Archive for the ‘Regulatory Capital’ Category

OSFI Revises Rules for LRCNs; Finally Provides Information for Insurers

Friday, March 19th, 2021

The Office of the Superintendant of Financial Institutions Canada (OSFI) has announced:

OSFI has published an update to its July 18, 2020 capital ruling on the Limited Recourse Capital Notes (LRCNs). The revised ruling now addresses LRCN issuances from institutions of all sizes and across different industry sectors.

The revisions include a number of clarifications to the ruling’s conditions and limitations, which are part of OSFI’s prudent approach to assessing the quality and quantity of financial instruments used as regulatory capital. This is consistent with our mandate to protect the rights and interests of depositors, policyholders and financial institution creditors, while also allowing financial institutions to compete effectively and take reasonable risks.

The ruling continues to conclude that federally regulated financial institutions may recognize the LRCNs as regulatory capital subject to the capital treatment, conditions and limitations set out in the revised ruling. Should you have any questions, please contact

The new limits are set out in the appendix to the new rules:

LRCN Issuance Limitations by FRFI Sector
Note: For life insurers, the following limitations supplement and are subject to any existing capital composition limits set out in OSFI’s capital guidelines. P&C insurers and mortgage insurers should consult OSFI’s Capital Division in respect of the limitations applicable to any prospective LRCN issuances.

LRCN Issuance Cap Floor
AT1 Greater of $150 million, 0.75%
RWA, or 50% of the
institution’s aggregate net AT1
Lesser of 0.30% RWA or 20% of
the institution’s aggregate AT1
Life Tier 1 Capital
other than
Greater of $150 million or
12.5% of Net Tier 1 capital
5.0% of Net Tier 1 capital

The “Floor” has the following effect:

The Cap may be removed with the prior approval of OSFI’s Capital Division. In seeking this approval, a FRFI must demonstrate that it has issued institutional preferred shares and/or other Additional Tier 1 capital instruments (other than LRCNs) targeted towards institutional investors that, in aggregate, are no less than the applicable limit, or Floor, set out in the Appendix. If the FRFI’s outstanding institutional preferred shares and/or other Additional Tier 1 capital instruments issued to institutional investors were to subsequently drop below the Floor, the FRFI would not be permitted to issue additional LRCNs in excess of the Cap until it has re-established compliance with the Floor. The Floor will not apply where the LRCNs are issued exclusively to a FRFI’s affiliates.

IAIS Says No To DeemedRetractions

Thursday, November 14th, 2019

The International Association of Insurance Supervisors has released a bevy of documents related to the supervision of Internationally Active Insurance Groups.

Of these, the most important for our purposes is the “Technical Note on ICS Version 2.0 for the monitoring period” which states:

Principal Loss Absorbency Mechanism (PLAM): A distinction is made for mutual and non-mutual IAIGs. For non-mutual IAIGs, the 10% limit for Tier 1 Limited financial instruments will be maintained for Tier 1 Limited financial instruments that do not have a PLAM. An additional 5% allowance is granted to those Tier 1 Limited financial instruments that do have a PLAM. The limits are stated as a % of the ICS capital requirement.

For mutual IAIGs: A PLAM is not required as part of Tier 1 Limited capital resources and the limit for Tier 1 Limited capital resources is maintained at 30% of the ICS capital requirement

So that’s an end to the saga that began in February, 2011. As an investor, I’m shocked; as a taxpayer who will end up footing the bill if one of our outsized insurance companies goes down, I’m disappointed.

Update: An end? Or a new beginning? The Canadian Office of the Superintendent of Financial Institutions – which has disgraced itself throughout the negotiations for ICS 2.0 – has announced:

While broadly supportive of the goals of the Insurance Capital Standard (ICS), the Office of the Superintendent of Financial Institutions (OSFI) did not support the ICS design proposed for a five-year monitoring period at the Executive Committee Meeting of the International Association of Insurance Supervisors (IAIS) in Abu Dhabi, United Arab Emirates.

OSFI’s view is that that the Standard in its current form is not fit for purpose for the Canadian market. Specifically, the proposed capital requirements for long-term products are too high to be compatible with OSFI’s mandate of allowing Canadian insurers to compete and take reasonable risks.

During the five-year monitoring period, OSFI will continue its work in trying to achieve an international capital standard for insurance companies that works for all jurisdictions.

Quick Facts

  • Canadian insurers will continue to be subject to the requirements of OSFI’s robust capital frameworks for federally regulated insurance companies.
  • An initiative of the IAIS, the International Capital Standard is a proposed common capital standard for large internationally active insurance groups.

So, maybe a PLAM for Tier 1 Limited capital resources is a bargaining chip …

Update: There hasn’t been much press coverage of this, but here are two articles:

Update, 2019-11-17: States and Feds Split on Major World Insurance Standards Deal

Update, 2019-11-18: OSFI rebuffs global capital rules for insurers.

IAIS Releases ICS 2.0 Consultation Comments

Friday, April 5th, 2019

The International Association of Insurance Supervisors has released the comments received to its 2018 ICS 2.0 Consultation. Assiduous Readers will remember that the comment period closed at the end of October, 2018 and included the following questions that are critical to the question of Deemed Maturities for Insurance issues:

The consultation document, downloadable from the above page, contains the critical (for our purposes) question:

173. The IAIS is considering whether to set an additional criterion requiring Tier 1 Limited instruments to have a principal loss absorbency mechanism (PLAM). Such mechanisms would provide a means for financial instruments to absorb losses on a going-concern basis through reductions in the principal amount and cancellation of distributions. Without such mechanisms these instruments might only provide going concern loss absorbency through cancellation of distributions.

