Finally the Ontario Securities Commission (“OSC”) and the Financial Services Regulatory Authority (“FSRA”) released concurrently finalized proposed changes to the rules governing the mortgage syndication market . For existing mortgage syndicators promoting non-qualified syndicated mortgage (“NQSM”) investments it is either very good news or very bad news – and there’s no middle ground.
The Good News
The regulators have divided the market by class of subscribers. If your class of subscribers generally meet the definition of “Permitted Client” (for a complete list of “Permitted Clients” see Schedule A of Summary Table below) under National Instrument 31-103 — Registration Requirements, Exemptions and Ongoing Registrant Obligations normally overseen by the OSC, 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.
The Big Change
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. FSRA, to its credit, has done a complete “180”. Trusting Permitted Clients to know well how to take care of themselves, there are now no prescribed deliveries or mandated disclosures to Permitted Clients not individuals. Initial disclosure requirements are minimal. There are unique requirements when dealing with individual persons (i.e., persons not corporations, partnerships or trust, etc.) who are Permitted Clients, but none are terribly burdensome and most are addressed through simple disclosure.
The Big Win
The other big “win” is that there will be no need for additional registrations with the OSC as contemplated in earlier drafts of the proposed legislation. There is a required quarterly report that must be filed with FSRA by the syndicator ten days following the end of each calendar month summarising the syndicator’s activity in the NQSM market.
There are 18 categories of Permitted Client – the obvious ones are our charter banks, trust companies, dealers, etc. The three most commonly used categories in the retail market are:
- (i) an individual who beneficially owns financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $5 million;
- (ii) a person or company that is entirely owned by an individual or individuals referred to in the above paragraph, who holds the beneficial ownership interest in the person or company directly; and/or
- (iii) 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.
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.
For a complete list of “Permitted Clients”, see: Schedule A of Summary Table below.
The Bad News – Welcome to the Exempt 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 your activities fall under the auspices of National Instrument 45-106 — Prospectus Exemptions and you will account to both the OSC and FSRA. 45-106 governs the “exempt market”, or what is more commonly referred to as the “private capital market”. Though the rules governing this private capital market are extensive, it is a much simpler forum in which to raise capital than that public capital markets. As it is the mandate of the OSC to oversee all activities in our private and public markets, 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!
Back to School
Mortgage syndicators will have to learn the rules of the exempt market. On the bright side, they will discover that disclosure requirements related to offerings to accredited investors are quite flexible – the general rule of thumb is to provide the investor what would be reasonable for them to make an investment decision. “Disclosure” can mean something as simple as a term sheet or something more elaborate like a “confidential information memorandum” or “offering memorandum” (See our articles What the Heck is a Term Sheet? and What the Heck is an Offering Memorandum? with respect to these matters).
Under N.I. 45-106 there are 23 classes of “accredited investor”. Beyond that there’s a fistful of other exemptions syndicators will now be able to rely upon for distributing their product – the “Friends, Family, Business Associates” exemption, the “Minimum Amount” exemption, the “asset acquisition” exemption and so on.
The Loss of the $60,000 Investment Limit
A big blow for many syndicators is the loss of the $60,000 investment limit. Section 24.2 of the regulation has been deleted. 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. Unfortunately, the investment limits are smaller. For those persons who do not qualify as Accredited Investors, the exemption divides them into “eligible investors” and investors not eligible. Eligible investors can invest up to $30,000 of securities offered under an offering memorandum, and may invest up to $100,000 if the amount over the $30,000 cap is deemed “suitable” for the investor by an independent securities dealer. For investors who are not eligible, the investment cap is $10,000 with no allowance to go over.
Offering memoranda are not cheap to prepare. They are technical, relatively complex and require the talent of a good (and likely expensive) corporate lawyer.
More Bad News – You gotta get Registered
The syndicator will have to be registered with the OSC in some capacity. There are proposed amendments to the rules governing registration that will permit the regulator to consider “relevant securities industry experience” to include experience obtained at a registered or licenced mortgage brokerage. The syndicator though will undoubtedly be required to take the exempt markets exam to demonstrate proficiency in exempt market placement. As a “registrant”, the syndicator will be subject to the same standards of practice as all other security dealers subject to OSC oversight. Syndicators will also have to wrap their minds around the OSC rules governing KYC (“know-your-client”) and its sister obligation KYP (“know-your-product”) which are extensive and very much unlike what the ordinary mortgage broker/agent is exposed to in their current licensing exercises.
The syndicator as an issuer will also now be reporting to the OSC and filing “reports of exempt distributions” ten days after the syndicator closes its syndication. It is anticipated this may be a major irritant (and cost) for syndicators, though the OSC in its commentary suggests that syndicators should be treated the same as all other issuers in the exempt market.
Though it is not yet determined, once mortgage syndication falls under the auspices of the OSC so that registered “dealers” or “restricted dealers” are required to carry out the solicitation and trade, those parties may now be subject to the Financial Transactions and Reports Analysis Centre of Canada (“FINTRAC”) reporting requirements of securities dealers like EMDs. Currently, mortgage brokers are not required to file the CSA Reporting Form for complying with the monthly suppression of terrorism and Canadian sanctions reporting obligations under certain federal provisions. This may change.
A year and half ago we speculated about nine major aggravations these new rules might cause syndicators. You can see them here: Mortgage Syndicators: Nine New Stresses Courtesy of the New OSC Rules.
At Fundscraper, we are 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 common investment risks. A qualified investor can begin Fundscraper’s process and complete a subscription within twenty minutes from their tablet and desktop and, soon, their phone.
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 typically 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 ally helps put the mortgage syndicator back in business with far less administrative headaches..
Fundscraper is today’s solution. Visit us at www.fundscraper.com.