On March 8, 2018, the Canadian Securities Administrators (CSA) published for a 90-day comment period ending June 6, 2018, proposed changes aimed at substantially harmonizing the regulatory framework for syndicated mortgages in Canada. These changes are detailed in the proposed amendments to National Instrument 45-106 Prospectus Exemptions and National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (the Proposed Amendments), as well as changes to Companion Policy 45-106CP Prospectus Exemptions (the Proposed Changes).
The Proposed Amendments will introduce additional investor protections related to the distribution of syndicated mortgages and will increase harmonization regarding the regulatory framework for syndicated mortgages across all CSA jurisdictions, while the Proposed Changes will provide guidance regarding the new requirements introduced by the Proposed Amendments and regarding the determination of the issuer of a syndicated mortgage.
All CSA jurisdictions currently have prospectus and registration exemptions for securities that are mortgages (the Mortgage Exemptions) if they are sold by a mortgage broker licensed in the Canadian jurisdiction where the property is located. In Alberta, British Columbia, Manitoba, New Brunswick, Québec and Saskatchewan, the Mortgage Exemptions are not available for syndicated mortgages.
The Proposed Amendments include changes to the prospectus and registration exemptions available for the distribution of syndicated mortgages. In particular, the Proposed Amendments:
- Remove the prospectus and registration exemptions under sections 2.36 of NI 45-106 and 8.12 of NI 31-103, respectively for the distribution of syndicated mortgages in the CSA jurisdictions where the exemptions are available;
- Introduce additional requirements to the offering memorandum exemption under section 2.9 of NI 45-106 (the OM Exemption) that apply when the exemption is used to distribute syndicated mortgages; and,
- Amend the private issuer prospectus exemption under section 2.4 of NI 31-103 (the Private Issuer Exemption) so that it is not available for the distribution of syndicated mortgages.
A syndicated mortgage is defined by CSA staff as a mortgage in which two or more persons participate, either directly or indirectly, as lenders in the debt obligation that is secured by the mortgage. Over the last number of years, there has been what CSA staff term “a significant increase” in the offering of syndicated mortgages in certain jurisdictions in connection with real estate development. These offerings are often sold to retail investors and in that light, says CSA staff, they potentially raise investor protection concerns because they may:
- be used to raise seed financing for real estate developments, such as the costs of initial design proposals and start-up expenses;
- be sold based on projected values of a completed development;
- not be fully secured by a charge against real property, since the amount of the loan may significantly exceed the current fair value of the land;
- be subordinate to future financings, such as construction financing, which may be substantial and effectively render the investment more similar in risk to an equity investment rather than a fixed income investment;
- be offered by issuers with no source of income, rendering the payment of ongoing interest dependent on future financing or reserves from the principal advanced; and,
- be subject to the risk of delay and increased costs inherent to real estate development.
Summary of Proposed Changes:
Changes to the Mortgage Exemptions:
Consistent with the current approach in Alberta, British Columbia, Manitoba, New Brunswick, Québec and Saskatchewan, the Proposed Amendments, together with related legislative amendments in Ontario, would remove the Mortgage Exemptions for syndicated mortgages in Newfoundland and Labrador, the Northwest Territories, Nova Scotia, Nunavut, Ontario, Prince Edward Island and Yukon.
Under the Proposed Amendments, alternative prospectus exemptions will be required for the distribution of syndicated mortgages in all CSA member jurisdictions. CSA staff expect that syndicated mortgages will most likely be offered primarily under the Accredited Investor Exemption under section 2.3 of NI 45-106 (the AI Exemption), the OM Exemption or the Family, Friends and Business Associates Exemption under section 2.5 of NI 45-106 (the FFBA Exemption), although other prospectus exemptions may be available.
In those jurisdictions where the Mortgage Exemption already applies to syndicated mortgages, market participants engaged in their trading would be required to consider whether the registration requirement applies to them. Since some of these firms are usually engaged in repeat rounds of financing activities, CSA staff expect that they will either will be required to become registered as a dealer or will have to rely on a registration exemption.