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The consultation document, and the files with respondents’ answers to the questions, may be downloaded from the IAIS Insurance Capital Standards page. The ‘critical questions’, ##52-54, are found in Section 6 Reference ICS – Capital resources (public). The IAIS notes that:

The IAIS received 56 submissions in response to the 2018 ICS Consultation Document of which 18 were requested by the respondents to be kept confidential. Therefore, the comments that are posted here publicly are a subset of those that the IAIS will be taking into account as it moves forward with the ICS.

Q52 Section 6 Is a PLAM [Principal Loss Absorbency Mechanism] an appropriate requirement for Tier 1 Limited financial instruments? Please explain any advantages and disadvantages of requiring a PLAM.

There were 17 responses, 8 yes and 9 no.

OSFI answered “No”:

A PLAM is one option considered to assess loss absorbency in a going concern. However, OSFI’s view is that PoNV (point of non viability) loss absorbency could also be considered. Specifically, the IAIS could consider loss absorbency on a going concern basis, as well as on a gone concern basis with contractual or statutory) PoNV triggers. It is possible that an insurer could fail before a PLAM trigger occurs due to the lagging nature of PLAM triggers. Moreover, PLAM triggers could have adverse signalling effects in respect of the financial condition of the issuer, which could precipitate non-viability.

This advocacy of ‘point of non viability loss absorbency’ is consistent with the NVCC rules OSFI has imposed on banks and with its answer to the 2016 consultation. Assiduous readers will remember that I consider the ‘adverse signalling effects’ of a PLAM trigger to be a feature, not a bug; high triggers are good things, and I’m not the only one who says so:

Moreover, high-trigger CoCos would presumably get converted not infrequently which, in terms of reducing myopia in capital markets, would have the merit of reminding holders and issuers about risks in banking.

Broadly speaking, Europeans were in favour of PLAM, although some expressed concerns about complexity: China Banking and Insurance Regulatory Commission (CBIRC); European Insurance and Occupational Pensions Authority (EIOPA); Insurance Europe; Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); General Insurance Association of Japan; Financial Supervisory Service (FSS) & Financial Services Commission (FSC); Legal & General; Association of British Insurers. Comments included EIOPA’s remark:

Requiring a PLAM, i.e. write-down or conversion features, provides a means for the principal of a financial instrument to absorb losses on a going-concern basis. Without such mechanisms these instruments only provide going concern loss absorbency through cancellation of distributions.

Naysayers were dominated by American regulators and firms: Dai-ichi Life Holdings, Inc., American Council of Life Insurers, National Association of Mutual Insurance Companies; Prudential Financial, Inc.; American Property Casualty Insurance Association (APCI); MetLife, Inc; Property Casualty Insurers Association of America (PCI); and the National Association of Insurance Commissioners (NAIC). The Americans have a high degree of concern regarding the continued eligibility of “surplus notes”, as exemplified by the response of the National Association of Mutual Insurance Companies:

PLAM is an addition to the discussion that NAMIC strongly opposes. NAMIC does not see any value in a PLAM requirement. It is simply a way to further complicate the ICS 2.0 providing no value. It seems to be designed to reduce the value of allowing surplus notes to qualify as Tier 1 capital resources.

The elephant in the room is AIG and the European bank bail-outs that left Tier 1 noteholders unscathed, at least relatively. How can anybody say with a straight face that loss absorbency via cessation of dividends is sufficient in the face of those memories?

Q53 Section 6 If a PLAM requirement is not introduced, what amount should be included in ICS capital resources for instruments that qualify as Tier 1 Limited, to reflect going concern loss absorbency? Please explain.

OSFI’s answer is a disgrace:

Capital composition limits address the concerns related to loss absorbency of Tier 1 Limited instruments and therefore their full face amount should be included in the ICS capital resources.

In other words, OSFI would have us believe that since Limited Tier 1 Capital is a limited proportion of the insurers’ high quality capital, it doesn’t really matter whether it’s actually high quality or not. Disgusting.

EIOPA and BaFin stepped into the breach:

Without a PLAM requirement, it is difficult to see how the principal of an instrument absorbs losses in a going concern basis.

Interestingly, the Property Casualty Insurers Association of America (PCI) stated:

In support, PCI cites the response of OSFI-Canada to a similar question in the prior ICS consultation

and quoted in full the dovish response to the 2016 consultation … including the grudging support for a NVCC solution.

Others stated that cessation of distributions worked just fine, e.g., American Property Casualty Insurance Association (APCI):

Tier 1 Limited instruments already provide loss absorbency on a going concern loss basis through cancellation of distributions. Reducing the principal amount of these instruments is only necessary during resolution.

Q54 Section 6 Are there other criteria that could be added to enhance the ability of financial instruments to absorb losses on a going concern and / or on a gone concern basis? Please explain.

OSFI had nothing to say. BaFin and EIOPA had identical answers again:

• In T1, mandatory cancellation of distributions on breach of capital requirement (i.e. a lock-in feature).
• In T2, mandatory deferral of distributions and redemption of principal on breach of capital requirement (i.e. a lock-in feature).
• Requirement for early repurchase (within 5 years from issuance) to be funded out of proceeds of new issuance of
same/higher quality (all tiers).

I don’t quite understand this response. Does “cancellation” mean cancellation forever and ever on T1, as opposed to a temporary “deferral” on T2? How about redemptions? Would such instruments have any rights if the issuer actually did go bankrupt ten years later? And I don’t understand what they mean by an early purchase requirement at all.

So, there you have it. I don’t find anything particularly surprising here; there might be some meaning behind the heavy American participation in this consultation, but an outsider such as myself would be foolish to speculate on just what that meaning might be.

Comment Period Expires for IAIS Public Consultation on ICS 2.0

Saturday, November 3rd, 2018

Readers will remember that I am very interested in the IAIS deliberations regarding the definition of Insurance company Tier 1 Limited Capital (which includes preferred shares); I take the view that rules comparable, if not identical to the bank NVCC rules will be imposed by OSFI at some point in the future.

I do not expect OSFI to act until a global standard is agreed upon.

