National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Relief to permit a senior loan exchange-traded fund to borrow cash up to an amount equal to 10% of NAV as a temporary measure to accommodate requests for the redemption of units of the fund -- relief needed due to longer settlement times of senior loans -- relief subject to numerous conditions -- National Instrument 81-102 Investment Funds.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.6(a)(i), 19.1.
May 29, 2015
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 ALPHAPRO MANAGEMENT INC. (the Filer)
The principal regulator in the Jurisdiction (the Decision Maker) has received an application from the Filer 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 National Instrument 81-102 Investment Funds (NI 81-102), from subparagraph 2.6(a)(i) of NI 81-102 to permit the Horizons Active Floating Rate Senior Loan ETF (HSL) to borrow cash in an amount that does not exceed 10% of its net asset value, as a temporary measure to accommodate requests for a redemption of a Prescribed Number of Units (as defined below) of HSL (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 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 each jurisdiction of Canada outside of Ontario (together with Ontario, the Jurisdictions).
Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined herein.
The following terms shall also have the following meanings:
(a) Authorized Dealer means a registered dealer that has entered, or intends to enter, into an agreement with the Filer authorizing the dealer to subscribe for, purchase and redeem a Prescribed Number of Units from HSL on a continuous basis from time to time.
(b) Designated Broker means a registered dealer that has entered, or intends to enter, into an agreement with the Filer to perform certain duties in relation to HSL, including posting a liquid two-way market for the trading of Units on the TSX or another marketplace.
(c) Designated Counterparty means a person or company, or the direct or indirect parent company of such person or company, whose securities have a "designated rating", as defined in National Instrument 44-101 Short Form Prospectus Distributions.
(d) Prescribed Number of Units means, in relation to HSL, the number of Units determined by the Filer from time to time for the purpose of subscription orders, exchanges, redemptions or for other purposes.
(e) TSX means the Toronto Stock Exchange.
(f) Unitholder means a beneficial and registered holder of a Unit.
(g) Units means the class E units and advisor class units of HSL, and Unit means one of them.
The decision is based on the following facts represented by the Filer:
1. The Filer, a corporation incorporated under the laws of Canada, which has its head office in Toronto, is and will be the manager and trustee of HSL.
2. The Filer has retained its affiliate, Horizons ETFs Management (Canada) Inc. (Horizons), to act as the portfolio manager of HSL.
3. Horizons has retained the services of AlphaFixe Capital Inc. (AlphaFixe) to act as the sub-advisor of HSL.
4. HSL is a mutual fund trust governed by the laws of Ontario and is a reporting issuer under the laws of all of the Jurisdictions.
5. HSL is subject to NI 81-102, subject to any exemptions therefrom that have been, or may be, granted by the applicable securities regulatory authorities.
6. HSL is an exchange-traded fund whose securities are primarily traded on the TSX.
7. Units of HSL are qualified for distribution in each of the Jurisdictions pursuant to a long form prospectus dated January 29, 2015 (the Prospectus).
8. Except in respect of Horizon's late filing of an application to add additional jurisdictions to its category of registration, none of Horizons, the Filer or HSL is in default of securities legislation in any of the Jurisdictions.
9. The investment objective of HSL is to seek to provide Unitholders with a high level of current income by investing primarily in a diversified portfolio of U.S. senior secured floating rate loans and debt securities, with capital appreciation as a secondary objective. HSL may also invest in exchange-traded funds that provide exposure to senior loans. HSL will, to the best of its ability, seek to hedge its non-Canadian dollar currency exposure to the Canadian dollar at all times.
10. HSL has text box disclosure in the Prospectus and in its summary disclosure document stating that (i) HSL invests primarily in senior secured loans, which are generally rated below investment grade debt, (ii) settlement periods for senior secured loans may be longer than for other types of debt securities, such as corporate bonds, and (iii) HSL is not a substitute for holding cash or money market securities.
11. HSL has also disclosed in the Prospectus that (i) HSL will generally not invest more than 5% of its assets in a single senior loan issue, (ii) HSL will generally maintain an average rating for the senior loan portfolio of BB-/B+ rating and will not invest in securities of issuers rated below B-- or in unrated securities, and (iii) HSL will primarily invest in issues with a minimum tranche size of USD 400 million and will not invest in any issues where the tranche is less than USD 100 million.
12. Throughout the day, AlphaFixe has access to quotations with bid-ask spreads from the major broker-dealers active in the senior loan market. This information enables AlphaFixe to monitor and assess the liquidity of the portfolio assets and the market as a whole. AlphaFixe actively monitors earnings reports, price movements and bid-ask spreads of HSL's portfolio as part of its active management, and monitors compliance to the investment strategy in real-time. HSL's portfolio of senior loans is actively monitored by AlphaFixe, and AlphaFixe processes all information available to it as part of its daily portfolio management activities.
13. In addition to the ongoing monitoring of the markets and the HSL portfolio assets described above, each individual investment goes through a fundamental credit analysis (qualitative and quantitative), which includes stress tests, before the actual investment. These stress tests will include, amongst other things:
(a) revenue/EBITDA projections and sensitivity analysis including break-even point;
(b) margin projections and sensitivity analysis;
(c) impact of interest rates on cash flows;
(d) free cash flow analysis; and
(e) any other specific analysis appropriate for a particular sector and/or investment.
