A budget implementation act containing provisions for a Canadian legislative covered bond framework may receive royal assent within four weeks, but the timing of a new regime appears otherwise unclear and potentially requiring as long as 12 months, while other uncertainties remain despite the release of proposed legislation last week.

“Everything is on hold,” said a funding official at one Canadian issuer. “It’s just a draft law that has to go through the parliamentary process and that will take at least a few weeks, especially because there 400 pages of other stuff that everyone will want to dissect.

“The government has a majority so technically it could do whatever it wants, but it will take time, and also for CMHC to come out with requirements.”

CMHC headquarters, Ottawa

The Canadian government last Thursday (26 April) introduced Bill C-38 to implement budget measures tabled at the end of March. As previously reported, the bill contains provisions for a legislative covered bond framework, including the prohibition of use of mortgages insured by Canada Mortgage & Housing Corporation (CMHC or the Corporation) as covered bond collateral.

Via amendments to the National Housing Act (NHA) the bill mandates CMHC to establish a covered bond registry and sets out investor protection provisions. A funding official at a Canadian issuer said that he is very pleased with the protective language in the act, citing bankruptcy and insolvency protection measures.

A covered bond analyst described as “quite straightforward” the provisions regarding insolvency protection, but in a more general context said that secondary legislation and Ministry of Finance regulations will be more interesting than primary legislation.

The Covered Bond Report understands that CMHC’s mandate to establish a registry and establish conditions for registration will be effective from the date Bill C-38 comes into force, which, according to the funding official is likely to happen within four weeks.

However, provisions in Bill C-38 that modify the country’s Bank Act to prohibit Canadian banks from issuing covered bonds outside the NHA framework will only come into force on a date determined by order of the Governor in Council – the government, in other words.

“The timing for implementation of the new covered bond regime is a bit complex,” said Aaron Palmer, partner at Blakes, Cassels & Graydon. “Each bank will be permitted to continue issuing under their existing non-legislative programmes until some future date to be determined by the federal Minister of Finance.”

One of the Canadian funding officials said it is presumably only after the CMHC’s registry is in place that an order in council would be given, with Palmer noting that although the timing for establishing the registry is difficult to predict it could conceivably be in place in eight to 12 months.

The other funding official wondered whether it may be “politically incorrect” to continue issuing covered bonds back by CMHC collateral when a government plan to prohibit such activity is on the table.

Early reactions to the draft legislation last week included a market participant wondering whether or not issuers could decline to join the CMHC covered bond register and continue issuing covered bonds backed by CMHC collateral outside framework, but according to another Canadian funding official there appears to be no such option for federally regulated financial institutions.

Provincial cooperative credit societies, meanwhile, which are not federally regulated, will be permitted to join the CMHC registry although funding officials queried whether they would be able to issue outside the framework if they wished.

One said that this seemed possible, but that he doubted they could use CMHC-insured assets as collateral given what he described as a prohibition going forward on CMHC from guaranteeing payments on collateral, and that it would therefore make little sense to not issue under the framework, unless non-residential mortgage assets were being targeted for use as collateral.

There is a provision in Bill C-38 amending the NHA to prohibit CMHC from guaranteeing principal or interest payments on covered bonds, as defined in a new section to be added to the NHA, but another market participant pointed out that this is an activity that CMHC does not currently carry out and that the prohibition is therefore somewhat irrelevant.

Whether or not covered bond issuers would be able to “transition” existing covered bonds into ones eligible under the new legislation was another question raised by market participants in initial reactions, but understanding did not seem to have advanced in this regard. One funding official questioned how a programme with a prospectus that commits to using a certain type of collateral could be transitioned, and pointed out that it also difficult to speak about transitioning until information is available about any additional requirements the CMHC may come up with.

Palmer said that when those banks that have CMHC-insured mortgages in their cover pools are no longer permitted to issue contractual covered bonds they may have to leave those covered bonds outstanding with one insured mortgage cover pool and then establish a new cover pool of non-insured mortgages for future issuance of legislative covered bonds.

Lawyers at Norton Rose, meanwhile, said that those issuers with CMHC-insured collateral based programmes will be required to “reconstitute” their cover pools for issues of covered bonds after the legislation is adopted and comes into force, which they said is expected in a matter of months.

In a note to covered bondholders Toronto-Dominion Bank said that if the covered bond provisions included in Bill C-38, as constituted by the amendments to the NHA and Bank Act, are implemented as drafted then: the bank will not be allowed to issue covered bonds under its $10bn global programme; the programme will not be allowed to be registered under the proposed framework; and covered bonds issued under the programme will not be permitted to be exchanged for legislative covered bonds under the proposed framework because of the covered bond collateral limitation included in the latter.

Meanwhile, funding officials were pleased that, contrary to some reports on the framework, the proposed legislation is silent on the matter of a cap on overcollateralisation, after a 10% limit had been mooted as part of a government consultation.

“That is something we advocated,” said one, “because it is less than ideal, optimal, or desirable to bake in a hard number while the regulator has full ability to introduce limits.”

Another market participant echoed this view, noting that the lack of an OC cap in the legislation meant that any move in this direction would be handled by the Office of the Superintendent of Financial Institutions (OSFI).

Regarding implications of the introduction of legislation for the market profile of Canadian covered bonds, a funding official there took issue with suggestions that the legislative moves would lead to a wave of euro benchmark supply from Canadian issuers in response to newfound demand for paper from the jurisdiction.

A lack of euro Canadian covered bond issuance since 2008 has not been due to investors shunning such paper, he said, but because the cross-currency basis swap has made euro levels more expensive than issuing in other jurisdictions and also issuing senior unsecured debt at home.