Securitization – Expected Practices

Document Properties

  • Type of Publication: AdvisoryFootnote 1
  • Category: Capital
  • Date: October 2008
  • Audiences: Banks / BHC / T&L / Life / IHC / P&C / Co-op

This Advisory, which applies to all federally regulated entities (FREs)Footnote 2, updates and complements the following OSFI guidance:

  • Guideline A, Capital Adequacy Requirements (CAR A) Banks/T&L

  • Guideline A-1, Capital Adequacy Requirements (CAR A-1) Banks/T&L

  • Guideline B-5, Asset Securitization

The Advisory is subject to modification based on future changes to international capital rules or due to market developments. In particular, OSFI expects new international guidance in early 2009 and expects to update this Advisory after such additional international guidance is finalized.

Statement of Regulatory Principles

This Advisory is in furtherance of the principle articulated in the legislation governing FREsFootnote 3 that every financial institution is required to establish and adhere to investment and lending policies, standards and procedures that a reasonable and prudent person would apply in respect of a portfolio of investments and loans to avoid undue risk of loss. The existing guidance broadly defines the various activities related to securitization and establishes minimum capital requirements; it also recognizes that all potential issues may not be addressed and that additional guidance may be required to address market developmentsFootnote 4.

This Advisory is also intended to expand on two principles in existing securitization guidelines that relate to prudent risk management practices. First, a FRE should understand the inherent risks of the activity and be competent in structuring and managing such transactions.Footnote 5 Second, OSFI expects a FRE to manage its exposure to, and hold appropriate capital for, risk arising from its relationship with a securitization special purpose entity (SPE).Footnote 6These principles should apply to traditional and synthetic securitizations, re-securitizations and other similar forms of structured finance transactions such as collateralized debt/loan obligations.


For the purposes of this Advisory, terms have the meaning ascribed thereto in CAR A-1. In addition, the following terms have the following meanings in this Advisory:


has the meaning ascribed thereto in CAR A-1 but also includes a re- securitization (unless the context otherwise requires).


means any “traditional securitization” (as defined in CAR A-1), or any “synthetic securitization” (as defined in CAR A-1), where one or more of the assets owned by the SPE or to which investors are ultimately exposed (e.g. due to a credit default swap or due to the assets purchased and posted as collateral under such a credit default swap) is itself a securitization exposure (i.e. an exposure that, without including the impact of any underlying securitization exposure, meets the securitization exposure definition in section 6.1 of CAR A-1). For example, a securitized collateralized debt obligation (CDO) interest in a pool of asset-backed securities (ABS) with underlying loan receivables, and a liquidity facility for the CDO, would both be a re-securitization exposure as the ABS is itself a securitization exposure; conversely, a liquidity facility for the ABS would not be a re-securitization as the loan receivables are not a securitization exposure.

1. Investment and Lending Policies For Securitization

FREs are, regardless of whether they are investors or participants in a securitization, expected to establish investment and lending policies that set limits on the institution’s exposure to related borrowers and risks. The categories and limits for such risks are primarily left to the judgement of institutions but they should be reviewed by FREs on an ongoing basis and, as different risks arise or become material, such categories and limits should change.

As part of a FRE’s policies and procedures governing the management and hedging of securitization exposures, FREs should consider whether risks arising from such assets and transactions require a review of exposure or risk limits. For example, when investing in collateralized debt obligations or re-securitizations, exposure limits should be set based on the aggregation of asset risk arising from the ultimate underlying assets (as well as considering the risks arising from the SPE and securitization structure and from the sponsors).

In setting these limits, a FRE should consider its securitization exposures and the underlying assets under a variety of potential scenarios including an evaluation of these limits and exposures across all direct and indirect exposures of the FRE in order to track aggregations by, for example, industry segment or geographic area. FREs should use stress tests to ensure that they understand the correlations between various exposures to the SPE, sponsor, the underlying risks and risk mitigants and how they will perform under a variety of potential (even if remote) adverse circumstances. This information should help a FRE to fully understand its risks and mitigants and ensure that it is comfortable with the controls and positions taken. Regular and on-going stress testing should also help identify, at an early stage, changes in the underlying risk position, correlations between the risks hedged and its mitigants or changes in environmental factors - to thereby help facilitate proactive risk management actions where necessary.

