Underwriting regulatory financial reporting and capital requirements

Effective Date: December 31, 2024

This Guidance Note is being issued to provide:

• background information on the roles Dealer Members perform to facilitate issuer company capital
• related guidance on regulatory financial reporting and capital requirement issues that arise when a Dealer Member enters into a securities underwriting commitment.

Background information

Dealer Members play an important role in issuer company capital raising by agreeing to:

• assume a portion of a new issue’s underwriting liability and sell the new issue offering, or
• engage in efforts to sell the new issue offering.

Where a new issue involves Dealer Members assuming an underwriting liability, distinct activities are agreed to and carried out by the:

• syndicate group manager1,
• the syndicate group members2, and
• the selling group members3.

The carrying out of these activities is important to ensuring that the new issue offering is widely and fairly distributed to investors wanting to participate in it and the issuer company raises its capital in a cost-efficient manner.

Guidance on regulatory financial reporting and capital requirement issues that arise when a Dealer Member assumes a new issue underwriting liability

Where a Dealer Member assumes a new issue underwriting liability (as a syndicate group member), both regulatory financial reporting and capital requirement issues arise due to their assumption of new issue underwriting risk.

The regulatory financial reporting issues that arise largely relate to determining when an underwriting commitment has been entered into and when new issue sales can be recorded. The capital requirement issues that arise almost exclusively relate to determining how to provide for the residual new issue underwriting risk during and after the offering distribution period.

The remainder of this Guidance Note provides guidance on these issues by responding to commonly asked regulatory financial reporting and capital requirement questions relevant to when a Dealer Member assumes a new issue underwriting liability. These questions and the pages within this Guidance Note where these questions are discussed are as follows:

1. When has a Dealer Member entered into an underwriting commitment?
2. How does a Dealer Member record an underwriting commitment for regulatory financial reporting purposes?
3. What are common Dealer Member approaches to risk provisioning/hedging/funding underwriting commitments?
4. How does a Dealer Member value any unsold portion of the underwriting during the period from underwriting commitment date to underwriting settlement date?
5. What are the effective margin rates to be used in determining the amount of capital that must be provided for an underwriting commitment?
6. How do you calculate the capital required for a particular underwriting?
7. How are exempt purchaser expressions of interest to be recorded?
8. When can sales be recorded?
9. How do the recommended approaches for expressions of interest and sales compare?
10. When can underwriting fees be recorded?
11. When must syndicate accounts be settled?

1. When has a Dealer Member entered into an underwriting commitment?

Several forms of financing agreements are currently in use within Canada. In some cases, the financing agreement terms do not make it clear whether the Dealer Member is entering into an agency financing or an underwriting commitment. Whether or not entering into a financing agreement constitutes a committed underwriting is a question of fact. If enough pricing terms (in addition to all other non-pricing terms) are agreed to, the Dealer Member has entered into an underwriting commitment.

A Dealer Member is only required to report financial information within Investment Dealer and Partially Consolidated (IDPC) Form 1 when it has entered into an underwriting commitment. To assist in determining whether a Dealer Member has entered into an equity security underwriting commitment, a definition of the term “commitment” is set out in IDPC Rule subsection 5130(5). The definition stipulates that two of the following three pricing terms (in addition to all other non-pricing terms) must be agreed to before a Dealer Member is considered to have entered into an equity security underwriting commitment:

• Issue price
• Number of shares
• Issue commitment amount [issue price x number of shares]

Since the equity security issue commitment amount is equivalent to the issue price multiplied by the number of shares, agreeing to any two of the above three terms will effectively means the third term has been agreed to as well.

A similar approach would be applied in determining whether a Dealer Member has entered into a fixed income security underwriting commitment. Specifically, where any two of the following three pricing terms (in addition to all other non-pricing terms) are agreed to by a Dealer Member:

• Issue price
• Coupon rate and frequency
• Issue yield

and the issue commitment amount is also agreed to, the Dealer Member is considered to have entered into a fixed income security underwriting commitment.

Under an agency financing agreement, the Dealer Member does not commit to purchase a specified number of shares at a specified issue price (or in the case of a fixed income offering a specified issue commitment amount, at a specified price and coupon rate) but rather agrees to market the securities offering for the issuer, as agent, on a best-efforts basis. As a result, agency financings are not considered to be committed underwritings.

