On April 11, 2013, the Loan Syndications and Trading Association (LSTA) and the American Bankers Association (ABA) issued a joint letter to Office of the Controller of the Currency, the Board of Governors of the Federal Reserve System  and the Federal Deposit Insurance Corporation (collectively, the Agencies) requesting that the “compliance date” of May 21, 2013 listed in the final guidance be removed and that the guidance be revised to provide for up to twelve months for affected institutions to implement the Agencies’ suggestions.  In the letter, the LSTA and ABA stated that more time is required for member institutions to make changes to their policies, procedures and management information systems in order to meet the recommendations in the final guidance.  They also indicated that there are interpretive questions remaining in respect of the final guidance that still need to be addressed.  These include whether the guidance is essentially a binding rule (notwithstanding the Agencies’ statements to the contrary).

External Complaint Bodies

Bank customers are currently able to refer unresolved complaints regarding a bank’s products or services to an external complaint body that will seek a resolution impartially. Banks operating in Canada are already members of such external complaint bodies. The new regulations seek to entrench standards for the operation, impartiality and transparency of all external complaint bodies that provide services in Canada’s banking sector. The regulations include criteria for receiving and maintaining Ministerial approval to act as an external complaint body. They also establish certain service standards for such bodies, including a requirement to issue final written recommendations to parties to a dispute within 120 days after the proper referral of complaint.

The Federal Consumer Agency of Canada

The Financial Consumer Agency of Canada Act (Canada) has been amended to expand the role of the Federal Consumer Agency of Canada (FCAC) to include oversight of the regulation of customer complaints and the activities of external complaint bodies. The FCAC has published an Application Guide for External Complaint Bodies for use by entities seeking to serve that role.

Impact for Banks

Banks in Canada already have dedicated procedures and personnel for addressing customer complaints, in accordance with industry standards and legislation and regulations currently in effect. As a result, banks are generally well positioned to meet the new regulatory requirements. The new regulations do set out standards for information disclosure to ensure consistency across the banking sector. This includes providing certain information regarding their complaints procedures and external complaints bodies to its customers as well as annual public disclosure regarding complaints addressed internally by the bank.

Please contact any one of Stephen D.A. Clark, Kashif Zaman and Victoria Graham if you have any questions on the above.

On March 22, 2013, U.S. regulators, consisting of the Office of the Controller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Federal Reserve) and the Federal Deposit Insurance Corporation (FDIC and, collectively with the OCC and the Federal Reserve, agencies), issued their final interagency guidance on leveraged lending.

The final guidance updates and replaces existing guidance from 2001 and forms the basis of the agencies’ supervisory focus and review of supervised financial institutions. These institutions include national banks, federal savings associations and federal branches and agencies supervised by the OCC; state member banks, bank holding companies, S&L holding companies and all other institutions for which the Federal Reserve is the primary federal supervisor; and state nonmember banks, foreign banks having an insured branch, state savings associations and all other institutions for which the FDIC is the primary federal supervisor. Institutions subject to the final guidance include U.S. branches and agencies of foreign banking organizations. The compliance date for the final guidance is May 21, 2013.

The final guidance outlines, for agency-supervised institutions, high-level principles related to safe-and-sound leveraged lending activities, including underwriting considerations, assessing and documenting enterprise value, risk management expectations for credits awaiting distribution, stress testing expectations, pipeline portfolio management and risk management expectations for exposures held by the institution. Although the final guidance was not adopted as a rule, actions taken by a supervised institution inconsistent with the guidance would, at a minimum, be subject to supervisory criticism.

The final guidance does not provide a bright-line definition of leveraged lending, instead urging supervised institutions to ensure that their policies include criteria to define leveraged lending that are appropriate to the institution. However, the final guidance does provide certain common definitions of leveraged lending, including the following:

• transactions whose proceeds are used for buyouts, acquisitions or capital distributions (e.g., so-called dividend recaps)
• transactions in which the borrower’s total debt/EBITDA exceeds 4 to 1 or senior debt/EBITDA exceeds 3 to 1 (in each case measuring debt on a gross basis rather than net of cash on hand).

