Canada: Asset Securitization - Recent Developments Of Importance

Last Updated: May 16 2008
Article by Robert M. Scavone and Don M.E. Waters

Originally published in 2008 Lexpert / American Lawyer - Guide to the Leading 500 Lawyers in Canada

Turmoil In The ABCP Market

Despite a relatively uneventful winter and spring, 2007 proved to be a watershed year for the asset-backed commercial paper market in Canada, and after the liquidity crisis of mid-August things may never be the same again. Storm clouds had been gathering ever since DBRS Limited (DBRS) revised its ratings criteria for CDO-based ABCP programs in January 2007 to require, among other things, that liquidity support for subsequent CDO-based ABCP transactions not be limited to a general market disruption and must remain available without the confirmation of rating of such ABCP. The introduction of the revised criteria substantially reduced the level of new CDO-based ABCP transactions while market participants determined how to proceed in light of the changes. But it was not until mid-summer, when the sub-prime crisis in the US began to impact the market for non-bank sponsored or "third-party" asset-backed commercial paper in Canada, that the market for such paper dried up almost overnight. The root of the problem was a unique feature of Canadian liquidity facilities that derived from the bank regulators' capital treatment.

ABCP (short-term commercial paper with terms one to 364 days, typically 30 or 60 days) is usually repaid at maturity through "rollovers": new ABCP is sold and the proceeds are applied to repay maturing ABCP. However since there is always a possibility that insufficient ABCP will be rolled over on any given maturity date all ABCP backed by longer term assets requires a backup liquidity facility to provide substitute funding to mitigate the rollover risk. However, in contrast to the US, in Canada liquidity facilities typically could be drawn only on the occurrence of a "general market disruption" (GMD). The source of that requirement was Guideline B-5 of the Office of the Superintendent of Financial Institutions (OSFI), which accorded favorable regulatory capital treatment to those liquidity facilities that could be drawn only on a GMD. Although non-GMD or "global style" liquidity was not prohibited, a lender providing such a facility would incur additional regulatory capital charges. In addition, prior to the changes to DBRS' ratings criteria in 2007 for both CDO-based ABCP and traditional ABCP, global style liquidity had not been required in order to obtain a rating from DBRS. Further, in July 2006 DBRS announced standard market disruption language that it considered acceptable for CDO-based ABCP. Deviation from the permitted language could result in a lower rating of the ABCP. Even so, the draw conditions were still restrictive enough that the likelihood of a liquidity facility ever being drawn seemed remote. In fact before August 2007 it is generally believed that no liquidity facility backing ABCP had ever been involuntarily drawn in Canada, not even in the wake of September 11, 2001.

All this changed dramatically when on August 13, 2007, one of the largest sponsors of third-party ABCP, Coventree Capital Inc., announced that "as a result of the current unfavorable conditions in the Canadian asset-backed commercial paper market it has been unable to place new ABCP to fund the repayment of previously issued ABCP maturing today". Coventree issued draw notices requesting funding under liquidity facilities that supported the ABCP in the aggregate amount of $700 million. A number of liquidity providers, however, took the position that no GMD existed and they refused to fund. Similar scenarios were played out with other third-party conduits and within days the third-party ABCP market had essentially ground to a halt. Noteholders who had invested short-term funds in ABCP issued by about 20 third-party conduits found their funds effectively frozen.

In an effort to bring some order to the growing chaos in the ABCP markets, on August 16 a consortium organized by the Caisse de dépôt et placement du Québec on behalf of the largest holders of third-party ABCP signed an agreement in principle (which became known as the "Montréal Accord") to effect a 60-day standstill during which the parties would work together to restructure 22 affected third-party conduits. Liquidity draw requests would be rescinded; collateral calls would be suspended during the standstill, no liquidity draws would be made for an additional 150-day period following the standstill, and investors and parties would work together to convert their outstanding ABCP to long-term floating rate notes. Working out the details of the restructuring proved more complex than had been originally anticipated, and as a result on October 16 the parties agreed to extend the standstill until December 14, 2007. As of October 17, only one of the conduits, Skeena Capital Trust, had announced a concrete restructuring plan, which would see the principal of the smaller investors repaid in full with the larger investors accepting long term high-yield floating rate notes issued by a new trust.

At this point it is difficult to predict the long-term consequences of what some commentators have referred to as the "ABCP meltdown". One immediate result is that in response to the new DBRS criteria for granting an investment grade rating to ABCP, general market disruption facilities will almost certainly be replaced by "global style" liquidity that does not require a market disruption to be drawn. On October 17, DBRS published a list of "Global Liquidity Standard-ABCP Compliant issuers" sponsored by six Canadian and two international banks that met the global-style liquidity standards published by DBRS on September 12. Competitive pressures may demand that all Canadian ABCP conduits adopt this standard.