14. Senior loans, compared to equivalently rated unsecured high yield bonds, typically offer a higher recovery rate because of the protection offered by their secured nature and their priority claim relative to other debt instruments. This security is generally achieved by liens on physical or non-physical assets and, even if not realized through liquidation, can greatly increase recovery in a reorganisation scenario.
15. The sale of a senior loan between HSL and a Designated Counterparty will always be subject to the standard terms and conditions for par / near par trade confirmations published by the Loan Syndications and Trading Association (the Terms), which Terms are binding on the parties to the transaction and do not contain any "outs" for force majeure or the stress or dislocation of the senior loan market.
16. The purchaser that will be interacting with HSL with respect to a senior loan will always be a dealer that is a Designated Counterparty that is subject to the Terms.
17. AlphaFixe will seek to maintain borrower and industry diversification among HSL's senior loan portfolio. When selecting senior loans, AlphaFixe will seek to implement a fundamental analysis approach of risk/return characteristics. Senior loans may be purchased by AlphaFixe in the primary and secondary markets as the opportunities for investment present themselves. Senior loans may be sold in the secondary market if, in the opinion of AlphaFixe, the risk-return profile deteriorates or to pursue a more attractive investment.
18. HSL may invest up to 20% of its net assets in cash, cash equivalents and/or other floating rate debt instruments. HSL may also invest up to 20% of its net assets in investment grade corporate bonds and 20% of its net assets in high yield debt securities. HSL may make these investments by investing in exchange traded funds that provide exposure to the applicable asset classes. At all times, subject to the Cash Conditions (as defined below), at least 10% of HSL's portfolio will be comprised of cash and/or securities that settle within three business days. HSL will, to the best of its ability, seek to hedge its non-Canadian dollar currency exposure to the Canadian dollar at all times.
19. Units may generally only be subscribed for or purchased directly from HSL by Authorized Dealers or Designated Brokers in an amount equal to a Prescribed Number of Units (or multiple thereof) on any day when there is a trading session on the TSX or another recognized stock exchange in Canada.
20. The net asset value per Unit of each class of HSL is calculated and published daily in the financial press and on the Filer's website at www.horizonsetfs.com.
21. Designated Brokers perform certain other functions, which include standing in the market with a bid and ask price for Units for the purpose of maintaining liquidity for the Units.
22. Except for Authorized Dealer and Designated Broker subscriptions for a Prescribed Number of Units, as described above, and other distributions that are exempt from the prospectus delivery requirement under the Legislation, Units generally may not be purchased directly from HSL. Investors are generally expected to purchase and sell Units, directly or indirectly, through dealers executing trades through the facilities of the TSX or another marketplace in Canada. Units may also be issued directly to HSL's investors upon the reinvestment of distributions of income or capital gains.
23. Unitholders of HSL that wish to dispose of their Units may generally do so by selling their Units on the TSX, through a registered broker or dealer, subject only to customary brokerage commissions. Unitholders of HSL may also redeem their Units for cash at a redemption price equal to 95% of the closing price of the Units on the TSX on the effective date of redemption. A Unitholder that holds a Prescribed Number of Units or an integral multiple thereof may also exchange such Units for cash based on the net asset value of such Units.
24. The Filer believes that the U.S. senior loans that will be held by HSL can be liquidated in an orderly fashion given the size and depth of the overall U.S. senior loan market. However, as the time it will take HSL to settle a senior loan's disposition is typically longer than that of equity securities, and notwithstanding the fact that HSL will always maintain at least 10% of its assets in cash and other liquid investments, the Filer has determined that it would be prudent for HSL to have the ability to use a temporary overdraft facility from time to time with a value of up to 10% of its net asset value to assist, if necessary, in meeting redemption requests, and it is for this reason that the Filer has applied for the Exemption Sought.
The Decision Maker 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 Maker under the Legislation is that the Exemption Sought is granted provided that:
(a) if trading of the Units on the TSX is suspended for a period exceeding 30 days, HSL will begin taking all necessary steps to ensure that all amounts borrowed under the overdraft facility are fully repaid as soon as commercially reasonable, but no later than 90 days from the date of suspension, provided that such repayment need not be completed if the suspension is lifted within 90 days from the date of the suspension;
(b) HSL does not make a distribution to Unitholders where that distribution would impair the ability of HSL to repay the funds borrowed under the overdraft facility;
(c) HSL's next renewal prospectus or amendment to prospectus to be filed in connection with the continuous distribution of Units discloses the maximum percentage of assets of HSL that the borrowing may represent, HSL's intended use of the amounts borrowed under the overdraft facility, the material terms of the overdraft facility and the risks arising from the borrowing under the overdraft facility; and
(d) HSL may only borrow cash in excess of 5% of net asset value if all of the following conditions are satisfied:
(i) after giving effect to the borrowing, the outstanding amount of all borrowings of HSL does not exceed 10% of the net asset value of HSL;
(ii) HSL has entered into a fully binding agreement with a Designated Counterparty(s) to sell a senior loan(s) in order to satisfy redemption requests, but the settlement period on the senior loan(s) exceeds three days;
(iii) the amount of cash that HSL borrows does not exceed the amount of cash that it will receive in respect of the sale of the senior loan(s) referred to in paragraph (d)(ii) above; and
(iv) HSL has sold all of the securities in its portfolio, other than senior loans, and has used all of its available cash in order to satisfy redemption requests
(collectively, the Cash Conditions).
The Exemption Sought expires on a date that is 18 months after the date of this decision.