National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief from certain specified derivatives and custodial requirements to permit mutual funds to enter into swap transactions that are cleared through a clearing corporation -- relief required because of new U.S. requirements to clear over-the-counter derivatives including swaps -- decision treats cleared swaps similar to other cleared derivatives -- National Instrument 81-102 Mutual Funds.
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, ss. 2.7(1) and (4), 6.8(1), 19.1.
September 4, 2013
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
TD ASSET MANAGEMENT INC.
The principal regulator in the Jurisdiction has received an application from TD Asset Management Inc. and any affiliate of TD Asset Management Inc. (collectively, the Filer) for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation), pursuant to section 19.1 of National Instrument 81-102 Mutual Funds (NI 81-102), exempting each existing mutual fund managed by the Filer, to which NI 81-102 applies, and any future mutual fund manager by the Filer, to which NI 81-102 applies (each a Fund and, collectively, the Funds) from:
(i) the requirement in subsection 2.7(1) of NI 81-102 that a mutual fund must not purchase an option or a debt-like security or enter into a swap or a forward contract unless, at the time of the transaction, the option, debt-like security, swap or contract has a designated rating or the equivalent debt of the counterparty, or of a person or company that has fully and unconditionally guaranteed the obligations of the counterparty in respect of the option, debt-like security, swap or contract, has a designated rating;
(ii) the limitation in subsection 2.7(4) of NI 81-102 that the mark-to-market value of the exposure of a mutual fund under its specified derivatives positions with any one counterparty other than an acceptable clearing corporation or a clearing corporation that settles transactions made on a futures exchange listed in Appendix A to NI 81-102 shall not exceed, for a period of 30 days or more, 10 percent of the net asset value of the mutual fund; and
(iii) the requirement in subsection 6.1(1) of NI 81-102 to hold all portfolio assets of a mutual fund under the custodianship of one custodian in order to permit each TD Fund to deposit cash and portfolio assets directly with a Futures Commission Merchant (as defined below) and indirectly with a Clearing Corporation (as defined below) as margin,
in each case, with respect to cleared Swaps (as defined below) (the "Requested Relief").
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission is the principal regulator for this application; and
(b) the Filer has provided notice that subsection 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in each of the other provinces and territories of Canada (each an "Other Jurisdiction").
Terms defined in NI 81-102, National Instrument 14-1-1 Definitions, and MI 11-102 have the same meaning if used in this decision, unless otherwise defined. Capitalized terms used in this decision have the following meanings:
"CFTC" means the U.S. Commodity Futures Trading Commission
"Clearing Corporation" means each of the Chicago Mercantile Exchange Inc., ICE Clear Credit LLC and LCH.Clearnet Limited and any other clearing organization that is permitted to operate in the Jurisdiction or the Other Jurisdiction, as the case may be, where the Fund is located
"Dodd-Frank" means the Dodd-Frank Wall Street Reform and Consumer Protection Act
"Futures Commission Merchant" means any futures commission merchant that is registered with the CFTC and is a member of a Clearing Corporation
"OTC" means over-the-counter
"Swaps" means the swaps that are, or will become, subject to a clearing determination issued by the CFTC, including, without limitation, fixed-to-floating interest rate swaps, basis swaps, forward rate agreements in U.S. dollars, the Euro, Pounds Sterling or the Japanese Yen, overnight index swaps in U.S. dollars, the Euro and Pounds Sterling and untranched credit default swaps on certain North American indices (CDX.NA.IG and CDX.NA.HY) and European indices (iTraxx Europe, iTraxx Europe Crossover and iTraxx Europe HiVol) at various tenors.
"U.S. Person" has the meaning attributed thereto by the CFTC
This decision is based on the following facts represented by the Filer:
1. The Filer is, or will be, the investment fund manager of each TD Fund. The Filer is registered as an investment fund manager in the Provinces of Ontario, Québec and Newfoundland and Labrador and is registered as a portfolio manager and exempt market dealer in all of the provinces and territories of Canada. The Filer is also registered under the Commodity Futures Act (Ontario) in the category of commodity trading manager in the Province of Ontario.
2. The Filer is, or will be, a portfolio manager to the TD Funds. Certain TD Funds may have a sub-adviser, which may or may not be an affiliate of the Filer.
3. Each TD Fund is, or will be, a mutual fund created under the laws of the Province of Ontario and is, or will be, subject to the provisions of NI 81-102.
4. Neither the Filer nor the TD Funds are, or will be, in default of securities legislation in any Jurisdiction.
5. The securities of each TD Fund are, or will be, qualified for distribution pursuant to a prospectus that was, or will be, prepared and filed in accordance with the securities legislation of the Jurisdictions. Accordingly, each TD Fund is, or will be, a reporting issuer or the equivalent in each Jurisdiction.
