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 Investment Funds.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.7(1) and (4), 6.8(1), 19.1.
June 24, 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 RUSSELL INVESTMENTS CANADA LIMITED (the Filer)
The principal regulator in the Jurisdiction has received an application from the Filer for a decision under the securities legislation of the Jurisdiction (the Legislation) pursuant to section 19.1 of NI 81-102 exempting all Existing Funds (as defined below) and all investment funds for which the Filer becomes the manager in the future (the Future Funds and together with the Existing Funds, the Funds) which, in either case, are permitted by their investment objectives and investment strategies to enter into derivative transactions from:
(a) the requirement in subsection 2.7(1) of NI 81-102 that the 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;
(b) the limitation in subsection 2.7(4) of NI 81-102 that the mark-to-market value of the exposure of the Fund under its specified derivatives positions with any one counterparty other than an acceptable clearing corporation or a clearing corporation that clears and 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 Fund; and
(c) the requirement in subsection 6.1(1) of NI 81-102 to hold all portfolio assets of the Fund under the custodianship of one custodian in order to permit each 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) on the terms and conditions provided for in this decision (collectively, the Requested Relief).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions:
(a) the Ontario Securities Commission is the principal regulator for the 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 of the other provinces and territories of Canada (together with Ontario, the Applicable Jurisdictions).
Terms defined in MI 11-102, National Instrument 14-101 Definitions and NI 81-102 have the same meaning if used in this decision, unless otherwise defined. In addition, the following capitalized terms have the respective meanings given to them below:
(a) CFTC means the U.S. Commodity Futures Trading Commission;
(b) Cleared Swaps means swaps that are, or will become, subject to a clearing determination or a clearing obligation issued by the CFTC or ESMA, as the case may be;
(c) Clearing Corporation means any clearing corporation registered with the CFTC or central counterparty authorized by ESMA, as the case may be, that, in either case, is also permitted to operate in an Applicable Jurisdiction where the Fund is located;
(d) Dodd-Frank Act means the Dodd-Frank Wall Street Reform and Consumer Protection Act;
(e) EMIR means the European Market Infrastructure Regulation;
(f) ESMA means the European Securities and Markets Authority;
(g) European Economic Area means all of the European Union countries and also Iceland, Liechtenstein and Norway;
(h) Existing Fund means each existing mutual fund (i) of which the Filer is the manager, (ii) to which the provisions of NI 81-102 apply, and (iii) which ispermitted by its investment objectives and investment strategies to enter into derivative transactions;
(i) Futures Commission Merchant means any futures commission merchant that is registered with the CFTC and/or a clearing member for purposes of EMIR, as applicable, and is a member of a Clearing Corporation;
(j) OTC means over-the-counter;
(k) Portfolio Adviser means the Filer, any affiliate of the Filer, and any third party sub-adviser retained from time to time by the Filer, or an affiliate of the Filer, to manage all or a portion of the investment portfolio of one or more Funds; and
(l) 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 a corporation incorporated under the laws of the Province of Ontario with its head office located in Toronto, Ontario. The Filer is registered in each of the provinces and territories of Canada in the categories of investment fund manager, portfolio manager and exempt market dealer. The Filer also is registered in Ontario as a commodity trading manager and as a mutual fund dealer exempt from membership in the Mutual Funds Dealer Association of Canada. The Filer also is registered in Manitoba as an adviser (commodities).
2. The Filer is the manager of each Fund. The Filer, or an affiliate of the Filer, is the portfolio adviser to each Fund. Third party sub-advisers may be appointed as sub-advisers to all or a portion of the investment portfolios of the Funds.
3. Each Fund is, or will be, a mutual fund to which the provisions of NI 81-102 apply or will apply.
4. Neither the Filer nor any Fund is in default of securities legislation in any Applicable Jurisdiction.
5. The investment objective and investment strategies of each Fund permit, or will permit, the Fund to enter into derivative transactions, including swaps, with Canadian, U.S. or other international counterparties in compliance with the provisions of NI 81-102 regarding the use of derivatives applicable to such Fund. Each Existing Fund currently uses or, in the future, may use interest rate swaps and/or credit default swaps in its portfolio. The Filer considers swaps to be an important investment tool that is available to each Portfolio Adviser to properly manage each Fund's portfolio.