2. End of Zero Capital for General Market Disruption Liquidity Facilities

The CAR guidelines and Guideline B-5 provide guidance as to the risk weights to be ascribed to exposures arising from the provision of liquidity lines and define an eligible liquidity facilityFootnote 7. Eligible liquidity facilities for securitizations in Canada have, historically, taken two different forms: (1) generally available eligible liquidity lines (so-called “global style liquidity facilities”); and (2) liquidity lines only available during a general market disruption (“GMD liquidity facilities”). Eligible global style liquidity facilities attract higher capital usage (e.g. 20% or 50% credit conversion factors, for under 1 year and greater than 1 year exposures respectively, under the CAR standardized approach to securitization) because they represent higher risk of loss to the institution that provides them. Eligible GMD liquidity facilities (which attract a 0% credit conversion factor under the Basel II standardized approach to securitization) have not attracted capital because the legal availment rights were very restrictive, thus limiting the potential that the provider would experience credit losses.

Effective immediately, GMD liquidity facilities provided by Canadian FREs will no longer result in zero capital usage (e.g. a 0% credit conversion factor will cease to apply under the standardized approach) and will, regardless of the approach (e.g. standardized approach; internal ratings based approach) used to measure risk arising from securitization exposures, receive the same credit conversion factors and capital treatment as global style liquidity facilities. In particular, when using an internal ratings-based approach, no reduction in risk exposure for a liquidity facility will apply if it is structured as a GMD liquidity facility and such facility shall be treated in a manner consistent with global style liquidity facilities. This guidance reflects that, while GMD liquidity facilities may not exhibit material credit risk, recent events have shown that other risks do exist (such as reputational risk)Footnote 8 and that, consequently, a capital charge is appropriate. To implement this change, CAR A and A-1 and Guideline B-5 are amended as set forth in, respectively, Appendices A and B hereto.

3. Capital Charges for Short Term Liquidity Facilities

As noted above, under the standardized approach, eligible global style liquidity facilities for securitizations receive a lower capital treatment for commitments of one year or less and higher capital treatment for commitments of greater than one year. The lower capital charge for under one year commitments that acted as liquidity facilities was intended to reflect the ability of the lender to undertake a review each year of the obligor and the facility terms. When markets are functioning well, short-term liquidity facilities are frequently renewed on an ongoing basis. In practice, liquidity facilities may form a structural part of securitizations and their cessation may have broader implications – as such, originators and sponsors that provide liquidity facilities may be motivated to renew liquidity facilities for reasons (e.g. the desire to keep assets off balance sheet or to earn securitization fee revenues) which are not strictly related to the economics and terms of the facilities.

FREs seeking one year or less capital treatment for a liquidity facility are obliged to have appropriate processes in place to treat each renewal as a maturity of the obligation and the extension as a separate and new obligation. As such, it is important to follow prudent lending practices to ensure that a reputational risk does not arise and to ensure that such facilities are indeed short term. In particular, where the renewal of a one year or less liquidity facility is motivated by considerations which extend beyond the economics and terms of the liquidity facility, that facility should be treated as a longer term facility.

4. Securitization Activities and Reputational Risk

Public perception of a FRE can be affected by reputational risk. To minimize its exposure arising from its relationship with a SPE, a FRE should, to the extent possible, ensure that its securitization roles and responsibilities are clearly disclosed to all relevant stakeholders.

A FRE may, either directly or indirectly through subsidiaries or related persons, be involved with a securitization in a number of capacities (e.g. investor; asset originator; asset supplier; credit enhancer; liquidity support provider; establishing a SPE; administering a SPE; swap counterparty; and/or dealing in securities issued by an SPE). A FRE should assess its various activities related to a securitization or other structured products to consider the impact these roles and/or products may have on its reputation.

The CAR A-1 definition of a “sponsor” of a securitization SPE includes an institution that , in fact or in substance, manages or advises the securitization programme, places securities into the market or provides liquidity or credit enhancementsFootnote 9. Sponsorship may also be perceived if a FRE is directly or indirectly a credit protection purchaser from a synthetic securitization or is a supplier of assets to a securitization. While being a dealer in the securities issued by a securitization SPE creates securities law obligations, it should not suggest sponsorship on its own; however, if dealer activities are combined with other involvement by the FRE or its affiliates, sponsorship may result.

