Ontario Commission des 22nd Floor 22e étage
Securities valeurs mobilières 20 Queen Street West 20, rue queen ouest
Commission de l’Ontario Toronto ON M5H 3S8 Toronto ON M5H 3S8
September 19, 2017
In the Matter of the Securities Legislation of Ontario (the Jurisdiction)
and
In the Matter of the Process for Exemptive Relief Applications in Multiple Jurisdictions
and
In the Matter of the European Stability Mechanism and the European Financial Stability Facility (the Filers)
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Filers for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for an exemption from the requirement (as set out in subsection 53(1) of the Legislation) to file and obtain a receipt for a preliminary prospectus and a prospectus in respect of a trade in certain debt securities issued by the Filers if the trade would be a distribution of the security (the Exemption Sought).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission (the OSC) is the principal regulator for this application; and
(b) the Filers have provided notice that subsection 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, Quebec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Yukon, Northwest Territories and Nunavut (together with Ontario, the Jurisdictions).
Interpretation
Terms defined in National Instrument 14-101 Definitions, MI 11-102 and National Instrument 45-106 Prospectus Exemptions (NI 45-106) have the same meaning if used in this decision, unless otherwise defined.
Representations
This decision is based on the following facts represented by the Filers:
The Filers have selected the OSC as the principal regulator because they expect Ontario will be the Jurisdiction in which there is the greatest interest, among the Canadian provinces and territories, in purchasing securities issued by them.
The EFSF was created as a temporary crisis resolution mechanism by the member states of the euro area on June 7, 2010. It was set up in the wake of the euro area sovereign debt crisis as a means of providing financial assistance to euro area member states experiencing or threatened by financing difficulties. Financial assistance provided by the EFSF was financed through the issuance of bonds and other debt instruments in the capital markets.
The EFSF is a limited liability company (société anonyme) incorporated under Luxembourg law and having its office in Luxembourg. It has 17 shareholders, which are Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, The Netherlands, Portugal, Slovakia, Slovenia and Spain (together, the EFSF Member States).
Principal and interest on debt securities issued by the EFSF are fully guaranteed by the EFSF Member States. The contribution keys of each guarantee combined are equal to 100% of EFSF's liabilities. The guarantee mechanism is designed to avoid a situation where the EFSF would default if an EFSF Member State to which it was providing financial assistance defaulted on its payments. Each EFSF Member State is a guarantor, unless it is a beneficiary of financial assistance from the EFSF or ESM, in which case it may "step out" of the guarantee structure for future issuances. Greece, Ireland and Portugal, which have received financial assistance from the EFSF, and Cyprus, which has received financial assistance from the ESM, have stepped out as guarantors of the debt securities of the EFSF. The guarantees are issued on a several (not a joint and several) basis and all guarantors rank equally and pari passu amongst themselves.
If a guarantor does not meet its obligations under the EFSF guarantee mechanism, guarantees from the remaining guarantors are called upon to cover the shortfall by way of an over-guarantee structure. Under the over-guarantee structure, each guarantor provides an over-guarantee contribution of up to 165% of its contribution key percentage multiplied by the relevant EFSF liability. The actual over-guarantee percentage (AOGP) depends on the goal of the over-guarantee structure of ensuring that the over-guarantee contribution keys of the highly-rated guarantors alone cover 100% of each EFSF liability. Currently, the highly-rated guarantors are Austria, Finland, France, Germany, Luxembourg and The Netherlands, each of which has a credit rating for its long-term debt of AA or higher from Standard & Poor’s and Fitch Ratings and Aa2 or higher from Moody’s Service. The AOGP in respect of each EFSF liability is calculated as of the date on which that liability is assumed and is not affected by subsequent changes in the credit rating of any guarantor. The current AOGP (except for short-term instruments) is 160.4452452%.
