National Policy 11-203 -- Process for Exemptive Relief Application in Multiple Jurisdictions -- Mortgage fund granted relief from subsections 2.3(b) and (c) of NI 81-102 provided fund complies National Policy Statement 29 (NP29), other than (i)requirement to invest in mortgages with a loan-to-value ratios up to 75% unless mortgage insured or guaranteed (75% LTV Requirement) and (ii) prohibition on holding mortgages in which related parties of the fund have an interest as mortgagor -- Fund unable to rely on section 20.4 of NI 81-102 due to exemption sought from NP29 -- Restriction on loan-to-value ratios in NP 29 was intended to mirror requirements in the Bank Act (Canada) -- Bank Act and Trust and Loan Companies Act (Canada) amended in 2007 to permit Banks and trust companies to grant mortgages with loan-to-value ratio up to 80% without requiring insurance or guarantee -- mortgages selected for investment by fund solely on pre-determined criteria including yield and term provided by portfolio manager to Scotia Mortgage Corp. (SMC) -- Neither SMC nor fund's portfolio knows any details of mortgagors, including name and employment information at time of purchase -- manual process to exclude related party mortgages from consideration is time-consuming and expensive -- fund's independent review committee must approve policies and procedures create to deal with related party mortgages held by the fund -- relief from 75% LTV requirement terminates if mortgage provisions in the Bank Act or Trust and Loan Companies Act are further amended.
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, ss. 2.3(b), 2.3(c), 19.1, 20.4.
National Policy Statement 29 Mutual Funds Investing in Mortgages, ss. III(2.1)(f), III(2.1)(i).
National Policy 11-203 Process For Exemptive Relief Applications in Multiple Jurisdictions.
July 28, 2009
IN THE MATTER OF
THE SECURITIES LEGISLATION OF
IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF
APPLICATIONS IN MULTIPLE JURISDICTIONS
IN THE MATTER OF
SCOTIA SECURITIES INC. (SSI) AND
SCOTIA MORTGAGE INCOME FUND (the Fund)
(SSI and the Fund are collectively referred
to herein as the Filers)
The principal regulator in the Jurisdiction has received an application from the Filers for a decision under the securities legislation of the Jurisdiction (the Legislation) for an exemption, pursuant to section 19.1 of National Instrument 81-102 Mutual Funds (NI 81-102), from subsections 2.3(b) and (c) of NI 81-102, provided that the Fund complies with National Policy Statement 29 (NP 29) except for:
(a) the prohibition contained in paragraph III(2.1)(f) of NP 29, which prohibits a mutual fund from investing in mortgages an amount which is more than 75% of the fair market value of the property securing the mortgage, except under certain circumstances (the 75% LTV Requirement), and
(b) the prohibition contained in paragraph III(2.1)(i) of NP 29, which prohibits a mutual fund from investing in mortgages on property in which
(i) any senior officer, director or trustee of the mutual fund, its management company or distribution company, or
(ii) any person or company who is a substantial security holder of the mutual fund, its management company or its distribution company, or
(iii) any associate or affiliate of persons or institutions mentioned in subparagraphs (i) or (ii), except in the case of a mortgage on a single family dwelling for less than $75,000, has an interest as mortgagor
(the Related Party Mortgages Prohibition)
(the 75% LTV Requirement and the Related Party Mortgages Prohibition are collectively, the Exemption Sought).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission (OSC) is the principal regulator for this application; and
(b) the Filers have provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in each of Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, the Northwest Territories, Nova Scotia, Nunavut, Prince Edward Island, Québec, Saskatchewan and the Yukon.
Terms defined in National Instrument 14-101 Definitions and Multilateral Instrument 11-102 Passport System (MI 11-102) have the same meaning if used in this decision, unless otherwise defined.
This decision is based on the following facts represented by the Filers:
1. SSI is a corporation governed under the laws of the province of Ontario and has its head office located in Toronto, Ontario.
2. SSI is the manager and trustee of the Fund.
3. The Fund is an open-end mutual fund established under the laws of the province of Ontario and is qualified for distribution in each of the provinces and territories of Canada under a simplified prospectus and annual information form dated November 3, 2008, as amended. The Fund is a reporting issuer under the securities legislation of each of the provinces and territories of Canada.
4. The Filers and the Funds are not in default of any requirements of applicable securities legislation.
5. SSI has appointed an independent review committee (IRC) for the Fund pursuant to National Instrument 81-107 Independent Review Committee for Investment Funds (NI 81-107).
6. SSI has appointed Scotia Cassels Investment Counsel Limited (the Portfolio Manager) to provide portfolio management and investment advisory services to the Fund.