Those who have followed my arguments to support my position may well be getting impatient, although not as impatient as I am. So, I’ll just pass along the news that the comment period for the IAIS Public Consultation: Risk-based Global Insurance Capital Standard (ICS) Version 2.0 has expired:

The purpose of this consultation document (CD) is to solicit feedback from stakeholders on the ICS ahead of the completion of ICS Version 2.0, scheduled for late-2019, before the monitoring period begins on 1 January 2020. This CD covers both issues related to the ICS Version 2.0 monitoring period and the technical aspects of the design and calibration of ICS Version 2.0.

This CD is the third IAIS consultation in a multi-year process to develop the ICS. The IAIS issued its first and second ICS consultation documents in December 2014 and July 2016, respectively. In addition, the IAIS has conducted three quantitative Field Testing exercises in the development of the ICS – in 2015, 2016 and 2017. Currently, the IAIS is conducting its fourth quantitative ICS Field Testing exercise, with data to be submitted in August 2018.

At the same time as this consultation on ICS Version 2.0, the IAIS is also consulting on the Common Framework for the Supervision of IAIGs (ComFrame). While ICS is part of the ComFrame, it was agreed by the Executive Committee of the IAIS in June 2017 that ICS Version 2.0 would be adopted as a stand-alone document in 2019. As such, there are two separate consultation documents.

The consultation document, downloadable from the above page, contains the critical (for our purposes) question:

173. The IAIS is considering whether to set an additional criterion requiring Tier 1 Limited instruments to have a principal loss absorbency mechanism (PLAM). Such mechanisms would provide a means for financial instruments to absorb losses on a going-concern basis through reductions in the principal amount and cancellation of distributions. Without such mechanisms these instruments might only provide going concern loss absorbency through cancellation of distributions.

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I will also note that:

7. Comments must be sent electronically via the IAIS Consultations webpage.1 All comments will be published on the IAIS website unless a specific request is made for comments to remain confidential.

I will be keeping a sharp eye out for publication of comments received, I assure you, and will pass them on.

DBRS: Canadian Banks’ Trends Now Stable on Bail-In Approval

Wednesday, April 25th, 2018

DBRS has announced that it has:

changed the trend to Stable from Negative on the Long-Term Issuer Ratings, Senior Debt Ratings and Deposits ratings of the Bank of Montreal, The Bank of Nova Scotia, the Canadian Imperial Bank of Commerce and the National Bank of Canada. These actions result from the publication by the Minister of Finance of the final rules related to the Bank Recapitalization Regime (the Bail-in Regime). DBRS notes that the Stable trends on the long-term ratings of The Toronto-Dominion Bank and Royal Bank of Canada were unaffected. For these domestic systemically important banks (D-SIBs) to which the Bail-in Regime is applicable, DBRS has created a new obligation named Bail-inable Senior Debt. This new obligation rating reflects the senior debt that these banks will begin issuing once the Bail-in Regime goes into effect on September 23, 2018. Lastly, DBRS has downgraded the legacy Subordinated Debt ratings of these D-SIBs by one notch.

The revision of the trend to Stable from Negative for the affected long-term ratings reflects DBRS’s view that a downgrade of existing senior debt for the D-SIBs is now unlikely. It is anticipated that systemic support would still be sufficient to add a notch for such support until the D-SIBs issue adequate amounts of Bail-inable Senior Debt to meet their total loss-absorbing capacity (TLAC) requirements. Once an adequate level of bail-inable debt has been issued, the likelihood of future systemic support would be much lower. Accordingly, the notch of support would then be withdrawn. However, the new Bail-inable Senior Debt creates an additional buffer that better protects all senior obligations that cannot be bailed in under the regulation. Therefore, DBRS does not expect to downgrade any long-term ratings of existing senior obligations of the D-SIBs.

When issued, DBRS will rate the new Bail-inable Senior Debt at the level of each bank’s Intrinsic Assessment (IA), reflecting the risk of a D-SIB being put into resolution.

The downgrades of the legacy Subordinated Debt ratings reflect the structural subordination to the Bail-inable Senior Debt.

This has been telegraphed for a long, long time:

OSFI Dovish on Insurance Tier 1 Eligibility Rule

Saturday, April 15th, 2017

OSFI has disgraced itself yet again with its response to the International Association of Insurance Supervisors’ 2016 Insurance Capital Standard Consultation.

The question is:

Q70 Section 5.3.1: Should Tier 1 Limited financial instruments be required to have a principal loss absorbency mechanism?

OSFI’s answer, found in the document “Section 5 Capital resources (Public)” that is linked on the above page, is “No”.

The follow-up question is:

Q70.1 Section 5.3.1 If “no” to Q70, should the principal be considered to provide loss absorbency on a going concern basis? Please explain how the instrument demonstrates loss absorbency on a going concern basis.

OSFI answers “Yes”, with the explanation:

Tier 1 Limited and Unlimited instruments provide loss absorbency on a going concern basis through the discretion the issuer has to not pay or cancel coupons on the instrument and the non-cumulative nature of such payments. The principal amount of such claims is only extinguished in resolution (regardless of accounting).

OSFI does not support principal loss absorbency mechanisms whereby instruments can be written down or converted into equity under going concern/early triggers (and that are not at the discretion of the supervisory authority) due to concerns that such triggers can lead to financial instability and adverse signalling regarding the issuer’s financial condition (as observed with CoCos issued by European banks earlier this year, for example). OSFI would only support such mechanisms where they result in a full and permanent write-off of the instrument at the point of non-viability where the IAIG has entered into resolution.

Note: What is an “IAIG”?:

An IAIG is a term under ComFrame for insurance groups or financial conglomerates that exceed thresholds on international activity and size. The IAIS defines an IAIG as a large, internationally active group that includes at least one sizeable insurance entity. There are two criteria for an insurance group to be identified as an IAIG: 1) International Activity — premiums are written in not fewer than three jurisdictions, and percentage of gross premiums written outside the home jurisdiction is not less than 10% of the group’s total gross written premium; and 2) Size —based on a rolling three-year average, total assets of not less than USD 50 Billion, or gross written premiums of not less than USD 10 Billion.

