Securities Law & Instruments

Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- exemption from sections section 2.1(1), and 2.8(1)(d) and (f)(i) of National Instrument 81-102 -- Mutual Funds to permit i) the funds when they open or maintain a long position in a standardized future or forward contract or when they enter into or maintain an interest rate swap position and during the periods when the funds are entitled to receive payments under the swap, to use as cover, a right or obligation to sell an equivalent quantity of the underlying interest of the standardized future, forward or swap, and ii) to permit one global bond mutual funds to invest more than 10 percent of net assets in debt securities issued by a foreign government or supranational agency subject to conditions.

Applicable Legislative Provisions

National Instrument 81-102 Mutual Funds, ss. 2.1(1), 2.8(1), 19.1.

September 6, 2013

IN THE MATTER OF
THE SECURITIES LEGISLATION OF
ONTARIO
(the Jurisdiction)

AND

IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF
APPLICATIONS IN MULTIPLE JURISDICTIONS

AND

IN THE MATTER OF
NORTHWEST & ETHICAL INVESTMENTS L.P.
(the Filer)

AND

IN THE MATTER OF

NEI GLOBAL TOTAL RETURN BOND FUND
(the Total Return Bond Fund)

DECISION

Background

The principal regulator in the Jurisdiction has received an application from the Filer on behalf of all existing and future mutual funds managed by the Filer that are subject to National Instrument 81-102 Mutual Funds (NI 81-102), other than money market funds as defined in NI 81-102 (collectively with the Total Return Bond Fund, the Funds), for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for an exemption, pursuant to section 19.1 of NI 81-102, from the following sections of NI 81-102:

(a) sections 2.8(1)(d) and 2.8(1)(f)(i) of NI 81-102 (the Cash Cover Exemption) to permit each Fund, when it:

(i) opens or maintains a long position in a debt-like security that has a component that is a long position in a forward contract or in a standardized future or forward contract; or

(ii) enters into or maintains a swap position and during the periods when the Fund is entitled to receive payments under the swap,

to use as cover a right or obligation to sell an equivalent quantity of the underlying interest of the standardized future, forward or swap; and

(b) section 2.1(1) (the Foreign Government Securities Exemption) to permit the Total Return Bond Fund to invest up to:

(i) 35% of the Fund's net asset value at the time of the transaction in evidences of indebtedness of any one issuer if those evidences of indebtedness are issued, or guaranteed fully as to principal and interest, by supranational agencies or governments other than the government of Canada, the government of a jurisdiction in Canada, or the government of the United States of America and are rated "AAA" by Standard & Poor's, or have an equivalent rating by one or more other designated rating organizations; and

(ii) 20% of the Fund's net asset value at the time of the transaction in evidences of indebtedness of any one issuer if those evidences of indebtedness are issued, or guaranteed fully as to principal and interest, by supranational agencies or governments other than the government of Canada, the government of a jurisdiction in Canada or the government of the United States of America and are rated "AA" by Standard & Poor's, or have an equivalent rating by one or more other designated rating organizations.

(such evidences of indebtedness are collectively referred to as Foreign Government Securities)

(collectively, the Exemption Sought).

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 section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, the Northwest Territories, Nunavut and Yukon (the Other Jurisdictions).

Interpretation

Terms defined in NI 81-102, National Instrument 14-101 Definitions, and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.

Representations

This decision is based on the following facts represented by the Filer:

The Filer

1. The Filer is a limited partnership formed under the laws of Ontario with its head office in Toronto, Ontario. Northwest & Ethical Investments Inc., which is the general partner of the Filer, is a corporation formed under the laws of Canada with its head office in Toronto, Ontario.

2. The Filer is registered as an investment fund manager in Ontario, British Columbia, Newfoundland and Labrador and Quebec, and a portfolio manager in Ontario and British Columbia.

3. The Filer is, or will be, the manager of the Funds, and may be the portfolio manager of a Fund. The Filer may appoint one or more portfolio managers or sub-advisors to provide the Filer with investment advice in respect of a Fund's investments in securities.

The Funds

4. To the extent that a Fund may invest in futures or options on futures, the Filer will appoint a portfolio manager (Futures Adviser) that is duly registered under the Commodities Futures Act (Ontario) or that has obtained an exemption from the applicable registration requirements under that Act.

5. Each Fund is, or will be, an open-ended mutual fund trust established under the laws of Ontario or a class of shares of a mutual fund corporation incorporated under the laws of Ontario.

6. Securities of the Funds are, or will be, offered by a simplified prospectus filed in one or more provinces and territories of Canada and, accordingly, each Fund is, or will be, a reporting issuer in one or more provinces and territories of Canada. In the case of the Total Return Bond Fund, a preliminary simplified prospectus was filed via SEDAR in the Jurisdictions on July 25, 2013.

