Covered Bonds in Canada – OSFI’s role in supporting the integrity of the framework — Remarks by Superintendent Jeremy Rudin to the European Covered Bond Council, Vancouver, British Columbia, April 18, 2018

27 April 2018

EMF-ECBC welcomed the Superintendent, Jeremy Rudin at the 27th ECBC Plenary Meeting in Vancouver on the 18 April 2018, to present the OSFI’s role in supporting the integrity of the framework in three ways.


Good morning.

I know that many of you in this room have travelled a long way to be here today. I would like to welcome you to the beautiful city of Vancouver, a place where I spent some happy years at the beginning of my career. My thanks also go to the European Covered Bond Council for inviting me here to share a regulator’s perspective on the issuance of covered bonds. As Canada’s prudential financial regulator, our mandate is to protect the interests of the banks’ depositors and other creditors, while allowing banks to compete effectively and take reasonable risks.

One way that we at the Office of the Superintendent of Financial Institutions, or OSFI, fulfil this mandate is to ensure that the banking system is operating on a stable footing, and can remain resilient in times of stress. Today, I am going to look at the Canadian covered bond market through that lens.

Covered bonds in Canada — their contribution to financial stability

The global financial crisis taught us many lessons, one of them was the importance for banks to have a wide range of funding sources so that they can remain viable in times of stress.

Covered bonds are debt securities issued by a financial institution that are collateralized against a pool of assets designed to cover claims should an issuer fail.

As opposed to asset-backed securities that are created in a securitization and are no longer ‘on the books’, covered bonds continue as obligations of the issuer.

This means the investor has recourse against both the issuer and the pool of cover asset, often known as ‘dual recourse’.

Issuing covered bonds can significantly diversify a bank’s sources of funding, as these instruments differ from both bank senior debt and securitized assets in ways that can be quite important to investors.

The fact that covered bonds offer dual recourse makes them attractive to investors seeking triple-A rated assets, an investor base that few banks can reach with senior debt.

Moreover, Canada has recently put into place a Bank Recapitalization Regime, more commonly known as ‘bail-in’, that provides authorities with a tool that can quickly convert a failing systemically important bank’s senior unsecured debt into common shares.

Under the new bail-in regulations, pubished earlier today by the Department of Finance, an increasing amount of senior debt issued by Canada’s largest banks will be subject to bail-in, further highlighting the differences between covered bonds and senior debt.

While securitized assets are not subject to bail-in, they still differ from covered bonds in significant ways. Covered bonds not only offer dual recourse, they also avoid the incentive problems that can arise when banks originate assets in order to sell them on to investors.

All of this means that covered bond issuance can help diversify a bank’s funding sources, making the bank more resilient in times of stress.

The significance of a legislative framework

Canadian banks only began issuing covered bonds in 2007, and in a short period they have become a valuable funding source for lenders. Since issuing the first Canadian covered bond, total issuance has exceeded $200 billion and the level of outstanding debt has been steadily increasing.

Initially, Canadian covered bond issuance was undertaken using a contractual framework. In the aftermath of the global financial crisis, the Government of Canada determined that a legislative framework would be superior to the contractual approach.

Providing a legislative framework would further diversify the investor pool as some investors choose, or are required to hold only those covered bonds issued under a legislative regime. Moreover, there was a risk that relying on an untested contractual approach would make it less likely that funding would be available when most needed, in times of stress.

The Canadian legal framework increased resilience by providing statutory protection for investors, enhancing disclosure requirements, and prescribing both eligible issuers and cover pool collateral. Under this framework, the national housing agency, Canada Mortgage and Housing Corporation, takes the lead role in administering the framework and maintaining a covered bond registry.

So, where does OSFI fit in? We at OSFI support the integrity of the covered bond framework in three ways:

  1. As I noted earlier, a major part of our mandate is to protect the interests of depositors and other creditors to banks, so we keep a close eye on the safety and soundness of the banks that issue Canadian covered bonds.
  2. We set a limit for issuance of covered bonds by each bank to ensure that the financial stability benefits of covered bonds are not dissipated by excessive issuance.
  3. We play a role in ensuring the soundness of the cover assets themselves.

I will take a few moments to elaborate on each of these three elements.

Supervision of covered bond issuers

The first element is the broad supervision of the issuers.

This is important because, as you know, the first recourse of the holder of a covered bond is to the issuing institution.

Currently, there are seven covered bond issuers in Canada. Six of these are our largest banks, the Domestic Systemically Important Banks, or D-SIBs, all of which are subject to OSFI supervision.

