Category: Blog

The Ontario Securities Commission (OSC) and the Financial Services Regulatory Authority (FSRA) recently released proposed changes to the new rules for mortgages. If you’re an existing mortgage syndicator promoting non-qualified syndicated mortgage (NQSM) investments, you’ll either think it’s very good news or very bad news. We’ll walk you through the proposed changes.

Key Points

• The regulators have divided the market by class of subscribers. If your class of subscribers generally meet the definition of a Permitted Client then you’re in luck! It will actually be easier for you to carry on your business than it was before the material changes made to the regulations in July 2018 when the Form 3 disclosure was introduced.
• Fundscraper is able to show syndicators how they can continue profitably in business and give them the comfort that between them and the regulator stands a seasoned platform that will shield them and provide protection for their investors. 

How is the NQSM market changing?

Section 31.1 of Regulation 188/08 has been deleted in its entirety and with it the burdensome disclosure regime that brought to a halt the NQSM market. There are no longer prescribed deliveries or mandated disclosures to Permitted Clients not individuals. Initial disclosure requirements are minimal. In other words: Permitted Clients can be trusted to take care of themselves.

Under this new regime, FSRA has made every effort to facilitate and make efficient capital market investment in the NQSM by Canada’s biggest stakeholders.

Who qualifies as a permitted client?

There are 18 categories of Permitted Client. The obvious ones are charter banks, trust companies, dealers, and the like. The three most commonly used categories in the retail market are:

1. An individual who beneficially owns financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $5 million
2. A person or company that is entirely owned by an individual(s) referred to in the above paragraph, who holds the beneficial ownership interest in the person or company directly
3. A person or company, other than an individual or an investment fund, that has net assets of at least $25 million as shown on its most recently prepared financial statements

What are the pros of the NQSM market change?

The regulators have divided the market by class of subscribers. If your class of subscribers generally meet the definition of a Permitted Client then you’re in luck! It will actually be easier for you to carry on your business than it was before the material changes made to the regulations in July 2018 when the Form 3 disclosure was introduced. Additionally, there will be no need for additional registrations with the OSC as contemplated in earlier drafts of the proposed legislation.

What is the private capital market?

If you are not dealing with Permitted Clients or you are dealing with a mix of Permitted Clients and persons who are not, then you fall into the exempt market, aka the private capital market. The OSC will oversee all of your activities in connection with your investors and will require that you provide the same standard of care as it mandates for all dealers. FSRA will continue to oversee all of your activities related to your dealing in mortgages. So, like a dumbbell, the OSC will be at one end of your deal and the FSRA will be at the other!

What are the cons of the NQSM market change?

A big blow for many syndicators is the loss of the $60,000 investment limit. Under this exemption, anyone was permitted to invest up to $60,000 in a NQSM within a 12 month period. To capture those smaller investors, syndicators will now likely have to fall back on the offering memorandum exemption (and its supplement for mortgage syndication) to continue servicing these smaller investors. Under the new guidelines, investment limits are smaller and are subject to eligibility.

The syndicator will also have to be registered with the OSC in some capacity — and will be subject to the same standards of practice as all other security dealers subject to OSC oversight. They’ll likely be required to take the exempt market exam to demonstrate proficiency in exempt market placement, and will have to learn a new investing vocabulary.

Additionally, the syndicator will also now be reporting to the OSC. It is anticipated this may be a major irritant (and cost) for syndicators, though the OSC suggests that syndicators should be treated the same as all other issuers in the exempt market.

For more potential pain points, we outlined more major aggravations the new OSC rules might cause syndicators.

How can I work around the new rules?

Fundscraper is a mortgage syndicator’s solution. We’re registered with FSCO as a mortgage brokerage and with the OSC as an Exempt Market Dealer in the Province of Ontario (as well as British Columbia, Alberta, Quebec, New Brunswick and Prince Edward Island). We have spent the last three and half years perfecting our online compliance procedures with the full expectation of the changes happening today in the mortgage syndication market. We discovered that by creating an interactive online environment we can greatly reduce the costs of compliance while delivering best-in-practice solutions. Once we qualify investors, we apply computer generated algorithms to their investment decisions to assess suitability of investment and flag syndicated mortgage risks.

