On August 1, 2014, the Department of Finance issued for comment the Taxpayer Protection and Bank Recapitalization Regime: Consultation Paper. The Consultation Paper outlines the proposed bail-in regime applicable to Canada's domestic systemically important banks (D-SIBs),1 as a follow-up to the announcement in the 2013 federal budget that such a regime would be forthcoming in Canada.

Bail-in regimes have been or are in the process of being implemented in a number of other jurisdictions following the 2008 financial crisis, including the United States, the United Kingdom and the European Union. Bail-in regimes aim to limit taxpayer exposure ("bail-out" exposure) in the event of the failure of systemically important ("too big to fail") financial institutions, by requiring that the institution's shareholders and creditors, rather than taxpayers, absorb losses in the case of the institution's failure. In 2011, the G-20, including Canada, endorsed the Financial Stability Board's Key Attributes of Effective Resolution Regimes for Financial Institutions in 2011, a set of best practices for the resolution of financial institutions which contemplates the establishment of a bail-in regime.

The proposed Canadian bail-in regime grants to the Government of Canada two significant conversion powers with respect to Canadian D-SIBs' outstanding capital and debt. First, the government is granted the power to permanently convert "eligible liabilities" of the D-SIB into common equity. Second, the government is granted the power to permanently cancel existing shares.

Each of the two new conversion powers can only be exercised if two preconditions have been met. First, the Superintendent of Financial Institutions must have determined that the bank has ceased or is about to cease being viable. Second, full conversion of the bank's non-viable contingent capital (NVCC) instruments must have occurred (NVCC instruments are capital instruments that by their terms convert into common shares if regulatory authorities determine that the bank is no longer viable).

Eligible liabilities of D-SIBs subject to the conversion power consist only of "long-term senior debt," which is senior unsecured debt that is tradable and transferable with an original term of over 400 days. Secured debt and deposits are specifically excluded. Therefore, the regime does not contemplate a "Cyprus-style" bail-in, whereby depositors could be asked to participate in the bail-in. Depositors remain specifically protected under the existing Canadian deposit insurance framework (which the Department of Finance indicates it will also review to ensure that depositors remain adequately protected). In addition, the proposed conversion power with respect to eligible liabilities will apply only to debt that is issued after implementation of the new bail-in regime, with no retroactive application to existing debt. There will be a transition period prior to the application of the regime.

The proposal also sets forth disclosure requirements applicable to documentation relating to long-term senior debt, in order to increase transparency for potentially affected investors. The underlying documents will be required to include specific disclosures with respect to the conversion powers as well as a clause requiring the investors to submit to the Canadian bail-in regime, notwithstanding any provision of foreign law to the contrary.

The formula for conversion of the long-term senior debt is to be based on a specified multiple of the most favourable conversion formula for the bank's outstanding NVCC instruments. By way of example, the contingent conversion formula for Royal Bank of Canada's recent NVCC subordinated debt offering is 1.5 times note value (compared to 1 time the principal amount for the NVCC preferred shares) divided by the conversion price (which is the greater of a floor price of $5 and the current market price of the common shares), so the conversion multiplier for long-term senior debt issued by Royal Bank of Canada following the implementation of the bail-in regime would be greater than 1.5. Governmental authorities will be responsible for determining the total amount of debt to be converted, which will be based on their determination that the post-conversion D-SIB will be well capitalized with a sufficient capital buffer. Conversion is to occur on a pro rata basis and to respect the hierarchy of claims on a relative (not absolute) basis, with no creditor or shareholder to be made worse off than in a traditional liquidation. Creditors and shareholders who are made worse off would be compensated through existing processes under the Canada Deposit Insurance Corporation Act.

The proposed regime also makes D-SIBs subject to a new capital requirement, the Higher Loss Absorbency Requirement, which aims to ensure that the affected banks have sufficient loss-absorbing capacity for the proposed conversions. The Higher Loss Absorbency Requirement is to be calculated on the sum of the bank's regulatory capital and long-term senior debt, and will be subject to a uniform and public minimum requirement administered by OSFI. To account for the possible effects of contagion, banks will be required to exclude from the calculation investments in both the bank's own and other banks' long-term senior debt. As capital instruments and senior debt instruments will have a different treatment under the capital adequacy rules and the Higher Loss Absorbency Requirement, D-SIBs may eventually alter their mix of capital in order to achieve an optimal situation.

Finally, the Department of Finance notes in the Consultation Paper that some aspects of the Canadian bail-in regime differ from the regimes in other jurisdictions, notably the United States, as a result of the lack of holding company structure for banks in Canada. The department is requesting input with respect to potential benefits of instituting a holding company structure in Canada.

Comments on the proposed bail-in regime are due on September 12, 2014.


1 The Office of the Superintendent of Financial Institutions (OSFI) has designated the following banks as D-SIBs: Bank of Montreal, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada and The Toronto-Dominion Bank.

To view original article, please click here.

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.