FSRA Consultation on Supervision Approach for Non-Qualified Syndicated Mortgage Investments (NQSMIs) with Permitted Clients and Legacy NQSMIs

Several comments indicated support for the change in regulation of non-qualified syndicated mortgage investments(s) (NQSMIs). They noted: 

• The data-driven, risk-based approach strikes an appropriate balance between protections for retail investors and reduced burden for transactions with permitted clients.  
• Data reporting will provide an overview of trends, especially during these uncertain times. 
• There is support for policies that support FSRA principles-based regulation, with an ability to enforce and provide exemptive relief. 
• The Permitted Client threshold is appropriate.

We thank the commenters for their support.

FSRA will use a risk-based and data-driven approach to supervise NQSMIs with Permitted Clients and Legacy NQSMIs as described in our Approach Guidance No. MB0041APP. 

Several comments indicated the industry may require a longer transition period to prepare for the change in regulation. Commenters suggested an effective transfer date of July 1, 2021.

The effective date of the transfer is decided by Ontario government. In response to stakeholder feedback, it has been moved to July 1, 2021 from March 1, 2021.

Comments suggested:

• It would be more effective and less burdensome if all NQSMIs were regulated by one regulator. This would avoid having some entities report to both FSRA and the OSC and creating a barrier to entry.
• Regulatory duplication should be eliminated in cases where oversight by FSRA of mortgage arranging may not be required because coverage may already exist under the OSC regime.
• Transactions with Permitted Clients should be allowed to be completed through an OSC registrant. For example, registration with the OSC should not be triggered if there are three investors in a mortgage, two of which are Permitted Clients and one of which is a non-Permitted Client.
• Avoiding regulatory duplication also avoids duplication of E & O insurance premiums.
• The responsibilities of FSRA and the OSC for overseeing NQSMIs should be clear. The proposed demarcation is complex. It is affected by numerous factors including commercial development aims of the project, loan-to-value ratios, and investor classification as an institutional party or high net worth individual. It is essential, however, that investors are not exposed to potential harm from gaps in regulatory coverage as a result of oversight being split between two agencies.

FSRA will retain oversight of NQSMIs with Permitted Clients¹, while responsibility for regulation of NQSMIs with non-permitted clients will transfer to the OSC.
This change / split in regulation:

• Provides enhanced investor protection for riskier types of syndicated mortgages marketed to non-Permitted Clients (including retail investors); and
• Allows for reduced regulatory burden on NQSMIs with Permitted Clients, which do not require similar expanded protections for non-Permitted Clients under the securities regime.

Reducing Burden re: Distribution of NQSMI and Arranging a Mortgage on behalf of a Borrower
The exemption from licensing under the MBLAA for dealers registered with the OSC was expanded:

• In cases where the NQSMI is being distributed to both Permitted and non-Permitted Clients, the distributor has the option of having all their distributions (to non-Permitted and Permitted Clients) put through a dealer registered with the OSC (e.g., Exempt Market Dealer (EMD)). The dealer is not required to be licensed under MBLAA to conduct such transactions. However, the dealer is required to be licensed under the MBLAA if it is conducting other MBLAA regulated activities.  
• Dealers may also be exempt from licensing under the MBLAA when dealing or trading in NQSMIs with investors and a borrower that is a Permitted Client (i.e., borrower is likely to require the same borrower protections as non-Permitted Client borrowers under the MBLAA).  

The language for the exemption from licensing outlined in O. Reg. 407/07 section 14.1 under the MBLAA should be consistent with the language in O. Reg. 188/08 (i.e., include ‘investors and lenders’ versus only ‘investors’).
The exemption is restricted to dealings with those “who are not permitted clients”: However, registered dealers with the OSC should be able to deal or trade with Permitted Clients as well as non-Permitted Clients.
The exemption also prohibits registered dealers from qualified syndicated mortgages.

Language in O. Reg. 407/07 and O. Reg. 188/08 was made consistent.  

The exemption language in O. Reg. 407/07 was clarified. Registered dealers with the OSC are allowed to deal and/or trade in NQSMIs with investors / lenders and deal with NQSMI Permitted Client borrowers. They do not require a MBLAA licence to do so. However, the dealer does require licensing under the MBLAA if it is conducting other MBLAA regulated activities.  

The exemption in O. Reg. 407/07 does not allow registered dealers to deal or trade in qualified syndicated mortgages (QSMs). This has not changed from the current regulation. QSM transactions continue to be regulated by FSRA.  
 