If you’re not thrilled about the new OSC rules, we can help.

Fundscraper is able to show syndicators how they can continue profitably in business and give them the comfort that between them and the regulator stands a seasoned platform that will shield them and provide protection for their investors. Having Fundscraper as a trusted ally helps put the mortgage syndicator back in business with far less administrative headaches. Contact us to get started today.

Mortgage investment corporations (MICs) have been around since 1973. MICs are a terrific vehicle for bringing like-minded investors together to collectively invest in one of Canada’s hottest investment products: mortgages!

Purchasing a mortgage is too expensive for many investors and may overly concentrate their investment portfolio in one asset class. MICs, however, mitigate those risks and add diversification. By bringing together several investors under one roof, the MIC can invest in more than one mortgage, distributing the risk among the members. The MIC can also distribute returns to its investors without making any withholding.

Any broker or agent seeking to create a MIC should seek advice and direction of a qualified lawyer. We put together an overview of the issues to keep in mind as you seek to create a MIC and/or advise your client to invest in one.

Key Points

• Purchasing a mortgage is too expensive for many investors and may overly concentrate their investment portfolio in one asset class. MICs, however, mitigate those risks and add diversification. 
• The Tax Act also deems a mortgage investment corporation to be a public company. The benefit of being deemed a public corporation is that the shares of a public corporation are qualified investments for registered plans, including registered retirement savings plans, registered retirement income funds, and tax-free savings accounts.
• Every prospective investor should receive a suitability assessment, regardless of who they are or how much capital they have to invest.

Promoter (n): the person who organizes the MIC and promotes it to investors.

How to establish a MIC

The first step is creating a corporation, which you or your lawyer can do online with an approved service provider. After the company is incorporated, you will have to “organize” it by appointing directors and officers, establishing a registered head office, and putting in place a by-law.

In order to be considered a MIC under the Tax Act, it must have the following attributes:

1. It must be a Canadian company
2. It can only invest the funds of the corporation in mortgages that are secured against real property situated in Canada
3. It cannot manage or develop property
4. There must be at least 20 shareholders, with no one shareholder owning more than 25% of the issued shares of any class of sharers of the corporation
5. At least half of the property of the corporation must be in cash, deposits, and mortgages secured on houses or on property included within a housing project
6. Debt is within the limits set out in the Income Tax Act

What makes a MIC special is the treatment it receives under the Tax Act.

The Tax Act also deems a mortgage investment corporation to be a public company. The benefit of being deemed a public corporation is that the shares of a public corporation are qualified investments for registered plans, including registered retirement savings plans, registered retirement income funds, and tax-free savings accounts.

If the MIC fails to qualify in any one aspect above, it risks losing its tax status as a MIC and its shares will no longer be considered qualified investments. It will have to impose withholding, and shareholders will not be happy.

MICs are not publicly traded companies, so they can only raise money in the private investment markets under rules that govern raising private capital.

Who can invest in a MIC?

In Ontario, there are very strict rules about soliciting people to invest in a venture, including MICs. Raising money in the private markets is much less expensive than in the public markets, as one does not need to prepare and file an offering document (i.e., a prospectus) with the Ontario Securities Commission (the OSC). The most common way that a company organizes and brings in early investors is via the private issuer exemption.

To use the private issuer exemption, the following elements must be in place:

• There must be a provision in the articles of the corporation (or an agreement among shareholders) that a shareholder cannot trade their shares without consent of the board.
• There cannot be more than 50 shareholders, not including employees of the corporation.
• Those 50 shareholders must have a pre-existing relationship with the Corporation, including: an employee of the Corporation, an accredited investor, or a spouse, family member, close personal friend, or business associate of a founder.

Once the corporation passes the 50 shareholder threshold, the corporation is subject to various reporting obligations related to raising capital. It is necessary that the corporation seek appropriate legal advice at this stage.