In addition there have been calls for greater transparency in disclosure from ABCP issuers. In the past some investors have complained that ABCP conduits are essentially "black boxes" that provide little or no disclosure regarding the underlying assets. The disclosure in information memoranda for ABCP has typically been very general in nature. With little specific information regarding the collateral, ABCP investors have had to rely heavily on the DBRS rating to decide whether to invest in a particular issue of ABCP. However investor confidence in the ratings assigned third party Canadian ABCP was severely eroded when investors began to fear that some of the third party ABCP was backed (directly or indirectly through credit default swaps) by the sub-prime mortgages that were imploding in the US and also began to appreciate that the assets supporting much of the third-party ABCP were complex credit derivatives whose current mark to market value had plummeted. It remains to be seen whether investors will demand prospectus level exposure for ABCP to restore confidence in the market.

Elimination Of Withholding Tax

Canada and the United States signed a widely anticipated 5th protocol (the Protocol) to the Canada-US Tax Treaty (the Treaty) on September 21, 2007. Once it has been ratified by both countries, the Protocol will ultimately eliminate withholding tax on conventional interest payments made by Canadian taxpayers to US residents. These changes will remove some of the economic disincentives to cross-border securitizations of interest bearing assets of Canadian residents to US resident special purpose vehicles (SPVs) and the issuance of debt securities by Canadian resident SPVs to US resident purchasers.

The Protocol will enter into force once it has been ratified by both the Canadian and United States governments. The Government of Canada intends to proceed with a bill at the earliest opportunity. The earliest date on which the Protocol could enter into force is January 1, 2008. This would require both countries to ratify the Protocol in 2007. The Canadian government has announced that upon ratification of the Protocol, the Income Tax Act (Canada) will also be amended in order to eliminate the withholding tax on interest paid to all arm's length non-residents, regardless of their country of residence. However, the timing remains to be seen for the elimination of withholding tax for payments to persons of countries of residence other than the US.

Regulatory Developments

Currently the rules providing for the capital adequacy in respect of securitization are primarily addressed in OSFI's Guidelines B-5 and B-5A. The new international capital standard for internationally active banks of the Basel Committee on Banking Supervision (Basel II) will come into force for the Canadian Banks on November 1, 2007. Basel II addresses the various potential exposures of banks relating to securitization of its or other party's assets and sets out the corresponding required levels of capital for such exposures. In particular, to receive more beneficial capital treatment, liquidity facilities and servicer advances will need to meet Basel II's specific requirements for "eligible liquidity facilities" and "eligible servicer cash advance facilities", respectively. It is interesting to note that Basel II ultimately preserved special capital treatment for Canadian-style eligible liquidity facilities that are only available in a general market disruption. It seems unlikely that these provisions will be relied upon in any meaningful way in the future in the Canadian market given recent market developments.

In addition, amendments to Part XIII of the Insurance Companies Act (Canada), which came into force on April 20, together with certain policy clarifications by OSFI, have helped to open the door for the provision of "monoline" financial guarantee insurance by foreign-based insurers. Previously foreign based insurers were effectively prohibited from providing such insurance as credit support for asset backed securities because the risk was located in Canada. However, in a letter dated May 14, 2007, OSFI indicated that its regulatory focus would shift from the location of the risk to the location of the insurance in determining whether Part XIII applied. Thus a monoline contract concluded outside Canada would not fall under OSFI regulation. In a Ruling 2007-03 released on October 25, 2007, OSFI confirmed this new regulatory policy with respect to residual value insurance provided in Canada by a foreign insurer. These changes should hopefully provide market participants with another structuring tool that has largely been absent from the Canadian market.

PPSA Updates

The most recent set of changes to the Personal Property Security Act (Ontario) (PPSA) came into force on August 1, 2007. Among the legislative amendments is a change in the treatment of anti-assignment clauses. The amended PPSA now provides that an assignment of a contract or account receivable to a third party in contravention of an anti-assignment clause will not invalidate the assignment. Originators of receivables will now be able to finance accounts through securitization which in the past would have been treated as ineligible under securitization programs. However, the assigning party may still be liable for breach of contract with respect to the assignment. It is worth noting that the change in treatment only applies to the assignment of "the whole of the account or chattel paper". As a result, an assignment of an undivided interest in a receivable (as opposed to the entire receivable) would still be subject to any contractual prohibition. Nevertheless, this change will bring Ontario into line with the state of the law in many of the other provinces and provide additional flexibility to companies looking for different financing alternatives for their receivables.

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2008 McMillan Binch Mendelsohn LLP

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

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

Authors
Robert M. Scavone
 
In association with
Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
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
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions