OSFI Finalizes NVCC Advisory

OSFI has released a final Advisory on NVCC, with some changes from the draft advisory which was discussed on PrefBlog. The draft advisory has been removed from OSFI’s website in accordance with their policy to ensure that the rationale behind their policies and their development is not understood by investors. Naturally, no comment letters have been published, nor have any documents been referenced that might provide any vestiege of support for their arbitrary and capricious rule-making.

The final advisory begins with a non-sequiter that would not be tolerated in Grade 4:

All regulatory capital must be able to absorb losses in a failed financial institution. During the recent crisis, however, this premise was challenged as certain non-common Tier 1 and Tier 2 capital instruments did not absorb losses for a number of foreign financial institutions that would have failed in the absence of government support.

Principle 3 from the draft advisory, giving the Superintendent the right to trigger conversion if she feels like it, with no appeal, has been retained. Banks are urged to hire lots of former OSFI employees.

There is now a requirement that there be a floor on the conversion price – this did not exist before:

Principle # 4: The conversion terms of new NVCC instruments must reference the market value of common equity on or before the date of the trigger event. The conversion method must also include a limit or cap on the number of shares issued upon a trigger event.

On the one hand, this will prevent so-call “death spirals”. On the other hand, it may make NVCC instruments harder to issue during times of crisis. The necessity of such an unprincipled principle is necessary due to OSFI’s insistence on “low-trigger” NVCC, at a time when the rest of the world has determined that “high-trigger” NVCC is the way to go (see, for example, statements by officials of S&P, more from S&P, Switzerland, the UK, respected academics, and other respected academics, and an equivocal view from IMF staff).

Principal #8, which throws contract law into the same garbage bin as bankruptcy law, has been retained:

Principle # 8: The terms of the NVCC instrument should include provisions to address NVCC investors that are prohibited, pursuant to the legislation governing the DTI, from acquiring common shares in the DTI upon a trigger event. Such mechanisms should allow such capital providers to comply with legal prohibitions while continuing to receive the economic results of common share ownership and should allow such persons to transfer their entitlements to a person that is permitted to own shares in the DTI and allow such transferee to thereafter receive direct share ownership.

Section 2 seeks to ensure permanent employment and many future job opportunities for OSFI employees:

Section 2: Information Requirements to Confirm Quality of NVCC Instruments

While not mandatory, DTIs are strongly encouraged to seek confirmations of capital quality from OSFI’s Capital Division prior to issuing NVCC instruments11. In conjunction with such requests, the DTI is expected to provide the following information….