Changes Proposed for Exempt Offerings of Short-Term Debt and Securitized Products in Canada

The Canadian Securities Administrators (the “CSA”) have published for comment proposed amendments (the “Proposal”) to National Instrument 45-106 Prospectus and Registration Exemptions (“NI 45-106”). The Proposal seeks to:

• amend the existing prospectus exemption relating to short-term debt securities (the “Short-Term Debt Exemption”); and
• create a new prospectus exemption for the sale of short-term securitized products backed by traditional or conventional assets (the “Short-Term Securitized Product Exemption”).

The Short-Term Debt Exemption

The current exemption

The Short-Term Debt Exemption permits the distribution of commercial paper (“CP”[1]), which is a form of short-term debt issued as notes. CP is generally issued in Canada to provide capital for short-term financing needs of a company or “bridge financing” for a new capital investment or corporate take-over until longer-term securities are issued. CP is issued in the “exempt market” under a prospectus exemption with no resale restrictions under applicable securities law.

The existing Short-Term Debt Exemption provides that the prospectus requirement does not apply to a distribution of CP maturing not more than one year from the date of issue, if the CP distributed:

• is not convertible or exchangeable into, or accompanied by a right to purchase another security other than CP; and
• has a designated rating from a designated rating organization (a “DRO”) or its DRO affiliate.

The designated rating provision requires CP to have at least one credit rating that meets or exceeds a specified minimum rating (referred to below as the “credit rating threshold condition”). Although it does not require more than one credit rating, if an issuer obtains another credit rating, each rating must be at or above the specified minimum. This additional rating requirement has been termed the “split rating condition”.

The problem

The split rating condition causes difficulty for issuers with multiple credit ratings, not all of which meet the split rating condition. Because such issuers cannot rely upon the Short-Term Debt Exemption, they are often forced to seek exemptive relief on a case-by-case basis. As a result, the CSA, through its own analysis and feedback provided by market participants, has come to realize that the existing Short-Term Debt Exemption provided a regulatory disincentive for issuers to obtain additional credit ratings. The CSA also notes that the Short-Term Debt Exemption can be unfair, as it can result in differential treatment for certain issuers with similar credit risk.

e.g., Issuer A with one designated rating could utilize the exemption, while Issuer B, with an identical credit risk and designated rating, would be prohibited if it had obtained an additional rating that did not meet the minimum rating threshold.

Proposed New Short -Term Debt Exemption

The Proposal seeks to maintain the existing credit rating threshold condition in the Short-Term Debt Exemption, but modify the split rating condition.

As illustrated in the chart below, the Proposal would now require an issuer to have:

• at least one credit rating that satisfies the credit rating threshold condition; and
• no credit rating below the modified split rating condition.

The credit ratings related to the Short-Term Debt Exemption are set out in the chart below.

Note: “DBRS” means DBRS Limited, “Fitch” means Fitch, Inc., “Moody’s” means Moody’s Canada Inc. and “S&P” means Standard & Poor’s Ratings Services (Canada).

The CSA believe this modified split rating condition more accurately reflects how short-term credit ratings correlate across DROs and according to the Proposal: (a) removes the regulatory disincentive for some issuers to obtain an additional credit rating; (b) provides consistent treatment of issuers with similar credit risk; and (c) maintains the current credit quality of CP distributed under the Short-Term Debt Exemption.

 Proposed New Short-Term Securitized Product Exemption

Under the Proposal, the CSA have also published a Short-Term Securitized Product Exemption. This will be a new prospectus exemption that targets issuers of certain types of short-term securitized products (i.e., traditional or conventional short-term asset-backed commercial paper).

A “short-term securitized product” means a securitized product that is a CP that matures not more than one year from the date of issue. A “securitized product”, simply stated, means a security that is governed by a trust indenture that provides a holder with an interest in an asset pool of cash-flow generating assets in which an issuer has a property interest and which entitles a holder to principal and interest payments.

The CSA seeks to exclude short-term securitized products from being distributed under the Short-Term Debt Exemption and the private issuer, friends and family, founders and offering memorandum exemptions.

Under the Short-Term Securitized Product Exemption, issuers of short-term securitized products will be required to:

• have credit ratings from at least two DRO’s that meet or exceed a prescribed minimum rating. The prescribed minimum ratings will be higher than the minimum credit ratings proposed for the Short-Term Debt Exemption (as discussed above);
• meet certain liquidity support requirements; and
• contractually agree that its asset pool will consist only of traditional asset classes such as bonds, leases, mortgages and receivables, or securities of other issuers subject to the same asset class restrictions. This will exclude an asset pool that includes credit derivatives or highly structured or leveraged credit products.

In addition, issuers will be subject to additional disclosure requirements, which include:

• preparing and delivering a mandatory information memorandum to investors prior to any purchase that sets out certain specified disclosure; and
• a contractual obligation of the issuer to investors to provide the following ongoing disclosure:
  • a prescribed “monthly disclosure report”, made available within 30 days of month end, providing investors with an update in assets held, the flow of funds and any securitization transactions during the relevant period, as well as risk retention and interest alignment disclosure; and
  • a “timely disclosure report”, in the event of a change to the information in the most recent monthly disclosure report or the occurrence of an event “that would reasonably be expected to materially affect either payments on that class of short-term securitized product or performance of the assets in the asset pool”.

Issuers will not be required to file the above disclosure with any Canadian securities regulators, but will be required to undertake to deliver the monthly and timely disclosure reports upon request. In addition, the form of the report of exempt distribution pursuant to NI 45-106 will be altered to add “securitization conduit” as an industry classification to permit the securities regulators to better collect information regarding exempt-market securitization transactions.

The comment period for the Proposal ends on April 23, 2014.  A copy of the Proposal can be found here.

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Disclaimer

This blog is not intended to create, and does not create an attorney-client relationship. You should not act or rely on information on this blog post without first seeking the advice of a lawyer.  This material is intended for general information purposes only and does not constitute legal advice.  For legal issues that arise, the reader should consult legal counsel.

Authors:

Brian Koscak is a Partner at Cassels Brock & Blackwell LLP located in Toronto, Ontario and Chair of the Exempt Market Dealers Association of Canada. Brian is also a member of the Ontario Securities Commission’s Exempt Market Advisory Committee. Brian can be reached by phone at 416-860-2955, by e-mail at bkoscak@casselsbrock.com or on twitter @briankoscak. Brian also regularly writes about Canadian securities law matters on his personal blog at www.briankoscak.com.

Alexandra Iliopoulos is a Partner at Cassels Brock & Blackwell LLP located in Toronto, Ontario

Afzal Hasan is an Associate at Cassels Brock & Blackwell LLP located in Toronto, Ontario