Bail-In Implementation Update

On September 23, the Bank Recapitalization (Bail-in) Conversion Regulations under the Canada Deposit Insurance Corporation Act, the Bank Recapitalization (Bail-in) Issuance Regulations under the Bank Act (collectively the Bail-In Regulations) and the Office of the Superintendent of Financial Institution's Total Loss Absorbing Capacity (TLAC) Guideline will come into effect. These represent the final step in the implementation of the bail-in regime that will allow for the expedient conversion of certain bank liabilities into regulatory capital in the highly unlikely event that a domestic systemically important bank (D-SIB) becomes non-viable. For a more detailed discussion about the substance of the Bail-In Regulations, please see our bulletins entitled "Government of Canada Publishes Bail-In Regulations" and "Final Bail-In Regulations and Related Guidelines Published."

What You Need To Know

• The Superintendent issued orders to each D-SIB, setting the minimum risk-based TLAC ratio at 21.5% of risk-weighted assets and the minimum TLAC leverage ratio at 6.75%.
• The CSA published (i) CSA Staff Notice 46-309 Bail-in Debt, which addresses the distribution or trade of bail-in debt to investors, and (ii) CSA Staff Notice 81-331 Investment Funds Investing in Bail-in Debt.
• A question raised by marketplace participants is whether a liability of a D-SIB outstanding prior to September 23 under a bond indenture, deposit note or similar instrument could be made subject to the bail-in regime by a D-SIB without the consent of the holder of that liability as a result of the D-SIB issuing additional debt under that same instrument on or after September 23. In our view, that existing liability could not be made subject to the bail-in regime without the consent of the holder.

D-SIB Formal Designation and TLAC Minimum

On August 21, the Superintendent of Financial Institutions issued orders to Canada's six largest banks, Bank of Montreal, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, The Bank of Nova Scotia and The Toronto-Dominion Bank, formalizing OSFI's identification as these banks as D-SIBs in March 2013. In addition, the Superintendent issued orders to each D-SIB, setting the minimum risk-based TLAC ratio at 21.5% of risk-weighted assets and the minimum TLAC leverage ratio at 6.75%.

CSA Staff Notices

On August 23, the Canadian Securities Administrators (CSA) published two notices outlining CSA staff's views regarding the implementation of the bail-in regime. The first notice (CSA Staff Notice 46-309 Bail-in Debt) addresses the distribution or trade of bail-in debt to investors located in Canada and the second notice (CSA Staff Notice 81-331 Investment Funds Investing in Bail-in Debt) provides guidance for investment fund issuers that may invest in bail-in debt. CSA staff will continue to monitor developments regarding the implementation of the bail-in debt regime and will consider whether additional guidance is needed.

CSA Staff Notice 46-309 Bail-in Debt

This notice sets out the CSA's view that there are different investment risks between bail-in debt and other types of unsubordinated debt. The notice also conveys the regulatory expectation that distributions or trades of bail-in debt by persons or companies in the business of trading in securities to investors located in Canada be done (i) by or through a registered dealer in accordance with relevant investor protection requirements under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registration Requirements (NI 31-103), or (ii) in compliance with the international dealer registration exemption in NI 31-103.

CSA Staff Notice 81-331 Investment Funds Investing in Bail-in Debt

This notice sets out the CSA's view that bail-in debt is an eligible investment for a money market fund (so long as the bail-in debt continues to meet the prescribed eligibility requirements applicable to money market funds as set out in National Instrument 81-102 Investment Funds). This is consistent with Torys’ view set forth in the bulletin "Final Bail-In Regulations and Related Guidelines Published." The notice also reminds investment fund managers who will or may hold bail-in debt, that (i) they must fully understand and take into consideration key features and risks of bail-in debt and take into consideration any risks to their funds as a result of such investment (e.g., the risk the CDIC may convert all or a portion of the bail-in debt into common shares), (ii) any such holdings must be consistent with the fund’s investment objectives and strategies, and (iii) such funds must consider their disclosure obligations to their security holders (e.g., appropriate risk disclosure about bail-in debt and distinctions between bail-in debt and non-bail-in debt).  

Re-Openings

Under the Bail-in Regulations, a liability will be subject to the bail-in regime only if it is issued on or after September 23, or, in the case of a liability issued before that date, its terms are amended on or after that day to increase its principal amount or to extend its term to maturity.

A question raised by marketplace participants is whether a liability of a D-SIB outstanding prior to September 23 under a bond indenture, deposit note or similar instrument could be made subject to the bail-in regime by a D-SIB without the consent of the holder of that liability, as a result of the D-SIB issuing additional debt under that same instrument on or after September 23. In our view, that existing liability could not be made subject to the bail-in regime without consent of the holder for the following reasons.

It is a well-established principle of Canadian contract law that an agreement between parties cannot be amended by one party to provide for new terms (i.e., a bail-in conversion right) unless the other party consents to that amendment. This basic principle arises out of the same legal requirements that must be satisfied in order to create an enforceable agreement, including a mutual intention of the parties to be legally bound. Accordingly, a D-SIB could not unilaterally amend the terms of an outstanding liability such that it becomes subject to the bail-in regime.

We understand that according to the terms of certain instruments under which liabilities were issued by D-SIBs prior to September 23, amendments may be made without the consent of the holder in specified circumstances (i.e., under an amendment provision that permits amendments to be made that do not adversely affect the rights of a holder in a material respect). The specific terms of those instruments would need to be examined to determine if those provisions would permit amendments such that existing liabilities could become subject to the bail-in regime without consent of the holders. 

In our view, however, except for amendment provisions that specifically contemplate the bail-in regime, a court would conclude that an interpretation of amendment provisions permitting existing liabilities of a D-SIB to become subject to the bail-in regime without the holder’s consent would not accord with the intentions or reasonable expectations of the parties and therefore would not be given effect.

To discuss these issues, please contact the author(s).

This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.

For permission to republish this or any other publication, contact Janelle Weed.

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