However, it is heartening to observe that the other four IAIS full members who provided public answers (European Insurance and Occupational Pensions Authority (Europe; the developers of the “Solvency 2” regime), BaFin (Germany), Financial Supervisory Service (Korea) and the National Association of Insurance Commissioners (USA)) all answered question 70 with “Yes”.

So I continue to believe that “Deemed Retractions” will eventually apply to Insurers and Insurance Holding Companies; I believe that while OSFI may well continue its ridiculous insistence on “low-trigger” conversions, it will adopt a global standard once the rest of the world agrees on conversion.

I will also note that in Canada, forcible conversion of Tier 1 capital for banks is also low-trigger, but this did not stop OSFI from demanding NVCC compliance for bank preferred share issues, which in turn led to “Deemed Retraction” for bank issues.

Now, is all that clear as mud? Sorry, but I’ve got PrefLetter to get out and don’t have much time for linking to previous material on this issue.

Update, 2017-4-19: As noted above, OSFI’s response included:

such triggers can lead to financial instability and adverse signalling regarding the issuer’s financial condition (as observed with CoCos issued by European banks earlier this year, for example).

For a review of the performance – and reasons behind this performance of European CoCos, see Europe’s CoCos Provide a Lesson on Uncertainty:

Contingent convertible bonds (CoCos) issued by European global systemically important banks (G-SIBs) as part of their total loss-absorbing capacity (TLAC) are meant to enhance financial stability by forcing investors to absorb losses when a bank is under stress. Coupon payments are made at issuers’ discretion while loss absorption can be triggered at regulators’ discretion. This study investigates price effects of four press releases by Deutsche Bank AG in February 2016 related to the bank’s willingness and ability to make its upcoming CoCo coupon payments. Expected cash flow models capture changes in CoCo default risk, while event dates capture uncertainty effects. The price of a European G-SIB peer group portfolio declined a statistically significant 2.0-2.5 percent over two days in response to Deutsche Bank’s first press release. Deutsche Bank’s efforts to allay its own CoCo investors’ concerns appeared to increase concerns among CoCo investors generally. The results show potential negative effects of regulatory discretion.

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S&P Revises Bank Outlook to Stable on Federal Complacency

Saturday, December 12th, 2015

Standard & Poor’s has announced:

  • •We continue to evaluate the likelihood, degree, and timeframe with respect to which the default risk of systemically important Canadian banks may change as a result of the government’s progress toward introducing a bank bail-in framework.
  • •We now expect that the timeframe could be substantially longer than we had previously assumed. We see the absence of the topic from the new government’s Dec. 4 Speech from the Throne as recent, incremental evidence in this regard.
  • •We now do not expect to consider the removal of rating uplift for our expectation of the likelihood of extraordinary government support from the issuer credit ratings (ICRs) on systemically important Canadian banks until a point beyond our standard two-year outlook horizon for investment-grade ratings, if at all.
  • •When and if we remove such uplift, the potential ratings impact will also consider uplift for additional loss-absorbing capacity, as well as any changes to our stand-alone credit profiles on these banks.
  • •As a result, we are revising our outlooks on all systemically important Canadian banks to stable from negative.

On Dec. 11, 2015, Standard & Poor’s Ratings Services revised its outlooks on the Canadian banks that it views as having either “high” (Bank of Montreal, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada, The Toronto-Dominion Bank), or “moderate” (Caisse centrale Desjardins and National Bank of Canada) systemic importance, to stable from negative (see ratings list). The issuer credit ratings (ICRs) on the banks are unchanged.

We believe that the potential negative ratings impact of a declining likelihood of extraordinary government support, at least within our standard two-year outlook horizon, has subsided. This reflects our updated view that there could be an extended implementation timetable–2018 or later–for the proposed Canadian bail-in framework. Importantly, at the point we would consider removing any uplift from the likelihood of extraordinary government support from our ratings, we would also consider the potential ratings impact of any uplift for additional loss-absorbing capacity (ALAC), as well as any
changes to our stand-alone credit profiles (SACPs) on these banks. In our view, the extended timetable introduces some potential that either the presence of ALAC or fundamental changes in credit quality at individual banks might come into play more than under the previously contemplated timetable.

We had revised our outlooks on systemically important Canadian banks to negative chiefly in reaction to the former government’s “Taxpayer Protection and Bank Recapitalization Regime” consultation paper of Aug. 1, 2014, as we then expected a bail-in regime could be fully implemented by 2016 (see “Outlook On Six Big Canadian Banks Revised To Negative Following Review Of Bail-In Policy Proposal,” published Aug. 8, 2014, on RatingsDirect). A number of subsequent developments have caused us to re-evaluate this expectation:

  • •In its April 2015 budget proposal, the former government affirmed its intention to introduce a bank bail-in regime in Canada, but it provided only very limited additional information relative to what it had outlined in its 2014 consultation paper; nor did the government make substantial subsequent public statement on the topic; nor did it specify timing for the announcement of its fully-developed (post-consultation) legislative proposal.
  • •The Oct. 19 federal election changed the party in government to Liberal (center-left), from Conservative (center-right). The former government’s proposed bail-in regime did not feature prominently in election debates.
  • •The new government’s Dec. 4 Speech from the Throne made no mention of the proposed bail-in framework, nor were any of the legislative priorities enumerated therein closely related, in our opinion. We believe this indicates the introduction of a bail-in framework is not among the immediate priorities of the new government.