While sponsorship should not indicate that a FRE has obligations to the securitization SPE or investors beyond the FRE’s contractual obligations, sponsorship may create a perception that the FRE will use the knowledge that arises from its involvement, and will discharge its other responsibilities, in a reasonable manner. A failure, or perceived failure, to do so can create reputational risk for a FRE. While FREs should understand the inherent risks of participating in securitizations and should have the required competencies to structure and manage such transactions, it is also essential that they provide adequate disclosure about their role(s) to third party stakeholders wishing to make a fully informed investment or other decision.

A FRE must consider and, where practicable, mitigate the reputation risk associated with being an asset originator or securitization sponsor. In particular, FREs should identify all existing securitization SPEs where they could reasonably be considered to have a sponsorship or asset origination role and should ensure that they are clearly disclosing the nature and extent of their involvement with those securitizations in an ongoing and publicly available manner – e.g. on the FRE’s website and in any disclosure documents related to the issuance of securities by a securitization SPE. Further, as securitization sponsors have on occasion taken on unexpected responsibilities and incurred unexpected costs as a result of sponsorship, FRE’s should consider whether the risks arising from their involvement with securitizations have been adequately provided for in their internal capital adequacy and liquidity planning processes.

In addition, FREs performing non-sponsorship roles such as providing normal course investment research or investment advice concerning securities issued by a securitization SPE, or performing custodial or administrative tasks related to a securitization (e.g. which do not require special knowledge of the securitization or involve an active participation in a securitization), should ensure that their roles and activities are clearly understood and communicated to minimize potential misunderstandings concerning the nature of their involvement, reputation risk and legal liability.

5. Use of Ratings From External Credit Assessment Institutions

External credit ratings are used in a number of guidelines to establish minimum capital requirements. FREs are reminded that external ratings are only one indication of the credit quality of an exposure. It is the FRE’s responsibility to establish prudent lending practices and procedures and to understand the underlying risk of their exposures. Further, FREs as users of third party credit ratings are cautioned to carefully consider the limitations of any third party risk assessment. For example, such ratings may be based on information that is not publicly available and the rating may not have considered information that the FRE considers to be material or relevant (e.g. considers credit risk but not other risks; does not consider risk concentrations specific to the FRE). A FRE may consider available third party risk assessments when forming its own views but should also seek to identify differences in methodology or approach from its own preferred methodology.

The existing capital guidelines use ratings from external credit assessment institutions (ECAI) when determining the minimum capital requirements from securitizationsFootnote 10. The CAR standardized and the CAR A-1 internal-ratings based approach and Guideline B-5 also reference ratings and other external factors when determining the minimum capital requirements arising from securitization exposures as well as the amount of recognition given to credit risk mitigants.Footnote 11 However, while third party credit ratings or risk assessments may be used to indicate credit quality related to minimum capital requirements, reliance on external credit ratings is not a substitute for each FRE making its own risk assessment. When a FRE’s own prudential risk assessment results in a higher assessment of risk than the external rating, the FRE is expected to use its own higher risk assessment to ensure that it has adequate capital to absorb potential losses. This risk assessment could either be incorporated in a higher minimum capital requirement by overriding the implied rating or through the establishment of a higher internal capital target.

Historically, a single rating for a Canadian securitization was accepted practice for many sponsors and, in the past, was accepted by some investors. However, the general practice in some other major markets has been to obtain more than one rating. Further, many Canadian securitization SPEs have obtained or are obtaining second ratings.

