Canada: Department Of Finance Contemplates Covered Bonds Legislation

On May 11, 2011, the Department of Finance issued a consultation paper dealing with covered bonds. This consultation paper contemplates the adoption of covered bonds legislation and seeks comments with respect to the content of that legislation. The enactment of covered bonds legislation would implement a proposal made by the federal government in the 2010 budget and would respond to requests made by many of the Canadian banks for such legislation. The Consultation Paper is open for comments until June 10, 2011.

A covered bond is a bond issued by an issuer (for our purposes a Canadian bank) and collateralized by a pool of assets that meet certain eligibility criteria. In Europe, this collateralization is often accomplished by designating certain assets as being allocated to a collateral pool. Legislation then provides that the holders of the covered bonds issued in relation to the designated pool have a priority claim upon the assets in the designated pool. In Canada, the assets are actually transferred to an SPV which, in turn, guarantees the covered bonds. The priority afforded by the Canadian structure is the result of the application of ordinary legal principles (much the same principles as are relied upon in the context of a securitization) and not specific legislation. In fact, there are currently no existing legislative or regulatory provisions or other regulatory guidance specifically dealing with covered bonds in Canada other than a letter issued by the Office of the Superintendent of Financial Institutions on June 27, 2007. This letter provided that covered bonds must not, at the time of issuance, make up more than four per cent of the total assets of the bank or other deposit taking institution. OSFI also stated at the time that it expected that the pledging policies of banks and other deposit-taking institutions would be amended to address the issuance of covered bonds. Since covered bonds are in substance a form of secured borrowing, it certainly makes sense that they would be addressed in the pledging policy.

Even in the absence of legislation, covered bonds have been issued by Canadian banks by using the transfer to an SPV, as described above, as a means of providing the assurance of priority provided by legislation in Europe. The Consultation Paper acknowledges that the existing non-legislative approach "provides a high level of disclosure to investors" and provides assurance to investors that "if the issuer defaults, the assets in the cover pool will be used to prevent any disruption of cash flows to investors." The Consultation Paper also acknowledges that the existing non-legislative approach has proven to be successful in developing a covered bonds market for Canadian issuers.

Why then is legislation being contemplated? The Consultation Paper provides two reasons. Dealing with the second stated reason first, the Consultation Paper notes that some international investors are restricted from purchasing bonds under a non-legislative framework. The creation of a legislative framework would, therefore, enhance market access for Canadian banks. This may well be a most worthwhile policy objective (I leave for others to discuss the theoretical impact on depositors and other unsecured creditors of bank). Unfortunately, there is little or no discussion in the Consultation Paper as to what must be included in covered bonds legislation in order to ensure the ability to access these "international investors".

Meanwhile, the first stated reason is more confusing. Specifically, the Consultation Paper states that "the issuer's assurances in the prospectus that the cover assets will be available for the benefit of covered bond investors are not a substitute for statutory protection". It is unclear, however, whether what is meant by this statement is that the existing legal protections arising from the transfer of assets to an SPV are insufficient, or that the issuer's representation and covenant that adequate and appropriate assets have in fact been transferred is not sufficient. If it is the first rationale, being that the transfer of assets to an SPV is insufficient to confer legal priority, then that rationale is inconsistent with the statement in the Consultation Paper that the existing non-legislative framework provides covered bond investors with assurance of payment. It is also questionable in light of the fact that the Consultation Paper contemplates that the proposed legislation would continue to require a transfer to an SPV (the proposed legislative action in relation to the insolvency of trusts would, however, be useful). In addition, since the transfer approach is essentially the same mechanism as is used in a wide range of securitization transactions, one cannot help but wonder if Finance is really casting doubt upon that mechanism. The second rationale would appear to invoke the risk that a Canadian bank might represent and undertake to do something and then not do it. On this rationale, the legislation would be dealing with the risk that Canadian banks might engage in conduct in relation to the bank's investors that is, in substance, fraudulent. It is also worthy of note that the risk that inadequate or insufficient assets might be allocated to covered bond investors could arise equally in a designation structure, as in Europe, or a transfer structure, as in Canada.

How then would legislation deal with these issues? As described, the contemplated legislation appears to be directed at three broad areas.

First, certain aspects of the legislation would deal with issues that are prudential in character. These areas would include legislation around eligible issuers, the extent of permitted over-collateralization, record-keeping and the transfer of excess assets to the SPV. Prudential issues of this sort would normally be addressed between OSFI and banks and would not typically require legislation. In practice, such issues would much more commonly be addressed by means of prudential guidance issued by OSFI. In fact, as seen above, the existing four per cent limit was not enacted by way of legislation.

Second, other aspects of the proposed legislation would address the form of the covered bonds transaction. The matters falling into this class would include matters in relation to the permitted legal form of the SPV, eligible assets, whether uninsured mortgages could be used, the manner in which assets in the pool should be valued and whether and how assets could be substituted into the pool. Consistency may well be important. However, market forces usually end up imposing consistency where consistency is important and it is unclear to me how consistency mandated by legislation would represent an improvement. In addition, legislation is an odd way of ensuring that transactions respond to the requirements of an international market. Indeed, in many areas, the contemplated legislation could simply codify existing practice (such as by way of requiring a transfer to an SPV). Weighing in the balance against any legislative prescription of the terms of the transaction is the risk that the legislator will either get it wrong or the market will evolve, with the result in both cases being that the legislation ends up mandating a form of transaction inconsistent with what is required in the international market.

The third area is the most curious of all. It would involve the creation of a Covered Bond Registrar. The responsibilities of this august personage are as yet undefined, but would appear to involve a review of the terms of the transaction and a certification that the transaction meets the requirements of the legislation. This is a role that does not currently exist within Canadian financial institutions law and the assumption of this role would represent a very major departure for any existing Canadian financial institutions regulator. Indeed, it is very hard to imagine that this is a role that OSFI would willingly undertake, not least because of the potential of a conflict with its primary role as a prudential regulator. In addition, it is difficult to see what real comfort such a regulator would, as a practical matter, bring to a transaction beyond that already provided by trustees, underwriters, counsel and rating agencies.

I would not want to be taken as opposing the legislation. Ensuring diverse funding sources is important and if that object requires legislation, then legislation there should be. However, the various elements of the proposed legislation are arguably unnecessary, potentially restrictive and inflexible and may involve structural issues and issues of conflicting roles. What is not considered in the Consultation Paper is whether all of these things must be done in order to achieve the benefit of diverse funding, or whether some more modest approach would equally suffice.

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.