Moreover, with Canada experiencing no government bank bail-outs, nor large bank failures, for decades, we believe the political incentive to rapidly end “too-big-to-fail” is less in Canada than in the U.S. and several EU countries, which are jurisdictions under which we have already removed uplift for our expectation of the likelihood of extraordinary government support from our ratings (see “U.S. Global Systemically Important Bank Holding Companies Downgraded Based On Uncertain Likelihood Of Government Support,” and “Most European Bank Ratings Affirmed Following Government Support And ALAC Review,” both published Dec. 2, on RatingsDirect). We will take this factor into consideration as we continue to evaluate our view on the likelihood of extraordinary government support in Canada relative to not only the U.S. and Europe, but also other jurisdictions where we maintain a government support assessment of “supportive” or “highly supportive” under our criteria (such as for many countries in Latin America and Asia-Pacific; see “Banking Industry Country Risk Assessment Update: November 2015,” published Nov. 27).

We now believe the procedural hurdles to passing legislation and related regulations (the latter after passage of the former) for a bail-in regime will alone require a minimum of one-to-two years, after the new government decides on a final legislative framework to propose to Parliament. Considering all of this, we now expect the eventual date for initial implementation of the bail-in regime (that is, banks issuing bail-inable debt) could be in 2018 or later.

In addition, and in contrast to bail-in frameworks outlined by U.S. authorities or in European countries like Germany, Canadian officials’ statements have made clear that only debt issued or renegotiated after an initial implementation date would be subject to conversion. It will take some time for the banks to issue or renegotiate bail-inable debt. We believe this means it could take several years after the initial implementation date before we would consider a Canadian bail-in regime effective, so as to provide a viable alternative to the direct provision of extraordinary government support.

As well, and again in contrast to the U.S. and EU jurisdictions, Canadian governments have made no attempt to limit their ability to provide direct extraordinary support to their banks, if needed. We expect bailing in senior creditors to be the first Canadian policy response in the face of a crisis. At the same time, we believe Canadian governments would be likely to consider all policy options, in such a circumstance. It is therefore not certain that the introduction of a bail-in regime would of itself result in our revising our government support assessment on Canada to “uncertain” from the current “supportive” and the removal of rating uplift for our view on the likelihood of extraordinary government support from our ICRs on systemically important Canadian banks. Rather, our decision would depend, among other factors, on the details of the eventual bail-in regime, including the extent to which bail-inable and unbail-inable senior debt is distinguishable.

Partly to honor G-20 and other international commitments, the Canadian government will, we expect, present a finalized legislative proposal for the bail-in framework in 2016 or 2017. However, we expect an implementation date that could be in 2018 or later, and we think it could take at least one and possibly several years more for substantial bail-in eligible debt to be in place. With a runway that long, the potential ratings impact from removing uplift for the likelihood of extraordinary government support is beyond our standard two-year outlook horizon for investment-grade ratings, and could by then be more meaningfully affected by either ALAC uplift (from the bail-inable debt, assuming our related criteria are met) or SACP changes, than under the previously contemplated timetable.

When the government presents the detailed provisions of the framework, along with a more specific timeframe, we will review the applicable notching for various bank liabilities, taking into account the framework’s implications on different instruments. We expect that issue ratings on new bail-inable instruments will be at a level that is notched in reference to banks’ SACPs, while ratings on non-bailinable senior debt may continue to incorporate rating uplift above the banks’ SACPs, based on our expectation of the likelihood of extraordinary government support, or ALAC.

Our outlooks on the systemically important Canadian banks are stable, based on our reassessment of the likelihood, degree, and timeframe with respect to which the default risk of systemically important Canadian banks may change as a result of the government’s progress toward introducing a bank bail-in framework. We believe that the likelihood of extraordinary government support will continue to be a factor in systemically important Canadian bank ratings throughout the current outlook period.

Moreover, we believe these banks will continue to exhibit broad revenue diversification, conservative underwriting standards, and strong overall asset quality. Our current view is that the impact of low oil prices on their profitability and credit quality will be contained, given the modest direct exposure of the banks to the oil and gas sector, and the limited knock-on impact so far on consumer credit in regional economies affected by low oil prices.

On the other hand, we continue to monitor a number of key downside risks to our ratings on these banks, including low margins, high Canadian consumer leverage, residential real estate prices we believe are at least somewhat inflated in some parts of Canada, a Canadian macroeconomic outlook that is very tentative, and the higher-risk nature of certain recent foreign acquisitions.

The August 2014 imposition of Outlook-Negative was reported on PrefBlog, as was the federal consultation on the recapitalization regime. As far as I can tell, the comments received on the consultation paper have not been published; I believe this is because Canadians are too stupid to understand smart stuff like legislation and parliament and all that – if given a pile of comments to work through, we’d probably try to eat them.

Issues affected are:







Update On OSFI Insurer Regulation

Thursday, December 10th, 2015

OSFI Assistant Superintendent Neville Henderson gave a speech to the 2015 Life Insurance Invitational Forum:

Domestic Insurance Capital Standards

On the domestic front, we are still on track to implement OSFI’s new life insurance regulatory capital framework in 2018. The new capital framework will provide a superior risk based assessment methodology for determining capital requirements. The new test will make use of more current analysis and methodologies as well as explicitly taking into account mitigating actions and diversification benefits. It will allow our capital requirements to remain state of the art compared to those of other jurisdictions.

The capital changes in the new framework are explicitly calibrated to a consistent level of conditional tail expectation (CTE) across the various risks. Actuarial valuation of insurance company liabilities are explicitly intended to include conservative margins with the degree of conservatism varying across risks.

To help ensure that this approach results in consistent capital measures across companies, OSFI has asked the Canadian Institute of Actuaries and the Actuarial Standards Board to consider certain issues with a view to updating actuarial standards and /or guidelines if required.

To avoid double counting and inconsistent treatment of different risks, this new framework will include margins for adverse deviations as an available capital resource.

While we are awaiting the results of Quantitative Impact Study (QIS)7, we are in the process of planning to conduct two framework runs, one in 2016 followed by another one in 2017. These “test drives” will allow us to validate the new capital test and help insurers gear up for the updated regulatory compliance requirements under the new framework.

