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OSC

THE INVESTMENT FUNDS PRACTITIONER

From the Investment Funds and Structured Products Branch, Ontario Securities Commission



The Practitioner is an overview of recent issues arising from applications for discretionary relief, prospectuses, and continuous disclosure documents that investment funds file with the OSC. It is intended to assist investment fund managers and their staff or advisors who regularly prepare public disclosure documents and applications for exemptive relief on behalf of investment funds.

The Practitioner is also intended to make you more broadly aware of some of the issues we have raised in connection with our reviews of documents filed with us and how we have resolved them. We hope that fund managers and their advisors will find this information useful and that the Practitioner can serve as a useful resource when preparing applications and disclosure documents.

The information contained in the Practitioner is based on particular factual circumstances. Outcomes may differ as facts change or as regulatory approaches evolve. We will continue to assess each case on its own merits.

The Practitioner has been prepared by staff of the Investment Funds and Structured Products Branch and the views it expresses do not necessarily reflect the views of the Commission or the Canadian Securities Administrators.

REQUEST FOR FEEDBACK

This is the 19th edition of the Practitioner. Previous editions of the Practitioner are available on the OSC website www.osc.gov.on.ca under Investment Funds & Structured Products on the Industry tab. We welcome your feedback and any suggestions for topics that you would like us to cover in future editions. Please forward your comments by email to investmentfunds@osc.gov.on.ca.

ANNOUNCEMENTS

Project RID

The Canadian Securities Administrators (CSA) has recently approved the launch of a new policy project aimed at re-examining the investment fund disclosure regime. This initiative ties into the CSA priority, as set out in its 2016-19 business plan, to review the regulatory burden for reporting issuers to identify areas that would benefit from a reduction of any undue regulatory burden and streamline requirements without reducing investor protection or the efficiency of the capital markets.

Co-led by investment funds staff at the OSC and AMF, and with the participation of the other CSA jurisdictions, the Rationalization of Investment Fund Disclosure ("Project RID") initiative will review the existing disclosure requirements to identify potentially redundant or obsolete disclosures that should be reconsidered by the CSA. This review will be conducted during 2017, and staff is targeting mid-2018 for publication of any proposed rule amendments for comment.

Prior to the publication of the proposed rule amendments, stakeholders are welcome to provide staff with comments and recommendations. In Ontario, please contact John Mountain, Director, Investment Funds and Structured Products Branch, or Vera Nunes, Manager, Investment Funds and Structured Products Branch, OSC.

Changes in Investment Funds and Structured Products Branch Management Responsiblities

To promote consistency and transparency, the management responsibilities within the Investment Funds and Structured Products Branch have been recently structured as follows:

conventional mutual funds -- Vera Nunes, Manager

investment funds other than conventional mutual funds and structured products, including exchange-traded funds (ETFs), closed-end funds, structured notes, alternative funds, scholarship plans, and labour-sponsored investment funds -- Darren McKall, Manager

branch oversight and intelligence, including file screening and assignment, branch policies and procedures, issue-oriented reviews and continuous disclosure reviews, and exempt market matters -- Raymond Chan, Manager

Issuers and their counsel are encouraged to direct their inquiries to the appropriate branch manager.

Adoption of a T+2 Settlement Cycle for Conventional Mutual Funds

On September 5, 2017, equity and long-term debt markets in Canada and the United States are expected to shorten their standard settlement cycle from three days after the date of a trade (T+3) to two days after the date of a trade (T+2). On April 27, 2017, the CSA published amendments to National Instrument 24-101 Institutional Trade Matching and Settlement (NI 24-101) to facilitate the migration to a T+2 settlement cycle in equity and long-term debt markets, and to update, modernize and clarify certain provisions of NI 24-101. As part of the amendments made to NI 24-101, secondary-market trades in exchange-traded fund (ETF) securities will become subject to NI 24-101. As a result, dealers and advisers that trade in ETF securities will be required to comply with NI 24-101's rules that promote the "matching" of such trades by noon on T+1 and the settlement of such trades by the "standard settlement date" (now T+2, from T+3) as of September 5, 2017.

On April 27, 2017, Notice and Request for Comment Adoption of a T+2 Settlement Cycle for Conventional Mutual Funds Proposed Amendments to National Instrument 81-102 Investment Funds (the Notice) was published. As outlined in the Notice, staff's expectation is that all conventional mutual funds will adopt a T+2 settlement cycle on September 5, 2017.

The Notice includes proposed amendments to NI 81-102 (the Proposed Amendments) to require conventional mutual funds to settle on T+2. Filers are encouraged to submit comments to the Proposed Amendments, in writing, on or before July 26, 2017. We anticipate publishing final rules aimed at implementing the Proposed Amendments in the late Summer of 2017 (Publication Date) and that the Proposed Amendments will be proclaimed into force expeditiously after the Publication Date.

APPLICATIONS

Update on Pooled Fund-on-Fund Relief

In a recent Commission decision granting exemptive relief from the investment restrictions in securities legislation for pooled fund-on-fund structures{1} whereby the top fund and the underlying fund are under common management and both funds are organized in a Canadian jurisdiction, a new condition was included to require that a top fund not invest in an underlying pooled fund unless the underlying pooled fund complies with the provisions of National Instrument 81-106 Investment Fund Continuous Disclosure (NI 81-106) that apply to a "mutual fund in Ontario" as defined in the Securities Act (Ontario).

