Canada Implements Bail-In Regime

Canada’s bank recapitalization (bail-in) regime came into effect on September 23. The bail-in regime provides the Government of Canada with a statutory power to direct the Canada Deposit Insurance Corporation (CDIC) to convert, in whole or in part, specified eligible instruments of a domestic systemically important bank (D-SIB) into common shares of the D-SIB (or its affiliates) in the highly unlikely event that a D-SIB becomes non-viable.

The Office of the Superintendent of Financial Institutions (superintendent) has designated the Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada and Toronto-Dominion Bank as D-SIBs pursuant to powers given to the superintendent under the Bank Act.

The bail-in regime is aimed at ensuring that (a) taxpayers are protected from having to bail out a D-SIB in the highly unlikely event of such an institution running into financial difficulty; and (b) Canada’s financial system remains strong by clarifying that banks’ shareholders and creditors are responsible for bearing losses, thereby giving them stronger incentives to monitor the bank’s risk-taking activities.

Regulations under the Canada Deposit Insurance Corporation Act (CDIC Act) and the Bank Act provide details of the conversion, issuance and compensation regimes relating to bail-in instruments issued by D-SIBs, and a Total Loss Absorbing Capacity (TLAC) Guideline published by the Office of the Superintendent of Financial Institutions provides guidance to ensure that D-SIBs have sufficient loss absorbing capacity to support the recapitalization of a non-viable D-SIB.1

Conversion

Pursuant to the Bank Recapitalization (Bail-in) Conversion Regulations under the CDIC Act, any unsubordinated instrument of a D-SIB with an initial term to maturity greater than 400 days that is unsecured and has been assigned a CUSIP or ISIN number will be subject to the bail-in regime. Instruments explicitly excluded from the bail-in regime include covered bonds, derivatives, certain structured notes and certain other liabilities. Deposits (other than deposit notes) with the D-SIB will also not be subject to the bail-in regime.

The Bank Recapitalization (Bail-in) Conversion Regulations also define the conditions for conversion of bail-in-able instruments. The Superintendent must report a D-SIB to the CDIC where the Superintendent determines that a D-SIB has ceased, or is about to cease, to be viable and the viability of the D-SIB cannot be restored or preserved by the exercise of the Superintendent's power under the Bank Act. On receipt of such a report, the CDIC may request the Minister of Finance to recommend that an order be made to carry out a conversion under the CDIC Act, and upon such recommendation, the Governor in Council may direct the CDIC to carry out the conversion.

The CDIC must use its best efforts to ensure that a senior bail-in-able instrument is converted into common shares only if all subordinate bail-in-able instruments and any subordinate non-viability contingent capital have previously been converted or are converted at the same time.

Issuance

Pursuant to the Bank Recapitalization (Bail-in) Issuance Regulations under the Bank Act, a D-SIB must ensure that a bail-in-able liability issued by the bank includes each of the following in its terms: (a) the holder of the liability is bound, in respect of that liability, by the CDIC Act (including the conversion of the liability into common shares under the CDIC Act and the variation or extinguishment of the liability in consequence) and by the applicability of the laws of Canada or of a province of Canada in respect of the operation of the CDIC Act with respect to the liability; (b) the holder of the liability attorns to the jurisdiction of courts in Canada with respect to the CDIC Act and those laws; and (c) the terms referred to in (a) and (b) above are binding on the holder of the liability despite any other terms of the liability, any other law that governs the liability and any other agreement, arrangement or understanding between the parties with respect to the liability.

In addition, D-SIBs must ensure that the terms attached to a bail-in-able share issued by the bank provide that the share is subject to conversion into common shares under the CDIC Act, and D-SIBs are required to disclose in a prospectus, information circular, other offering memorandum or similar document related to the share or liability, that the share or liability is subject to conversion into common shares under sections 39.2(2.3) of the CDIC Act. D-SIBs are also prohibited from advertising or otherwise promoting bail-in eligible liabilities as deposits (including in their name) to purchasers in Canada.

Compensation

The CDIC Act provides that any shareholders or creditors who are in a worse financial position than they would have been had a federal member institution (including a D-SIB) been subject to a resolution power of CDIC made pursuant to sections 39.13(1) of the CDIC Act are entitled to be paid compensation by CDIC. The framework for determining the compensation, if any, to which a prescribed person under the regulations is entitled in the event of a bail-in conversion is set forth in the Compensation Regulations under the CDIC Act.

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1 On August 21, 2018, 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%.

This article was originally published in the The Lawyer's Daily.

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