(Post-FSRA board approved version)

Background

FSRA’s Board Approved Draft Capital Adequacy Requirements for Credit Unions and Caisses Populaires Rule (Rule) promotes a stronger credit union sector through the assessment and maintenance of adequate and appropriate forms of internal capital and better alignment with international standards with adjustments similar to other Canadian jurisdictions.

The Rule sets new requirements for:

  • calculation of capital ratios and supervisory minimums (Tier 1 and Tier 2 Capital, Risk Weighted Assets, Capital Conservation Buffer, Total Capital Ratio, and Leverage Ratio) Credit, Operational, and Market Risk
  • internal Capital Adequacy Assessment Process (ICAAP)

The Rule will be made under the new Credit Unions and Caisses Populaires Act, 2020 (CUCPA 2020), once proclaimed into force.  

Stakeholder consultation

On June 14, 2021, the Rule was posted for public consultation for a 90-day period, ending on September 14, 2021. During this period, FSRA held a technical briefing that was accessible to the public and engaged in multiple meetings with credit union sector stakeholders to respond to comments and questions about the Rule.

Outcome of consultation

Based on the feedback from the consultation, FSRA has made the following changes to the Rule:

  • expanding the risk weighting categories to include additional investments, in a manner consistent with international best practices (e.g., Basel Committee on Banking Supervision capital requirements). For example:
    • inclusion of additional investments that would receive a 100% risk weighting and not be subject, by default, to a 1250% risk weighting
    • clarifying the type of investments that receive a 1250% risk weighting
    • providing details on the risk weighting for corporate bonds and short-term commercial paper
    • providing details on the risk weighting for equity investments in funds
  • adding a new section on regulatory adjustments for investments in capital instruments and other Total Loss Absorbing Capacity (TLAC) instruments of financial institutions and foreign institutions
  • adding a new section on equity investments in funds
  • updating the definition section to reflect added risk weighted investments

Feedback from the consultation

Most stakeholder comments were requests for clarification on risk weightings to ensure that all relevant asset categories are treated in accordance with international standards in a manner appropriate for Ontario’s credit unions. During the consultation period, it became apparent that a number of asset categories not addressed in the consultation draft are relevant for Ontario’s credit unions and should be included in the Rule. FSRA has made many changes to the Rule to reflect stakeholder feedback, such as including the internationally accepted treatment for investments relevant to Ontario credit unions. The changes are intended to bring the document more in line with international standards and improve consistency. The changes do not change the original policy intent of the Rule nor do they introduce new requirements beyond the internationally accepted treatments as requested in stakeholder submissions.

FSRA is also developing reporting templates that reflect the application of the Rule to support credit unions’ capital reporting to FSRA if the Rule comes into force.

FSRA would like to thank all stakeholders that commented on the Rule. FSRA has carefully considered all comments before finalizing and submitting the Rule to the Minister of Finance.

FSRA received written submissions from the following ten credit unions and associations, which are available on FSRA’s website:

 

Organization

Representative

1

Alterna Savings and Credit Union (Alterna)

Rob Paterson

2

Canadian Bankers Association (CBA)

Alex Ciappara

3

Canadian Credit Union Association (CCUA)

Nick Best

4

Central 1 Credit Union (Central 1)

-

5

Desjardins Group (Desjardins)

Bernard Brun

6

DUCA Credit Union (DUCA)

Doug Conick

7

FirstOntario Credit Union (FirstOntario)

Lloyd Smith

8

“Group of Five”

Meridian, FirstOntario, DUCA, Alterna, Libro

9

Libro Credit Union (Libro)

Stephen Bolton

10

Meridian Credit Union (Meridian)

Tara Daniel

Subject

Stakeholders

Summary of Stakeholders’ Feedback

FSRA’s Response

Transition Period

  • Alterna
  • CCUA
  • DUCA
  • FirstOntario
  • Group of Five
  • Libro
  • Meridian

Stakeholders proposed that the minimum capital requirements detailed in the Rule be introduced through a transition period.    

 

Stakeholders noted that a transition period will give credit unions adequate time to manage short-term operations and long-term business plans. Without a transition period, there could be unintended business consequences.