2. How does a Dealer Member record an underwriting commitment for regulatory financial reporting purposes?

Once it has been determined that a Dealer Member has entered into an underwriting commitment, for all or a portion of a particular securities offering, the Dealer Member must record both its obligation to the issuer as a liability and the offering securities position it has agreed to buy as an asset. The Dealer Member’s share of the obligation to the issuer must be recorded, based on the agreed upon offering issue price. The amount of the obligation initially recorded cannot be reduced by deducting any underwriting fees it is to receive pursuant to the underwriting agreement. The offered securities position should be recorded based on its market value, which initially will be the same as the commitment obligation.

3. What are common Dealer Member approaches to risk provisioning/hedging/funding underwriting commitments?

Where a Dealer Member has entered into an underwriting commitment it must:

• provide capital for the underwriting risk it assumes during the period from underwriting commitment date to underwriting settlement date or enter into a recognized hedging strategy to reduce that risk, and
• arrange for financing, where necessary, to ensure that it can meet its funding obligation to the issuer on the underwriting settlement date.

Common approaches to risk provisioning/hedging

During the period from underwriting commitment date to underwriting settlement date, the Dealer Member assumes the risk that it will not be able to sell all of its portion of the underwriting commitment by the underwriting settlement date. To address this risk, the Dealer Member must either:

• provide capital for the unsold portion of its underwriting commitment4, or
• enter into an acceptable hedging arrangement that reduces the risk associated with the unsold portion of its underwriting commitment.

Acceptable hedges that can either reduce or eliminate the capital required on the unsold portion of the Dealer Member’s underwriting commitment include:

• entering into a Standard Form New Issue Letter (SFNIL), and
• entering into a capital rental arrangement with another Dealer Member (capital rental arrangement counterparty).

Standard Form New Issue Letter

The required minimum terms that must be included within any SFNIL that a Dealer Member enters into are that:

• the Dealer Member must have the ability to draw-down funds on the strength of the new issue only

• the loan issuer must:

  • qualify as an acceptable institution5, or
  • qualify as an acceptable counterparty6 and provide sufficient collateral (held in escrow at an acceptable institution),

  to ensure that the loan issuer can advance adequate funds on settlement date

• the loan issuer must agree to advance funds on settlement date:

  • for the Dealer Member’s unsold portion of the new issue,
  • at a stated loan value [a percentage of the new issue price],
  • at a stated interest rate, and
  • for a stated period of time [which must equal or exceed a prescribed minimum period],

  and

• the loan issuer must agree to waive any right of set-off against other assets of the Dealer Member.

A sample SFNIL template is available on the CIRO website.

Capital rental arrangement

The required minimum terms that must be included within any capital rental arrangement that a Dealer Member enters into include the following minimum terms:

• the contract type – in this case the type would be a put option contract
• the contract premium – the premium would generally be determined in relation to the fees to be earned associated with the underwriting
• the contract exercise price – to transfer all risk to the capital rental arrangement counterparty, the exercise price would be set at the underwriting issue price; where an exercise price lower than the issue price is set, both the Dealer Member and the capital rental arrangement counterparty will be providing capital on the underwriting
• the contract size – the number of shares subject to the capital rental arrangement
• the contract expiry date – negotiable

Common funding approaches

Common approaches that can be used by the Dealer Member to meet its funding obligation to the issuer on the underwriting commitment settlement date include:

• the issuance of additional share capital
• the issuance of a subordinated loan (including a subordinated loan issued through a pre-arranged standby subordinated loan agreement)
• the entering into a SFNIL or capital rental arrangement, both of which allow the Dealer Member to transfer its ownership of any unsold portion of the new issue to the loan issuer/ capital rental arrangement counterparty on the underwriting commitment settlement date

In the case of the subordinated loan option, there is no mandatory minimum term for the loan agreement, but the loan may not be repaid without the approval of CIRO.

4. How does a Dealer Member value any unsold portion of the underwriting during the period from underwriting commitment date to underwriting settlement date?

Generally, to comply with generally accepted accounting principles, all security positions held must be marked to market daily. However, in the case of unsold underwriting positions the following should be considered:

• Dealer Members are prohibited from selling new issue securities to others at a price above the underwriting issue price during the period from underwriting commitment date to underwriting settlement date; and
• Dealer Members will not actually suffer a mark to market loss on an underwriting unless the market value of the unsold underwriting position drops below the underwriting net issue price (issue price net of underwriting fee).

As a result, the value reported for any unsold portion of an underwritten position during the period from underwriting commitment date to underwriting settlement date should be determined as follows:

1. Where the market value of the underwritten position equals or exceeds the issue price, the unsold portion of the underwritten position shall be valued at the issue price7.
2. Where the market value of the underwritten position equals or exceeds the net issue price and is less than the issue price, the unsold portion of the underwritten position shall be valued at the issue price.
3. Where the market value of the underwritten position is less than the net issue price, the unsold portion of the underwritten position shall be written down by the amount of this drop in value below net issue price.