We should also have a final guideline ready for issue in July 2016, following input from the industry on the draft. Any anomalies uncovered in the testing will be taken into consideration prior to implementation. This will allow time for industry feedback and enable insurers to plan and prepare their systems for implementation of the framework in early 2018.

Global Insurance Capital Developments

While work continues on the domestic front, there are also developments in standards for internationally active insurers.

The International Association of Insurance Supervisors (IAIS) is refining the Basic Capital Requirement (BCR) and Higher Loss Absorbency (HLA) requirements for Global Systemically Important Insurers (GSIIs) for implementation in 2019. Work in this area is aimed at mitigating or avoiding risks to the global financial system.

To eventually replace the BCR, the IAIS is developing an internationally agreed upon risk based capital test. The Insurance capital standard (ICS 1.0) for the broader list of Internationally Active Insurance Groups (IAIG) will be ready by the end of 2016, for implementation in 2019.

OSFI looks carefully at the Canadian marketplace and Canadian requirements before deciding whether to adopt international standards. We will take ICS into consideration as we fine tune our current capital tests. The work we do on the OSFI life insurance framework already includes many of the changes stemming from these international standards and we don’t expect ICS 1.0 to be as sophisticated as our current Minimum Continuing Capital and Surplus Requirements (MCCSR) capital test. Consequently, we do not foresee a need to implement any significant changes.

The significant changes will likely come as ICS 2.0 is finalized. It may bring sufficient worldwide convergence for OSFI to start thinking about implementation.

The important thing about ICS is that this is what will determine whether or not preferred shares must be convertible into equity (or have other pre-bankruptcy capital loss absorption features) in order to be counted as Tier 1 capital. This proposal is outlined in the Consultation Paper “Risk-based Global Insurance Capital Standard” which is available in a ludicrously inconvenient manner, paragraph 92 with associated question 25:

92. The IAIS is considering a requirement for a principal loss absorbency mechanism to apply to Tier 1 instruments for which there is a limit. This principal loss absorbency mechanism would provide a means for such instruments to absorb losses on a going-concern basis through reductions in the principal amount in addition to cancellation of distributions.

Question 25. Should Tier 1 instruments for which there is a limit be required to include a principal loss absorbency mechanism that absorbs losses on a going-concern basis by means of the principal amount in addition to actions with respect to distributions (e.g. coupon cancellation)? If so, how would such a mechanism operate in practice and at what point should such a mechanism be triggered?

OSFI’s response to this question is available in the document “Compiled Responses to ICS Consultation 17 Dec 2014 – 16 Feb 2015”, which is also available in a ludicrously inconvenient manner:

No, OSFI does not support the inclusion of a principal loss absorbency mechanism on Tier 1 instruments for which there is a limit. Tier 1 instruments must be able to absorb losses on a going concern basis, which these instruments do through coupon cancellation.

Despite this, I expect that OSFI will adopt whatever ends up being in ICS, as in this way any future criticism will be deflected to the international body and they will be able to keep their jobs and continue angling for future employment with those whom they currently regulate.

OSFI’s response to this – and other – questions has never been explained to the Canadian public as far as I know, because we’re disgusting taxpayer and investor scum, not worth the dirt underneath our own fingernails.

Further discussion of the capital standard and my reasons for believing that the NVCC rule will be applied to insurers and insurance holding companies are provided in every edition of PrefLetter.

OSFI: Ineffectual, Uninformed Grandstanding on D-SIBs

Wednesday, March 27th, 2013

The Office of the Superintendent of Financial Institutions has announced:

Canada’s six largest banks have been identified as being of domestic systemic importance, and will be subject to continued supervisory intensity, enhanced disclosure, and a one per cent risk weighted capital surcharge by January 1, 2016.

Grant Robertson of the Globe claims:

The move is designed to avert a liquidity crisis in the sector, and comes on top of the 7 per cent of capital that the Office of the Superintendent of Financial Institutions (OSFI) requires them to hold, which can be easily liquidated by the banks during a time of financial pressure to stabilize operations.

This shows a common confusion between “liquidity” and “solvency”. If you own a house worth a million with no mortgage, but can’t pay for groceries, you are solvent, but illiquid. If you pay for the groceries with all that’s left of the 1.5-million mortage you took on the place five years ago, you are liquid, but insolvent. There was a time when reporters were familiar with their subjects and had the names and ‘phone numbers of experts available to explain arcane elements of business news. Imagine that!

The adjustment to the capital rules under discussion here addresses expectations of solvency but do nothing directly to address liquidity.

Be that as it may, OSFI provided some charts with its cover letter to the banks:

Click for Big

As is OSFI’s habit, the Advisory giving effect to the decision, Domestic Systemic Importance and Capital Targets – DTIs, makes only the slightest possible effort to explain the decision:

The common equity surcharge associated with D-SIB status in Canada will be 1% Risk Weighted Assets (RWA).This surcharge takes into account the structure of the Canadian financial system, the importance of large banks to this financial architecture, and the expanded regulatory toolkit to resolve a troubled financial institution. This means that banks designated as a D-SIB will be required to meet an all-in Pillar 1 target common equity Tier 1 (CET1) of 8% RWA commencing January 1, 2016. The 1% capital surcharge will be periodically reviewed in light of national and international developments. This is consistent with the levels and timing set out in the BCBS D-SIB framework.