Comments suggested:

• Renewal of a NQSMI should not require any further reporting to FSRA if the renewal has no new investors replacing existing investors and/or new investors being added to current prior syndication. The Mortgage Servicing Agreement entered with the investors and the Mortgage Administrator should outline what is required at the time of renewal (e.g., whether the administrator can renew with or without investor consent).
• It is burdensome to be subject to filing requirements at every mortgage renewal. The industry sometimes keeps renewal terms shorter to keep financing costs down for clients.
• Given how development/construction projects are funded through multiple fundings and the associated security value improvement with each funding, reporting should consider multiple fundings and the cumulative nature of lender exposure in the required reporting. Viewing these transactions as “one-time” advances can create confusion and inaccurate or misinterpreted information.
• Loans with retail investors that originated prior to the transfer of regulation for NQSMIs with non-Permitted Clients to the OSC, but which have future advances after that date should not be subject to the prospectus requirement.

Whether new funding related to an existing NQSMI is considered a new NQSMI depends on whether such future advances are previously agreed upon contractually and whether the terms of the new funding advances change materially.
Where a renewal or new funding is not contemplated in the original mortgage agreement and has to be renegotiated, or if the terms of the new funding change materially, FSRA considers it a new NQSMI.
See also comment and response no. 6 in Annex A of OSC Notice of Amendments to OSC Rule 45-501 – Ontario Prospectus and Registration Exemptions relating to Syndicated Mortgages, December 7, 2020. 
 

Several comments suggested:

• The threshold for NQSMIs transactions that should remain with FSRA (i.e., those with Permitted Clients) may be too high.
• NQSMIs with Accredited Investors and Permitted Clients should remain under FSRA oversight.
• Other criteria should be considered in identifying such a threshold. For example, projects could be categorized by size in dollar amount / number of investors.
• Level of wealth is not always an indication of financial sophistication. Priority, therefore, should be given to developing and adopting a genuine test for measuring an investor’s financial acumen and ability to evaluate risk.

The definition of Permitted Client should be expanded to include:

• Accredited investors, where no commission is being paid to secure such investors;
• Mortgage brokerages, brokers or agents. As individuals and firms qualified to advise investor clients, they should be qualified to invest on their own behalf. A mortgage brokerage acting on its own behalf is currently a member of a Designated Class.
• Close friends, family and business partners of the mortgage brokerage where such investors are not solicited from the public.
• Business associates, who, because of association with the issuer, have a knowledge and understanding of the issuer well beyond that of a “retail investor”.
• Accredited investors with at least $2 million net investable assets as they have illustrated a level of sophistication, or ability to have advisors.

In addition, it was noted that it is important to harmonize the definition of “permitted client” that is proposed to be included in Ontario Regulation 188/08 – Mortgage Brokerages; Standards of Practice with the current definition of a “permitted client” in National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations.

The Permitted Client delineation for NQSMI transactions that will remain with FSRA was chosen because FSRA estimates that half of the investors in previous high-profile NQSMI cases were members of a designated class of lenders or investors, some of which experienced substantial losses.
Consistent with the framework in place for securities regulators, it is expected that Permitted Client investors / lenders have the resources, investment experience and/or knowledge to manage their investments, and do not require the enhanced investor protections that were developed to protect less sophisticated investors under the FSRA or securities regimes.
We note project size and the number of investors is not generally determinative as to whether investors require enhanced protections and that parties could easily structure investments to avoid limits on project size or number of investors.
The definition of Permitted Client in O. Reg. 188/08 is substantially the same and has the same effect as that in National Instrument 31-103, reducing burden and uncertainty and allowing consistency with definitions used in the securities regime.
We note that a full transfer of oversight of all NQSMIs (including NQSMIs distributed to Permitted Clients) was originally contemplated. Based on input from stakeholders, we believe that the revised approach, where NQSMI transactions distributed to Permitted Clients will remain with FSRA, strikes an appropriate balance.

A comment noted:
Obligations in O. Reg. 188/08 differentiate between individual and entity Permitted Clients. However, what is the difference if an investor invested through an entity (Personal Investment Corporation) or personally in their own name?

FSRA acknowledges the comment of the stakeholder.
Notwithstanding the above, the establishment of a personal investment corporation (PIC) is an indication of financial sophistication, which is perceived to require reduced investor protections compared to an individual.

