- Type of Publication: Guideline
- Category: Prudential Limits and Restrictions
- Date: May 2003
- No: B-11
- Audiences: Banks / T&L / Co-op / Canadian Life / P&C / Fraternals
This Guideline is intended to assist federally regulated financial
institutions (FRFIs) in establishing,
as required by the relevant provisions of FRFI legislation, policies regarding the creation of
security interests in their property and the acquisition of beneficial interests in property that is
subject to security interests, hereafter referred to as “pledging.” This
is not a Guideline pursuant to statutory authority found in FRFI
legislation; therefore, it does not have force of law.
The Guideline outlines factors that OSFI expects the FRFI's board of
directors or committee of the board to consider when establishing pledging
policies. These factors are aimed at ensuring that a FRFI’s policies
reflect its business operations and associated risks and that the policies
are implemented effectively.
OSFI expects that FRFIs will also develop pledging policies on an
enterprise-wide basis, in a manner consistent with their overall liquidity
and other risk management practices.
The Guideline will be applied when the new legislative provisions on
pledging come into force. These provisions will require that the directors
of a FRFI establish pledging policies, and that the FRFI adheres to those
policies. However, the requirements will not apply in respect of pledging
by an insurance company or deposit-taking FRFI to secure an obligation to
the Bank of Canada or, in the case of a deposit-taking FRFI, to the Canada
Deposit Insurance Corporation.
FRFI legislation defines “security interest” as an interest in or charge
on property by way of mortgage, lien, pledge or otherwise taken by a
creditor or guarantor to secure the payment or performance of an
obligation. Although certain activities, such as securities lending, may
result in the creation of security interests, actually determining whether
a specific activity or transaction results in pledging rests on the
particulars of the transaction.
OSFI recognizes that pledging is an integral part of a number of
activities or transactions that are important to FRFIs’ operations. Some
of those activities or transactions, such as liquidity management, use of
derivatives and securities lending, may themselves be subject to other
OSFI guidelines. The objective of pledging by a FRFI is generally to
secure its own financial obligations. However, pledging is also part of a
number of activities that reduce risk to the FRFI and to the financial
system. For example, pledging may be used in support of a FRFI’s
derivative contracts to hedge interest, currency or other market risks. As
well, pledging requirements associated with participation in certain
systems, such as clearing houses and payment systems, can help contribute
to reducing systemic risk.
Pledging can affect a FRFI’s ability to meet its liquidity requirements.
For example, in the event of a liquidity crisis, a FRFI’s ability to
borrow money may hinge upon the availability of unencumbered assets. Therefore, OFSI expects FRFIs to
consider liquidity risk in establishing their pledging policies. Pledging
policies can also affect unsecured creditors, because the higher the
proportion of pledged property, the fewer the assets available for
unsecured creditors (i.e., depositors, policyholders and other creditors)
in the event of a FRFI’s insolvency.
OSFI expects FRFIs’ pledging policies to reflect an appropriate balance
between the need to conduct their business and compete, the responsibility
to effectively manage the risks related to their operations, and the
interests of their unsecured creditors. In this context, information
relating to pledged assets is important from a liquidity management
standpoint and, in the event of insolvency, becomes critical for
depositors, policyholders and other unsecured creditors. Identifying
business activity categories that require pledging and reporting pledged
assets are key elements of a FRFI’s pledging policies.
IV. Pledging Policies
OSFI expects FRFIs to establish and implement pledging policies that are
approved by the board of directors or a committee of the board. These
policies establish the framework within which pledging can occur in
relation to various business activities. Further, OSFI expects that the
board or board committee will review the policies at least annually and
approve significant changes to them. When approving such policies, OSFI
expects that the board or board committee will take into account factors
such as the institution’s size, the nature and complexity of its
operations, its overall risk philosophy, and its ability to monitor and
control transactions that require pledging. Where it is appropriate to do
so, the policies may specify the parameters for delegation of certain
responsibilities and functions necessary to the implementation of some of
the elements set out below.
A FRFI’s pledging policies should encompass the following elements:
An outline of the FRFI’s objectives when engaging in activities that
require pledging, having regard to the FRFI’s policy towards risk and
risk management, including its tolerance of risk.
A description of the business reasons (e.g., hedging, liquidity
management, access to markets, support for its core operations) for
the activities or transactions that require pledging. Examples of such
activities or transactions include:
participation in securities depositories and various clearing and
settlement systems (including systems for payments and foreign
derivatives operations (e.g., pledging to counterparties in respect of
over the counter derivatives operations);
borrowing on a secured basis (e.g., mortgaging of property);
capital equivalency deposits (e.g., to satisfy the requirements of a
Appropriate limits on pledging for particular business activities,
having regard to whether the value of the assets pledged is reasonable
in relation to the benefits that the FRFI can expect to derive from
the activity or transaction that requires pledging. Such limits are
particularly important when the activity does not involve risk
mitigation. The level of pledging for particular activities and the
aggregate level of pledging for the institution, and on an
enterprise-wide basis, should be assessed with respect to their
significance to the FRFI’s liquidity requirements and policies, the
strength of its capital and its ability to absorb losses, and to the
potential effect that the pledging may have on unsecured creditors,
including depositors and policyholders.
Quantitative limits on an individual officer’s ability to execute
agreements or approve transactions that require pledging, taking into
account the standards that the FRFI has in place (see item 3). Each
FRFI should determine the circumstances where individual (per officer)
transaction limits as well as aggregate limits would be appropriate.
Measures aimed at monitoring the value of assets pledged in various
activities or transactions, as well as the aggregate value of assets
pledged, and the performance of appropriate stress tests to determine
any additional collateral the FRFI may have to pledge under various
scenarios (e.g., market movements or triggers such as rating
The basis on which reporting and monitoring of pledging should be
performed, having regard to the type and nature of the operation and
including other factors such as whether contracts are subject to
novation or other legally valid forms of netting. Reporting should
include information relating to pledged assets and unencumbered
The frequency and format of internal reporting for monitoring
adherence to the policies.
Appropriate practices and procedures to ensure that the policies are
respected. For instance, although individual departments engaging in
activities or transactions that require pledging are expected to have
proper controls in place for these operations, ultimate responsibility
for the oversight of all such operations is expected to reside in a
single, clearly defined department or individual that is independent
of the departments where the operations originate.
A requirement that regular (at least annual) board (or board
committee) reviews be carried out of established policies and of the
FRFI’s adherence to the policies.
Where FRFIs have other internal policies in relation to activities or
transactions that require pledging, these policies should be included (or
referred to) in their pledging policies.