Changes to the Offering Memorandum Exemption:
The OM Exemption allows for the distribution of syndicated mortgages to retail investors based on the premise that adequate disclosure being provided to potential investors. In the marketing of these offerings, mortgage syndicators often stress the projected value of the completed development and the fact that the syndicated mortgage is secured against real property. The protection provided by this security interest, however, depends primarily on the current fair market value of the real property relative to the obligations and any prior ranking charges.
Issuers will still be allowed to distribute syndicated mortgages under the OM Exemption, but under the Proposed Amendments, will face more stringent disclosure requirements. Issuers will have to deliver a current fair market value appraisal of the of the property that is the subject of the syndicated mortgage to potential investors. The appraisal must be prepared by a qualified third-party appraiser independent of the issuer. Any other valuation of the property disclosed by the issuer would be required to have a reasonable basis in fact. The issuer will also be required to disclose any and all material factors and assumptions underlying that value and whether the valuation was prepared by a qualified appraiser who is also independent of the issuer.
Consistent with the current approach in British Columbia, the Proposed Amendments also include supplemental disclosure requirements for syndicated mortgages, including disclosure of development risks, prior obligations secured against the real property and the price paid by the developer to acquire the real property. The intention of these amendments is to require adequate information for:
- potential purchasers under the OM Exemption to make an informed investment decision; and,
- any registrants involved in the distribution to discharge their obligations to know the product being offered and to conduct a meaningful analysis of the suitability of the investment.
Issuers of syndicated mortgages would be required to meet the requirements of Form 45-106F2 Offering Memorandum for Non-Qualifying Issuers, as supplemented by proposed Form 45-106F18 Supplemental Offering Memorandum Disclosure for Syndicated Mortgages. The new disclosure requirements include information regarding the business and financial position of the borrower under the syndicated mortgage.
While CSA staff expect that the issuer and borrow will generally be the same entity, in circumstances where the issuer of the syndicated mortgage is not the borrower, its ability to rely on the OM Exemption will depend on its ability to provide the required information regarding the borrower and to certify that it does not contain a misrepresentation. The CSA considers information regarding the borrower to be essential since the borrower will be required to make payments of principal and interest under the syndicated mortgage.
Any mortgage broker involved in the distribution of a syndicated mortgage under the OM Exemption would also be required to provide a certificate stating the offering memorandum does not contain a misrepresentation with respect to matters within its knowledge and that the mortgage broker has made best efforts to ensure that matters that are not within its knowledge do not contain a misrepresentation. While the latter is a current regulatory requirement in British Columbia, in some other jurisdictions a person who certifies an offering memorandum is subject to the statutory right of action for purchasers if the offering memorandum contains a misrepresentation.
Removal of the Private Issuer Exemption:
The Proposed Amendments would remove the availability of the Private Issuer Exemption for the distribution of syndicated mortgages. The CSA staff believes that the Private Issuer Exemption, intended for small businesses to raise capital, is not appropriate for products such as syndicated mortgages. CSA staff believe that the with the continued availability of the FFBA Exemption and the AI Exemption, this proposed amendment should not significantly restrict the range of potential purchasers for syndicated mortgages.
By removing the Private Issuer Exemption for syndicated mortgages, CSA staff believe this would result in more consistent reporting for syndicated mortgage distributions through the report of exempt distribution.
Impact on Investors
CSA staff expects that investors in syndicated mortgages who purchase under the amended OM Exemption would be entitled to enhanced disclosure relating to their investment. The expectation by the CSA is that this will result in more informed investment decisions by investors and enable registrants involved in the distribution to better fulfill their obligations related to the distribution. CSA staff also note that investors in syndicated mortgages distributed under other prospectus exemptions will also benefit from the potential involvement of a registrant in the distribution, in the same manner as for the distribution of other real estate-related securities.
CSA Notice and Request for Comment Proposed Amendments to National Instrument 45-106 Prospectus Exemptions and National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations relating to Syndicated Mortgages and Proposed Changes to Companion Policy 45-106CP Prospectus Exemptions, is available for download from the websites of the participating jurisdictions.
For more information, please call Barbara Hendrickson at BAX Securities Law (416) 601 -1004.
This publication is not intended to constitute legal advice. No one should act on it or refrain from acting on it without consulting with a lawyer. BAX does not warrant or guarantee the accuracy or currency or completeness of the publication. No part of this publication may be reproduced without the prior written permission of BAX Securities Law.