The Canadian Securities Administrators (CSA) has published two different proposals that affect securities lending arrangements, namely amendments to the early warning reporting (EWR) regime and amendments to the rules applicable to non-redeemable investments funds.
The proposed amendments to the reporting threshold, triggers and related disclosure requirements under Canada’s early warning reporting (EWR) regime are intended to “provide greater transparency about significant holdings of issuers’ securities”. These amendments could affect the conduct of certain equity derivative transactions and related hedging activities.
Currently, under the EWR regime, prescribed disclosure is required by any investor that acquires beneficial ownership of, or the power to exercise control or direction over, 10% or more of any class of a public company’s voting or equity securities. Additional reporting is required on each incremental acquisition of 2%, as well as a change in a material fact contained in an earlier report.
The key changes under the proposals that affect securities lending arrangements include:
– Decreasing the reporting threshold from 10% to 5%. According to the CSA, lowering the EWR threshold to 5% would recognize that investors are interested in the relevant information for more than simply a signal of a take-over bid.
– Clarifying that the reporting trigger applies to a 2% decrease in ownership and any decrease below the new 5% threshold. In light of this, the reporting requirement would specifically apply to lenders under securities lending arrangements However, the proposals would exempt the lender from reporting securities lent out as a disposition or reacquired on termination of the loan under a “specified securities lending arrangement” that provides an “unrestricted” ability for the lender to recall the securities (or identical securities) before the record date for a meeting of securityholders and/or requires the borrower to vote the securities in accordance with the lender’s instructions.
– Expanding the reporting trigger to capture descriptions of securities lending arrangements; lenders and borrowers will have to disclose the material terms of any reportable securities lending arrangement (including duration and recall provisions) and the same with respect to any specified securities lending arrangement where it is being reported in the context of another reportable transaction.
– Creating an exception for lenders under certain specified securities lending arrangements, but not for borrowers.
According to a circular by Margaret Grottenthaler, Amanda Linett , Ruth Elnekave and Kathleen Ward of Stikeman Elliot law firm, proposed changes could have the following implications:
– The proposed changes may result in increased compliance costs and we would expect the volume of reporting under the EWR regime to increase significantly.
– With the lower 5% threshold, securities lenders and borrowers who may not have previously been caught may have to publicly disclose holdings.
– Securities lenders will need to distinguish between specified securities lending arrangements and those that are not and implement different reporting processes for each.
The CSA is also proposing amendments to National Instrument 81-102 Mutual Funds (NI 81-102) that would bring non-redeemable investment funds within the scope of the instrument that applies to reporting issuers. This is Stage 1 of Phase 2 of the CSA’s plan to modernize the regulation of investment funds. The purpose of the amendments is to create consistency in product regulation between various types of publicly traded funds.
Currently, mutual funds cannot borrow securities, but can lend securities according to current regulations, which include obtaining at least 102% collateral value, requiring that loans terminate on demand, requiring the borrower to make all equivalent income payments, meeting the requirements of the Income Tax Act for the securities lending arrangement safe-harbor, and ensuring that the market value of all securities loaned is no more than 50% of the “total assets” of the fund, not including collateral received for securities loans and repo sales. What is acceptable collateral is also prescribed. In addition, mutual funds must use a securities lending agent who is the custodian of the fund. Prospectus disclosure is required with regards to the intention to engage in securities lending.
Under the CSA’s proposal, these securities lending requirements would also be extended so as to apply to nonredeemable investment funds. The 50% total asset test would be changed to a 50% net asset value test for both types of funds.
There is also a request for feedback on disclosure relating to the costs of securities lending. The CSA believe greater transparency is required with respect to the costs, particularly if the agent is related to the manager. It may be misleading if the fund is marketed as having a lower management fee, but the affiliated agent is collecting fees under the securities lending agency agreement. Current financial statement disclosure allows disclosure of return from securities lending on a net basis. The CSA is requesting feedback on what would be the most appropriate type of disclosure.
The CSA is also considering requiring information about the agent to be disclosed in the AIF or prospectus, including whether the agent has an indemnity obligation under the arrangements and whether SEDAR disclosure of the securities lending agency agreement should be required.
The CSA’s is seeking comments on the proposed amendments by June 12, 2013.
CSA Proposed Reporting and Mutual Fund Regime Changes in Canada to Affect Securities Lending
The Canadian securities regulator has proposed changes to the early warning reporting (EWR) regime and to the rules applicable to non-redeemable investments funds.