 

There were two variations in the request for a transition period:

 

  1. some commenters requested a transition period for all the minimum capital requirements detailed in the Rule
  2. some commenters requested a transition period only for the Capital Conservation Buffer (CCB)

The FSRA CEO will have the power to approve a transition period for a credit union on a case-by-case basis pursuant to section 80 of the CUCPA 2020.

 

The CUCPA 2020 will provide credit unions with greater flexibility on investments and business activities. This greater flexibility may expose credit unions to additional risk and it is therefore important to have appropriate counterbalances in the capital framework to ensure risks are being capitalized and managed appropriately.

 

Under the Rule the minimum CCB is not part of the minimum total capital ratio. If a credit union’s CCB falls below the 2.5% minimum, the credit union would have to meet the proposed requirements detailed in section 14 of the Rule.

 

The CCB is designed to avoid breaches of the minimum total capital ratio and can be drawn down during periods of stress. Other jurisdictions in Canada have adopted a CCB.

 

As such, FSRA will only consider a transition period on a case-by-case basis.

Grandfathering Investments

  • CCUA
  • Libro

Stakeholders requested clarification on the following as it relates to investment shares being considered Tier 1 capital:

  • whether shares issued before the Rule coming into force are considered Tier 1 capital
  • whether shares issued after the Rule comes into force, but issued in the same series and classes as shares issued prior to the Rule coming into force, are considered Tier 1 capital
  • whether shares issued as dividends on investment shares are exempted from the five-year holding period requirement
  • whether investment shares issued after the Rule comes into force but representing payment of dividends on classes and series of investment shares already outstanding prior to the Rule coming into force still qualify as Tier 1 capital
  • whether investment shares included as qualifying contributions to a Registered Retirement Savings Plan that are redeemed before the five-year holding period qualify as Tier 1 capital

Investment shares issued before the Rule comes into force would continue to be treated as Tier 1 capital.  

 

Shares issued after the Rule comes into force would have to meet the requirements set out in the Rule to be considered Tier 1 capital. This includes new shares issued under existing classes of shares and dividends paid as shares on existing investment shares.

 

The CUCPA 2020 will provide credit unions with greater flexibility on investments and business activities. This greater flexibility may expose credit unions to additional risk and it is therefore important to have appropriate counterbalances in the capital framework to ensure risks are being capitalized and managed appropriately.

Redemption Provisions

  • CCUA
  • DUCA

A stakeholder requested confirmation that the following provisions will continue to apply as it relates to redemption of shares:

 

  • redemption provisions for each class and series will be as specified by the original offering statement for that class and series as reviewed and receipted by the applicable Ontario regulatory authority and as communicated to and understood by the purchaser prior to issuance
  • credit unions may redeem only 10% of the shares outstanding in any class in any one year and those shares eligible for redemption during the following 12 months are deducted from Tier 1 calculations (and assigned to Tier 2, whether such redemptions actually occur or not)
  • redemptions (as well as declaration and payment of dividends) are at the discretion of a credit union’s Board of Directors who have a fiduciary duty to allow only those redemptions consistent with the credit union maintaining capital adequacy provisions as required by CUCPA 2020, Regulations and the Rule

 

A stakeholder also proposed that the wording on redeemable shares be updated to align with OSFI.

FSRA confirms that the statements made as they relate to the redemption of shares are correct.

 

Offering statements must conform to the requirements in the Rule. What is outlined in an offering statement still applies unless the credit union is issuing share dividends.

 

For clarification, no shares can be redeemed or purchased for cancellation by the credit union in the first five years after the shares have been issued.  Also, the terms of the shares cannot require the credit union to redeem or purchase the shares at a rate of more than 10% of the outstanding shares of that class during any one year period.

 

Redemptions continue to be at the discretion of a credit union’s Board.

 

Based on the comments received, FSRA has updated the wording on redeemable shares, in a manner consistent with international standards.

Financial Technology and Community Investments

  • Alterna
  • CCUA
  • DUCA
  • FirstOntario
  • Group of Five
  • Meridian

Stakeholders proposed that the limit of 1% of total capital for Financial Technology Investments and Local Community Investments to receive a 100% risk weighting should be increased.

