The Office of the Superintendent of Financial Institutions has decided to let financial institutions issue covered bonds, subject to certain restrictions.

In a letter to the industry issued in February, OSFI requested that financial institutions refrain from issuing covered bonds while potential regulatory and policy concerns associated with these instruments were reviewed. It has now concluded the initial review of the regulatory considerations.

“We note that covered bonds — debt obligations issued by a deposit taking institution and secured by assets of the DTI or of any of its subsidiaries — provide a number of benefits but also raise concerns,” it says. “For example, covered bonds can improve funding diversification and lower costs. However, they also create a preferred class of depositors, reducing the residual level of assets available to be used to repay unsecured depositors (including the Canada Deposit Insurance Corporation) or other creditors in the event of insolvency, depending on the amount issued and the nature of credit enhancements.”

To balance the benefits and concerns associated with covered bonds, OSFI has decided to limit the issuance of covered bonds, and to impose several conditions: covered bonds must not, at the time of issuance, make up more than 4% of the total assets of the DTI; total assets for the purpose of the limit will be equal to the numerator of the asset-to-capital multiple; and, OSFI expects DTIs’ current pledging policies to be amended to specifically take into account the issuance of these instruments, consistent with the limits and conditions it is imposing. OSFI also expects board or committee approval of these specific policy changes prior to the issuance of covered bonds.

If at any time after issuance the 4% limit is exceeded, the firm must immediately notify OSFI, it says. Excesses due to factors not under the control of the issuing institution, such as foreign exchange fluctuations, will not require the firm to take action to reduce the amount outstanding. For other excesses, the firm must provide a plan showing how it proposes to eliminate the excess quickly.