Purpose of the proposed approach
For the first time, we will require investors and FSRA to be made aware of whether syndicated mortgage investments bear the red flags (indicia) associated with a high-risk transaction.
For investors, this means they will be better informed.
For FSRA, it enables real-time data collection, which will enable us to identify when high-risk transactions are being marketed to retail investors, and FSRA can then take immediate action to investigate these transactions, which could lead to suspension or revocation of a mortgage brokerage’s licence and/or an Administrative Monetary Penalty if those transactions are not appropriately disclosed and marketed or otherwise are inconsistent with obligations under applicable law.
General framework of the proposed approach
Accountable Governance – FSRA relies on the principal broker and brokers in a mortgage brokerage to create an appropriate supervision framework for a brokerage’s operations and to provide oversight over the actions of its agents and brokers.
Risk-based – FSRA’s level of supervision of a brokerage will depend on the nature, size, complexity and risk profile of the brokerage. Where identified risks are higher, such as they are engaged in high-risk syndicated mortgage transactions, the expected level of supervision will increase accordingly.
Data-driven judgement – FSRA will focus on collecting data from brokerages and using it to appropriately assess and target supervision on the highest risk brokerages.
Proactive – FSRA will (e.g. by identifying those engaged in high-risk syndicated mortgage transactions) create forward-looking risk assessments of brokerages to implement processes to identify issues early and provide timely intervention, as required.
Targeted – FSRA will, as early as practicable in the sales and mortgage processes, focus on high-risk syndicated mortgage transactions with retail investors and brokerages that are putting retail investors at the highest risk of loss. Retail investors generally have less knowledge, experience and resources to assess and absorb potential losses from riskier syndicated mortgage investments.
High-risk syndicated mortgages / risk-based framework
Based on an analysis of 246 syndicated mortgage transactions completed over the past several years, FSRA identified the three risk factors below as the key red flags of potential harm to retail investors.
- High Loan-to-value Ratio – In transactions where the loan-to-value is greater than 100% (e.g. once all debt with equal or greater priority to the syndicated mortgage is fully drawn), there is risk that the mortgage security may not be enough to cover the syndicated mortgage if the investment project fails. The value of the property used must be the value of the property based on its current condition, use and zoning as of the appraisal date.
- Subordination Clause – If the syndicated mortgage includes a subordination clause, there is risk that the priority of the syndicated mortgage may be lowered (‘subordinated’) behind other debt without the investors’ consent, potentially leaving investors with insufficient security to cover their syndicated mortgage (e.g. a loan-to-value ratio greater than 100%).
- Conflicts of Interest – In transactions where the borrower or developer is related to the mortgage administrator, there is risk that the administrator is not independent and may favour the interests of the borrower/developer over those of the investors. That is, the administrator may not properly represent the interests of investors against the borrower due to a conflict between the interests.
FSRA will require brokerages to provide retail investors an additional summary disclosure for syndicated mortgage transactions that have one or more of the above-noted indicia of high risks in a syndicated mortgage. See proposed form of disclosure, form 3.2.1 which, when adopted, will be part of form 3.2.
Mortgage brokerages that deal with designated investors1 will not be affected by this targeted approach.
For high-risk syndicated mortgages, mortgage brokerages will be required to submit to FSRA a proposed new Form 3.2.1 – Supplemental Disclosure for Retail Investors in a High-risk Syndicated Mortgage, in addition to the already required disclosure form 3.2.
The summary disclosure provided in form 3.2.1 will:
- provide retail investors who wish to invest in high-risk syndicated mortgages with a clear warning that the investment is risky;
- outline the specific risks related to high-leverage mortgage security, and whether there are related parties involved in the syndicated mortgage transaction; and
- summarize the fees payable to the mortgage brokerage, broker and/or agent and any related parties for the high-risk syndicated mortgage investment.
Real-time Review of High-risk Syndicated Mortgages
Effective June 8, 2019, FSRA Rule 2019-001 (“Assessments and Fees”) requires that mortgage brokerages must file with FSRA the investor disclosure form (3.2) within five (5) days of providing it to the first potential or actual investor in a non-qualified syndicated mortgage, along with a $200 fee to defray FSRA’s costs.
In addition, once form 3.2.1 is formally adopted, mortgage brokerages must file the supplemental disclosure form (3.2.1) within five (5) days of providing it to the first potential or actual retail investor in a high-risk syndicated mortgage. The filing of this form does not require payment of an extra $200, if the fee has already been paid with the filing of a form 3.2 for the syndicated mortgage.
Filing of the forms with FSRA is not required for each subsequent potential or actual investor in a syndicated mortgage; however, the disclosure forms 3.2 and (once formally adopted) 3.2.1 must be provided to each potential or actual investor.
The syndicated mortgage disclosure form(s) must be submitted in hard copy.
As a result of the Fee rule and supplemental disclosure, FSRA will capture real-time data including but not limited to the amount, nature and purpose of new non-qualified syndicated mortgage transactions. At any time, FSRA may follow up with brokerages to better understand the transactions in which they are involved, to ensure consumer protection. However, FSRA’s resources will be focused on higher-risk transactions linked to retail investors and based on a targeted approach of focusing on the above red flags.
FSRA will reach out to mortgage brokerages that have brokered high-risk syndicated mortgages in the past to ensure they are submitting fees and the required forms appropriately. Where they are not, FSRA will take appropriate action (e.g., enforcement and onsite reviews).
FSRA has a range of enforcement actions that may be implemented in cases of non-compliance with the supplemental disclosure requirement. These enforcement options include suspension or revocation of licence and/or Administrative Monetary Penalties.
For the consumer – The new disclosure form will:
- Promote greater awareness that syndicated mortgages can be high-risk investments and that they should understand these risks before making a decision to invest their money in these products.
For the regulator – The new disclosure form will:
- Enable FSRA to quickly assess the level of risk of the mortgage transaction in real-time, to identify when high-risk transactions are being marketed and then take action. Actions could include suspension or revocation of a brokerage’s licence and/or requiring the payment of an Administrative Monetary Penalty if the required disclosures or filings are not completed on a timely basis or if such transactions do not otherwise comply with applicable law.
- Real-time data collected through the filing of disclosure forms will provide FSRA with an enhanced understanding of the syndicated mortgage market overall and the role of high-risk transactions.
For the industry – The new disclosure form will:
- Foster professional conduct and practices, deterring deceptive or fraudulent conduct through appropriate additional regulatory burden for a small percentage of mortgage brokerages engaged in high-risk transactions.
- Support increased confidence in the syndicated mortgage market by clearly identifying high-risk transactions.
FSRA is committed to promoting high standards of business conduct, protecting the rights and interests of consumers, and fostering, strong, sustainable, competitive and innovative financial services sectors.
1. The designated classes of investors are defined in Section 2 of Ontario Regulation 188/08 (Mortgage Brokerages: Standards of Practice). There are 13 classes of designated investors. These include classes for individuals who have net income before taxes and net financial assets above a defined limit.