the Canadian regulatory authority that supervises bank holding companies, banks and other deposit-taking institutions (OSFI ) issued an Advisory that clarifies OSFI 's expectations with respect to rights of redemption under so-called regulatory event clauses governing certain capital instruments of bank holding companies, banks, and federally regulated trust and loan companies (collectively, DTIs), and provided guidance as to the phase-out schedule for recognition of capital instruments that are no longer eligible for inclusion as regulatory capital (Additional Tier 1 capital or Tier 2 capital) under the Basel III banking rules.
Beginning January 1, 2013, recognition of non-qualifying capital instruments of DTIs will be capped at 90%, with the cap reducing by 10% annually thereafter, with the cap reduced to zero on first fiscal quarterly reporting date of 2022. In the event that DTIs have capital instruments that are in excess of the "cap" on non-qualifying instruments, such DTIs would cease to receive the expected capital benefit of such instruments beginning January 31, 2013 (or March 31, 2013 in the case of DTIs with a December 31 yearend).
The Advisory provides that capital instruments issued by DTIs prior to September 12, 2010 that previously qualified as regulatory capital but do not meet the Basel III criteria for regulatory capital will be considered non-qualifying capital instruments and subject to the phase-out, as will capital instruments issued before January 1, 2013 that meet the Basel III criteria for regulatory capital, except that they do not meet the new minimum requirements to ensure loss absorbency at the point of non-viability (NVCC requirements), as announced in the Basel Committee press release of January 13, 2011. Capital instruments issued between September 12, 2010 and January 1, 2013 that do not meet one or more of the Basel III criteria for regulatory capital (other than the NVCC requirements) will be fully excluded from regulatory capital as of January 1, 2013 (i.e., they will not be subject to the phase-out described in the Advisory). Capital instruments issued after January 1, 2013 must meet all of the Basel III criteria for regulatory capital (including the NVCC requirements) to qualify as regulatory capital.
In the Advisory, OSFI also states that it expects DTIs to comply with the Basel III requirements concerning the phase-out of non-qualifying capital instruments, while maximizing the amount of available regulatory capital and, to the maximum extent practicable, giving effect to the legitimate expectations of the parties to such capital instruments (as evidenced by the terms of such instruments). Accordingly, pursuant to OSFI 's guidance, a DTI should prioritize redeeming capital in a way that will give effect to the following priorities: (a) maximize the amount of non-qualifying capital instruments outstanding during the Basel III transition period (based on the assumption that all capital will be redeemed at the earliest regular par redemption date); and (b) minimize the amount of capital that would be subject to a regulatory event.
OSFI has provided extensive guidance as to how this is to be achieved. In particular, banks will have to redeem the non-qualifying capital instruments or convert them to a form of capital, such as common equity, that complies with the regulations. In the Advisory, OSFI encourages the banks to manage their capital within the applicable caps (with a view to maximizing the amount of non-qualifying capital instruments outstanding during the Basel III transition period) by redeeming these instruments only at their regular redemption dates or otherwise using existing provisions or rights (such as conversion rights), while minimizing the amount of capital that would be subject to a "regulatory event" early redemption.
Canada's major banks have begun responding to the new guidelines, in particular in respect of the guidance to minimize the amount of capital that would be subject to a regulatory event. To date, The Toronto-Dominion Bank and Canadian Imperial Bank of Commerce have indicated that early redemption of certain capital trust notes may be necessary in 2022, the final year of the phase-in period. Royal Bank of Canada and The Bank of Nova Scotia have said that they do not expect it will be necessary to invoke "regulatory event" early redemption clauses for any of their securities.
OSFI states that it expects DTI that forecast using regulatory event redemptions to develop a regulatory event redemption schedule specifying the expected redemption date for each non-qualifying instrument, to disclose this schedule to the public as soon as practicable (bearing in mind legal and disclosure requirements) and keep the schedule updated should circumstances change.
This Advisory does not apply to regulated life insurance companies, insurance holding companies, federally regulated property and casualty insurance companies or cooperative credit associations. OSFI will, after consultation, determine how and to what extent the Basel III rule changes will be applied to these institutions will release additional guidance in the future.
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