6. The Dodd-Frank Act requires that certain OTC derivatives, including swaps, between certain categories of market participants be cleared through a Futures Commission Merchant at a Clearing Corporation. Generally, where one party to a swap is a U.S. Person and the other party to the swap is an investment fund (such as a Fund), that swap must be a Cleared Swap (absent an available exception).
7. EMIR will also require that certain OTC derivatives be cleared through a central counterparty authorized to provide clearing services for purposes of EMIR. Generally, where one party to a swap is a financial counterparty or a non-financial counterparty whose OTC derivative trading activity exceeds a certain threshold, in each case established in a state that is a participant in the Eurpopean Economic Area, that swap will be required to be a Cleared Swap. As at the date of this decision, no clearing obligation has been issued under EMIR; the first clearing directive is expected to be issued in the third quarter of 2015 and will be phased-in based on the category of both parties to the trade.
8. In order to benefit from both the pricing benefits and reduced trading costs that a Portfolio Adviser may be able to achieve through its trade execution practices for its advised investments funds and other accounts and from the reduced costs associated with cleared OTC derivatives as compared to other OTC trades, the Filer wishes for each Fund to have the ability to enter into Cleared Swaps.
9. In the absence of the Requested Relief, each Portfolio Adviser will need to structure the swaps entered into by the Funds so as to avoid the clearing requirements of the CFTC and under EMIR, as applicable. The Filer submits that this would not be in the best interests of the Funds and their investors for a number of reasons, as set out below.
10. The Filer strongly believes that it is in the best interests of the Funds and their investors to be able to execute OTC derivatives, including Cleared Swaps, with global counterparties to mitigate the legal, operational and back office risks faced by investors in the global swap markets.
11. A Portfolio Adviser may use the same trade execution practices for all of its advised investment funds and other accounts, including the Funds. An example of these trade execution practices is block trading, where a large number of securities are purchased or sold or large derivative trades are entered into on behalf of a number of investment funds and other accounts advised by one Portfolio Adviser. These practices include the use of Cleared Swaps if such trades are executed with a U.S. swap dealer. If the Funds are unable to employ these trade execution practices, then each affected Portfolio Adviser will have to create separate trade execution practices only for the Funds and will have to execute trades for the Funds on a separate basis. This will increase the operational risk for the Funds, as separate execution procedures will need to be established and followed only for the Funds. In addition, the Funds will not be able to enjoy the possible price benefits and reduction in trading costs that a Portfolio Adviser may be able to achieve through a common practice for its advised investment funds and other accounts. In the Filer's opinion, best execution and maximum certainty can best be achieved through common trade execution practices which, in the case of OTC derivatives, involve the execution of Cleared Swaps.
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 Funds. The Filer submits that the Funds should be encouraged to comply with the robust clearing requirements established by the CFTC and under EMIR by granting 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. This demonstrates that, 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 to each Fund.
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 when any rules applicable to customer clearing of OTC derivatives enter into force in a Jurisdiction where a Fund is located, the Clearing Corporation is permitted to offer customer clearing of OTC derivatives in that Jurisdiction; and provided further that, in respect of the deposit of cash and portfolio assets as margin:
(a) in Canada:
(i) the Futures Commission Merchant will be a member of a self-regulatory organization that is a participating member of the Canadian Investor Protection Fund; and
(ii) the amount of margin deposited and maintained with the Futures Commission Merchant will 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 Fund as at the time of deposit; and
(b) outside of Canada:
(i) the Futures Commission Merchant will be a member of a Clearing Corporation and, as a result, subject to a regulatory audit;
(ii) the Futures Commission Merchant will have a net worth, determined from its most recent audited financial statements that have been made public, in excess of the equivalent of $50 million; and
(iii) the amount of margin deposited and maintained with the Futures Commission Merchant will 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 Fund as at the time of deposit.
This decision will terminate on the coming into force of any revisions to the provisions of NI 81-102 that address the clearing of OTC derivatives.