7. The Portfolio Manager of the Fund is a corporation governed by the laws of the province of Ontario and is registered as an investment counsel and portfolio manager in each of the provinces and territories of Canada.
8. The investment objective of the Fund is to provide regular interest income. It invests primarily in high quality mortgages on residential properties in Canada. These mortgages are:
a) insured or guaranteed by Canadian federal or provincial governments, or their agencies, or
b) conventional first mortgages with loan-to-value ratios (LTV Ratio) of no more than 75%, unless the excess is insured by an insurance company registered or licensed under federal or provincial legislation.
9. The Fund currently has relief (the Existing Relief) from section 4.2 of NI 81-102, and the Portfolio Manager has relief from section 118 of the Regulations to the Securities Act (Ontario), and comparable provisions in the securities legislation of the applicable Remaining Jurisdictions, to permit the Fund to purchase and sell mortgages to and from Scotia Mortgage Corporation (SMC), an affiliate of The Bank of Nova Scotia (BNS), and to and from BNS, and other affiliates. BNS is the ultimate parent company of SSI and SMC.
10. BNS has agreed to repurchase from the Fund any mortgage purchased from SMC, BNS or an affiliate, if the mortgage is in default or is not a valid first mortgage or is not in compliance with the LTV Ratio (the BNS Guarantee).
11. Subsections 2.3(b) and (c) of NI 81-102 prohibit a mutual fund from purchasing a mortgage, other than a guaranteed mortgage, and from purchasing a guaranteed mortgage if, immediately after the purchase, more than 10 percent of the net assets of the mutual fund, taken at market value at the time of the purchase, would consist of guaranteed mortgages.
12. Section 20.4 of NI 81-102 provides an exemption from subsections 2.3(b) and (c) to a mutual fund that has adopted fundamental investment objectives to permit it to invest in mortgages in accordance with NP 29 if, among other conditions, the mutual fund complies with NP 29.
Insurance of Mortgages over 75% LTV Ratio
13. Paragraph III(2.1)(f) of NP 29 prohibits a mutual fund from investing in mortgages an amount which is more than 75% of the fair market value of the property securing the mortgage, except when
a) such mortgage is insured under the National Housing Act (Canada) or any similar act of a province, or
b) the excess over 75% is insured by an insurance company registered or licensed under the Canadian and British Insurance Companies Act (Canada), the Foreign Insurance Companies Act (Canada) or insurance acts or similar acts of a Canadian province or territory.
14. BNS and SMC are the originators of the mortgages contained in the Fund. BNS, as a chartered bank, is subject to the provisions of the Bank Act (Canada) (the Bank Act) and SMC is subject to the Trust and Loan Companies Act (Canada) (the TLC Act).
15. When subsection III(2.1) of NP 29 was originally implemented, it mirrored the prohibition contained in the Bank Act against lending an amount in excess of 75% of the LTV Ratio of the property securing the mortgage, unless the excess was covered by insurance, as outlined in paragraph III(2.1)(f)(ii) of NP 29.
16. On April 20, 2007, each of the Bank Act and the TLC Act was amended to increase the LTV Ratio applicable to companies subject to the legislation from 75% to 80%. Subsection 418(1) of each of the Bank Act and the TLC Act now provides that a company subject to the legislation shall not make a loan in Canada on the security of residential property in Canada for the purpose of purchasing ... that property ..., if the amount of the loan, together with the amount then outstanding of any mortgage having an equal or prior claim against the property, would exceed 80 per cent of the value of the property at the time of the loan, except in respect of, among other things:
a) a loan made or guaranteed under the National Housing Act or any other Act of Parliament by or pursuant to which a different limit on the value of property on the security of which the bank may make a loan is established, or
b) a loan if repayment of the amount of the loan that exceeds the maximum amount set out in subsection (1) is guaranteed or insured by a government agency or a private insurer approved by the Superintendent [of Financial Institutions]...
(subsection 418(1) of the Bank Act and the TLC Act is, the New LTV Ratio).
17. Accordingly, pursuant to the amended Bank Act and the amended TLC Act, BNS and SMC are no longer required to obtain mortgage default insurance for properties that fall within the 75.01% to 80% loan-to-value range (LTV Prohibited Mortgages).
18. Absent the 75% LTV Requirement in NP 29, the Fund would be permitted to invest in the LTV Prohibited Mortgages, provided that such investments constitute a small percentage of the Fund, such that the Fund remains primarily invested in high quality mortgages on residential properties in Canada.
