Overview of comments on the CSA's exempt market proposals

October 24, 2011

Whereas the comments on the definition of securitized product and the prospectus disclosure proposals were quite limited and restrained, those on the proposed exempt market rules were both extensive and harshly critical. The general themes were common to most commentators. The proposed rules:

  •  are an over‑reaction to the failure of the third‑party sponsored ABCP market in Canada;
  •  focus unnecessarily on risks inherent in high‑risk structures such as those originated under the originate‑to‑distribute model or synthetic structures that either did not or no longer exist in Canada;
  • inappropriately apply a one‑size‑fits‑all approach to the traditional securitization market; and
  • unfairly differentiates between securitized products and other high risk securities.

Three elements of the proposed new rules attracted the most attention. First, the creation of the new definition of “eligible securitized product investor” and the elimination of the other exemptions were generally attacked as unfairly stigmatizing securitized products and, it was contended, could lead to a patch‑work of different exemption criteria for different products. Certain commentators suggested that sufficient protection would result if all exempt purchases were required to be completed through registrants with their know‑your‑client and know‑your‑product obligations.  The implication in certain of the criticisms from dealers is that investors may come to view securitized products negatively due to the fact that they are to be treated differently under the proposal. It is not readily apparent, at least to me, how this would ever become an issue for investors other than, by definition, those who have been excluded under the new regime. The people most affected by the proposed change may, in fact, be those sitting at various trading desks who will have to be careful not to sell securitized products to non-eligible securitized product investors; but, having said that, I would have thought that their know-your-client and know-your-product obligations would have already necessitated the taking of such care.

The opposition to the proposal was not universal, however, at least in concept. Neither the author nor the American Securitization Forum (ASF) found the elimination of retail investors to be particularly troublesome. As stated by the ASF“ASF supports the view that complex securitized products offered without all of the protections of the prospectus‑delivery regime should be limited to investors who have the knowledge and experience to evaluate the securities they are considering for purchase and the ability to ascertain what disclosures, reports and other contractual features they require in connection with a prospective purchase”.

Virtually all commentators were united in their criticism of the requirement to provide an information memorandum. This strength of this criticism is only reinforced if the proposed change to the universe of eligible investors is conceded. Having eliminated the retail investor, what remain are precisely the highly sophisticated investors who have the knowledge of what they need and the ability to obtain it through negotiation. The proposal represents an unwarranted infringement on the right to contract and should, at minimum, be capable of being waived. (Similarly, the proposal requiring continuous disclosure in respect of exempt distributions runs afoul of this principle and should also be left to be negotiated by the participants.)

The ASF recommended that the CSA follow the U.S. approach which only requires delivery of an information memorandum if specifically requested by an investor or prospective investor. However, I continue to believe that this is a distinction without a difference. This view has recently been corroborated by the Securities Industry and Financial Markets Association (SIFMA) in their comment letter on the SEC’s Re‑Proposal of ABS Shelf Eligibility Conditions: “As a practical matter, however, this would mean that every issuer of structured finance products would need to compile and be prepared to provide all of the disclosure that would have been required in a registered public offering, whether or not any investor ultimately requests the information … The proposed changes … substantially eliminate the principal distinctions between registered public offerings and private offerings … In our view, the scope of the proposal is unjustified and the proposed changes could significantly impair the functioning of the private markets for structured finance products and reduce the availability of credit.”

There did not seem to be as much resistance in principle to the proposal to require minimum disclosure for short-term securitized products although several bank commentators indicated that it should not go beyond what is already required by the Bank of Canada for bank-sponsored conduits’ ABCP to qualify as collateral under the Bank of Canada’s Standing Liquidity Facility. In any case, according to CIBC (and seconded here), it is critical that the prescribed form contain program level information only, and not transaction details: “The costs and challenges in meeting the delivery requirement for updated transaction information in an information memorandum for each sale of ABCP could likely result in the ABCP market being eliminated.

Finally, and perhaps most importantly, is the proposal which would require issuers, sponsors and underwriters to certify that information memorandum contain no misrepresentation. As indicated by the ASF, the proposal “is without parallel in the U.S. securities laws”. No justification has been forthcoming (or, indeed, exists) for such an extension of liability in respect of these products as opposed to any other exempt investment, however risky. It is one thing to require enhanced disclosure; it is something entirely different and totally unconnected to impose enhanced liability. As indicated by CIBC such an extension “would likely result in the demise of the private placement market for securtized products because it would largely eliminate the distinction between public and private offerings”. In addition to increasing transaction costs (which would be passed on to investors), perhaps more importantly it would naturally “result in a redirection of issuance volumes towards exempt products with lower liability risks or costs associated with them”.

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