The seventh issuer is the Fédération des caisses Desjardins du Québec, which is the largest deposit-taking cooperative in Canada, supervised by Québec’s regulator, the Autorité des marchés financiers (AMF). Like the issuing banks, this cooperative has been designated as a systemically important financial institution by the AMF.

These issuers are subject to more intense supervisory scrutiny, higher capital requirements, stricter recovery and resolution planning requirements, and enhanced disclosure requirements.

The standards we set for our respective issuers are comparable enough to create a level playing field.

A prudential limit for issuance of covered bonds

Let us turn now to the second element — the prudential limit on the amount of covered bonds each bank can issue.

We have already discussed how covered bonds can contribute to financial stability; but this benefit can be undermined if the issuer sells too many covered bonds.

Consider, for example, what would happen during a significant economic downturn. The issuer could be obliged to replenish the collateral needed to support its existing covered bonds, diminishing the unencumbered assets ultimately backing the obligations to unsecured creditors.

Taken to an extreme, this could impede the issuer’s ability to roll over its unsecured debt, further aggravating the stresses on the institution.

In order to ensure that the financial stability benefits of covered bonds are not dissipated by excessive issuance, OSFI has applied a cap on issuance of four per cent of a bank’s total assets.

We are now taking a hard look at this limit and we are doing so in the context of our expectations on the banks’ overall management of asset encumbrance.

Any revisions that we might make to our approach must encourage banks to maintain enough unencumbered, high-quality assets when times are good to be able to meet both higher collateral requirements, and broader funding needs, if times turn sour.

Details on our thinking and proposed changes to our covered bond limit will emerge later this year when we begin a public consultation process, as we do whenever we revise our guidance.

The collateral — OSFI keeps a close eye on residential mortgage loans

This brings me to the third element — the cover pool assets and our role in supervising the underwriting standards used by issuing banks.

The eligible collateral for Canadian covered bonds is restricted to residential mortgage loans that are not insured against default. These are mortgages for homes on which the borrower has made a down payment of at least 20 per cent.

Residential mortgage lending represents a material portion of the activities at many federally regulated lenders. This importance is reflected in the fact that residential mortgage loans are the only credit products subject to specific OSFI guidance.

In 2012, we first released our dedicated mortgage underwriting guidance, known as Guideline B-20, which sets out clear principles for lenders to follow when underwriting residential mortgage loans. The baseline principles in B-20 emphasize the need for clear underwriting policies, a rigorous assessment of a borrower’s income and capacity to repay their mortgage loan, and a thorough valuation of the underlying property.

Recently, we saw a need to reinforce our expectations and adapt our standards to new developments and risks arising in the marketplace. We were particularly focused on the vulnerabilities stemming from historically high house prices, historically low mortgage rates, and the attendant risk of lender complacency when times are good.

We have strengthened our mortgage underwriting guideline and intensified our supervisory scrutiny in this area.

We are looking for clear evidence that lenders are:

  • taking necessary steps to validate that borrowers can meet their debt obligations through a range of economic conditions, including higher interest rates;
  • ensuring borrowers have a cushion to absorb changes to their cash flow;
  • relying less on collateral values in the underwriting process and more on borrower income in markets where housing prices have risen rapidly or where prices are high relative to incomes; and
  • holding more capital for mortgages to borrowers who have higher risk characteristics.

Some of the changes we recently introduced through our guidance apply only in markets where housing prices are elevated, while others apply nationwide.

For example, to target regions where housing prices are elevated, OSFI introduced additional capital requirements for loans made against properties in those regions.

However, our more rigorous requirements for income verification apply equally across the country.

Why? Because borrowers who cannot repay their mortgages pose the same risk to their lender when their property is in a market where prices are stable as it does in a market where prices are rising.

Similarly, our requirement that debt service limits be applied using a “stressed” interest rate applies nationwide. Because when interest rates rise, they will rise exactly the same amount from coast to coast to coast. Borrowers in the town of Val d’Or, Québec will be affected by rising interest rates just as much as borrowers in the city of Vancouver, British Columbia.


Let me recap. We at OSFI see the contribution that covered bonds can make to the overall stability of the banking system.

We will continue to support the integrity of the Canadian covered bonds framework by:

  • keeping a close eye on the safety and soundness of the banks that issue covered bonds in Canada;
  • ensuring that a prudential limit for issuance of covered bonds prevents excessive issuance and so safeguards the resiliency of banks in times of stress; and
  • ensuring the soundness of cover assets through the close supervisory scrutiny of mortgage underwriting standards in Canada.

The record of stability at Canadian banks has been a source of pride for the financial industry and Canadians more generally. We at OSFI will continue to work hard to ensure that Canadians can have confidence in their financial system.

Thank you for your time and I look forward to your questions.


Find the speech here.