Canada: The Prescribed Information Memorandum Requirements For Short-Term Securitized Products: The Devil Is In The Details

In previous blog entries, we introduced the CSA's proposed information memoranda requirements that are part of the recent securitization proposals. As noted previously, a condition of the securitized product exemptions (permitting prospectus and registration exempt issuance to eligible securitized product investors) is the delivery of an information memorandum to the purchaser at the same time or before the purchase of the securitized instrument. The CSA proposals differentiate between short-term and longer term securitized products. This blog entry will focus on short-term securitized products only.

Unlike the disclosure requirements for products of greater than one year in duration, the CSA provides prescribed form requirements for short-term securitized products, which terms are contained in proposed Form 45-106F7 and, according to the CSA, were developed following a review of existing ABCP information memoranda, the information the Bank of Canada expects when reviewing whether to accept ABCP issued by an ABCP program as eligible collateral for its standing liquidity facility and comment letters from market participants as part of the October 2008 ABCP Concept Proposals. We would urge ABCP conduit sponsors and administrators in particular to consider the following requirements and read the provisions of proposed Form 45-106F7 carefully. We believe that the information memorandum requirements for short term securitized products require in many cases substantially more disclosure than what ABCP conduits currently provide to their investors and these requirements may raise considerable practical and operational challenges for ABCP conduit sponsors and administrators (among others).

Proposed Form 45-106F7 requires identification of each significant party involved in the securitization, namely parties with a significant role in structuring the securitization transaction, the creditworthiness and liquidity of the program, the selection, acquisition, analysis and management of the assets, the distribution of the securitized products and the payment to securitized product holders and requires details in respect of the role and function of such significant party and description of its experience with respect to substantially similar assets. For sponsors, liquidity providers and providers of material program credit enhancement, additional information is required. Where any such significant party is retaining a tranche or portion of a tranche of the issuance, the description of the tranche interest so retained is to be disclosed.

The disclosure must include diagrams setting out the structure of the securitization under the securitization program and simplified diagrams as to the cash flows of the securitization program.

The form requirements include (among other things) a detailed description of the program including a description of the investment guidelines applied to the pool assets, the amount and nature of liquidity support, the amount and nature of program-wide credit enhancement and any other protections afforded to securitized product holders.

In addition, a summary of the pool assets is required. For each series of short-term securitized product to be distributed, the IM is required to disclose the range of asset types that may be included in the pool, the manner in which the issuer will gain access to underlying asset exposure and the due diligence or verification procedures that have been or will be applied in respect of the pool assets. Disclosure is required as to whether any of the pool assets include CDOs or similar obligations, credit default swaps and other credit derivatives, synthetic assets or derivatives or sub-prime assets. If the pool assets include any of the foregoing, enhanced disclosure is required including a description of those assets and the process for obtaining those assets.

The IM will need to describe the short-term securitized product, its distribution and offering including the material terms thereof as well as the flow of funds for the securitization program including payment allocations, payment dates and payment priorities and, vis a vis certain assets, the ranking of the securitization program in priority of payments if it would reasonably be required by a prospective purchaser to make an informed investment decision.

The disclosure document must describe conflicts of interest that exist or may be reasonably anticipated between or among significant parties and a securitized product holder, all fees and expenses to be paid or payable out of the cash flows from the pool assets and the identity of the parties receiving those fees or expenses. This could be problematic to the extent that it means disclosing confidential arrangements or proprietary business terms. In order of significance, the document will need to disclose risk factors to enable the prospective purchaser to make an informed investment decision with respect to the short-term product including credit and liquidity risks, legal risks that may exist (such as true sale and bankruptcy remoteness issues and other claims or contingent claims on the pool assets) and tax risks, among others. The CSA provides only an indicative list of the types of risk factors that should be included. Each issuer preparing an IM will need to consider the distinct risk factors applicable to its own program.

The issuer will need to describe the material terms of the existing program documents and transaction agreements. This may prove to be a challenge. If the information memorandum is to be distributed on or before each purchase and the conduit is a multi-seller, multi-asset ABCP conduit intended to acquire a diverse range of asset interests and to finance and refinance those assets over time with short term instruments, one can expect new transaction-specific or asset-specific agreements to be entered into with some frequency. The ABCP conduit issuer will need to regularly revisit the IM disclosure as a consequence. We'll revisit this issue in further detail later in this blog entry.

The other prescribed terms (in addition to those terms of general application to short or longer term products) include description of financial leverage and the credit rating of securitized product. Each memorandum (whether for short-term issuances or otherwise) must provide a description of the statutory or contractual rights of action or misrepresentation in favour of the purchaser, the resale restrictions that apply and include certifications from the issuer's CEO or CFO (or equivalent), promoter and sponsor as well a signed certificate from each underwriter. While the foregoing summarizes the salient aspects of some of the important prescribed terms, this blog entry doesn't identify every single disclosure term.

I'd like to share some further observations on the foregoing form requirements. After having completed a survey of a selection of ABCP conduit information memoranda, I believe the proposed form requirements will mean that for many ABCP conduit sponsors or administrators the current information memoranda in use will prove to be deficient after the proposed rules come into effect for ABCP conduit information memoranda. By and large, most current ABCP conduit information memoranda describe in general terms and broad language the aspects of the program that existed at the program inception and were not anticipated at the initial preparation of the IM to be reasonably capable of change or at least were described in a manner that such disclosure would remain correct after the passage of time and in particular after the introduction of new assets and originators into the securitization program. I don't think this manner and approach to IM disclosure will continue to suffice.

I believe that it will no longer be the case that an ABCP conduit administrator will be able to create a series specific IM on the initial creation and issuance of a series of notes and only revise or revisit the IM when there are material amendments to the terms and attributes of the series. The requirement to describe pool assets and transaction terms in particular will require frequent reconsideration of the IM requirements. This means that ABCP conduit sponsors will potentially need to revisit their IMs and enhance the disclosure whenever new deals are originated and transaction documents are finalized and will need to report on related performance of such assets. In addition to the time and expense that may be so associated, the question that I have is whether the requirements imposed by the prescribed terms can practically be achieved.

In the context of short-term securitized product conduits (such as ABCP conduits), I presume that the ABCP conduit is issuing instruments of varying maturities and refinancing or rolling those notes regularly, perhaps as frequently as daily. Given this presumed frequency of issuance and purchase of securitized instruments, is the obligation to deliver an IM (in prescribed from and containing no misrepresentation) to each ABCP purchaser at or before the time of purchase intended to be interpreted such that the ABCP distribution desk of a sponsor of an ABCP conduit is required to issue an IM to a purchaser of the ABCP on any day that a purchaser purchases including the rolling, renewal or refinancing of previously issued and created CP (ie. on the initial creation and each roll date thereafter). If this is the intention, it will mean each ABCP trader and the associated ABCP conduit administrator will need to confirm that the IM contains no misrepresentation and satisfies the prescribed terms as often as daily. This will then mean that from an operational and practical perspective the ABCP conduit is being asked to maintain current product disclosure virtually at all times – an administrative exercise that places the issuers of short-term securitized product (such as ABCP conduits) in Canada in an arena all by themselves. As it has with the continuous disclosure regime proposed for exempt purchases of securitized products, the CSA has imposed disclosure obligations on the short-term securitized product market that do not exist in any other exempt debt or equity market in Canada.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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