The BCBS D-SIB framework provides for national discretion to accommodate characteristics of the domestic financial system, and other local features, including the domestic policy framework. The additional capital surcharge for banks designated as systemically important provides credible additional loss absorbency given:

  • Extreme loss events as a percentage of RWA among this peer group over the past 25 years would be less than the combination of the CET1 (2.5%) capital conservation buffer and an additional 1%; and
  • Current business models of the six largest banks are generally less exposed to the fat tailed risks associated with investment banking than some international peers, and the six largest banks have a greater reliance on retail funding models compared to wholesale funding than some international peers – features that proved beneficial in light of the experience of the last financial crisis.
  • From a forward looking perspective:
    • o Canadian banks that hold capital at current targets plus a 1% surcharge (i.e. 8%) should be able to weather a wide range of severe but plausible shocks without becoming non-viable; and
    • o The higher loss absorbency in a crisis scenario (conversion to common equity or permanent write downs) of the 2% to 3% non-common equity capital in Tier 1 and subordinated debt in total capital required by Basel III also adds to the resiliency of banks.

It gives me a warm feeling inside knowing that OSFI has looked at the past twenty-five years of history to gauge extreme loss events; the Basel II guidelines supposedly calibrated more stringently:

The confidence level is fixed at 99.9%, i.e. an institution is expected to suffer losses that exceed its level of tier 1 and tier 2 capital on average once in a thousand years.

OSFI’s document has a few references, but only to other OSFI documents and a few Basel Committee on Banking Supervision hymn books; nothing of any meat, nothing that would provide any comfort that these guys have thought things through and know what they’re doing – but OSFI’s institutional intellectual dishonesty is well known.

Their efforts may be compared – just for starters – with a paper titled Australia: Addressing Systemic Risk Through Higher Loss Absorbency—Technical Note, published by the IMF and reposted by the Australian Prudential Regulation Authority. One of the useful features of this report is “Table 4. Cross-Country Comparison of Approaches to D-SIBs”, which – although one can hardly credit it – looks at what other countries are doing! Here’s an extract:

Country HLA
Singapore 2 percent additional by 2015
Sweden Accelerated adoption of Basel III; plus 3 percent by 2013; 5 percent by 2015
Switzerland 19 percent of RWA total capital, of which up to 9 percent cocos, by 2016
United Kingdom Proposal: 3 percent additional to Basel III and up to 17 percent of RWA loss absorbency for the largest institutions and ring-fenced entities
United States Supplementary Tier 1 of 3 percent of RWA for complex institutions

Now it may very well be that OSFI is taking a prudent route in being so much more lenient with the banks than their international counterparts – but you’d never know it from reading OSFI material. Canadians are forced to take it on trust that the banking regulator knows what it’s doing; and OSFI’s arrogance makes such trust an awfully scarce commodity.

One highly recommended example of how a prudential regulator should operate is the UK’s Independent Commission on Banking – Final Report Recommendations – September 2011:

The Independent Commission on Banking (the Commission) was established by the Government in June 2010 to consider structural and related non-structural reforms to the UK banking sector to promote financial stability and competition. The Commission was asked to report to the Cabinet Committee on Banking Reform by the end of September 2011. Its members are Sir John Vickers (Chair), Clare Spottiswoode, Martin Taylor, Bill Winters and Martin Wolf.

This report has one of its recommendations highlighted in the table extracted above:

As to that, the Commission recommends that the retail and other activities of large UK banking groups should both have primary loss-absorbing capacity of at least 17%-20%. Equity and other capital would be part of that (or all if a bank so wished). Primary loss absorbing capacity also includes long-term unsecured debt that regulators could require to bear losses in resolution (bail-in bonds). If market participants chose, and regulators were satisfied that the instruments were appropriate, primary loss-absorbing capacity could also include contingent capital (‘cocos’) that (like equity) takes losses before resolution. Including properly loss-absorbing debt alongside equity in this way offers the benefit that debt holders have a particular interest, in a way that equity holders do not, in guarding against downside risk. If primary loss-absorbing capacity is wiped out, regulators should also have the power to impose losses on other creditors in resolution, if necessary.

Assiduous Readers will recognize that I have a fundamental distaste for the trashing of five hundred years of bankruptcy law implied by the last sentence, but at least the rationale is spelt out in credible format – far different from the Canadian model.

OSFI: Life Insurance Regulatory Framework

Thursday, October 4th, 2012

On September 5 the Office of the Superintendant of Financial Institutions announced:

released a Life Insurance Regulatory Framework to provide life insurance companies and industry stakeholders with an overview of regulatory initiatives that OSFI will be focusing on over the period ending 2016. It outlines how the regulatory framework will evolve to ensure Canadians continue to benefit from a strong life insurance industry.

“In laying out OSFI’s initiatives, we hope to encourage discussion and strong participation by industry stakeholders in our regulatory development process,” said Mark Zelmer, Assistant Superintendent, Regulation Sector. “Canadians have benefited from a strong life insurance industry and a flexible, effective regulatory framework. Our initiatives aim to ensure this continues.”

The Framework outlines OSFI’s priorities and addresses issues such as corporate governance and risk management, evolving regulatory capital requirements, and promoting transparent information on the financial condition of life insurance companies to support the regulatory framework.

“This framework addresses OSFI’s key regulatory objectives and its approach to refining regulatory oversight and guidance that is already robust,” continued Mr. Zelmer. “By issuing the regulatory framework at this time, OSFI hopes it will help life insurers and industry stakeholders in their planning processes.”

I missed this at the time, but it was brought to my attention by Assuiduous Reader dudsy in the comments to another thread.

The document is titled Life Insurance Regulatory Framework. Naturally, my main concern is to parse the text for any hints about the application of the NVCC rule to insurers and insurance holding companies:

OSFI recognizes that life insurance companies are in many ways significantly different than banks, particularly due to the long-term nature of traditional life insurance business. Therefore, in considering these developments, OSFI will not indiscriminately implement any of them (e.g., Basel III) into the life insurance regulatory framework.

To achieve these objectives, OSFI will introduce enhancements to the regulatory framework for life insurance companies through:…Revised regulatory capital requirements guidance that:…Links risk measures to the quality of capital
available to absorb losses

OSFI is approaching the review of the regulatory capital requirements with the belief that, in aggregate, the industry currently has adequate financial resources (total assets) for its current risks.