 

Commenters expressed that the 1% limit is too restrictive and that a 1250% risk weighting on investments over that limit is punitive and impacts a credit union’s ability to compete.

The 1% limit is designed to recognize social and innovation-based investments that would otherwise receive a 1250% risk weighting. The 1% limit, which is not reflected in international standards, recognizes the importance of these types of investments for Ontario credit unions. The 1% limit allows flexibility while still ensuring prudent risk management.

 

Without greater detail on the type of investments, FSRA was unable to consider an increase to the 1% limit at this time

 

As a result of the consultation, FSRA has expanded the risk weighting categories in the Rule. Only Financial Technology Investments and Local Community Investments that are not otherwise captured in other categories in the Rule are included in the 1% limit and would receive a 100% risk weighting. Amounts above the 1% limit would attract a 1250% risk weighting.

Asset Categories and Risk Weightings

  • Alterna
  • CCUA
  • DUCA
  • FirstOntario
  • Group of Five
  • Libro
  • Meridian

Stakeholders requested that the following asset categories be included in the Rule:

  • Uninsured Mortgage Loans
  • Past Due Loans
  • Central 1 Investment Shares
  • Investments in Corporate Bonds and Short-Term Commercial Paper
  • Mortgage Backed Securities
  • Unrealized Gains and Accrued Receivables
  • Mortgage Servicing Rights
  • Deferred Tax Assets Arising from Temporary Differences
  • Computer Software Assets

FSRA’s intent is for the risk weightings in the Rule to reflect international standards.

 

FSRA acknowledges that a number of categories were not included in the consultation draft. During the consultation period it became apparent that additional categories should be included in the Rule.

 

Based on the feedback, FSRA has expanded the risk weighting categories as requested, in a manner consistent with international standards.

100% Risk Weightings

  • Alterna
  • CCUA
  • DUCA
  • FirstOntario
  • Group of Five
  • Libro
  • Meridian

Stakeholders requested that the 100% risk weighting categories be expanded to further reflect national and international standards.

 

Commenters expressed that extra clarification is needed to avoid investments incorrectly receiving a 1250% risk weighting.

FSRA’s intent is for the risk weightings in the Rule to reflect international standards.

 

As a result of the consultation, FSRA has expanded the 100% risk weighting category, in a manner consistent with international standards.

1250% Risk Weighting

  • Alterna
  • CCUA
  • DUCA
  • Group of Five
  • Meridian

Stakeholders indicated their concern that the Rule’s treatment for many assets that receive a 100% risk weighting in the Ontario Regulation 237/09 would now receive a 1250% risk weighting.

 

The commenters indicate that a 1250% risk weighting would be overly punitive and may deter credit unions from exploring new business activities.

 

While the CEO has discretion on the risk weighting for investments not captured in the Rule, credit unions may still receive a 1250% risk weighting before a new risk weighting is applied.

FSRA has made changes to clarify the application of the 1250% risk weighting by providing more details in the Asset Classes in Table 2 – Asset Risk Weightings and is more specific on the assets to which the 1250% risk weighting applies.

 

This change will reduce the likelihood that an investment would inappropriately receive a 1250% risk weighting.

Commercial Loans

  • CCUA
  • DUCA
  • FirstOntario
  • Group of Five
  • Libro

Stakeholders requested that the limit of $1.25 million for commercial loans be increased to a range between $3 to $5 million.

 

The proposed increase is to reflect changes in inflation and economic growth. Further, any increase should be reflected in the Liquidity Adequacy Requirement for Credit Unions and Caisses Populaires Rule.

Based on the comments received, FSRA has increased the limit for commercial loans, commensurate to inflation.

Deposits at Financial Institutions

  • Central 1

A stakeholder proposed that the risk weighting of deposits in institutions with a high credit rating and designated as systemically important should be lower than the 20% risk weighting detailed in the Rule.

FSRA’s intent is for the risk weightings in the Rule to reflect international standards. A risk weighting lower than 20% for deposits at financial institutions would not be aligned with international standards.

 

Therefore, FSRA did not implement this change.

Equity Investments in Funds

  • Alterna
  • DUCA
  • FirstOntario
  • Group of Five
  • Meridian

Stakeholders proposed that equity investments in funds be included in the Rule.

