New Regulatory Regime for Credit Rating Organizations

The Canadian Securities Administrators (CSA) are adopting National Instrument 25-101 Designated Rating Organizations (NI 25-101), related policies and related consequential amendments, that will impose new requirements on credit rating agencies or organizations (CROs) that wish to have their credit ratings eligible for use in securities legislation. The new instrument, related policies and related consequential amendments will come into force on April 20, 2012.

Background

CROs play a significant role in credit markets, and ratings issued by CROs are routinely referred to in offering and continuous disclosure documents of reporting issuers. However, CROs are not currently subject to formal securities oversight in Canada. The role of CROs in capital markets came under heavy scrutiny after the recent global credit crisis and asset-backed commercial paper crisis, when many assets highly rated by CROs and widely distributed to financial institutions worldwide turned out to be toxic assets. Since then, securities regulators in the United States and Europe have implemented new regulatory frameworks for CROs. The adoption of NI 25-101 is a first step to develop a securities regulatory regime in Canada for CROs that is consistent with international standards and developments.

Designated Rating Organizations

Pursuant to NI 25-101, a CRO may apply for designation as a “designated rating organization” (DRO). The application will be made by filing Form 25-101F1, which will have to be re-filed on an annual basis within 90 days of each DRO's financial year end. Although NI 25-101 will not make it mandatory for CROs to be designated as DROs in order for their credit ratings to be used in offering and continuous disclosure documents, the DRO concept will eventually replace existing references to “approved rating organization” and similar concepts currently found in Canadian securities legislation.

DROs will have to establish, maintain and ensure compliance with a code of conduct that complies with each provision of the IOSCO Code of Conduct Fundamentals for Credit Rating Agencies. A DRO will not be permitted to deviate from its code of conduct unless exemptive relief is obtained from applicable securities regulatory authorities.

In addition to the establishment of, and compliance with a code of conduct, DROs will also be required to:

• have policies and procedures in place to identify and manage conflicts of interest and to prevent inappropriate use or disclosure of certain confidential information;
• not issue or maintain a credit rating in the face of specified conflicts of interest;
• appoint a compliance officer responsible for monitoring and assessing the DRO's compliance with its code of conduct and securities legislation; and
• post a copy of their code of conduct prominently on their website.

Enhanced Disclosure Requirements

In addition, issuers will now be required to provide enhanced disclosure in offering and continuous disclosure documents if they have asked for or received a credit rating from a CRO for any of their outstanding securities, including disclosure of any payments made to a CRO with respect to the provision of such rating or any other services provided by the CRO to the issuer during the last two years.

Civil Liability of CROs

The CSA has indicated that it will continue to monitor developments in the United States, Europe and other jurisdictions and will assess methods of imposing greater civil liability on CROs and increasing CRO accountability.