For example, consider a situation in which a Dealer Member has agreed to the following underwriting commitment.

Commitment details

• Dealer Member’s share of the obligation to the issuer is 1,000,000 shares
• New issue price is $20 per share
• Underwriting fee is 5%

Valuation approach to be followed

5. What are the effective margin rates to be used in determining the amount of capital that must be provided for an underwriting commitment?

For all other offerings - The treatment of all other offerings is like that for equity security offerings with reductions in margin rates permitted where disaster out and/or market out clauses are in effect or where a Standard Form New Issue Letter has been obtained. Offerings, other than equity security prospectus offerings, are not eligible for the "normal new issue margin" rate reduction set out in IDPC Rule subsection 5130(5).

6. How do you calculate the capital required for a particular underwriting?

The following are suggested steps to be followed in determining the capital required for a particular underwriting.

• If an equity security prospectus offering, determine whether the security offering being underwritten qualifies for a reduced “normal new issue margin”. Secondary public offerings in equity and other listed securities with a normal margin rate of 25% or 50% will automatically qualify. Initial public offerings of equity securities of an issuer with a public float in excess of $500 million and that is in an industry sector known for low price volatility may also qualify, subject to the approval of Corporation staff.
• If a restricted equity security private placement, determine whether the alternative capital requirement approach set out in IDPC Rule section 5523 will be used. This alternative approach enables Dealer Members to determine their underwriting capital requirement based on the margin rate that would otherwise apply to an unrestricted equity security offering of the same issuer, subject to certain margin rate percentage minimums. Dealer Members may continue to calculate their underwriting capital requirement for private placements of restricted securities in accordance with the requirements set out in IDPC Rule sections 5520 through 5522 if they so choose.
• For all offerings, including fixed income security offerings, determine which out clauses are present and the periods for which they will be in effect. The underwriting agreement’s out clause wording should be compared with the mandatory, standard out clause language set out in IDPC Rule subsection 5130(5) for the disaster out and market out clauses. Where the underwriting agreement contemplates a material foreign tranche, other “disaster out” clause or “market out” clause wording may be acceptable, but it must conform to standardized wording that may be required in the relevant foreign jurisdiction.

Of note, a bought deal underwriting with a market out clause is not synonymous to an agency deal underwriting. IDPC Rule sections 5520 through 5522 recognize this distinction by requiring that either 5% or 10% of normal new issue margin be provided for the residual bought deal risk:

• For all offerings, including fixed income security offerings, determine whether a capital requirement reduction, based on exempt purchaser expressions of interest, is available. For a Dealer Member to reduce its underwriting capital requirement, based on “expressions of interest” from exempt purchasers:

  • the allocation between retail and exempt purchasers must be finalized,
  • expressions of interest received from exempt purchasers must be verbally affirmed and the affirmation must be appropriately documented (refer to the definition of “appropriate documentation” within IDPC Rule subsection 5130(5)), and
  • the market value of the underwriting must be more than 90% of the new issue value (90% x issue price x number of shares) of the underwriting.

  Where a Dealer Member takes advantage of this capital requirement reduction it should be noted that the reduction may be subject to an underwriting concentration charge, calculated pursuant to IDPC Form 1, Schedule 2A.

• Where a Standard Form New Issue Letter (SFNIL) has been obtained, determine the capital requirement reduction. As the SFNIL is a negotiated risk sharing agreement between the Dealer Member and a SFNIL issuer (bank or other financial institution), the decision to obtain or not to obtain a SFNIL will be a function of its availability, its cost and the capital requirement “savings” that are generated by entering into the agreement. In determining the capital requirement “savings”, the Dealer Member should consider that an underwriting concentration charge, calculated pursuant to IDPC Form 1, Schedule 2A, may apply. As an alternative to the SFNIL, the Dealer Member may consider entering into a capital rental arrangement (i.e., buying a put option for their underwriting commitment) with another Dealer Member.

7. How are exempt purchaser expressions of interest to be recorded?

The existence of documented exempt purchaser11^,12 expressions of interest will not result in any regulatory financial reporting accounting entries. Rather, the sole purpose for documenting exempt purchaser expressions of interest is to demonstrate that the syndicate manager has fully sold (but not yet contracted) the exempt purchaser allotment of a particular prospectus offering in advance of final prospectus clearance.