Commenters asked:

• What are the requirements for verifying investor status? A practice Engagement Manual might be a good method to ensure consistency throughout the industry.
• Is verification of investor status required for each NQSMI transaction or only at initial participation as a “new” brokerage Permitted Clients? Most clients are repeat clients and maintaining a lender client list may be an easier way to maintain and provide support without creating duplication in efforts.
• Can allowing investors the right to waive any such assessment or verification be considered?

In addition, if the investor would like to proceed with an investment regardless of advice to the contrary, standard forms of waiver of liability should be available to standardize the industry. 

Mortgage brokerages must take reasonable steps to verify the status of a client (Permitted Client or non-Permitted Client). As noted in FSRA’s proposed Approach Guidance, these steps should include, at a minimum:

• Documenting the steps taken to confirm investor status; and
• Obtaining signed confirmation of Permitted Client status from the investor / lender and/or borrower.

Investor status determines whether the transaction falls under the securities regime with respect to distribution of an NQSMI. As such, investors / lenders will not be allowed to waive the obligation of a mortgage brokerage to confirm their status.

A commenter noted:

• Where are the borrower classes define? What are the categories? 

Permitted Client is a categorization of clients. Clients may be borrowers or investors. FSRA has clarified this in its Approach Guidance. 

One commenter suggested concern with reduced disclosures for Permitted Clients (i.e. no offering memorandum required).
Another noted the conflict of interest disclosure obligations should be consistent across all client classes. The industry is struggling to treat investors differently.

Permitted Clients represent clients with strong investment knowledge and experience and / or resources, and we are of the view that they would have the ability to obtain all the information they require to make and manage their investment decisions without FSRA prescribing certain disclosure. If a mortgage brokerage determines certain investors require specific additional disclosures, or if an investor requests additional information, there is no prohibition for the brokerage to provide such disclosure.
In addition, the approach generally aligns with the approach in the securities regime, so that we are levelling the playing field for dealers/brokers who conduct the same business.

One commenter suggested marketing materials and presentations should be prohibited from containing statements that the investment is “mortgage-backed” or “secured by a mortgage registered on title” unless the materials and presentations immediately state, with equal prominence, that:
(a) the mortgage does not make the investment secure or guarantee repayment because the value of the land may be insufficient to cover all debts, including those that may rank ahead of the syndicated mortgage lenders, and
(b) a syndicated mortgage therefore is an inherently risky investment in which investors may lose some or all the money they invest.
It is imperative that these qualifying statements be included prominently in all marketing materials and presentations. The warnings will not be effective if they are only conveyed later in the subscription process or solely through disclosure documents at the point of sale.

The MBLAA and its regulations contain several provisions prohibiting licensees from giving or inducing others to give false or deceptive information when carrying on the business of dealing or trading in mortgages.  
The public relations materials of licensees must not contain false, misleading or deceptive information. Statements that misrepresent features (e.g., risks) of a transaction may be considered misleading.
FSRA agrees that any statements that suggest an investment in NQSMI is guaranteed would be misleading.

A commenter noted:

• Disclosure made as part of the original Offering Memorandum (OM) or other provision under OSC should be considered enough for FSRA’s oversight and the required MBLAA disclosures, such as:
• Disclosure of the mortgage administrator’s relationships with each borrower; and
• Disclosure of any conflicts of interest that the mortgage administrator or an employee administering the mortgage may have in connection with the mortgage.

Disclosure as part of an OM under the Securities’ regime does not exempt a mortgage brokerage from its disclosure requirements under MBLAA if the NQSMI transaction falls under FSRA’s oversight.
Mortgage brokerages can choose how they provide required disclosures to Permitted Client investors to fulfill their MBLAA requirements. This could include using valid offering memoranda / information from the memoranda to make the required disclosures.

A commenter noted:

• The definition of “syndicated mortgage” does not appear to recognize related persons and entities (e.g., an individual, corporations owned by the individual, or a corporation and any of its subsidiaries).
• A heavier regulatory burden should not be required when an investor uses funds held under diverse vehicles.
• The use of “permitted syndicate” definition is recommended.

Revising the definition of syndicated mortgage is outside the scope of this current initiative.
The language for the definition of QSM in s. 2 of O. Reg. 188/08 of the MBLAA has been adjusted to be substantially like, and have the same effect as, that under OSC Rule 45-501.
This includes clarification that:

• the syndicated mortgage cannot be subordinated to future financing without the consent of each lender;
• there is no existing agreement that requires the lenders of the syndicated mortgage to consent to future subordination of the syndicated mortgage; and
• no person or company can consent to future subordination of the syndicated mortgage on behalf of the lenders of the syndicated mortgage without obtaining the consent of each lender.

