48 Private Capital Markets | Spring 2014 | www.pcmacanada.com
or suspension of registration. In addition, firms will incur late filing
fees of $100 for each business day that the filing is late, to a
maximum of $5,000 annually. Ouch, that hurts!
Registrants’ annual audited financial statements must be
prepared using IFRS as required under NI 52-107 and Part
12, Division 4 of NI 31-103 sets out their financial reporting
obligations. This requires EMDs to deliver their annual audited
financial statements (and related calculation of excess working
capital - the NI 31-103F1) within 90 days after their financial
year end. The financial statements are required to be prepared
on a non-consolidated basis (which IFRS refers to as “Separate
Financial Statements”). The OSC noted that the annual audited
financial statements must include a sentence indicating that the
financial statements are prepared in accordance with the financial
reporting framework specified in Section 3.2( 3)(a) or for foreign
firms, section 3. 15 of NI 52-107 and a description of the financial
reporting framework used. This added sentence should also be
referenced in the auditor’s report.
Thankfully, starting in February 2014, the Form 31-103F1
Calculation of Excess Working Capital (Form 31-103F1) must
be filed electronically. The OSC notes that some firms are not
accurately calculating their excess working capital on Form
31-103F1. When calculating excess working capital (EWC),
registered firms should use the accrual basis of accounting,
not the cash basis of accounting- and this includes the interim
monthly financial statements. From EWC, a firm should exclude
any current assets that are not readily convertible into cash, such
as prepaid expenses and security deposits with service providers.
The definition of what constitutes “readily convertible into cash”, in
my experience, is often one the toughest judgment calls for both
management and its independent auditor.
The OSC also notes that it is concerned with firms that include
in working capital any accounts receivables, especially those due
from related parties, which are not readily convertible to cash.
Accounts receivables that are not realizable in to cash in a prompt
and timely manner should be excluded from the excess working
capital calculation. The OSC suggests that where a firm believes
that related party receivables could be promptly received, the firm
should maintain on file documentary evidence to support this
assertion. Acceptable evidence could include audited financial
statements of the related party or a bank statement supporting that
the related party has cash available at that time. This guidance is
welcomed as the determination is a challenge. It’s my experience
that SROs such as IIROC and the MFDA provide a more rigorous
definition of what is an allowable asset (i.e. working capital) for
regulatory capital purposes.
The OSC noted that registrants need to deliver to it a copy of
all executed subordinated loan agreements. If the agreement is not
delivered to the OSC, then it will not be considered subordinated
for purposes of the EWC calculation. The CSA has specifically
addressed this issue in its December 5, 2013 suggested revisions
to NI 31-103. Don’t forget that before you repay any subordinated
debt, you may also notify the regulator of this before it is repaid.
That notice is due 10 days before repayment. The regulator may
request further documentation to demonstrate that the EMD
continues to have excess working capital.
The OSC noted some instances where a market risk deduction
(i.e. a margin/haircut deduction from working capital) has not
been made for the value of securities held by the registrant. Each
security held is assigned a market risk margin rate as set out in
Schedule 1 of 31-103F1. However, if you are an active proprietary
trader be careful with the margin rules, Unlike IIROC’s inventory
margin rules, there are no capital offset rules for hedged short
positions, options and warrants. Firms are reminded to provide
supporting documentation of the market risk calculation as part of
the annual and interim financial statement filings.
The OSC notes that registered firms are required to know
their capital position at all times. Many people are surprised to find
that the capital required is not only the $50,000 cash in the bank.
Sufficient liquid assets are required to cover other working capital
requirements (e.g. accounts payable and accrued liabilities), FIB
insurance deductibles, market risk and guarantees, if any. Thus,
I like to suggest that an EMD maintains liquid assets of at least
$75,000 to $100,000 dependent on the nature of the business.
What should you do in the unfortunate event your EMD
reports a capital deficiency? As Form 31-103F1 does not have
early warning indicators (as you find with other SROs), capital
deficiencies do arise. It’s important that an EMD has contingency
plan to deal with these rare situations. A capital deficiency must
be resolved on a timely basis, usually within 48 hours. Thus, it’s
important that financial statements and EWC calculations be
prepared and reviewed by management on a timely basis.
The OSC notes that E WC cannot be less than zero for more that
2 consecutive days. The OSC should be contacted immediately
to explain the details of the deficiency, be provided a copy of
the calculation EWC and related supporting documentation,
outline the plan to resolve the deficiency and steps to avoid its
recurrence and finally, provide evidence of how the deficiency was
resolved (cash injections and copies of the executed subordination
agreement or share capital issued).After a capital deficiency is
resolved, the OSC notes that it will either recommend terms and
conditions be placed on an EMD’s registration (e.g. filing for a
period the monthly financial reports and the Form 31-103 F1) or
provide a warning letter to the registrant.
Keep your own firm in mind while you take the time to review
the report for the OSC, and be open to its advice, or help from
other professionals. One great place to start is by attending the
PCMA’s Annual CFO Education Series: Financial Regulatory
Reporting Certificate Program. It is being held in Calgary,
Vancouver and Toronto in Fall 2014, and it’s where we review in
significant depth your financial regulatory requirements. It might
be a good use of your time. And along with other refreshments,
we also serve carrots.
For more information contact:
email@example.com | 416.515.3893