Regulators closely watching income trusts

(June 18, 2003) Representatives from the Ontario Securities Commission (OSC) and the Alberta Securities Commission (ASC) fielded lots of questions at the second national summit on income trusts in Toronto last week, sponsored by the Canadian Institute. The regulators provided an update on initiatives underway to crack down on income trusts in both provinces. Both commissions are taking a close look at disclosure requirements and, specifically, just what investors need to know.

Speaking on the panel were Iva Vranic, manager of finance for the OSC and Marsha Manolescu, deputy director of legislation with the ASC. As more and more businesses turn to income trusts as a means to raise capital, a major concern for regulators is that such funds are marketed on the basis of cash distributions.

Better disclosure, they said, is key when it comes to making sure investors have the information they need to make an informed choice, particularly when it comes to business income trusts. As the structure of trusts becomes more complex, regulators are keen to ensure that investors know what they’re getting into.

Accounting standards is one of the issues, said Vranic: “Do investors understand that a lot of the information that goes into a distributable cash calculation is based on non-[generally accepted accounting principles] measures?” If not, that needs to be clearly stated in any materials investors receive, he added.

A major feature of the disclosure initiatives involves stability ratings — an independent rating agency’s opinion regarding the stability and sustainability of an income trust’s cash distribution stream. Rating agencies such as Standard and Poor’s assess a trust’s underlying business model — and whether or not their distributable cash targets are sustainable over the medium and long term.

Currently only 25 of all listed income trusts have been rated as it’s not compulsory. Regulators are strongly urging other trusts to become rated. Said the ASC’s Manolescu, “Is it required? No. Is it useful? We think so.” That’s because investors looking to buy into the cash flow of a company through an income trust can use stability ratings to give them “a comparability aspect” to supplement information given to them in the prospectus.

However, not everyone agrees that sustainability ratings are useful — or fair. Stephen D. Rotz, director of corporate development and treasurer with the Davis and Henderson income trust, believes that income trusts and traditional equities should be treated the same way: “When they ask every other equity to have a stability rating, that’s fine and we’ll all be on a level playing field.”

Moreover, Rotz said, the added cost of paying for the rating would be passed directly to the unitholders, impacting their distributable cash.

He also questioned the usefulness of such measures: “Income trusts and equities have the same risks,” said Rotz, and investors need to understand that. “There’s no guarantee that distributions will happen forever — and you could have the price of the underlying unit price come down — come down dramatically. And that risk is always there.”

The regulators are also wary of the fact that businesses raise capital through income trusts primarily because of the tax advantages. As the OSC’s Vranic pointed out, “if it weren’t for the various tax advantages of using this structure, the operating company would have gone to market directly.”

And that seems to be one of the main reasons that Alberta has held back when it comes to following Ontario’s lead in amending the limited liability laws. While they’re following the situation in Ontario with interest, Manolescu says that the ASC is concerned about encouraging companies to switch from a corporate to a trust structure. “I know there is significant concern that the federal government may do something to impact on it as well.” So a “piecemeal” approach to regulation, she said, doesn’t deal with the “bigger picture” when it comes to income trusts.

Caroline Cakebread is a Toronto-based investment writer.

(06/18/03)