Comments noted:

• The definition of qualified syndicated mortgage investments (QSMIs) included in the OSC consultation document and the draft O. Reg. 188/08 Mortgage Brokerages: Standards of Practice differ slightly.
• For on-going consistency, one regulation / rule should refer to the other.

The qualified mortgage carve-out should be expanded while keeping low-risk syndicated mortgage investments under FSRA oversight. The expanded QSM definition should include:

• All land types, enabling commercial deals and others to be written without residential component.
• A lower LTV threshold. The 90% LTV is too high; the fair market value of a property can be volatile and depends on a variety of factors.
• Fully approved and funded construction mortgages. Initial advances on a qualified construction mortgage can be on a ‘Simple Mortgage’ basis, e.g. ‘land loan’ phase, before project approvals, subject to 90% LTV on ‘as-is’ valuation only.
• If any form of subordination / loss of priority clause is contemplated, it should be quantified, included for qualification purposes, and disclosed. If it cannot be quantified, the mortgage is not suitable as a “qualified syndicated mortgage”. Consent to subordination later without explicit disclosure requirements is inconsistent with the regulatory regime.
• Support for the use of ‘as is’ valuation, LTV <90% (fully drawn), no subordination, and no brokerage conflicts of interest in order to qualify as a QSMIs.
• Syndication is not an indicator of loan/borrower risk.
•  Eligible investors should include any single lender, single ‘permitted’ lender, multiple ‘permitted’ lenders, multiple retail lenders, agents and brokers.

A qualified syndicated mortgage is intended to be secured by a ‘straightforward’ type of existing property (primarily residential). It is not appropriate that the definition be broadened to include other types of property or projects, such as development projects or commercial or industrial property.
Investments in properties that are primarily commercial or industrial are more likely to require an understanding of the risks relating to an operating business (e.g., an approved zoning at origination can be further amended and cause delays) and have not been included in the definition of qualified syndicated mortgage for this reason.
See comment and response no. 9 in Annex A of OSC Notice of Amendments to OSC Rule 45-501 – Ontario Prospectus and Registration Exemptions relating to Syndicated Mortgages, December 7, 2020.

The definition of a NQSMI may be too vague. It is unclear who is the issuer.

See comment and response no. 7 in Annex A of OSC Notice of Amendments to OSC Rule 45-501 – Ontario Prospectus and Registration Exemptions relating to Syndicated Mortgages, December 7, 2020. 

Comments indicated:

• The frequency and costs of reporting should be limited / minimal.
• Frequent reporting places a regulatory burden on lower-risk brokerages and administrators who deal exclusively with Permitted Clients.
• Outside of the Annual Information Return (AIR), there should be a reduction in reporting and other compliance requirements for brokerages and administrators who have limited their syndicated mortgage activity to commercial transactions involving sophisticated parties.
• The regulator should define exactly what it is looking for and why to make it easier for the parties providing the information to comply.
• All data submitted by NQSMI participants should be given the highest standard of protections by FSRA, the OSC and MOF, and retained solely for purposes consistent with FSRA’s supervisory plan, namely compliance and review of NQSMI related activities.
• When a NQSMI is renewed it is treated as a new distribution and a new filing is triggered. We understand that under OSC rules, this would no longer be the case. We would appreciate clarification from FSRA regarding filing expectations for NQSMI that are renewed at maturity.
• There should be improved data interface / software tools / website to lessen the burden of providing / analyzing information (i.e., leverage the power of technology).
• Specific feedback was provided for each of the data points required in the Quarterly Data Report.

Mortgage brokerages must submit to FSRA quarterly data reports for NQSMIs with Permitted Clients. This level of reporting is substantially less than the current supervisory approach, which requires mortgage brokerages to complete and file with FSRA each form 3.2 (although streamlined) provided to the first potential investor / lender
While the data to be reported include the names of investors, as previously provided on the Form 3 series, this information will not be published on the FSRA website and will continue to be held in strict confidence by the regulator, as appropriate.
As Form 3.2 no longer applies to NQSMI transactions with Permitted Clients on or after the transfer date, the $200 fee also no longer applies to these transactions, resulting in savings for every NQSMI transaction.
Specific feedback was provided for each of the data points required in the Quarterly Data Report. See Revised Table at end of Approach guidance.
Reporting requirements will be divided between the OSC and FSRA depending upon which will have primary oversight.