6. The investment objective and investment strategies of each TD Fund permit, or will permit, the TD Fund to enter into derivative transactions, including Swaps. The portfolio management team of the Filer considers Swaps to be an important investment tool that is available to it to properly manage each TD Fund's portfolio. As at the close of business on July 26, 2013, the existing TD Funds have entered into foreign exchange swaps and credit default swaps on indices that had an aggregate absolute notional value of approximately $62.1 million.
7. Dodd-Frank requires that certain OTC derivatives be cleared through a Futures Commission Merchant at a clearing organization recognized by the CFTC. On November 28, 2012 the CFTC issued its first mandatory clearing determination pursuant to Dodd-Frank. These final rules require that all Swaps between certain categories of market participants be cleared. Generally, where one party to a Swap is a U.S. Person, that Swap must be cleared, absent an available exception. The CFTC has also adopted final rules that create a phased-in implementation schedule for compliance with these mandatory clearing determinations. The timing of when a Swap must be cleared under any mandatory clearing determination depends upon the category of entity that the market participant falls within. The Swap is subject to the latest compliance date for one of the counterparties. In the case of the Filer, the relevant compliance date is September 9, 2013.
8. Currently, the TD Funds enter into Swaps on an OTC basis with a number of Canadian, U.S. and international counterparties. These OTC Swaps are entered into in compliance with the derivatives provisions of NI 81-102. The Filer has comprehensive risk management policies and procedures in place to manage the risks associated with the use of derivatives, including Swaps. Derivative transactions on behalf of a TD Fund may only be initiated by authorized investment personnel approved by senior management of the Filer who confirm that these individuals have the necessary proficiency and experience to use derivatives. The exposure of the TD Funds to derivatives is monitored by the Filer's portfolio management and risk management groups on an independent basis. Counterparties, including Futures Commission Merchants, used in a derivatives transaction can only be from an approved counterparties list. Approved counterparties are monitored by the Filer's internal credit committee.
9. In the absence of the Requested Relief, the Filer may need to structure certain Swaps entered into by the TD Funds so as to avoid the clearing requirements of the CFTC. The Filer respectfully submits that this would not be in the best interests of the TD Funds and their investors for a number of reasons, as set out below.
10. It is in the best interests of the TD Funds and their investors to continue to have the flexibility to execute OTC derivatives with U.S. Persons, including U.S. swap dealers, after September 9, 2013.
11. In its role as a fiduciary for the TD Funds, the Filer has determined that central clearing represents the best choice for the investors in the TD Funds to mitigate the legal, operational and back office risks faced by investors in the global swap markets.
12. As a member of the G20 and a participant in the September 2009 commitment of G20 nations to improve transparency and mitigate risk in derivatives markets, Canada has expressly recognized the systemic benefits that clearing OTC derivatives offers to market participants, such as the TD Funds. The Filer respectfully submits that the TD Funds should be encouraged to comply with the robust clearing requirements established by the CFTC by granting them the Requested Relief.
13. The Requested Relief is analogous to the treatment currently afforded under NI 81-102 to other types of derivatives that are cleared, such as clearing corporation options, options on futures and standardized futures. From a policy perspective, the Requested Relief is consistent with the views of the Canadian securities authorities in respect of cleared derivative trades
14. For the reasons provided above, the Filer submits that it would not be prejudicial to the public interest to grant the Requested Relief.
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator under the Legislation is that the Requested Relief is granted provided that, in respect of the deposit of cash and portfolio assets as margin:
(a) in Canada,
(i) the Futures Commission Merchant is a member of a SRO that is a participating member of CIPF; and
(ii) the amount of margin deposited and maintained with the Futures Commission Merchant does not, when aggregated with the amount of margin already held by the Futures Commission Merchant, exceed 10 percent of the net asset value of the TD Fund as at the time of deposit; and
(b) outside of Canada,
(i) the Futures Commission Merchant is a member of a Clearing Corporation and, as a result, is subject to a regulatory audit;
(ii) the Futures Commission Merchant has a net worth, determined from its most recent audited financial statements that have been made public or from other publicly available financial information, in excess of the equivalent of $50 million; and
(iii) the amount of margin deposited and maintained with the Futures Commission Merchant does not, when aggregated with the amount of margin already held by the Futures Commission Merchant, exceed 10 percent of the net asset value of the TD Fund as at the time of deposit.
This decision will terminate on the earlier of (i) the coming into force of any revisions to the provisions of NI 81-102 that address the clearing of OTC derivatives, and (ii) two years from the date of this decision.