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Financial Operations FAQ: Regulatory financial statement capital (otherwise known as regulatory capital)



One of the main roles of IIROC’s Financial and Operations Compliance department (FinOps) is to assess whether firms have enough capital for the type and scope of their business activities. FinOps monitors firms for compliance with IIROC financial rules to reduce the possibility of financial failure due to excessive leverage or risky business practices.

Frequently asked questions

 


These frequently asked questions have been prepared to assist Dealer Members in understanding the approval process over regulatory capital 1, either by the Dealer Member issuing shares 2 or debt.

For clarity, we have supplemented the FAQ with decision trees – Exhibits 1 to 3. These decision trees illustrate the approval process for change requests from Dealer Members relating to the regulatory capital in the business. Exhibit 4 is a standard risk disclosure acknowledgement form that is required when a non-industry investor is involved.

  1. Where are the IIROC rule references for eligible sources of regulatory capital?

  2. Who are the source providers of eligible regulatory capital?

  3. What are the main sources of eligible regulatory capital?

  4. Are all classes of preferred shares considered eligible regulatory capital?

  5. How is the percentage ownership of a Dealer Member calculated for purposes of seeking IIROC approval for changes in capital structure?

  6. What is the threshold level of Dealer Member ownership for which District Council approval is required?

  7. Is IIROC approval required for any change (either increase or decrease) to the Dealer Member’s regulatory capital?

  8. Where are requests for changes in regulatory capital amount or structure sent? And how much lead time is needed in order to get approval?

  9. For share capital changes (increases and decreases), what supporting documents are required to be provided by a Dealer Member?

  10. What concerns does IIROC have in respect to subordinated loan investors that are not otherwise officers or employees of the Dealer Member?

  11. How can a commercial revolving loan facility between a Dealer Member and an approved industry investor be structured as a subordinated loan?

 

1. Where are the IIROC rule references for eligible sources of regulatory capital?

IIROC Dealer Member Rules 5 (Ownership of Dealer Member securities) and 6 (Dealer Member holding companies, related companies and diversification) provide the basis for the sources of regulatory capital for a Dealer Member. For a comprehensive reading of these rules, you will need to refer to IIROC Dealer Member Rules 1, 7 and 17.

 

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2. Who are the source providers of eligible regulatory capital?

Any person [whether an individual, partnership (general partnership or limited partnership), corporation (publicly owned or privately held), trustee or unincorporated organization] may invest in or lend to a Dealer Member subject to compliance with the applicable Dealer Member rules.

 

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3. What are the main sources of eligible regulatory capital?

In addition to internally generated profit and retained earnings and Form 1 capital allowances relating to the accounting of non-refundable leasehold inducements by landlord of office premises, the two sources of regulatory capital in an IIROC Dealer Member are:

a) from persons investing in the Dealer Member by way of equity – whether through common shares or preferred shares

b) from persons lending funds to the Dealer Member by way of subordinated loan

Regulatory capital can take the form of equity (common and classes of preferred shares) and the form of debt supported by an industry prescribed subordinated loan agreement.

Equity in the firm Debt to the firm
Common shares Classes of Preferred shares Special warrants, options and any other security with a convertible feature Subordinated loan

 

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4. Are all classes of preferred shares considered eligible regulatory capital?

No. Preferred shares that have a retraction feature - where the shareholder retains the right at their option to redeem the preferred shares – are not considered as eligible regulatory capital for purposes of Form 1, unless the terms of the retraction feature is subject to IIROC approval. Classes of preferred shares that are redeemable only at the option of the Dealer Member are permitted as eligible regulatory capital. To address IFRS accounting departures 3, Form 1 permits balance sheet classification for such preferred shares as issued capital (as opposed to liabilities).

Refer to Exhibit 1

 

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5. How is the percentage ownership of a Dealer Member calculated for purposes of seeking IIROC approval for changes in capital structure?

For purposes of regulatory review and approval, the shareholder interest of a Dealer Member is generally calculated on a fully diluted basis. That is, in determining the economic interest of shareholders, consideration must be given to all classes of shares, options and warrants outstanding and conversion features of subordinated debt outstanding.

Changes in share capital that result in shareholdings (on a fully diluted basis) that meet or exceed thresholds of 10%, 20% and 50% will determine the extent of IIROC due diligence review of the transaction and the approvals required. For example, this calculation will be used with respect to the holding company (IIROC Dealer Member Rules 6.1 and 6.2), related company (IIROC Dealer Member Rules 6.3 to 6.5) and guarantee agreement requirements (IIROC Dealer Member Rule 6.6).

For the purposes of determining a significant equity interest (10% or greater interest) under IIROC Dealer Member Rule 5.4, consideration must also be given to whether the threshold has been met based on the projected issued and outstanding shareholdings (on an undiluted basis) following the proposed transaction.

Refer to Exhibit 1

 

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6. What is the threshold level of Dealer Member ownership for which District Council approval is required?