Effective October 31, 2008, new securities issued by securitization SPEs, other than securities issued as a result of the “Montreal Accord”Footnote 12, must be rated by at least two recognized ECAIs to permit, in the case of any securitization exposure related to such securities, the use of a standardized or internal ratings-based approachFootnote 13, or an Internal Assessment ApproachFootnote 14, by a FREFootnote 15. In all cases where a securitization exposure arises from a re-securitization and the exposure is acquired after October 31, 2008, the securities issued by the re-securitization SPE (or such securitization exposure), other than securities issued as a result of the “Montreal Accord”, must be rated by two recognized ECAIs to permit a FRE to use a ratings-based or Internal Assessment Approach for such exposure.Footnote 16 Further, in the case of a re-securitization exposure acquired after October 31, 2008, the Supervisory Formula under CAR can only be applied based on the ultimate underlying assets (e.g. the third party loans or receivables giving rise to cash flows) and not based upon securities issued by any underlying securitization. When a FRE uses two ratings which correspond to different risk weights, the higher of the two risk weights must be used. With innovative or highly structured products such as re-securitizations, FREs should exercise caution when relying on ratings if significant disagreement exists between ratings agencies as to the efficacy of using ratings to evaluate risk.

6. Securities Purchases and Implicit Support

Capital rules recognize that, while a FRE may (for market making purposes) purchase a small amount of securities issued by a securitization, retaining or purchasing significant securities exposures may undermine the transfer of credit risk (such risk transfer being fundamental to the capital relief provided by securitization)Footnote 17. FREs have historically from time to time purchased a small amount of securities issued by securitization SPEs to provide a trading inventory. However, when third party investors are unwilling to purchase all of the securities being issued by an SPE, FREs have purchased securities issued by SPEs they sponsor. When such a FRE is also the liquidity provider to the securitization, such purchases may represent an alternative method for the FRE to provide liquidity support to the SPE.

While CAR permits FREs sponsoring a SPE to purchase securities pursuant to their predetermined legal obligations, a course of conduct involving discretionary purchases of securities by an FRE that is an asset originator (or supplier) to a SPE may evidence “implicit support”Footnote 18. Where a FRE provides implicit support to a securitization, the FRE must hold capital against all of the exposures associated with the securitization as if they had not been securitizedFootnote 19. As such, FREs should review their practices and procedures to ensure that they are respecting these rules.

Finally, when a FRE holds securities issued by a securitization SPE for which it is the liquidity provider, the aggregate capital charge (i.e: for such securities and the liquidity exposure combined) should, except when such securities represent a normal course trading inventory, be no less than the charge which would have arisen had the liquidity facility been drawn by an amount equivalent to the amount of securities held. Normal course trading inventory is to be determined based on policies established by a FRE to reflect the securities it needs to hold in a normal market to continue its ordinary course trading activities on behalf of its securities customers.

7. Re-Securitization Exposures

Re-securitizations are, by their nature, generally more complex than securitizations of unsecuritized assets as they represent a securitization exposure to an underlying securitization exposure. While re-securitizations share many of the same issues and features as securitizations of unsecuritized assets, because additional risks exist, it may not be appropriate to apply the same risk assessment and capital adequacy measures to re-securitizations as are applied to other securitizations. For example, reliance on the credit ratings ascribed to the securitization exposures held by the re-securitization may be misleading unless a detailed analysis of the underlying assets in the underlying securitizations is performed (e.g. to ensure that those assets will perform as expected under stress test scenarios and that those underlying assets do not pose any concentration risks and provide sufficient diversity). Further, as CAR’s securitization capital framework is premised on risk diversification, consideration must be given to whether the assets held by a re-securitization are sufficiently granular and whether there is the absence of risk correlation, both of which are required to achieve the lowest risk weights available under CAR.

FREs should ensure that the risk and capital adequacy assessment processes they use to evaluate re-securitizations is adequate and considers the additional risks and complexities associated with re-securitizations. Generally, everything else being equal, the capital should be higher for re- securitization exposures than traditional securitized assets as re-securitizations have greater complexity and risk. Until such time as further guidance is issued, the capital treatment of re- securitization exposures should, effective at the FRE’s 2008 fiscal year end, be calculated, as applicable: (A) for deposit-taking institutions, using the CAR “Base risk weights” set out in paragraphs 615 or 616, as applicable (or, in the case of non-granular exposures, the “Risk weights for tranches backed by non-granular pools” set forth in such paragraphs); (B) for life insurance companies, using the next higher “Factor” under Annex 1 “Life Insurance Companies” to Guideline B-5 than would otherwise apply based on the rating; and (C) for property and casualty insurance companies, using a Factor which is double the “Factor” set out in Annex 1 “P&C Companies” to Guideline B-5.