7. The Filer and the Funds are not in default of securities legislation in any jurisdiction of Canada.

8. The investment objective and investment strategies of each Fund are, or will be, set out in the Fund's simplified prospectus. Where specified in its investment strategies, a Fund may invest in specified derivatives in order to seek exposure to securities of markets and may also use derivatives to hedge against potential loss. When specified derivatives are used for non-hedging purposes, each Fund that is permitted to use derivatives is, or will be, subject to the cover requirements of NI 81-102.

Cash Cover

9. Sections 2.8(1)(d) and 2.8(1)(f)(i) of NI 81-102 do not permit covering the position in long positions in futures and forwards and long positions in swaps for a period when the Fund is entitled to receive payments under the swap, in whole or in part, with a right or obligation to sell an equivalent quantity of the underlying interest of the future, forward or swap. In other words, those sections of NI 81-102 do not permit the use of put options or short future, forward or swap positions to cover long future, forward or swap positions.

10. Section 2.8(1)(c) of NI 81-102 permits a mutual fund to write a put option and to cover it by holding a right or obligation to sell an equivalent quantity of the underlying interest of the written put option. This position has similar risks as a long position in a future, forward or swap. Therefore, the Filer submits that the Funds should be permitted to cover a long position in a future, forward or swap with a put option or a short future position.

11. The Filer, as investment fund manager, sets and reviews the investment objectives and overall investment policies of the Funds, which will allow for trading in derivatives. The derivative contracts entered into by or on behalf of the Funds must be in accordance with the investment objectives and strategies of each of the Funds and in compliance with NI 81-102.

12. Pursuant to its agreement with portfolio managers, sub-advisors or Futures Advisers, the Filer will permit such portfolio managers, sub-advisors or Futures Advisers to use derivatives for the Funds under certain conditions and limitations in order to gain exposure to financial markets or to invest indirectly in securities or other assets. Such agreement will also require such portfolio managers, sub-advisors or Futures Advisers to use risk management processes to monitor and measure the risks of all portfolio holdings within the Funds, including derivatives positions.

13. As the investment fund manager, the Filer will supervise and oversee the portfolio managers, sub-advisors and Futures Advisers in the use of derivatives as investments within the Funds and the Filer will put in place policies and procedures which will set out supervision and oversight processes to ensure that the use of derivatives is adequately monitored and derivatives risk is appropriately managed.

14. The annual information form of the Funds discloses, or will disclose, the internal controls and risk management processes of the Filer regarding the use of derivatives. The simplified prospectus and annual information form of the Funds that rely on the Cash Cover Relief will include disclosure of the nature of the Cash Cover Relief.

15. Without the Cash Cover Exemption, the Funds will not have the flexibility to enhance yield and to more effectively manage their exposure under specified derivatives.

Foreign Government Securities

16. The Total Return Bond Fund's investment objective is expected to be substantially as follows: "The investment objective of the Fund is to provide high level of current income with the potential for capital gains. The Fund will invest its assets primarily in global fixed income instruments from both developed and emerging markets. The Fund can invest across all sectors and credit qualities but will be primarily invested in investment grade securities. The Fund follows a socially responsible approach to investing."

17. To achieve the investment objective of the Total Return Bond Fund, it is expected that the investment team will engage an investment process that is based on a rigorous global top-down approach consisting of allocating the active risk of the Fund's portfolio proportionally across several sources of added value including duration management, country and yield curve decisions, sovereign bonds, credit allocations and currency management. The investment team will consider the macro-economic outlook for the markets and its views on the main global government, corporate and emerging bond, and currency markets.

18. As part of its investment strategies, the Total Return Bond Fund would like to invest a portion of its assets in Foreign Government Securities.

19. Section 2.1(1) of NI 81-102 restricts mutual funds from investing more than 10% of their net asset value in any single issuer, save and except for securities issued or guaranteed as to principal and interest by the Government of Canada or an agency thereof, or by the Government of any Province of Canada or an agency thereof, or by the Government of the United States of America or an agency thereof.

20. The Foreign Government Securities are not within the meaning of "government securities" as such term is defined in 81-102.

21. In the Companion Policy to NI 81-102, the Canadian Securities Administrators state their views on various matters relating to NI 81-102. Section 3.1(4) of the Companion Policy indicates that relief from paragraph 2.04(1)(a) of NP39, which is replaced by Section 2.1 of NI 81-102, has been provided to mutual funds generally under the following circumstances:

(a) 35% of the mutual fund's net asset value at the time of the transaction may be invested in evidences of indebtedness of any one issuer if those evidences of indebtedness are issued, or guaranteed fully as to principal and interest, by supranational agencies or governments other than the government of Canada, the government of a jurisdiction in Canada, or the government of the United States of America and are rated "AAA" by Standard & Poor's, or have an equivalent rating by one or more other designated rating organizations; and

(b) 20% of the mutual fund's net asset value at the time of the transaction may be invested in evidences of indebtedness of any one issuer if those evidences of indebtedness are issued, or guaranteed fully as to principal and interest, by supranational agencies or governments other than the government of Canada, the government of a jurisdiction in Canada or the government of the United States of America and are rated "AA" by Standard & Poor's, or have an equivalent rating by one or more other designated rating organizations.