Where expressions of interest have been received for the entire exempt purchaser allotment, the syndicate group manager must inform the other syndicate group members on a timely basis that this has occurred13. Once provided with this information, the syndicate group members may provide a reduced capital amount on the exempt purchaser allotment portion of its underwriting commitment, in accordance with the conditions set out in IDPC Rule:

• subsection 5130(5), definition of “appropriate documentation”,
• subsection 5130(5), definition of “exempt purchaser”, and
• section 5522, Margin requirements for underwriting commitments where expressions of interest from exempt purchasers have been affirmed.

In the case of the syndicate group manager, the reduced capital amount on the exempt purchaser allotment portion of their underwriting commitment would not be available to them where the other members of the syndicate group have not yet been informed that the entire exempt purchaser allotment has been fully sold14.

8. When can sales be recorded?

Sales to other dealers

The best approach to determining whether a syndicate group member can reduce its underwriting commitment and unsold security position, due to entering into sales arrangements with selling group or other dealers, is to determine whether the arrangement constitutes a committed or agency arrangement. In the event of a committed arrangement, the syndicate participant dealer may record a sale and the selling group dealer must record a commitment to purchase. In the event of an agency arrangement, the syndicate participant dealer may not record a sale. In the event the nature of the arrangement is not clear, the syndicate participant dealer may not record a sale.

Sales to clients – Prospectus offerings

The image below summarizes the basic steps that take place in a prospectus offering. The commentary that follows the image details the approach to be followed in recording client sales of prospectus offering securities.

As discussed in Note C above, for a prospectus offering, the current practice is that client sales may be recorded when they are contracted and that sales may only be contracted after the receipt for the final prospectus is issued. This practice is followed, because it is considered unlikely that clients will exercise their right of withdrawal (found in OSA Section 71(2)) to any material degree.

This practice also applies to sales to exempt purchasers that are contracted by the syndicate manager on behalf of all the syndicate group members. Consistent with the guidance for documented exempt purchaser expressions of interest, the syndicate manager must inform the other syndicate group members on a timely basis when exempt purchaser sales are being contracted, to ensure all syndicate members are able to record their portion of the exempt purchaser sales (and reduce their unsold portion of the underwriting commitment) at the same time as the syndicate manager.

Sales to clients – Private placements

As regulatory approval of a private placement is not required, the approach to be followed in recording client sales of a private placement will differ amongst dealers and will differ somewhat from a prospectus offering. Current Dealer Member practices for recognizing private placement sales to clients differ. Dealer Members generally use one of three recognition approaches: (1) record a sale once a verbal trade to an accredited investor has been documented, (2) record a sale once a signed subscription receipt has been received from an accredited investor, or (3) record a sale once the dealer has contracted the sale to the accredited investor. Most dealers use either the first or second approach listed above.

CIRO staff are of the view that private placement sales can be recorded on the date a verbal commitment is received from an accredited investor, provided sufficient documentation of this verbal commitment is obtained and retained and there is no significant impairment in the market value of the private placement (in comparison to the issue price). For the purposes of applying this approach, CIRO staff expect that:

• obtaining and retaining “sufficient documentation” would involve obtaining and retaining:

  • the required documentation set out in the definition for “appropriate documentation” in IDPC Rule subsection 5130(5), and
  • in the case of an individual client, a signed subscription agreement indicating that the client qualifies as an accredited investor,

  and

• there would not be a significant impairment in the market value of the private placement when the current private placement market value is at or above 90%15 of the new issue value (90% x issue price x number of shares).

9. How do the recommended approaches for expressions of interest and sales compare?

The table below compares the approaches to be followed in recording client expressions of interest and sales for prospectus offerings and client sales for private placement offerings:

10. When can underwriting fees be recorded?

IDPC Rule sections 5520 through 5522 stipulate that reduced capital may be provided on any unsold portion of the underwriting where out clauses (i.e. “market out” and “disaster out”) are in effect. Having said that, the risk reduction properties of these out clauses are only relevant in the event the Dealer Member exercises them. Where a Dealer Member provides reduced capital on an underwriting commitment due to an out clause being in effect, it is an indication that the Dealer Member assumes that the underwriting deal won’t proceed. Under these circumstances, it would be inappropriate for the Dealer Member to also record the underwriting fees that would be earned only if the underwriting proceeded.

In summary, underwriting fee revenue may be recorded when all underwriting agreement out clauses have expired or when a determination has been made by the Dealer Member that they will not be providing reduced capital on their underwriting commitment due to the presence of in effect out clauses. Where the out clauses contained in the Underwriting Agreement have not yet expired, the Dealer Member may choose to either:

• record the underwriting fee revenue and provide capital on its unsold underwriting securities position without taking any reduction in the margin rate used due to the presence of in effect out clauses; or
• not record the underwriting fee revenue and continue to provide capital on its unsold underwriting securities position that reflects the presence of in effect out clauses (in accordance with IDPC Rule sections 5520 through 5522).

