Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Securities Regulation, July 2008
- Regulations aimed at improving disclosure for Principal
Protected Notes issued by federally-regulated deposit taking
institutions came into force July 1, 2008
- Clarifications made to the provisions in the previously
proposed PPN Regulations regarding how the required
information is provided to investors and the requirements
regarding the use of past market performance information in
The federal government's Principal Protected Notes Regulations (the Regulations), which are aimed at improving disclosure for Principal Protected Notes (PPNs) issued by federally-regulated deposit-taking institutions, have been finalized and came into force July 1, 2008 pursuant to sections of the Bank Act, Cooperative Credit Associations Act and the Trust and Loan Companies Act. They replace the existing Index-linked Deposits Interest Disclosure Regulations, first introduced in 2002 and now seen as inadequate for the complex PPNs currently available in the market. These changes reflect the need to ensure that investors have sufficient information to make informed investment decisions, which is an important aspect of the existing federal financial consumer protection framework.
The federal Department of Finance had previously published for comment, on November 24, 2007, the proposed PPN Regulations (the 2007 Proposal). For a summary of the 2007 Proposal, please see our December 2007 Blakes Bulletin on Securities Regulation: Proposed Federal Regulations for Principal Protected Notes which can be found on Blakes Web site, in our Publications, Corporate Finance & Securities Regulation section.
The most significant changes in the Regulations from the 2007 Proposal include (i) clarification of the provisions regarding how the required information is provided to investors and the requirements regarding the use of past market performance information in advertisements, (ii) modification of the information to be provided in a case of an early redemption of a PPN, and (iii) deletion of the provisions dealing with the calculation of time with respect to disclosure via electronic means.
A PPN is defined as a financial instrument that is issued in Canada to an investor and that (a) provides for a payment to be made by the issuing institution that is determined, in whole or in part, by reference to an index or reference point, including (i) the market price of a security, commodity, investment fund or other financial instrument, and (ii) the exchange rate between any two currencies; and (b) provides that the principal amount that the issuing institution is obligated to repay at or before the PPN's maturity is equal to or more than the total paid by the investor for the PPN. Thus, PPNs guarantee the invested principal and offer returns that are linked to returns on an underlying investment product.
The Regulations stipulate the content, manner and timing of disclosure that certain issuing institutions are required to provide at the point of sale; the information that must be made available, upon request, to aid investors in monitoring their investment; and requirements for advertising PPNs. They represent a move away from prescriptive requirements to a principles-based and results-focused approach to regulating. The Regulations are applicable to Schedule I and II banks, the Canadian branches of Schedule III banks, credit unions governed by the Cooperative Credit Associations Act and federally-regulated trust and loan companies (the Institutions).
MODIFICATIONS TO CLARIFY THE POLICY INTENT OF THE REGULATIONS
Additional Guidance on How Information is to be
Disclosed to Investors
The provisions with respect to how the required information is to be provided to investors have been clarified. The Regulations now clearly set out the requirements applicable to Institutions, which depend upon whether the agreement is entered into in person, over the phone, or by electronic means.
Under the Regulations, at least two days before entering into a contract to issue a PPN (a PPN Contract), a synopsis of the following information must be provided by the Institution to the investor, both in writing (the Written Disclosure) and orally (the Oral Disclosure) by a person who is knowledgeable about the terms and conditions of the PPN (a Knowledgeable Person):
(a) the term of the PPN, and how and when the principal is to be repaid and the interest, if any, is to be paid;
(b) any charges and their impact on the interest payable;
(c) how interest is accrued, and any limitations in respect of the interest payable;
(d) any risks associated with the PPN, including, if applicable, the risk that no interest may accrue;
(e) the distinction between PPNs and fixed-rate investments with respect to the levels of risk and return;
(f) the circumstances in which a PPN could be an appropriate investment;
(g) if the PPN relates to a deposit that is not eligible for deposit insurance coverage by the Canada Deposit Insurance Corporation, the fact that it is not eligible;
(h) whether the PPN may be redeemed before its maturity and, if so, that redemption before maturity may result in the investor receiving less than the principal amount;
(i) the terms and conditions of any secondary market offered by the Institution;
(j) whether the investor may cancel their purchase of the PPN and, if so, how the purchase may be cancelled;
(k) whether the PPN provides that the Institution may amend the note and, if so, in what circumstances;
(l) whether the manner in which the PPN is structured or administered may place the Institution in a conflict of interest;
(m) any other information that could reasonably be expected to affect an investor's decision to purchase the PPN; and
(n) that the above information, in a full and complete manner, is available on request and that specific information regarding the value of the PPN is available on request after the PPN is issued.