In respect to share ownership, District Council approval is required when the ownership interest (including all associates and affiliates) is equal or greater than 10% of:

  • the voting securities, outstanding participating securities or total equity of a Dealer Member or
  • the voting securities, outstanding participating securities or total equity of a holding company of a Dealer Member.
Form of regulatory capital Threshold Is District Council approval required?
Equity Less than 10% ownership No
Equal or greater than 10% ownership Yes
Debt Not applicable No


Refer to Exhibit 1

Also, refer to IIROC Dealer Member Rules 5 and 6 for special provisions governing ownership by (a) industry investors in Dealer Members other than the Dealer Member for which the investor is employed/approved and (b) Dealer Members in other Dealer Members.

 

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7. Is IIROC approval required for any change (either increase or decrease) to the Dealer Member’s regulatory capital?

Yes. For both sources (equity and debt), the Dealer Member must obtain regulatory approval before the funds can be treated as eligible regulatory capital.

Refer to Exhibit 1 and Exhibit 2

For any common and preferred share redemption or subordinated loan repayment and agreement cancellation, the Dealer Member must seek prior IIROC approval before the funds are released.

Refer to Exhibit 3

 

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8. Where are requests for changes in regulatory capital amount or structure sent? And how much lead time is needed in order to get approval?

As a general rule, for any changes either to the regulatory capital amount or the capital structure of a Dealer Member, a notification letter must be sent to the Membership Coordinator in IIROC’s General Counsel’s Office (GCO) at least 20 calendar days 4 before the planned effective transaction date.

Specifically for changes to a subordinated loan, a request for approval letter must be sent to the Vice President of the Financial & Operations Compliance (FinOps) department.

Please allow for additional time if the proposed transaction will require approval of the District Council.

Three IIROC departments – General Counsel’s Office (GCO), Financial & Operations Compliance (FinOps) and Registration may be involved in the review and approval process.

Depending on the form of regulatory capital and the percentage ownership interest, the following departments will lead the review and approval process and will determine the extent of IIROC staff due diligence review required:

Form of regulatory capital Threshold Primary IIROC department
Equity Less than 10% ownership GCO
Equal or greater than 10% ownership Registration
Debt   FinOps

 

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9. For share capital changes (increases and decreases), what supporting documents are required to be provided by a Dealer Member?

  • A notification letter from the CFO (addressed to GCO) dated at least 20 calendar days before the planned effective transaction date describing the change in regulatory capital structure
  • A list of all shareholders (of all classes) – before and after the transaction – showing the shareholder names with the number and percentage of shares owned on an issued and outstanding (undiluted) basis and a fully diluted basis and highlighting increases in shareholder interest of and over 10%
  • Investor Notification Forms (INF) and Investor Application Forms (IAF) for new investors and investors proposing to own 10% or more of the Dealer Member, respectively
  • The most recent Risk Adjusted Capital (RAC) of the firm and the pro-forma impact on both RAC and Early Warning calculations – before and after the transaction
IIROC early warning rules specifically do not permit a firm to alter its capital structure that would result in triggering the early warning criteria (including payout of dividends).

Refer to Exhibit 1 and Exhibit 3

 

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10. What concerns does IIROC have in respect to subordinated loan investors that are not otherwise officers or employees of the Dealer Member?

As issuing of debt is considered under provincial securities laws an exempt distribution, subordinated loan investors must meet the definition of accredited investor or otherwise qualify to participate in the transaction. In addition, given the illiquidity of this type of investment and the potential lack of transparency and conflicts of interest, as a condition for IIROC approval, the Dealer Member must obtain written acknowledgement from the investor regarding: the receipt of full and sufficient financial and regulatory information about the Dealer Member, the investor’s understanding of the specific risks associated with the investment, including conditions of repayment being subject to regulatory approval and the receipt (or waiver) of independent financial advice.

Refer to Exhibit 2 and Exhibit 4

 

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11. How can a commercial revolving loan facility between a Dealer Member and an approved industry investor be structured as a subordinated loan?

It is common - after the elimination of standby subordinated loans - for Dealer Members to pre-arrange a revolving loan facility with a bank or an affiliate and to put in place a subordinated loan agreement that can be amended from time-to-time to reflect drawdowns and repayments.

To set up a revolving commercial loan arrangement so that it becomes subordinated debt, a Dealer Member will start by submitting to IIROC a standard subordinated loan agreement for at least the nominal amount of $1. Once the subordinated loan is approved and executed by IIROC, any drawdown (and any future repayment subject to IIROC approval) in respect to the commercial loan arrangement is evidenced as an amendment to Schedule A.

 

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Footnotes:


1 Regulatory financial statement capital as reported on Statement B line 4 of Form 1

2 In the case of Dealer Members that are structured as partnerships, the equivalent source is partnership capital.

3 Refer to Note 2 of the General notes and definitions to Form 1 (the regulatory financial report).

4 IIROC Rule 17.12

 

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