One comment suggested the current requirement for audited financial statements for a borrower in a NQSMI is not practical and should be removed.

The requirement for audited financial statements for a borrower will not apply to NQSMIs with Permitted Clients under the MBLAA regime after the transfer date based on the amendment to section 31.1 of O. Reg. 188/08. See securities regime requirements for NQSMI transactions with non-Permitted Clients.

Also see comment and response no. 15 in Annex A of OSC Notice of Amendments to OSC Rule 45-501 – Ontario Prospectus and Registration Exemptions relating to Syndicated Mortgages, December 7, 2020..

Comments indicated concern with obtaining ‘as is’ appraisals, how often they have to be updated, and the costs related to obtaining such appraisals, as well as use of LTVs:

• It is extraordinarily difficult to value a project during construction. The universe of potential buyers is reduced. The value is constantly changing when a project is under development and construction.
• LTV does not provide a reasonable proxy of the value that could be created through an appropriately managed “workout” scenario.
• A 6-month or 12-month updated appraisal requirement is not practical on construction projects. “As is” and “as complete” appraisals are obtained at the start of a project.
• To obtain an appraisal on a project in progress is costly. It is unlikely the borrower or investor would be willing to bear these costs.
• The mortgage brokerage should have discretion as to whether an appraisal is required.
• If a “value” is to be provided, additional clarity must be provided on the valuation approach to be taken.
• It may be challenging to find an AACI designated member to appraise a single-family residential property (or residential up to 4 units maximum) that is funded by a NQSMI. Most AACI designated members do not typically appraise such properties. As such, it may be far more expensive than it need be. The appraiser should have the competence and the scope set out by the Appraisal Institute of Canada to appraise the property type.
• An appraisal is not necessarily the driving decision to lend money.

The amendment to section 31.1 of O. Reg. 188/08 removes the explicit requirement for an appraisal for NQSMIs with Permitted Clients under the MBLAA regime.
Nonetheless, the LTV to be included in the quarterly data report must be calculated using the estimated “as is” market value of the property.
In addition, for construction and development mortgages, the Loan-to-Cost (LTC) ratio must be included in the quarterly data report.
Both the LTV and the LTC are required to be reported as they indicate a level of risk to the lender (i.e., a higher percentage represents a higher risk as the borrower has less equity interest in the project).
See securities regime appraisal requirements for NQSMI transactions with non-Permitted Clients.

Also see comment and response no. 15 in Annex A of OSC Notice of Amendments to OSC Rule 45-501 – Ontario Prospectus and Registration Exemptions relating to Syndicated Mortgages, December 7, 2020.

One comment suggested that regulators could co-ordinate with / rely on Auditors/Accountants to provide potential assurance that transactions are in line with FSRA/OSC requirements and reduce burden on the regulator. This could be a way to reduce duplicate work being performed by the auditors as well as the regulator.

FSRA examines mortgage brokerages and other licensees to assess regulatory compliance and consumer harm. At this time, FSRA is not contemplating requiring auditors / accountants to provide additional assurance because of the cost implication.

One comment suggested “Business associates” should encompass individuals who, because of association with the issuer, have a knowledge and understanding of the issuer well beyond that of a “retail investor”.

This is a policy issue beyond the scope of this current initiative.

One comment suggested FSRA should have exemptive relief power.
Exemptive relief orders provide clarity to businesses and the public on how a business may operate in a specific circumstance, as most exemptive relief orders will have terms and conditions attached to them.
Exemptive relief uses similar principles to “sandboxes.”
An example of when exemptive relief may have been appropriate relates to the requirement in Reg 188/08 that requires lenders to obtain audited financial statements from borrowers.

This is a policy issue beyond the scope of this current initiative.

One comment suggested it would be helpful for FSRA to provide clarity on which of its rules would be applicable to multi-jurisdictional transactions, such as when a mortgage is syndicated to investors located in Ontario on a property located in another Canadian jurisdiction.

The commenter may review the MBRCC tool or contact FSRA for further clarity on the multi-jurisdictional requirements. It is expected that licensees comply with requirements in all relevant jurisdictions.

One comment suggested licensing courses and / or continuing education should cover NQSMI related topics / brokerage obligations.

FSRA will review licensing education requirements to ensure relevant topics and competencies are covered.