There are three exceptions to the above disclosure requirements. First, if a PPN Contract is entered into by electronic means, then the Oral Disclosure is not required provided the Institution makes the Written Disclosure and discloses the telephone number of a Knowledgeable Person at least two days before entering into the agreement.
Second, if an Institution has made a public commitment under the Financial Consumer Agency of Canada Act to provide investors a two, or more, day rescission right, and the PPN Contract is entered into by electronic means or by telephone, the following rules apply: (i) if the agreement is entered into by electronic means, the Oral Disclosure is not required provided the Institution makes the Written Disclosure before entering into the PPN Contract and discloses the telephone number of a Knowledgeable Person before, or without delay after, entering into the contract; and (ii) if the agreement is entered into by telephone, the Oral Disclosure must be made by the Institution before entering into the PPN Contract and the Written Disclosure must be provided before, or without delay after, entering into the contract.
Third, the Written and Oral disclosure may be made at any time prior to the PPN Contract if the Institution and investor expressly consent to it and the contract is entered into with the investor in person.
Use of Past Market Performance Information in
The requirements regarding the use of past market performance information in advertisements have been expanded by specifying the disclosure required by Institutions using this kind of information.
In each advertisement that refers to features of a PPN or the interest payable, an Institution must disclose, in addition to how information about the PPN may be obtained:
(a) the manner in which interest is to be accrued, and any limitations in respect of the interest payable;
(b) if the advertisement gives an example of a situation in which interest would be payable, an example of another situation in which no interest would be payable;
(c) if the advertisement gives an example of a situation in which interest would be payable that is in addition to any minimum interest that is guaranteed, an example of another situation in which only the minimum interest would be payable; and
(d) if the PPNs are not eligible for deposit insurance coverage by the Canada Deposit Insurance Corporation, the fact that they are not eligible.
An Institution shall only use market information in an advertisement if the performance is represented fairly and, if hypothetical examples are used, the assumptions underlying those examples are realistic and disclosed in the advertisement. The fact that past market performance is not an indicator of future market performance must also be disclosed in the advertisement.
TECHNICAL MODIFICATIONS TO THE 2007
According to the federal Department of Finance, technical modifications to the 2007 Proposal were implemented to ensure that business practices are taken into account. To that end, in order to better reflect the price determination mechanisms used by Institutions, the information to be provided in a case of early redemption of a PPN has been modified. Whereas the 2007 Proposal required that an Institution disclose to the investor in writing the total amount of principal and interest payable under the PPN and the amount of any penalty or fee for its redemption or purchase, the Regulations now mandate that, in a case of early redemption of a PPN at the request of an investor, the Institution must disclose to the investor (i) the value of the PPN on the last business day before the day that the investor requests the redemption, or the value of the PPN based on the last available measure of the index or reference point on which the interest is determined; (ii) the amount of any penalty or charge; (iii) the net amount that the investor would have received for the redemption after deducting the amount referred to in paragraph (ii) from the value of the PPN referred to in paragraph (i); and (iv) when and how the value of the PPN will be calculated, and the fact that the value of the PPN may differ from the value referred to in paragraph (i).
In addition, since the upcoming Electronic Documents Regulations will set the requirements for communication by electronic means consistently across the Bank Act and all regulations, the provisions dealing with the calculation of time with respect to disclosure via electronic means have been deleted from the Regulations.
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.