Guidelines on Capital Requirements for Underwriters and Issuers of Securitized Instruments under the Securities

Industry Act, 1995

TTSEC Responses from the Breakfast meeting

Crowne Plaza July 18th 2006

Role of the Securities and Exchange Commission (SEC)

• A major function of the Securities and Exchange Commission is to maintain surveillance over the securities market and ensure open, fair and equitable dealings in securities.

• Within recent times the adequacy of the capital held by underwriters registered under the Securities Industry Act, 1995 (the SIA) has become a matter of concern to the Commission.

• With a capital requirement of five million dollars, underwriters registered under the SIA are not subject to the same requirements as those registered under the Financial Institutions Act, 1993 (the FIA).

The Review

• The Commission has reviewed the requirements of both Acts.

• Having regard to : the potential risks to the market that can result from

underwriting being undertaken by persons with inadequate capital

the inequity in the financial market of Trinidad and Tobago resulting from the different capital requirements applied to persons conducting the business of underwriting as registrants under the SIA and licensees under the FIA

The Decision

It has been decided to implement Guidelines for the regulation of underwriters.

These guidelines are intended upon their publication to be actively used by participants to guide their management of the industry.

We have grouped the comments from the Industry for our discussion here this morning.

Comments from the industry• Define free capital.

– Free Capital = Total Assets – Total Liabilities inclusive of Off Balance Commitments; for example, if an institution has shareholders equity of $8MM, with the present 8% guideline, it can underwrite up to $100MM of debt. However, if it already has another transaction of, for example, $35MM outstanding, then based on its free capital, it can only then underwrite a further $65MM.

• The expected composition of free capital should be indicated. This should include a mix of cash and securities as approved by the SEC. – Although we have not specified, we would initially just use the balance

sheet net capital figure. However, our preference would be that such funds be held in liquid form, i.e. cash or near cash instruments (i.e., governments securities, bank deposits, etc.)

• Should a multi-tier system be used: for example, derivative securities attracting a higher level of free capital given its riskier nature.– We advocate a single-tier approach at this point with a standard capital

requirement that applies to all underwriters.

Comments from the industry

• Free capital: to be maintained to maturity or early redemption?– Our concern is that the underwriter is able to fully fund his

commitment to the issuer. Hence the position is that free capital must be maintained until the underwriter has met his commitment to the issuer.

• How do you confirm available free capital?– Review of financial statement prepared by an independent

ICATT member and certified by the directors of the underwriting entity.

• Does free capital have to be in cash, from undrawn facilities, or guaranteed?– As before, our preference will be for it to be in liquid form, i.e.

cash or near cash instruments. Lines of credit and guarantees will also be acceptable.

Comments from the industry

• Will it be necessary to segregate the cash in the free capital?– No. At the present time, this will not be required.

• If the facility is syndicated, then the basis should be the aggregated free capital of the syndicate.– The aggregate free capital of the syndicate will be considered

if the facility is syndicated.

• Capital requirements: what if the transaction is best efforts as compared to fully underwritten?– No distinction is being made between the best efforts and fully

committed underwriting at this time. This may be reconsidered at a later time.

Comments from the industry

• Why should the issuer of a derivative security prove its ability to own it if it does not intend to retain it?– One cannot sell what one does not own. A party or parties to the transaction

must own the underlying securities, the rights and benefits of which will be subsequently transferred to the Trust or SPV to create the securitized instrument.

• If the risk is being transferred to the investor, why should the issuer be a reporting issuer (with its implied requirements of annual reports to be filed, amended registration statement, etc.,)– The person making the issue (i.e. creating the derivative) for the issue is

deemed responsible. However, if the person is able to contractually ensure that the Trustee or any other party satisfies the requirements of S. 66 in respect of the underlying security, then he may not be subject to this condition.

• What if the underlying security is, e.g., GOTT? What would be the required reporting requirements on performance?– All securities will be treated the same.

Comments from the industry• To be consistent, the minimum requirement should be $15MM as

in the FIA.– The FIA focuses primarily on banking. An additional component of

regulatory capital that takes into consideration risks specific to underwriting activity is necessary. However, it is possible that the minimum requirement of the SIA may be amended.

• For the identification of a new security, how are “material facts” defined.– “Material facts” in this context are those facts which establish clearly

that a new security is being created that is different from the underlying security, as opposed to a redistribution of that underlying security.

• Identification of a new issue should be driven by the disclosure of risk to the investor.– Agreed. The risks associated with a derivative security are different

from the risks associated with the underlying security, and these risks should be clearly disclosed to the investor.

Comments from the industry• The guidelines make no reference to IAS 39 which properly

deals with some of the issues raised.– IAS 39 deal with accounting for transactions whereas this

standard is focused on regulation of the risk associated withthe risk associated with underwriting issues. There may be similarities but the focus is fundamentally different.

• While the FIA imposes a higher capital requirement as compared to the SIA, Reg. 3 of the Financial Institutions (Prudential Criteria) Regs., 1994, does not include underwriting commitments in the definition of risk adjusted assets. Therefore, a licensee’s underwriting commitments are not taken into account in determining its capital adequacy.– The perspective of the regulator is different. Our concern is

focused on ensuring that an underwriter (bank or non-bank) can fulfill his commitments at the transaction level, while the Central Bank is focused on the health of banking entities at the macro-level.

Comments from the industry• Why impose guidelines in a market where the inability to fully commit

or underwrite a transaction reduces the likelihood of the long term success of an underwriter in any case? Let the market decide.– The potential for the success of the business model does not negate the

risk of engaging in the business. The Commission is concerned that the failure of underwriters to deliver on their commitments may undermine confidence in the market as a whole and is taking steps to ensure that these actors are adequately capitalized to meet their commitments.

• When does the SEC consider an underwriting commitment to be honoured; for example, on signing of a mandate or from signing of legal documentation?– The underwriting commitment is deemed to be honored when the issuer

receives the proceeds of the issue.

• How will the SEC distinguish firm underwriting from sub-underwriting commitments, or put options?– The onus is on the market to provide adequate proof to the Commission.

The matter of put options is to be considered in the future.

Comments from the industry• Is there to be a grace period for compliance?

– There is no grace period.

• Will proof of capital adequacy be required if securities are not required to be registered with the SEC?

– All securities underwritten under license granted by the Commission are subject to the regime.

• Define “capacity to acquire the underlying security”; would excess paid-up share capital of a subsidiary, affiliate or parent company suffice?– Yes, those would suffice, provided there is a legally binding commitment,

such as a guarantee, to ensure that the underwriter can meet the capital requirements.

• If operating under the exemptions of section 75 of the SIA, should registering as a reporting issuer still be required?

– Section 75 deals with exemption from the requirement for a prospectus, not with exemption from registration. Prospectus exempt securities must be registered and are subject to the regime. One of our concerns as well is that underwriters are not necessarily registered to issue securities (other than of their own institution).

Other comments

• The floor is now open to any additional concerns not covered in the foregoing discussion