Importantly, the final guidance does not consider asset-based loans (ABL) to be leveraged loans unless such loans are part of the entire debt structure of a leveraged obligor. In addition, the final guidance does not consider so-called fallen angels (loans that do not meet the definition of leveraged lending at origination, but migrate into that definition at a later date due to changes in the borrower’s financial condition) to be leveraged loans, on the basis that a loan should be designated as leveraged only at the time of origination, modification, extension or refinancing. Loans to investment grade borrowers were not categorically excluded in the final guidance from being leveraged loans. The final guidance does, however, indicate that its references to leveraged lending and leveraged loan transactions do not include “bond and high-yield debt.”

Click here to read the entire Updated on Osler.com, including highlights of the final guidance.

Developing a Financial Consumer Code

The Government intends to develop a “comprehensive financial consumer code” that would consolidate financial consumer protection rules that now appear in various legislation and related regulations. The code would be administered by the Financial Consumer Agency of Canada (FCAC). We can expect consultation with stakeholders to begin in 2013.

Domestic Systemically Important Banks

In March, 2013, the Office of Superintendent of Financial Institutions (OSFI) issued an advisory designating Canada’s six major banks as domestic systemically important banks (DSIBs). Due to the potential impact that the failure of a DSIB could have on the domestic economy, each DSIB will be subject to a risk-weighted capital ratio requirement equal to a 1% common equity surcharge as well as enhanced supervisory and disclosure requirements.

The budget also described the Government’s intention to implement a “bail-in” regime for DSIBs, including provision for the “very rapid conversion of certain bank liabilities into regulatory capital” in the event a DSIB’s viability is threatened. Following questions regarding the meaning of “certain bank liabilities”, the Department of Finance has clarified that it is referring to regulatory capital of the bank (which includes preferred shares and subordinated debt) which will be converted into common equity of the bank in case of a “bail-in”.  Such a conversion will be consistent with the Basel III capital rules now in effect in Canada which require that any regulatory capital (other than common equity) issued by banks should be convertible into common equity upon the occurrence of certain events.

Canadian Payments System

The Government intends to continue its review of elements of Canada’s payments system following the report of the Task Force for the Payments Systems Review. Recently, the FCAC issued Commissioner’s Guidance to clarify three issues related to the Code of Conduct for the Credit and Debit Card Industry in Canada (the “Code”). The budget includes the Government’s intent to finalize an addendum to the Code regarding mobile payments and to review the governance framework for the payments sector generally together with the Bank of Canada.

Canadian Financial Institutions in a Global Marketplace

The Government has indicated its intention to promote the strategic expansion of Canadian financial institutions internationally. In recognition of the global nature of financial markets, it will also propose allowing Canadian financial institutions greater flexibility to appoint non-residents as members of board committees, though the requirement that a majority of members be Canadian residents will remain.

The Role of Mortgage Portfolio Insurance

The Government will continue to address the role of mortgage portfolio insurance in Canada’s housing market. It intends to do so by:

• Limiting the insurance of low-ratio mortgages to those that are used in conjunction with securitization programs sponsored by the Canada Mortgage and Housing Corporation (CMHC); and
• Prohibiting any use of any CMHC insured mortgage as collateral in any securitization program other than those sponsored by CMHC.

Please contact any one of Stephen D.A. Clark, Kashif Zaman and Victoria Graham if you have any questions on the above.

As indicated in the BCBS framework, a bank’s systemic importance is related to the impact that its failure could have on the domestic economy. The criteria applied by OSFI in determining a bank’s systemic importance included the following:

• Size – The six banks identified as systemically important account for over 90% of total Canadian banking assets;
• Inter-connectedness – The six identified banks have, by far, the highest level of claims against, and obligations to, other financial institutions.  Those ties or “inter-connections” between institutions may increase the risk of problems spreading through the financial system; and
• Substitutability – The six identified banks are also the dominant participants in financial markets and systems such as underwriting, large value transfers, foreign exchange and clearing and settlement systems for payments and securities transactions. This makes each bank more difficult to replace as a participant in the event of any failure.