In the event of guarantor credit ratings being downgraded in the future, it is possible that the AOGP could increase up to the limit of 165% and that the then highly-rated guarantors would no longer guarantee 100% of a future EFSF liability. In such a scenario, the list of highly-rated guarantors would be progressively extended to include guarantors having lower credit ratings until such point that 100% of the EFSF liability is covered.
The EFSF's long-term debt is currently rated AA by Standard & Poor’s, Aa1 by Moody’s and AA by Fitch Ratings.
Following the creation of the ESM in 2012, it was decided that any new requests for financial assistance would be handled by the ESM only. The period for EFSF to enter into new loan agreements ended on June 30, 2013, but its funding currently extends until 2048. As of July 1, 2013, the EFSF may no longer engage in new financing programs or enter into new loan facility agreements. From that date, the ESM is the sole and permanent mechanism for responding to new requests for financial assistance by the EFSF Member States, plus Latvia and Lithuania who joined the euro zone after the creation of the EFSF (together, the ESM Member States). The EFSF will remain active in order to (i) receive loan repayments from beneficiary countries, (ii) make interest and principal payments to holders of EFSF bonds, and (iii) roll over outstanding EFSF bonds, as the maturity of its outstanding loans is longer than the maturity of bonds issued by the EFSF. The EFSF will be dissolved and liquidated when all financial assistance provided to EFSF Member States and all funding instruments issued by the EFSF have been repaid in full. Under its current terms, financial assistance that has been provided by the EFSF may be outstanding until as long as 2054. The final maturity for the financial assistance provided by the EFSF is 2040 for Portugal, 2042 for Ireland, and 2054 for Greece.
The ESM is the permanent crisis resolution mechanism for the ESM Member States. Its purpose is to provide stability support through a number of financial assistance instruments to ESM Member States that are experiencing, or are threatened by, severe financing problems.
The ESM Member States signed an intergovernmental treaty establishing the ESM on February 2, 2012 (the ESM Treaty). The ESM was inaugurated on October 8, 2012.
The ESM is an intergovernmental organization under public international law, having its head office in Luxembourg. The shareholders of the ESM are the ESM Member States.
Following a request for stability support by an ESM Member State, the European Commission (in liaison with the European Central Bank) is mandated by the ESM to make an initial assessment of the application for financial assistance. They assess the risk to the applicant ESM Member State’s financial stability, whether its public debt is sustainable (assessed, wherever appropriate, together with the International Monetary Fund), and its actual or potential financing needs. Based on this assessment, the Board of Governors of the ESM decides whether to grant (in principle) support in the form of a financial assistance facility. The Managing Director of the ESM then makes a proposal for adoption by the Board of Governors for a Financial Assistance Facility Agreement, including the terms of the financial assistance, the policy conditions, and the choice of instruments. Financial assistance is provided only after ensuring compliance with the policy conditions.
The ESM issues debt instruments in order to finance loans and other forms of financial assistance to the ESM Member States. The financial assistance is then used by the relevant ESM Member State for macroeconomic adjustment programs and/or bank recapitalization programs. Commitment to the applicable conditionality is a condition of financial assistance.
The ESM’s total subscribed capital is €704.8 billion, which consists of paid-in capital of €80.55 billion and committed callable capital of €624.3 billion. For so long as the EFSF continues to exist, the consolidated maximum lending capacity of the ESM and EFSF, as set out in the ESM Treaty and subject to review by the ESM’s Board of Governors, is €500 billion. Thus, the ESM’s subscribed capital exceeds the consolidated maximum lending capacity set out in the ESM Treaty by more than 40%. The ESM’s paid-in capital is not available for on-lending, but is maintained to protect creditors. Its committed callable capital is subject, among other safeguards, to an emergency capital call to avoid default on any ESM payment obligation, to be paid within seven days of receipt.
The ESM’s long-term debt is currently rated Aa1 by Moody’s and AAA by Fitch Ratings.
The default waterfall for both the EFSF and ESM is:
(a) Cash on hand.
(b) Issuance of new debt securities in the market.