Capital will improve in terms of its ability to absorb losses, from the perspective of both a “going concern” and a “gone concern” basis.

The last seems quite encouraging, as far as NVCC is concerned. More important to OSFI, however is plausible justification for mission creep and increased employment at OSFI:

OSFI may need more specialized resources as these initiatives are incorporated into our regulatory and supervisory frameworks.

They’re going to introduce something called ORSA, which does not, surprisingly, stand for OSFI Retirees Superannuation Arrangement, but Own Risk and Solvency Assessment:

The minimum capital requirements set in OSFI’s regulatory framework may not be adequate to address this institution-specific risk-taking, as the regulatory capital requirements are based on industry averages which, at any point in time, may not fully capture new risk exposures or product developments. For this reason, institutions should have their ORSA process. Life insurance companies should not simply rely on minimum regulatory capital requirements as a proxy or as a starting point for measuring their own risk profile.

ORSA should not be seen as an OSFI compliance requirement but as a sound business practice. This will be reflected in the principles-based approach OSFI will outline in the ORSA Guideline. The ORSA Guideline will build on existing industry practice and OSFI guidance while considering international practices, in addition to seeking input and perspective from Canadian industry stakeholders.

In the section titled “Evolving Regulatory Capital Requirements”, they say:

The objective of this review is to improve our regulatory capital requirements by:…Improving Risk Measurement…Recognize the quality of capital available to absorb losses on both a “going concern” and a “gone concern” basis

The evolution of regulatory capital requirements into a more risk sensitive framework may result in more volatile regulatory capital requirements (capital available and/or capital required). OSFI will consult with industry to assess whether that volatility provides a true reflection of the evolution of the risk and is thus “appropriate” for purposes of setting regulatory capital requirements, or whether the volatility in capital requirements amplifies the variations in risk and is thus “inappropriate.”

Of great interest is their commentary on accounting standards:

Where necessary, OSFI will consider measures to address inappropriate volatility. For example, we will investigate options to moderate the impact of volatility on regulatory capital requirements, when:
1. For remaining long duration liabilities, markets for matching purposes do not exist, and
2. For solvency purposes, accounting/actuarial rules do not appropriately reflect the long-term characteristics of these portfolios.

That might be code for “Don’t worry about the IFRS Insurance Contracts Exposure Draft, guys!” The Insurance Contracts issue is actually mentioned explicitly in the concluding section of the paper:

The IASB insurance contracts project (IFRS 4 Phase II) will have a significant impact. While the extent of the impact is not fully known (and will not be until the final standard is set), OSFI is committed to consulting with industry stakeholders on how the final standard should be incorporated into the regulatory framework. Ideally, our initiatives would incorporate a final IFRS 4 Phase II standard. However, should a significant delay occur in the IASB work, OSFI will continue to move its work forward using current international financial reporting standards.

The section titled “Capital and Risk Measurement”:

The level of protection being tested by OSFI in QIS 3 is for each risk separately to cover a 1-in-200 year event (a rare, but plausible scenario) over a one-year time horizon. OSFI believes this level of protection would be equivalent to the low end of the investment grade range. An adequate provision after one year is defined as the amount of assets required for the insurer to either fulfil its policyholders’ and senior creditors’ obligations over the remaining lifetime of the obligations or to transfer them to another company.

Of great importance is their admission that:

The current approach to determining liability and regulatory capital requirements for financial guarantees embedded in segregated fund products has the following drawbacks:
• It can produce values that are materially lower than the cost of hedging.

The closes that they get to addressing the NVCC issue with respect to preferred shares is:

OSFI believes that high quality capital instruments should form a substantial part of the capital resources of an insurer when times are good. This provides the company, and OSFI, with the flexibility to respond in a constructive way in times of stress.

OSFI will consider these elements in developing guidance for the level and quality of available capital in the revised regulatory capital requirements.

The review of the definition of capital component is necessary to incorporate lessons learned during the recent financial crisis. These relate to the quality of certain capital instruments during periods of stress, the appropriateness of deductions and adjustments made to regulatory capital. The review provides an opportunity to consider each available capital element and assess its contribution to two goals: financial strength and protection of policyholders and creditors.

Revisions will provide increased transparency with respect to the meaning and purpose of both total (protection of policyholders and senior creditors) and tier 1 (financial strength) capital elements.

OSFI believes going concern capital (tier 1) should be largely comprised of equity (common and perpetual preferred shares). Items not considered to be readily available to absorb losses in a stress scenario (i.e., not fungible, not permanent, introduce an element of double-counting) should be deducted from it. Going concern capital is important to support ongoing insurer viability over the longer term given the longer-term nature of the life insurance business.

Gone concern capital (total) helps ensure that policyholders and senior creditors can be paid when the insurer is in winding-up mode. Gone concern capital may include forms of lower-quality “additional” capital components, such as hybrids and subordinated debt instruments that meet minimum quality criteria.

OSFI plans to issue a draft Definition of Capital paper for public consultation in late 2012 or early 2013.

The phrase “lessons learned during the recent financial crisis” might – might! – be taken as a reference to hybrid capital not defaulting when financial institutions were bailed out, which is the justification for the NVCC rule.

However, the last sentence quoted implies that we’ll start getting some meat in the sandwich sometime around year-end … roughly TWO FREAKING YEARS after the NVCC rule was applied to banks.

The timeline section at the back gives the following estimates for “Definition of Capital”:
Project Initiation: 2011Q1
Quantitative Impact Study: 2013Q3
Public Consultation: 2013Q4
Final Guideline issued: 2014
Implementation Milestone: 2015

At this point, I see no reason to change my views regarding the potential for the eventual imposition of the NVCC rules on insurers and insurance holding companies in a similar manner to banks. The draft consultation to be issued around year-end may help firm up the matter; readers and investors should be aware that I may well change the “Deemed Maturity” date for insurers and insurance holding companies.