 

Stakeholders proposed two methods to determine the capital treatment for equity investments:  

 

  • adopt the Look-Through Approach (LTA) and the Mandate-Based Approach (MBA) detailed in Chapter 3 of OSFI’s Capital Adequacy Requirements Guideline
  • adopt a general requirement to account for non-publicly listed equity exposures at a 400% risk weighting, and publicly listed equity exposures at a 250% risk weighting detailed in the Chapter 4 of OSFI’s proposed Capital Adequacy Requirements Guideline

Based on the comments received, FSRA has expanded the risk weighting categories, which include equity investments in funds, in a manner consistent with international standards.  

 

Although changes to international standards with respect to the capital treatment of equity (or other) investments may be forthcoming, the extent and adoption of those changes are currently unknown. Once proposed changes are introduced, FSRA may consider future revisions to the Rule.

Significant and Non-Significant Investments

  • DUCA
  • Group of Five
  • Meridian

Stakeholders requested clarification on the definition of significant and non-significant investments.

Changes to the Rule have been made to clarify the definition of significant investments.

Capital Conservation Buffer

  • Alterna

A stakeholder proposed that a CCB is unnecessary for the Ontario credit union sector. Instead, they suggested that the ICAAP is sufficient.

FSRA’s position is that the CCB is an integral component of the international capital adequacy framework and has been adopted by international and Canadian jurisdictions.  

 

The CCB is designed to avoid breaches of the minimum total capital ratio and can be drawn down during periods of stress.

 

Therefore, FSRA did not remove the CCB requirement.

 

The CUCPA 2020 will provide credit unions with greater flexibility on investments and business activities. This greater flexibility may expose credit unions to additional risk and it is therefore important to have appropriate counterbalances in the capital framework to ensure risks are being capitalized and managed appropriately.

Minimum Total Supervisory Capital

  • Desjardins
  • Libro

Stakeholders requested clarification on what ratios make up the total minimum supervisory capital ratio.

The Rule sets out that the total supervisory capital ratio is the total of:

  • Tier 1 capital
  • Tier 2 capital  
  • capital conservation buffer

General Market – Interest Risk

  • Desjardins

A stakeholder requested that the Rule harmonize with other Canadian regulators for the formula (K x 0.15)/0.08.

FSRA is aware that some jurisdictions incorporate interest rate risk in their banking book as part of their ICAAP.

 

However, In Ontario, not all credit unions are required to complete an ICAAP. Therefore, it is important to set out this formula in the Rule so that all institutions are calculating interest rate risk in a consistent manner.

Movement of Investment Shares

  • DUCA

A stakeholder requested clarification on the capital treatment of investment shares that are being held at the credit union to facilitate a sale to another member.

Under the Rule, investment shares that were issued prior to the effective date of the Rule and met the criteria of Tier 1 capital under the Regulation will continue to be considered Tier 1 capital under the Rule.

 

If a credit union is temporarily holding a share previously issued for the purpose of immediately facilitating a member to member sale, and a new share is not being issued, then it would continue to be considered Tier 1 capital.

 

However, if shares are redeemed and new shares issued, these new shares would have to meet the requirements in the Rule to be considered Tier 1 capital.  

 

Any shares that are held by the credit union for itself cannot be included in capital calculations.

Patronage Shares

  • DUCA

A stakeholder requested clarification on whether the 12-month period related to patronage shares refers to a calendar year or a fiscal year.

The 12-month period is a rolling period as of the date of capital reporting.

Amortization

  • DUCA
  • Libro

Stakeholder requested clarification as to whether the requirement to amortize any security that is included in the credit union’s Tier 2 capital aligns with IFRS 9 Financial Instruments.

IFRS 9 generally requires financial liabilities to be recorded at amortized cost. In line with IFRS 9, the Rule requires Tier 2 capital instruments to be amortized on a straight-line basis “in the five years prior to the date on which the security must be redeemed, repaid or purchased by the credit union.

 

This requirement in the Rule aligns with the previous Ontario Regulation 237/09 and international standards.