APPENDIX A – Revisions to CAR A and CAR A-1


Eligible liquidity facilities

578. Banks are permitted to treat off-balance sheet securitisation exposures as eligible liquidity facilities if the following minimum requirements are satisfied:

  1. The facility documentation must clearly identify and limit the circumstances under which it may be drawn. Draws under the facility must be limited to the amount that is likely to be repaid fully from the liquidation of the underlying exposures and any seller-provided credit enhancements. In addition, the facility must not cover any losses incurred in the underlying pool of exposures prior to a draw, or be structured such that draw-down is certain (as indicated by regular or continuous draws);

  2. The facility must be subject to an asset quality test that precludes it from being drawn to cover credit risk exposures that are in default as defined in paragraphs 452 to 459. In addition, if the exposures that a liquidity facility is required to fund are externally rated securities, the facility can only be used to fund securities that are externally rated investment grade at the time of funding;

  3. The facility cannot be drawn after all applicable (e.g. transaction-specific and programme-wide) credit enhancements from which the liquidity would benefit have been exhausted; and

  4. Repayment of draws on the facility (i.e. assets acquired under a purchase agreement or loans made under a lending agreement) must not be subordinated to any interests of any note holder in the programme (e.g. ABCP programme) or subject to deferral or waiver.

579. Where these conditions are met, the bank may apply a 20% CCF to the amount of eligible liquidity facilities with an original maturity of one year or less, or a 50% CCF if the facility has an original maturity of more than one year. Where these conditions are met, the bank may apply a 50% CCF to the amount of eligible liquidity facilities. However, if an external rating of the facility itself is used for risk-weighting the facility, a 100% CCF must be applied.

Eligible liquidity facilities available only in the event of market disruption

580. [INTENTIONALLY LEFT BLANK] Banks may apply a 0% CCF to eligible liquidity facilities that are only available in the event of a general market disruption (i.e. whereupon more than one SPE across different transactions are unable to roll over maturing commercial paper, and that inability is not the result of an impairment in the SPEs’ credit quality or in the credit quality of the underlying exposures). To qualify for this treatment, the conditions provided in paragraph 578 must be satisfied. Additionally, the funds advanced by the bank to pay holders of the capital market instruments (e.g. commercial paper) when there is a general market disruption must be secured by the underlying assets, and must rank at least pari passu with the claims of holders of the capital market instruments.


637. Liquidity facilities are treated as any other securitisation exposure and receive a CCF of 100% unless specified differently in paragraphs 639 638 to 641. If the facility is externally rated, the bank may rely on the external rating under the RBA. If the facility is not rated and an inferred rating is not available, the bank must apply the SF, unless the IAA can be applied.

638. [INTENTIONALLY LEFT BLANK] An eligible liquidity facility that can only be drawn in the event of a general market disruption as defined in paragraph 580 is assigned a 20% CCF under the SF. That is, an IRB bank is to recognise 20% of the capital charge generated under the SF for the facility. If the eligible facility is externally rated, the bank may rely on the external rating under the RBA provided it assigns a 100% CCF rather than a 20% CCF to the facility.

OSFI Notes: A 20% credit conversion factor applies to liquidity lines with market disruption clauses that are mapped under the IAA.

639. When it is not practical for the bank to use either the bottom-up approach or the top-down approach for calculating KIRB, the bank may, on an exceptional basis and subject to supervisory consent, temporarily be allowed to apply the following method. If the liquidity facility meets the definition in paragraph 578 or 580, the highest risk weight assigned under the standardised approach to any of the underlying individual exposures covered by the liquidity facility can be applied to the liquidity facility. If the liquidity facility meets the definition in paragraph 578, the CCF must be 50% for a facility with an original maturity of one year or less, or 100% if the facility has an original maturity of more than one year. If the liquidity facility meets the definition in paragraph 580, the CCF must be 20%. In all other cases, the notional amount of the liquidity facility must be deducted.

