When corporations are looking for alternative sources of funds or intend to diversify their capital sources, one financial method that corporations may use is securitization or asset-backed securities.
In Canada, various laws and regulations apply to asset-backed securities that corporations should be mindful of when engaging in securitizations.
What is asset-backed securities in Canada?
Asset securitization is the general term used to refer to the practice of converting assets or a stream of cash flows or receivables into marketable securities to be sold to interested investors. Asset-backed securities (ABS) are one of the types of asset securitization. In an ABS, securities whose income or value is derived from the pooled, underlying assets are used to “back up” these securities.
Process of creating an asset-backed security
Creating an asset-backed security starts when the lender or the company – called the “originator” – sells these assets to a special purpose vehicle (SPV). Investors, in turn, receive payments either at a fixed rate or a floating rate through an account (or a trustee account) that is funded by the cash flows generated by these pooled assets.
Special Purpose Vehicle (SPV)
The SPV acts as the “issuer” which pools or arranges for these assets to be sold to prospective investors. An SPV may be created in the form of a trust, limited partnership, or a separate corporation. The SPV may also splice up these pooled assets through different “tranches”, which are then issued separately from the other tranches.
An asset-backed security that the SPV issues may be in a form of:
- Publicly issued ABS: issued with a prospectus, or those which are not listed on a regulated exchange, and are instead traded through over-the-counter transactions in proprietary trading platforms
- Privately issued ABS: issued without a prospectus and are traded through private entities
For a visual example of an SPV, watch this video:
To find out more about SPVs or any aspect of asset-backed securities, speak with a lawyer in your area. If you’re based in Montreal, for example, contact one of Lexpert’s best-ranked asset securitization lawyers in Québec.
Canadian laws governing asset-backed securities
Regulation of asset-backed securities is shared between the federal and the provincial governments; however, ABS regulation mainly falls under provincial and territorial laws. At this point, there is no single federal law or regulating authority covering securities.
Provincial regulations
Each province and territory have its own securities regulating authority: for example, Ontario has its Ontario Securities Commission (OSC). Québec has the Autorité des marchés financiers (AMC). British Columbia has the British Columbia Securities Commission (BCSC). Other provinces have their own regulating authorities.
These provincial and territorial securities commissions or regulating authorities are established and empowered by the respective provincial and territorial Securities Acts and Securities Regulations. They form the Canadian Securities Administrators (CSA), the umbrella organization to harmonize and coordinate securities regulation across Canada.
Federal regulations
While there are no regulatory requirements that apply to the creation of an SPV, it must follow the general laws on financial institutions such as those regulated by the Office of the Superintendent of Financial Institutions (OSFI).
The originator, the SPV, and the investors must also be aware of anti-money laundering legislation of Canada during the process of asset securitization.
Federal bankruptcy and insolvency laws also apply when an SPV is considered as “bankruptcy remote”, and when the originator has become insolvent or bankrupt. The federal laws that apply here include the Bankruptcy and Insolvency Act (BIA), the Companies' Creditors Arrangement Act (CCAA), and the Winding-Up and Restructuring Act (WURA).
Do you have questions regarding the different Canadian banking regulators? Leave a comment below or consult with one of Lexpert's top-ranked lawyers specializing in banking and financial institutions.
Difference between ABS and MBS
Mortgage-backed securities (MBS) are the securitization of pooled or packaged home mortgages, deriving its value from the cash flows of payments of these home mortgages.
There are varying interpretations on whether an MBS is a separate type of securitization from ABS or is another kind of ABS. Nevertheless, MBS and ABS work similarly, and its difference only lies in the assets it used to create these securities.
MBS are backed by home mortgages, while ABS are backed by other forms of financing.
What is an example of an asset-backed security?
Some examples of assets used in an asset-backed security are:
- credit card: cash flows or cash receivables arising out of credit card debts are pooled together to form an asset-backed security and are sold to interested investors
- auto loans: receivables or cash flows generated from auto loan payments (including principal, interest, penalties, and pre-payments) are pooled together to be traded as securitized assets
- student loans: a pool of outstanding student loans managed by a financial or an educational institution, to form an asset backed security
- Intellectual Property (IPs): where cash flows generated by any of the different types of IP (e.g., patents, copyrights, etc.), such as its license agreements, are used to create an asset-backed security
Other uncommon types of loan may be used in an ABS (which, in the perspective of the originator, is an asset since it will be generating income for them) such as equipment leases and loans, fleet leases, trade receivables, among others.
Are asset-backed securities risky?
Asset-backed securities are considered one of the less risky investments. Investors are ensured payments under an ABS, unless some external factors affect the payment of the assets used in the ABS – either payments are accelerated or borrowers default on payment of the loans that were pooled together.
Depending on the circumstances, asset-backed securities are preferred over other forms of investments such as corporate bonds. ABS remains unaffected by corporate changes in the originator, such as mergers and acquisitions (M&A) or restructuring.
On the part of the originator, engaging into ABS diversifies their portfolio for income-generating assets, providing them with additional capitalization to expand their operations.
Explore the topic of asset-backed securities in Canada by posting your questions in the comment section below or by getting in touch with any of Lexpert top-ranked asset securitization lawyers in Canada.