19. As the Fund currently acquires mortgages that are issued by either BNS or SMC, but is prohibited by the 75% LTV Requirement in NP 29 from acquiring any LTV Prohibited Mortgages, the Fund has had to monitor each of the BNS-originated and SMC-originated mortgages presented to it, in order to ensure compliance with NP 29.
20. The Fund uses a manual process to identify and exclude LTV Prohibited Mortgages. This process is time consuming and expensive.
21. In addition, in situations where there is a shortage of appropriate mortgages for the Fund's portfolio, eliminating the LTV Prohibited Mortgages from the available investment options may result in the Fund's potential investment options being limited in certain circumstances, to the detriment of the Fund.
22. The BNS Guarantee ensures that there is no increased risk of default to the Fund from holding LTV Prohibited Mortgages.
Investment in Related Party Mortgages
23. Paragraph III(2.1)(i) of NP 29 prohibits a mutual fund from investing in mortgages on a property in which:
a) any senior officer, director or trustee of the mutual fund, its management company or distribution company, or
b) any person or company who is a substantial security holder of the mutual fund, its management company or its distribution company, or
c) any associate or affiliate of persons or institutions mentioned in subparagraphs (i) or (ii), except in the case of a mortgage on a single family dwelling for less than $75,000,
has an interest as mortgagor (Related Party Mortgages).
24. When the Portfolio Manager determines which mortgages to include in the Fund, it does so on the basis of identifying a pre-defined set of criteria related to interest rate yield and duration. The Portfolio Manager provides these instructions to SMC and SMC randomly selects mortgages which meet these pre-defined criteria.
25. SMC does not know the name or employment position of the mortgagor(s) when it selects mortgages for presentation to the Portfolio Manager.
26. The name or employment position of the mortgagor is also unknown to the Portfolio Manager and SSI at the time the decision is made to include the mortgage in the portfolio and accordingly is not a factor in determining whether to include a particular mortgage in the Fund's portfolio.
27. Similarly, the holder of a mortgage which is selected by the Portfolio Manager for inclusion in the Fund's portfolio, does not know that the Fund has purchased their mortgage.
28. Accordingly, it is possible that a Related Party Mortgage could be presented to the Fund for inclusion in the portfolio without the knowledge of SMC, SSI, the Portfolio Manager or the mortgagor.
29. If such situation were to arise, absent relief from the Related Party Mortgages Prohibition, the Fund would be prohibited from purchasing Related Party Mortgages, pursuant to paragraph III(2.1)(i) of NP 29.
30. Investments by the Fund in Related Party Mortgages would only be made in accordance with the fundamental investment objective and investment strategies of the Fund.
31. Neither SSI nor the Portfolio Manager has any role in administering the mortgages purchased for the Fund, and the Fund is not the originator of any mortgages held in its portfolio. Accordingly, there is no financial or other benefit to a mortgagor if the Fund's portfolio holds a Related Party Mortgage.
32. SSI believes that it is in the best interests of the Fund for investments to be made in mortgages that conform to the yield and timeframe requirements of the Fund's investment objectives without consideration of the identity or employment position of the individual mortgagors.
33. The inclusion of LTV Prohibited Mortgages and Related Party Mortgages in the Fund's portfolio will represent the business judgment of responsible persons uninfluenced by considerations other than the best interests of the Fund.
34. The IRC of the Fund will consider the policies and procedures of the Fund and will provide its approval on whether the purchase of any Related Party Mortgage by the Fund achieves a fair and reasonable result for the Fund in accordance with subsection 5.2(2) of NI 81-107.
Each of the Decision Makers is satisfied that the decision meets the test set out in the Legislation for the Decision Maker to make the decision.
The decision of the Decision Makers under the Legislation is that the Exemption Sought is granted provided that:
1. the Fund's fundamental investment objectives permit the Fund to invest in mortgages in accordance with NP 29, and,
(a) a National Instrument replacing NP 29 has not come into force;
(b) the Fund complies with NP 29, except for the Exemption Sought;
2. with respect to the Exemption Sought:
(a) the purchase or sale is consistent with, or is necessary to meet, the investment objectives of the Fund;
(b) the IRC of the Fund has approved the transaction in accordance with subsection 5.2(2) of NI 81-107;
(c) SSI, as manager of the Fund, complies with section 5.1 of NI 81-107;
(d) SSI, as manager of the Fund, and the IRC of the Fund comply with section 5.4 of NI 81-107 for any standing instructions the IRC receives in connection with the transactions;
(e) the Fund keeps the written records required by paragraph 6.1(2)(g) of NI 81-107, and
3. provided that this Decision, as it pertains to the Exemption Sought from the 75% LTV Requirement only, shall terminate if the New LTV Ratio in the Bank Act or the TLC Act is amended at any time.