On March 9, the Canadian Securities Administrators (CSA) published a notice of the adoption of National Instrument 25-101 Designated Rating Organizations along with related consequential amendments.
The Instrument sets out relevant filing, disclosure, governance and other requirements applicable to a “designated rating organizations”. The “designation” requirement or trigger is set out (or will be set out) in securities legislation. The result is that a credit rating organization (CRO) will be required to apply to be a “designated rating organization” (DRO) in order for its credit ratings to be used to satisfy securities law requirements that require a credit rating to be given by a “designated rating organization.”
NI 25-101 provides the governance framework for DROs but there is, at the current time, no requirement to for credit ratings to be given by DROs – this is something the regulators will implement in the future. There will also be no change to the Canadian framework that exempts CROs from the civil liability provisions of securities legislation. The consequential amendments do, however, impact the disclosure required in a short or long form prospectus (including investment fund prospectus) as well as annual information forms (AIFs).
The Instrument and all consequential amendments come into force April 20, 2012. In the case of the prospectus disclosure (long form, investment fund and short form) the changes apply where the preliminary prospectus is filed on or after April 20, 2012. The changes to the disclosure required in an AIF apply for disclosure in respect of financial years ending on or after April 20, 2012.
The Instrument sets out the relevant filing, disclosure, governance and other requirements applicable to a “designated rating organization”. The Instrument includes the concept of a “DRO affiliate” and allows for a DRO to identify “DRO affiliates” in order to address the fact that a rating may be issued by either the DRO itself or a DRO affiliate.
A DRO must apply for designation by filing a Form 25-101F1 (although an NRSRO or “nationally recognized statistical rating organization”, as defined in the Securities and Exchange Act of 1934 may file its most recent form NRSRO as filed with the SEC). Any foreign CRO that applies to be a DRO must also file a Form 25-101F2 (designating an agent for service of process in Canada), as well as in respect of any “DRO affiliate” that does not have an office in Canada. A DRO is required to make an annual filing within 90 days of its year end, and promptly file any amendments to the information filed if it is materially inaccurate. The agent for service of process must remain in place for six years after the DRO has ceased to be a DRO or an DRO affiliate has ceased to be such.
The Instrument also imposes a number of requirements aimed at the independence and integrity of the ratings process.
Board of Directors
The Instrument requires that a DRO, or its DRO affiliate that is its parent, have a board of directors and sets out minimum composition and independence requirements for the board.
Code of Conduct
A DRO must establish, maintain and comply with a code of conduct that complies with Appendix “A” to the Instrument. A copy of the code must be posted prominently on its website and any amendments must be posted within five business days of the amendment coming into effect. The code of conduct must address, among other things:
- Quality and integrity of ratings process,
- Independence and conflicts of interest, and
- Responsibilities to the investing public and issuers.
The Code must also specify that it must not be waived.
A DRO is required to have a compliance officer that monitors and assesses compliance by the DRO and its employees with the code of conduct and securities legislation. The compensation of the compliance officer must not be linked to the financial performance of the DRO or its DRO affiliates and must be determined in a matter that preserves his or her independence.
Books and records
A DRO must keep books and records as prescribed, for a period of seven years in a safe location and durable form and in a manner that permits them to be furnished promptly to securities regulatory authorities on request. On this point, it should be noted that the OSC will have access to the books and records of both a DRO and DRO affiliate.
Impact on “Approved” ratings
A number of Canadian securities law rules include the concept of an “approved credit rating” or “approved rating organization”. Such “approved credit rating organizations” currently include Dominion Bond Rating Service Limited, Fitch Ratings, Moody's Investors Service, Standard & Poor's and any of their respective successors. None of these entities have ever been required to apply to be “approved” or “designated.” The adoption of the Instrument will have no impact on these, at this time, as these definitions are not proposed to be amended.
The regulators have stated in their notice that following the implementation of the Instrument and the application for designation by interested CROs, they propose to make further consequential amendments to, among other things, replace existing references to approved rating organizations and approved credit rating organizations with “designated rating organization”. Similar changes will also be made to the term “approved rating”.
Currently under NI 41-101, an issuer is generally required to file the “consent” of any expert whose statement or opinion is included in the prospectus and any such expert who has filed a consent is subject to civil liability for “misrepresentations” under securities legislation. CROs, however, are exempt from having to consent and the CSA have decided not to make any changes to the exemption.
In the U.S., the Dodd-Frank Wall Street Reform and Consumer Protection Act repealed a similar exemption that exempted an NRSRO from having to provide a consent if its ratings were included in a registration statement. Since the repeal of the U.S. exemption, NRSROs have refused to provide consent to their ratings being included in a registration statement, and the SEC has had to backtrack somewhat. Other jurisdictions have also faced similar problems.
The CSA are not currently proposing such changes because they do not think that the benefits of subjecting designated rating organizations to expert liability in Canada would outweigh the potential costs and have reiterated that, in Canada, the prospectuses and annual information forms must disclose if a credit rating has been sought or if the issuer is aware that one has or will be issued.