In certain Canadian jurisdictions, NI 81-106 does not apply to a mutual fund that is not a reporting issuer. The effect of the condition included in the relief is that when a pooled fund relies on the relief to invest in an underlying pooled fund organized under the laws of a Canadian jurisdiction where NI 81-106 does not apply, the underlying pooled fund must prepare annual audited financial statements and interim financial reports and deliver them to top fund investors, upon request. Filers with an underlying pooled fund not organized under the laws of a Canadian jurisdiction should consider providing submissions as to the appropriate review of financial statements and how best to provide relevant financial information to top fund unitholders.

Another new condition was added by the Commission to ensure that when purchasing and/or redeeming securities of an underlying fund, the filer shall act honestly, in good faith and in the best interests of the top fund and the underlying fund respectively. Given that the filer, in most cases, is the investment fund manager and the portfolio manager of the top funds and the underlying funds, it is important that the filer exercise the care and diligence that a reasonably prudent person would exercise in comparable circumstances.

PROSPECTUSES

CSA Mutual Fund Risk Classification Methodology

On December 8, 2016, the CSA published final amendments (the Final Amendments) that will mandate the CSA Mutual Fund Risk Classification Methodology (the Methodology) for use by fund managers to determine the investment risk level of conventional mutual funds and ETFs for use in the Fund Facts and ETF Facts, respectively.

Filers are reminded that for prospectus filings as of September 1, 2017, the investment risk level of conventional mutual funds and ETFs must be determined using the Methodology for each filing of a Fund Facts or ETF Facts, respectively. For preliminary prospectus filings made on or after September 1, 2017, the Fund Facts or ETF Facts should provide an investment risk level determined by the Methodology. For pro forma prospectus filings made on or after September 1, 2017, the Fund Facts or ETF Facts should provide an investment risk level determined by the Methodology at the time of the first renewal prospectus on or after September 1, 2017.

For filers who are subject to exemptive relief from a provision of Form 81-101F3 Contents of Fund Facts Document in relation to the disclosure under the heading "How risky is it?", such exemptive relief expires on September 1, 2017 in accordance with staff's interpretation of the sunset clause included in the Final Amendments.

Disclosure of Management Fees

As noted in the December 9, 2011 edition of the Practitioner, some mutual funds have management fees that are payable directly by securityholders and may vary from securityholder to securityholder. The disclosure about these management fees provided in the fund's simplified prospectus and Fund Facts include the highest possible rate or range of those management fees, as contemplated by Instruction 5, Part A, Item 8.1 of Form 81-101F1, or how fees applicable to that series compare to those applicable to other series offered by the same fund.

For mutual funds that have management fees that are payable directly by securityholders but do not vary from securityholder to securityholder, the management fee should be disclosed in the simplified prospectus and Fund Facts as a specified amount and should not be disclosed as a "maximum" management fee or "up to" the highest possible rate or range of those management fees, as any increase in the management fee would be subject to securityholder approval under Part 5, NI 81-102. The management fee disclosed in the simplified prospectus and Fund Facts should be the specified amount that is payable by the securityholders before any management fee rebates or waivers.

Earnings Coverage Ratios in Short Form Prospectuses

In recent reviews of short form prospectus filings, we have raised comments on earnings coverage ratio disclosure that did not appear to comply with the form requirements of National Instrument 44-101 Short Form Prospectus Distributions. Under item 6 of Form 44-101F1 Short Form Prospectus, the earnings coverage ratio is calculated by taking an issuer's net income under International Financial Reporting Standards and dividing it by borrowing costs and dividend obligations.

If a filer only presents an "adjusted" earnings coverage ratio by "adjusting" net income to remove gains and losses due to fair value changes, then earnings coverage ratios may not be comparable to other filers who have complied with the form requirements. Moreover, investors may be misled to believe that the "adjusted" earnings coverage ratio is calculated in accordance with the form requirements. Filers should disclose the earnings coverage ratio calculated in accordance with the form requirements. If a filer chooses to also provide supplementary disclosure, the derivation of the earnings coverage ratio should be disclosed and the "adjusted" earnings coverage ratio should not be given more prominence than the required disclosure.

Staff will continue to raise comments on short form prospectus filings when it appears that the earnings coverage ratio is not calculated in accordance with the form requirements, or when filers present an "adjusted" earnings coverage ratio without disclosing how it was derived.

ETF FACTS

Transition Period for Filing ETF Facts

On December 8, 2016, the CSA published final amendments (the Amendments) that will require ETFs to produce and file a summary disclosure document called "ETF Facts". The Amendments also introduce a new delivery regime which will require all dealers that receive an order to purchase ETF securities to deliver an ETF Facts to investors within two days of purchase, beginning December 10, 2018.

Filers are reminded that, as of September 1, 2017, an ETF that files a preliminary or pro forma prospectus must concurrently file an ETF Facts for each class or series of ETF securities offered under that prospectus. This means that for existing ETFs, the initial ETF Facts should be filed with the first renewal prospectus filed on or after September 1, 2017. The ETF Facts must also be posted to the ETF's or ETF manager's website after final receipt.

Until the initial ETF Facts is filed, ETF managers who obtained exemptive relief to prepare and file summary disclosure documents for ETF securities can continue to rely on that relief.

The initial ETF Facts filed may be reviewed by staff for strict form compliance with Form 41-101F4 Information Required in an ETF Facts Document (Form 41-101F4). Issuers and their counsel are encouraged to contact staff if there are any questions about the form requirements or instructions in Form 41-101F4.

{1} In the Matter of Sionna Investment Managers Inc., dated June 2, 2017