APPENDIX B – Revisions to Guideline B-5


An eligible liquidity facility that is in compliance with the conditions and scenarios described in sections 4.3.1, 4.3.2, and 4.3.3 is subject to the following capital treatment:

  • for a facility that is available in the event of a general market disruption, a 0% credit conversion factor (CCF) applies;

  • for a facility with an original maturity of one year or less or that is unconditionally cancellable at any time without prior notice, a 10% CCF applies; or

  • for a facility with an original maturity of more than one year, a 50% CCF applies.


Footnote 1

Advisories describe how OSFI administers and interprets provisions of existing legislation, regulations or guidelines, or provide OSFI’s position regarding certain policy issues. Advisories are not law; readers should refer to the relevant provisions of the legislation, regulation or guideline, including any amendments that came into effect subsequent to the Advisory’s publication, when considering the relevancy of the Advisory.

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Footnote 2

In this Advisory, the term FRE refers, as circumstances permit, to bank holding companies, banks, foreign bank branches, federally regulated trust and loan companies, federally regulated co-operative credit associations, fraternal benefit societies and federally incorporated or regulated life insurance and property and casualty insurance companies and insurance holding companies. If a FRE is not directly subject to the existing guidance which is updated by this Advisory, the general principles enunciated herein nevertheless apply to such FRE’s securitization activities (e.g. matters of prudent management and reputational risk).

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Footnote 3

See sections 465, 581 and 927 of the Bank Act, section 450 of the Trust and Loan Companies Act and sections 492, 551, 615 and 968 of the Insurance Companies Act.

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Footnote 4

See CAR A-1 paragraph 789.

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Footnote 5

See CAR A-1 section 6.3 and Guideline B-5 section 3.

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Footnote 6

See CAR A-1 section 6.2.9 and Guideline B-5 section 5.1.

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Footnote 7

For example, see CAR A and A-1 paragraphs 576 to 580 and CAR A-1 paragraphs 637 to 639.

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Footnote 8

GMD facilities have been converted to global style facilities in support of sponsored conduits.

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Footnote 9

CAR A-1 paragraph 543.

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Footnote 10

See CAR A-1 paragraphs 609 and 611 to 618 and Guideline B-5 sections 4.4 and 5.4.

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Footnote 11

For example, see CAR A-1 section 3.7 and paragraphs 565 to 570 and see Guideline B-5 sections 4.4 and 5.4.

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Footnote 12

The “Montreal Accord” is the restructuring agreement reached on December 23, 2007 by the Pan-Canadian Investors Committee for Third-Party Structured Asset-Backed Commercial Paper, approved by investors on April 25, 2008, and sanctioned by the Ontario Superior Court of Justice on June 5, 2008.

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Footnote 13

This two rating requirement also applies to any inferred ratings used under the CAR Ratings-Based Approach. Such two rating requirement may be satisfied by a combination of an external rating from one ECAI and an inferred rating based on a reference securitization exposure rated by another ECAI or by two ratings (based on external credit ratings from two ECAIs) of the same reference securitization exposure.

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Footnote 14

This two rating requirement for the CAR internal assessment approach requires, pursuant to CAR A-1 paragraph 620, that the unrated securitization exposure may only be rated under the IAA if the ABCP has two external ratings.

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Footnote 15

This two rating requirement applies whenever a FRE is seeking to use an external credit rating to establish the capital required to support a securitization exposure. In the case of deposit-taking institutions subject to CAR, the two rating requirement applies to securitization exposures regardless of whether the standardized or the internal Ratings-Based Approach is utilized; Section 5.4 of CAR A and Section 6.4 of CAR A-1 are amended accordingly. In the case of life insurance and property and casualty insurance companies subject to Guideline B-5, the two rating requirement applies when the capital use for a securitization exposure relies on an external rating; sections 4.4 and 5.4 of Guideline B-5 are amended accordingly.

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Footnote 16

This two rating requirement applies whenever a FRE is seeking to use an external credit rating to establish the capital required to support a re-securitization exposure and, as described in the preceding footnote, the existing guidance is amended accordingly.

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Footnote 17

See CAR A-1 paragraph 787.

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Footnote 18

See CAR A-1 paragraph 551.

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Footnote 19

See CAR A-1 paragraph 564; see also the final bullet point under CAR A-1 section 6.3.2.

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