The ramifications of being identified a systemically important bank include:

• A risk-weighted capital ratio requirement equal to a 1% common equity surcharge commencing January 1, 2016;
• Continuation of an enhanced level of supervisory intensity as reflected in OSFI’s Supervisory Framework; and
• Enhanced disclosure requirements including those recommended by the Financial Stability Board’s Enhanced Disclosure Task Force.

OSFI will continue to review matters covered by the Advisory and make any required updates, including to the list of systemically important banks and the related equity surcharge level.

This entry was authored by Stephen D.A. Clark, Kashif Zaman and Victoria Graham.

The full text of the amendments can be found here.  In summary, these amendments (a version of which was previously published in October 2012 for comment) are meant to address certain deficiencies identified by the Financial Action Task Force (“FATF”) in the customer identification and due diligence provisions of the Regulations. The FATF is the international standard setting body for AML/ATF activities.  Canada is a founding member of the FATF.  In its 2008 evaluation of Canada, the FATF identified deficiencies in Canada’s requirements relating to customer identification and due diligence, and Canada was found to be non-compliant with FATF Recommendation 5.  The stated purpose of these amendments are:

• to ensure that the reporting entities clearly understand their customer due diligence (“CDD”) obligations;
• to improve Canada’s compliance with Recommendation 5; and
• to promote the continuing strength of Canada’s AML/ATF regime.

The amendments to the Regulations make the following clarifications to the CDD provisions of the Regulations:

• The term “business relationship” would now be defined in the Regulations. The Regulations will also be amended to clarify that, in order to meet their obligations to identify and report suspicious transactions, reporting entities should conduct ongoing monitoring of business relationships with clients, using a risk-based approach, and should obtain information on the purpose of a business relationship when entering into a business relationship with a client.
• The circumstances in which reporting entities should take enhanced CDD measures in respect of high-risk customers, activities or transactions will be clarified to clearly indicate that enhanced measures should be taken in respect of all high-risk clients and activities, and a list of enhanced measures from which reporting entities could choose will be added. The measures will include keeping client information up to date and conducting enhanced ongoing monitoring.
• The Regulations require certain reporting entities to obtain identification information, in designated circumstances, from all persons who own 25% or more of a corporation or other entity. The amendments specifically clarify that those reporting entities should also obtain documentary evidence from the client that confirms the beneficial ownership information that they have obtained.
• The Regulations will be amended to clarify that no exceptions exist to reporting entities’ current obligations to conduct CDD measures in respect of any transaction or activity which gives rise to a suspicion of money laundering or terrorist financing.

Before these amendments to the Regulations come into force, the Financial Transactions and Reports Analysis Centre of Canada (Canada’s financial intelligence unit) and the Office of the Superintendent of Financial Institutions (responsible for administering the federal financial institutions statutes in Canada) will provide updated guidance in order to address the comments provided by stakeholders on the previous version of these amendments published in October 2012.

FRFI statutes generally prohibit a FRFI from dealing in goods such as commodities. This includes a prohibition on buying and selling commodities for a commercial purpose. However, the prohibition would not apply where the FRFI takes an ownership interest in commodities in connection with activities otherwise authorized by the applicable FRFI statute. For example, in the case of the Bank Act, a federally regulated bank may take an ownership interest in commodities where it does so in the context of the “business of banking” (which includes the provision of any financial service) or business which generally appertains to such business of banking.

In 2004, OSFI ruled on a commodity swap arrangement involving natural gas entered into by a federally regulated foreign bank. In the ruling, OSFI concluded that an FRFI that engages in physically settled commodity trading is providing a “financial service” (and, therefore, is engaged in the business of banking), provided that the FRFI:

• enters into such transactions only with customers who are producers or end users in the context of financial risk management services to those customers, or with other market intermediaries to manage its exposure to the relevant commodity; and
• takes title to the commodity only on a “transitory” basis and only in connection with, or for the purpose of facilitating, the settlement of such transaction.