A mortgage broker or agent cannot invite just anyone to invest in their MIC; investors may only be from a select group and not members of the general public.

What is an accredited investor?

Many promoters of MICs will only allow accredited investors to be investors. An accredited investor is an investor with pre-existing wealth and/or substantial income who has the financial freedom to invest in whatever they please. Because of their financial situation, regulatory authorities don’t think they need the same protections as other investors.

Important considerations for investing in MICs

The Private Issuer Exemption requires the issuer/promoter to assess whether the investment is suitable for the prospective investor regardless of who the investor might be. However, the most common deficiency cited by the OSC when auditing the use of the exemption is the absence of such a suitability assessment. Without it, it’s difficult to determine whether the investment is appropriate for the investor.

It’s not surprising that issues/promoters have been found guilty under securities law for not (i) adequately performing their due diligence obligations and (ii) retaining the services of a registered dealer when selling their security. To avoid conflict (and hefty fines), the issuer/promoter should retain the services of a registered independent securities dealer to facilitate subscriptions in the MIC.

Every prospective investor should receive a suitability assessment, regardless of who they are or how much capital they have to invest.

Lending and the Mortgages Act

In the Province of Ontario, everyone who wishes to be a lender must be registered under the Mortgages Act unless they are otherwise exempt or have employed the services of a registrant under the Mortgages Act to perform those services for them.

MICs are not required to be registered under the Mortgages Act. MICs generally take advantage of a provision under the regulation to the Mortgage Act that provides a person or entity is exempted from having to have a brokerage license if the person or entity carries on business as a mortgage lender solely through a mortgage brokerage or a person or entity that is exempt from the requirement to have a brokerage license.

Working with MICs can be very good for everyone involved: the broker, the investor, the lender, and the borrower. For the mortgage broker or agent, it is imperative that the rules be followed carefully.

Ontario has seen a lot of mortgage regulation changes in recent years. In 2018, the Canadian Securities Administrators (CSA) released a series of proposed changes that would see the OSC assume responsibility for the oversight of mortgage syndication in the Province of Ontario. Mortgage syndicators are waiting with bated breath to see what finally comes from the recent interventions of two competing regulatory bodies into their market. We’ll walk you through the latest developments.

Key Points

• Previously, the regulatory environment was relatively light. Now, the first major proposed change is that mortgage syndications are no longer exempt from the Securities Act (Ontario). The mortgage syndicator will now only be able to choose between distributing the syndicated product in the (i) public markets pursuant to a prospectus filed and reviewed by the regulatory authorities (highly unlikely given costs) or (ii) private markets under the rules governing private placements.
• The new rules are thought not to come into force until late in the Spring of 2019, if not early summer. It is further anticipated that the mortgage brokerage community will be given an extra year to comply.

Who are the mortgage syndicators and what do they do?

Mortgage syndicators are syndicated mortgage brokers who are regulated by FSCO. In Ontario, only syndicated mortgage brokers (and their agents) are allowed to deal in or advise upon mortgages. Given the proximity to the market, syndicated mortgage brokers are the natural syndicators. The job of the mortgage syndicator is to initiate, promote and organise the syndicate.

A syndicate, by definition, is a self-organised group of people. A syndicated mortgage is a mortgage where there are two or more persons acting as lenders. The lenders have a direct beneficial interest in the underlying mortgage.

It’s attractive to be part of a syndicate as the investor (who now becomes a lender) is sharing the risk of being repaid by the borrower with other investors/lenders of like mind.

What are the new mortgage syndication rules?

Previously, the regulatory environment was relatively light. Now, the first major proposed change is that mortgage syndications are no longer exempt from the Securities Act (Ontario). The mortgage syndicator will now only be able to choose between distributing the syndicated product in the (i) public markets pursuant to a prospectus filed and reviewed by the regulatory authorities (highly unlikely given costs) or (ii) private markets under the rules governing private placements.

Mortgage syndicators will likely do the latter, yet it won’t be without its challenges. It is expected that the OSC will impose a registration requirement that will require mortgage brokers to successfully complete some series of courses that will eventually evidence their competence to solicit and sell in the exempt market.