As a practical matter, underwriting fee revenue will generally be recorded at or near the close date of the underwriting.

11. When must syndicate accounts be settled?

The current IDPC Rules do not prescribe precisely when the accounts maintained by the syndicate group manager for the underwriting revenues and expenses must be settled-up with the syndicate group members17. Nevertheless, consistent with the requirement for the syndicate group manager to inform all syndicate group members that the entire exempt purchaser allotment has been fully sold18, we expect the syndicate group manager to settle-up the syndicate accounts with all syndicate group members either on or within a reasonable period after the close date of the underwriting commitment.

• 1The syndicate group manager is responsible for the carrying out of certain activities on behalf of the entire syndicate group. These activities include the selling of the exempt purchaser allotment on behalf of the syndicate group members, the communication of these exempt purchaser sales to the syndicate group members, the management of syndicate accounts on behalf of the syndicate group members and timely settling-up of these accounts with the syndicate group members.
• 2The syndicate group members participate in the distribution of the new issue to investors and share the underwriting commitment liability for the new issue.
• 3The selling group members participate in the distribution of the new issue to investors but do not assume any portion of the underwriting commitment liability for the new issue.
• 4Refer to response to Question #8 for details on when underwriting commitment sales can be recorded during the period from underwriting commitment date to underwriting settlement date and refer to response to Question #5 for details on the margin rates to be used to determine the capital that must be provided for the unsold portion of the underwriting commitment.
• 5The term “acceptable institution” is defined in IDPC Form 1, General Notes and definitions.
• 6The term “acceptable counterparty” is defined in IDPC Form 1, General Notes and definitions.
• 7This is because the underwritten position must not be sold above the new issue price during the underwriting period.
• 8Where either a SFNIL has been executed or a market out clause is in effect, the capital requirement is the same irrespective of whether there are documented expressions of interest from exempt purchasers.
• 9Where both disaster out and market out clauses are in effect, the capital requirement is the same as where only a market out clause is in effect.
• 10Capital requirements for any unsold portion of the new issue revert to the same requirements as for positions of the same issue trading in the secondary market at the earlier of: (1) the expiry of the relevant new issue agreement out clauses and the new issue letter (if obtained), and (2) 20 business days after the settlement date of the offering.
• 11Pursuant to IDPC Rule subsection 5130(5) an “exempt purchaser” is an accredited investor (as defined in securities legislation) who qualifies as an “institutional client”. Pursuant to IDPC Rule subsection 1201(2) an “institutional client” is a client who is one of the following:
  • - a non-individual who qualifies as an “acceptable counterparty” (as defined in IDPC Form 1),
  • - a non-individual who qualifies as an “acceptable institution” (as defined in IDPC Form 1),
  • - a non-individual who qualified as a “regulated entity” (as defined in IDPC Form 1),
  • - a non-individual registrant under securities legislation,
  • - a non-individual with total securities under administration or management of more than $10 million.
• 12Effective September 28, 2024, clients that qualify as “institutional clients” will be expanded to include:
  • - an individual with total securities under administration or management of more than $10 million,
  • - a non-individual hedger who requests and consents to being classified as an institutional client for accounts with qualifying hedging activities and hedge positions.
  For further information on these changes please consult the bulletin issued to implement Derivatives Rule Modernization, Stage 1.
• 13This requirement is included within the definition of “appropriate documentation” set out in IDPC Rule subsection 5130(5).
• 14Ibid.
• 15The 90% standard is the same standard used in determining whether exempt purchaser expressions of interest qualify for reduced capital treatment under IDPC Rule section 5522, Margin requirements for underwriting commitments where expressions of interest from exempt purchasers have been affirmed.
• 16Effective September 28, 2024, individual clients may qualify as “institutional clients” which means that individuals that qualify as both an accredited investor and an institutional client will qualify as an “exempt purchaser” as defined in IDPC Rule subsection 5130(5).
• 17In the United States, Financial Industry Regulatory Authority (FINRA) Rule 11880 sets out prescribed settlement dates for syndicate accounts relating to corporate debt security offerings and prescribed that the syndicate account settlement date be no later than the scheduled close date of the offering for syndicate accounts relating to public offerings.
• 18The requirement for the syndicate group manager to inform all syndicate group members that the entire exempt purchaser allotment has been fully sold is included within the definition of “appropriate documentation” set out in IDPC Rule subsection 5130(5).