In the new Advisory, OSFI acknowledges that the scope of transactions in which an FRFI might take an ownership interest in a commodity extends beyond transactions entered into for credit enhancement purposes, as was the case transaction considered in the 2004 ruling. For example, OSFI noted that the transactions might include an ownership interest in a commodity for time periods that extend beyond “transitory” periods or transactions in the nature of inventory financing. As a result, OSFI has set out the following principles for determining whether a transaction in which an FRFI takes an ownership interest in commodities generally appertains to the business of providing a financial service:

• Purpose of transaction: The ownership interest in commodities should arise from a transaction that the FRFI has entered into as an alternative to providing a traditional financial service to the customer (e.g., inventory financing, guarantee, letter of credit or risk management service).
• Duration of ownership: The FRFI should only retain ownership interests in commodities for a commercially reasonable period of time, having regard to the nature of the financial service that the transaction is intended to provide.
• Exposure: The FRFI should not, in the normal course of its business, be exposed to fluctuations in the price of the commodity as a result of the transaction. The FRFI’s exposure in this regard should not be fundamentally different in nature and degree from such exposures that arise from the provision of comparable traditional forms of financial services. On this basis, OSFI expects FRFIs to enter into an agreement to dispose of their ownership interest in commodities promptly after agreeing to acquire that ownership interest.
• Return: The return that is generated by a transaction that is an alternative to a traditional financial service and that involves a FRFI taking an ownership interest in commodities should not be based on fluctuations in the price of commodities but should rather have a close correlation to the return that would normally be generated by the comparable traditional financial service.

These principles would not apply to ownership interests in precious metals (which OSFI has acknowledged should be considered in a different light given the historical special status afforded to precious metals) or ownership interests resulting from realization of a security interest in collateral under a secured financing arrangement (which ownership interest, OSFI has noted, is incidental to the provision of the financial service).

OSFI has also set out minimum prudential standards for FRFIs engaging in activities that fall within the scope of the Advisory.

This entry was provided by Stephen Clark, Kashif Zaman and Victoria Graham, partners in our Financial Services group.  If you have any questions regarding the matters covered in this Advisory, please contact Stephen, Kashif or Victoria.

A copy the Consultation Paper and proposed Addendum to the Code, together with Backgrounder issued by the Department of Finance can be accessed through the following links:

• Consultation Paper/Addendum
• Backgrounder

The proposed Addendum clarifies that the rules relating to payment cards will apply at the payment application level and not the mobile device itself, and provides specific guidance in relation to four key elements of the Code, stated as follows:

• Element 4 ensures that merchants have choice in the type of payments they accept: a merchant who accepts credit card payments from a particular network will not be obligated to accept debit card payments from that same payment card network, and vice versa. The Addendum clarifies that merchants who accept credit and debit card payments through a mobile device from a particular network will not be obligated to accept all products in that payment network’s mobile wallet.
• Element 6 provides that competing domestic applications from different networks shall not be offered on the same debit card. The Addendum clarifies that competing domestic debit applications can reside on or be accessed by the same mobile device provided they are represented as separate mobile payment apps.
• Element 7 provides that co-badged debit cards are equally branded. The Addendum clarifies that equal branding applies to all virtual or electronic representations of payment applications. It also clarifies that establishing default preferences for payment should be done by consumers based on a clear and transparent process and users should be able to easily change default settings.
• Element 8 provides that debit and credit card functions shall not co-reside on the same payment card. The Addendum clarifies that separate credit and debit applications may reside on the same mobile device provided they are represented as separate mobile payment apps.

The proposed Addendum also specifically seeks comments on:

• whether the amended Code should apply to other entities enabling mobile payments (the Code currently applies to credit and debit card networks and their participants (e.g., card issuers and acquirers)); and
• whether express consent should be required from merchants to accept debit or credit  payment applications through a mobile device where there are no changes to fees and no new infrastructure purchases are required.

The proposed Addendum could impact mobile payment projects that are currently being in the process of being developed. Industry participants wishing to comment must do so within the 60 day comment period. Comments can be submitted to codeconsult@fin.gc.ca.

The deadline for comments is September 17, 2012.

The proposed changes are stated to reflect OSFI’s experience and observations as well as developments in international standards and best practices.  The comment period on the draft guideline closes September 14^th.  OSFI has indicated that a final version will be issued before the end of the year.