Interest Rate Risk Weight

  • DUCA

A stakeholder requested the rationale for the 20% risk weight for interest rate contracts.

FSRA’s intent is for the risk weightings in the Rule to reflect international standards. A 20% risk weighting for interest rate contracts aligns with international standards.

Credit Risk Rating of Residential Mortgage Loans

  • DUCA

A stakeholder requested an explanation on why the credit risk rating of a residential mortgage loan without a backstop from the government of Canada but insured, can receive the lowest risk weighting if rated by more than one agency.

 

The commenter indicated that the credibility of rating agencies varies.

The risk weighting for the portion of a residential mortgage loan that does not have a backstop guarantee provided by the Government of Canada but is insured by an insurer is detailed in Table 4 of the Rule.  

 

A credit union, if it provides prior notice to FSRA, may use a designated credit rating organization not specified in Table 4.

 

FSRA does not assess the credibility of credit rating agencies. The credit rating table aligns with international standards.

Credit Risk Exposure Reporting

  • DUCA

A stakeholder recommended that reporting to the Board on exposure to credit risk should occur 90 days after the end of each quarter instead of 60.

Timely reporting is important for FSRA to ensure that a credit union maintains the appropriate amount of capital and meets the minimum capital requirements detailed in the Rule at all times.

 

A reporting frequency of greater than 60 days would not be sufficient to ensure that FSRA has current data for this purpose.

 

Therefore, FSRA did not change the requirement to 90 days.

Definition of Investment Properties

  • DUCA
  • FirstOntario
  • Group of Five
  • Libro
  • Meridian

Stakeholders recommended that non-owner occupied residential properties receive a risk weighting of 35%.

The definition of residential property will be set out in the regulation under the CUCPA 2020. A FSRA rule cannot supersede this regulation.

 

On November 24, 2021 the Ministry of Finance launched its consultation on the draft regulation under the CUCPA 2020.

 

We encourage stakeholders to review the consultation draft and respond accordingly to the Ministry of Finance consultation.

Financial Distribution

  • FirstOntario
  • Libro

Stakeholders proposed that the requirement in which a credit union must not make any distribution that would cause the credit union to retain less than the percentage of the credit union’s earnings for its previous financial quarter be changed from quarterly to yearly.

Minimum capital requirements must be met by the credit union at all times. Quarterly restrictions on distributions are an appropriate cadence to facilitate FSRA's monitoring of the minimum capital requirements.

 

FSRA’s intent is for the requirements on financial distribution to reflect international standards. A quarterly cadence aligns with international standards.

Discretionary Bonus Payments

  • FirstOntario
  • Libro

Stakeholders proposed that the restriction on bonus payments if the credit union falls below the Capital Conservation Buffer minimum should be removed as this should be managed by the Board.

 

A commenter also requested clarification on what constitutes discretionary.

 

The commenter also expressed concern that this restriction could be circumvent through contract negotiation.

If a credit union falls below the minimum CCB requirement, it is important that it restrict distributions to rebuild its capital.

 

Discretionary bonuses are one example of such distributions that should be restricted for this purpose. This is in alignment with international standards.

 

Discretionary has its ordinary meaning and can include bonus payments to employees, directors, officers and contractors of the credit union and its subsidiaries.

Definitions

  • Libro

A stakeholder requested that the Rule receive regular updates to reflect changes to legislation and regulation and that these changes are discussed with the sector.

FSRA will consider updating the Rule as amendments are made to the legislation and regulations.

 

All FSRA rules must be updated at a minimum every five years.

ICAAP
  • Libro

A commenter requested clarification on how a credit union’s ICAAP interacts with the minimum total capital ratio and the CCB.

At a minimum, credit unions must meet the minimum ratios set out in the Rule.

 

A credit unions ICAAP should augment the minimum requirements and be reflective of the credit union’s business and risk profile. 

 

A credit union’s ICAAP cannot lower the minimum requirements set out in the Rule. 

IFRS9

  • DUCA
  • Libro

Commenters requested that the Rule align with the terminology used in IFRS 9 Financial Instruments.

Based on the comment received, FSRA has updated certain terminology in the Rule to reflect IFRS 9 Financial Instruments, in a manner consistent with international standards.