Why did the mortgage syndication rules change?

First, it was to harmonize the rules of mortgage syndication across the country. In Ontario mortgages are currently exempt from securities law and the oversight of the OSC. Once the changes are adopted, there will no longer be exemptions from securities law anywhere across Canada and the placement of mortgage security would have to comply with the rules governing the private and public investment markets.

Second, at the time the amendments were announced, the mortgage syndication market was in turmoil, leaving many inexperienced investors exposed to questionable deal offerings made into the market by overly aggressive promoters.

The new rules are thought not to come into force until late in the Spring of 2019, if not early summer. It is further anticipated that the mortgage brokerage community will be given an extra year to comply.

CSA changes vs FSCO changes

Within a month of the CSA announcing its changes, FSCO released its intent to overhaul the rules governing mortgage syndication. Rather haphazardly, FSCO unleashed a web of policies and procedures. Where the OSC thinks it may take a year or two to bring the mortgage brokerage community into line, FSCO thought a few months adequate.

Instead of adopting the seasoned approach of the CSA, FSCO created a one-size-fits-all solution from which no market participant is exempt. The ensuing confusion and the abrupt cessation of market activity was not surprising. The new rules were described at the time of their introduction as transitional, yet as at the date mentioned above, no one knows how long transition is going to be or to what degree the regulators are cooperating.

The new mortgage syndication rules became effective July 1, 2018 — the same day many syndicators governed by FSCO gave up business.

Mortgage syndicators have a choice: embrace the changes imposed by FSCO now, or wait and see what the OSC will require?

Mortgage syndicators are stuck between a rock and a hard place. Embracing the FSCO regulatory regime today will involve significant cost and client interruption. (Further, there’s no guarantee that once the OSC publishes its rules, the syndicator will not have to go back and revisit all of the work they just put in place.) However, if the syndicator chooses to wait it out, he or she will likely lose business. What’s the answer?

What should mortgage syndicators do now?

There’s a way to circumvent FSCO’S transitional rules: Retain a private market intermediary to carry out mortgage participation transactions that comply with the Securities Act (Ontario) instead of the Mortgages, Brokerages, Lenders and Administrators Act (Ontario).

In Ontario, private market intermediaries are referred to as exempt market dealers (EMDs). EMDs are fully registered securities dealers who engage in the business of trading in prospectus exempt securities (which soon will include syndicated mortgages), or any securities to qualified exempt market clients.

Whereas a syndicate is a self-organized group, an EMD will represent a group organized by a third party. In the area of mortgages, it is common to organize groups under mortgage investment corporations (MICs), mortgage trusts (Trusts), or limited partnerships (LPs) whose sole business is investing in mortgages. In any of these examples, the EMD is not selling syndicated interests of mortgages, but rather shares in a MIC, units in a trust or limited partnership interests in a limited partnership.

The mortgage syndicator can continue advising on mortgages, but the EMD is responsible for qualifying the investors and providing the independent investment advice that marks best practice for the OSC.

How Fundscraper can help

Fundscraper is registered with FSCO as a mortgage brokerage and with the OSC as an EMD in the Province of Ontario as well as British Columbia, Alberta, Quebec and Prince Edward Island. We have spent the last two and a half years perfecting our online compliance procedures with the full expectation of the changes happening today in the mortgage syndication market. We discovered that by creating an interactive online environment we can greatly reduce the costs of compliance while delivering best-in-practice solutions. Once we qualify investors, we apply computer-generated algorithms to their investment decisions to assess suitability of investment and flag common investment risks. A qualified investor can begin our process and complete a subscription within twenty minutes from the comfort of their own home.

At Fundscraper, we also enhance distribution by making available, if a client so chooses, a product offering to a much larger educated audience than the client would have access to alone. Fundscraper is able to show syndicators how they can continue profitably in business and give them the comfort that between them and the regulator stands a seasoned platform that will shield them and provide protection for their investors. Having Fundscraper as a trusted partner puts the mortgage syndicator back in business.