22. The simplified prospectus of the Total Return Bond Fund will disclose the risks associated with concentration of the net assets of the Fund in securities of a limited number of issuers.

Decision

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 Exemption Sought is granted provided that:

1. in the case of the Cash Cover Exemption:

(a) when a Fund enters into or maintains a swap position for periods when the Fund would be entitled to receive fixed payments under the swap, the Fund holds:

(i) cash cover in an amount that, together with margin on account for the swap and the market value of the swap, is not less than, on a daily mark-to-market basis, the underlying market exposure of the swap;

(ii) a right or obligation to enter into an offsetting swap on an equivalent quantity and with an equivalent term and cash cover that, together with margin on account for the position, is not less than the aggregate amount, if any, of the obligations of the Fund under the swap less the obligations of the Fund under such offsetting swap; or

(iii) a combination of the positions referred to in subparagraphs (i) and (ii) that is sufficient, without recourse to other assets of the Fund, to enable the Fund to satisfy its obligations under the swap;

(b) when a Fund opens or maintains a long position in a debt-like security that has a component that is a long position in a forward contract, or in a standardized future or forward contract, the Fund holds:

(i) cash cover in an amount that, together with margin on account for the specified derivative and the market value of the specified derivative, is not less than, on a daily mark-to-market basis, the underlying market exposure of the specified derivative;

(ii) a right or obligation to sell an equivalent quantity of the underlying interest of the future or forward contract, and cash cover that, together with margin on account for the position, is not less than the amount, if any, by which the market price of the future or forward contract exceeds the strike price of the right or obligation to sell the underlying interest; or

(iii) a combination of the positions referred to in subparagraphs (i) and (ii) that is sufficient, without recourse to other assets of the Fund, to enable the Fund to acquire the underlying interest of the future or forward contract;

(c) the Funds will not (i) purchase a debt-like security that has an option component or an option; or (ii) purchase or write an option to cover any position under section 2.8(1)(b), (c), (d), (e) or (f) of NI 81-102 if, immediately after the purchase or writing of such option, more than 10% of the net asset value of the Fund at the time of the transaction would be made up of (A) purchased debt-like securities that have an option component or purchased options, in each case, held by the Funds for purposes other than hedging, or (B) options used to cover any position under section 2.8(1)(b), (c), (d), (e) or (f) of NI 81-102;

(d) on the date that is the earlier of (i) the date when an amendment to the annual information form of the Funds is filed for reasons other than the Cash Cover Exemption and (ii) the date that the renewal annual information form of the Funds is receipted, the Funds shall

(i) disclose the nature and terms of the Cash Cover Exemption in the annual information form of the Funds; and

(ii) include a summary of the nature and terms of the Cash Cover Exemption in the simplified prospectus of the Funds under the Investment Strategies section or in the introduction to Part B of the simplified prospectus with a cross reference thereto under the Investment Strategies section for each of the Funds; and

(e) this Decision with respect to the Cash Cover Exemption will terminate on the coming into force of any securities legislation relating to the use as cover of a right or obligation to sell an equivalent quantity of the underlying interest of the standardized future, forward or swap in compliance with section 2.8 of NI 81-102.

2. in the case of the Foreign Government Securities Exemption:

(a) paragraphs (b)(i) and (b)(ii) of the Exemption Sought cannot be combined for any one issuer;

(b) the evidences of indebtedness that are acquired under the Foreign Government Securities Exemption are traded on a mature and liquid market;

(c) the acquisition of the evidences of indebtedness acquired pursuant to this Decision is consistent with the fundamental investment objectives of the Total Return Bond Fund;

(d) the simplified prospectus of the Total Return Bond Fund discloses the additional risks associated with the concentration of net asset value of the Total Return Bond Fund in securities of fewer issuers, such as the potential additional exposure to the risk of default of the issuer in which the Total Return Bond Fund has so invested and the risks, including foreign exchange risks, of investing in the country in which the issuer is located; and

(e) the simplified prospectus of the Total Return Bond Fund will include a summary of the nature and terms of the Foreign Government Securities Exemption under the investment strategies section and the type of securities covered by this Decision.

"Darren McKall"
Manage, Investment Funds Branch
Ontario Securities Commission