• Canadian Implementation of Basel III Capital Rules (Issuance of Non-Viability Contingent Capital)
  • September 21, 2011 | Author: Mary E. Kelly
  • Law Firm: Norton Rose Canada LLP - Toronto Office
  • To meet Basel III’s minimum requirements to qualify as Tier 1 or Tier 2 capital (Tiered Capital), all non-common instruments issued by deposit-taking institutions must include a provision whereby the instrument is either written off or converted into common equity upon the occurrence of a trigger event at the point of non-viability. On August 16, 2011, the Canadian regulatory authority (OSFI) that supervises banks and other federally-regulated deposit-taking institutions (DTIs) released its final advisory (the Advisory) outlining its expectations with respect to the issuance of Non-Viability Contingent Capital (NVCC) that would qualify as Tiered Capital for Basel III purposes.

    In the Advisory, OSFI sets out ten principles that will govern inclusion of NVCC instruments in regulatory capital as well as the process under which OSFI would assess whether such instruments qualify as additional Tiered Capital. The principles are explained in detail and include a requirement that the NVCC instrument be converted into common shares upon the occurrence of a trigger event. Specific trigger events are listed and include circumstances where, in the opinion of the Superintendant of Financial Institutions (the Superintendant), the DTI is no longer viable but its viability would be restored if all contingent capital instruments were converted. Conversion should result in a loss to the holders of the NVCC instrument as well as a dilution in the value of the common shares of the DTI. Conversion must be automatic and immediate without the need for further approvals and should not result in or cause a cross default of other instruments. Other Advisory principles address NVCC instruments originated by DTI foreign subsidiaries and DTI foreign parents and confirm that the NVCC instruments must meet all other criteria for inclusion under their respective tiers as specified in Basel III.

    The Advisory strongly recommends that DTIs seek confirmation of capital quality from OSFI prior to issuing NVCC instruments and sets out extensive information requirements in connection with any confirmation request. These requirements include delivery of an external legal opinion and an accounting opinion as well as a description of the rationale for the specified conversion method and capital projections demonstrating that the DTI will be in compliance with its internal target capital ratios.

    In assessing whether a DTI has ceased, or is about to cease, to be viable and that, after the conversion of all contingent capital instruments it is reasonably likely that the DTI’s viability will be restored or maintained, the Superintendant will consider a number of relevant facts and circumstances including (i) whether the DTI’s assets are sufficient to provide adequate protection to depositors and creditors, (ii) whether the DTI has lost the confidence of depositors, creditors and the public, and (iii) whether the DTI’s regulatory capital is eroding in a manner that would detrimentally affect depositors and creditors.

    The decision of whether to maintain a DTI as a going concern where it would otherwise become non-viable will be made by the Superintendant in consultation with other governmental and regulatory authorities including Canada Deposit Insurance Corporation, the Bank of Canada and the federal Department of Finance. The Advisory notes that the conversion of NVCC instruments would likely be used along with other public sector intervention, including liquidity assistance, to maintain a DTI as a going concern.

    The Advisory allows DTIs to continue to issue capital instruments that do not comply with the NVCC requirements but otherwise meet the Basel III criteria for inclusion as additional Tiered Capital until January 1, 2013. After that date, all such capital instruments that do not meet the NVCC requirements will be considered non-qualifying capital instruments and will be phased out beginning January 1, 2013 at the rate of 10 per cent each year for 10 years.