(c) Emergency liquidity sources, which are specific instruments that the EFSF and ESM have available in the event such an emergency situation arises.
(d) Retained earnings.
(e) In the case of the ESM, capital contributions.
(f) Guarantees in the case of the EFSF and capital calls in the case of the ESM.
For the EFSF guarantees, each guaranteeing EFSF Member State is requested, 10 business days before funds are needed, to provide its proportionate share of the required funds, based on its contribution key, within 2 business days. If there is a shortfall, each guaranteeing EFSF Member State that provided funds following the first request is requested to provide its proportionate share of the shortfall, again based on its contribution key. This process continues until the EFSF has the required funds. The requests in each case are not limited to the EFSF Member States with high credit ratings that have an over-guarantee contribution key, although, as stated above, the intent is for all such over-guarantee contribution keys to cover, in aggregate, the total amount of the indebtedness.
The process for paragraph 16(f) in the case of the ESM is for a capital call to be made to each ESM Member State to provide funds in proportion to its initial capital contribution. In the event of a shortfall, this process is continued through additional capital calls to contributing ESM Member States in the same proportion until the ESM has all required funds. Although contributions by the ESM Member States with high credit ratings are not prescribed by an over-guarantee contribution key, the protection against defaults is, if anything, stronger in the case of the ESM than the EFSF due in part to the ESM’s very high paid-in capital in excess of €80 billion. This stronger protection is reflected in the ESM’s higher credit rating.
The Basel Committee on Banking Supervision has included the Filers in the list of entities receiving a 0% risk weight under the Basel capital Framework. The Filers’ securities will also be included as Level 1 High Quality Liquid Assets (HQLA) under the Basel Committee’s liquidity coverage ratio (LCR) framework. The European Banking Authority, under its role in providing assessment on uniform definition on LCR, has recommended that euro notes issued by the Filers be considered as “Extremely High Quality Liquid Assets”.
Paragraph 2.34(2)(b) of NI 45-106 provides an exemption from the prospectus requirement for a distribution of a debt security issued by or guaranteed by a government of a foreign jurisdiction if the debt security has a designated rating from a designated rating organization or its DRO affiliate.
The goal of the EFSF’s over-guarantee structure is to ensure that the over-guarantee contribution keys of the highly-rated guarantors together guarantee, on a several basis, 100% of each liability of the EFSF. That goal is currently satisfied, with each such highly-rated guarantor having credit ratings for its long-term debt higher than the minimum level for a designated rating of A for Standard & Poor’s, A2 for Moody’s and A for Fitch. However, the EFSF is unable to rely on the exemption in paragraph 2.34(2)(b) of NI 45-106 because no foreign government having a designated rating guarantees the entire amount payable on a debt security issued by the EFSF. Instead the entire amount payable on such a debt security is guaranteed severally by multiple foreign governments each of which has a designated rating.
A capital call is not the same as a guarantee from a legal perspective. Consequently, the ESM is unable to rely on the exemption in paragraph 2.34(2)(b) of NI 45-106 even though ESM debt issuances have the backing of more than €80 billion of paid-in capital from European countries and other mechanisms, including capital calls, that offer comparable, or greater, protection.
The Filers are not in default of securities legislation in any Jurisdiction.
Decision
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted, provided that:
(a) the debt securities have a designated rating from a designated rating organization or its DRO affiliate; and
(b) the debt securities are distributed:
(i) only to “permitted clients” (as defined in National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103)) other than individuals; and
(ii) to investors in a Jurisdiction only by dealers that are registered in that Jurisdiction as a dealer or are relying in that Jurisdiction on the international dealer exemption in section 8.18 of NI 31-103.
The Exemption Sought shall terminate on the earlier of (i) the date that is five years after the effective date of this Decision, and (ii) the coming into force of material amendments to paragraph 2.34(2)(b) of NI 45-106.
“Grant Vingoe”
“Robert P. Hutchison”
Vice Chair Commissioner