Securities Law & Instruments

Headnote

NP 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Approval of mutual fund reorganization -- Approval required because merger does not meet the criteria for pre-approval -- merger conducted on a taxable basis and fund facts not delivered with circular -- Securityholders provided with timely and adequate disclosure regarding the merger.

Applicable Legislative Provisions

National Instrument 81-102 Investment Funds, ss. 5.5(1)(b), 19.1.

September 8, 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 FT PORTFOLIOS CANADA CO. (the Filer) AND IN THE MATTER OF FIRST TRUST SHORT DURATION HIGH YIELD BOND ETF AND FIRST TRUST ADVANTAGED SHORT DURATION HIGH YIELD BOND FUND

DECISION

Background

The principal regulator in the Jurisdiction has received an application from the Filer on behalf of First Trust Short Duration High Yield Bond ETF ("FHY" or the "Terminating Fund") and First Trust Advantaged Short Duration High Yield Bond Fund ("FSD" or the "Continuing Fund") for a decision under the securities legislation of the Jurisdiction of the principal regulator (the "Legislation") for approval pursuant to subsection 5.5(1)(b) of National Instrument 81-102 Investment Funds ("NI 81-102") in connection with the proposed merger of FHY and FSD (the "Requested Approval").

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 Multinational Instrument 11-102 Passport System ("MI 11-102") is intended to be relied upon in the jurisdictions of British Columbia, Alberta, Saskatchewan, Manitoba, Quebec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Yukon, Northwest Territories and Nunavut.

Interpretation

Defined terms contained in 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 the manager of FHY and FSD as well as Short Duration High Yield Portfolio Trust (the "Portfolio Trust"), which is the underlying fund of FSD. The Filer is a registered as an investment fund manager in the Province of Ontario.

2. The principal offices of the Filer, FHY and FSD are located at 330 Bay Street, Suite 1300, Toronto, ON, M5H 2S8.

3. Neither the Filer nor FHY or FSD is in default of the securities legislation of any province or territory of Canada.

The Funds

4. FSD is a closed-end investment fund established under the laws of the Province of Ontario pursuant to a declaration of trust dated April 26, 2011. Computershare Trust Company of Canada acts as the trustee of FSD.

5. FHY is an exchange-traded fund or an "ETF" established under the laws of the Province of Ontario pursuant to declaration of trust dated June 19, 2014. The Filer acts as trustee of FHY.

6. Each of FSD and FHY is a reporting issuer under the laws of all of the Passport Jurisdictions. The Portfolio Trust is a reporting issuer in the Provinces of Ontario and Quebec.

7. FHY offers common units and advisor class units (the "FHY Units"), which currently trade on the TSX under the ticker symbol FHY and FHY.A. FSD's issued Class A units currently trade on the TSX under the ticker symbol FSD.UN., and its issued Class F units are not listed for trading (the "FSD Units").

8. FSD, through exposure to a diversified portfolio comprised of high yield debt and other assets acquired and held by the Portfolio Trust, seeks to achieve the following objectives: (i) provide FSD unitholders with attractive, monthly, tax-advantaged distributions and (ii) preserve capital. FSD obtains exposure to North American high yield bonds, and in particular short duration high yield bonds. Under normal circumstances, at least 70% of the fund's total assets are invested in below investment-grade North American debt securities, comprised primarily of U.S. dollar-denominated debt securities. The focus is on short duration high yield bonds with a maximum remaining term to maturity of five years. The holdings of the portfolio are diversified by industry sector, maturity and credit rating.

9. To achieve its investment objective, FSD has entered into a forward agreement with The Bank of Nova Scotia (the "Counterparty") dated May 20, 2011 (the "Forward Agreement"). The return to unitholders of FSD is dependent upon the return on the portfolio held by the Portfolio Trust by virtue of the Forward Agreement. Pursuant to the Forward Agreement, the Counterparty has agreed to deliver to FSD on May 20, 2016 a portfolio of common shares Canadian public companies that are "Canadian securities" for the purposes of the Tax Act with an aggregate value equal to the redemption proceeds of a corresponding number of units of the Portfolio Trust, net of any amount owing by the FSD to the Counterparty. FSD will continue to maintain this structure after the Conversion (as defined below) for as long as FSD may derive benefits from it under Canadian tax laws. After May 20, 2016, FSD will no longer employ a forward agreement and will thereafter hold all of its portfolio investments directly.

10. FHY seeks to provide its unitholders with a high level of current income with a secondary investment objective of capital appreciation. FHY primarily invests in a diversified portfolio of below investment grade debt securities as rated by Moody's Investor Services, Inc., and Standard & Poors (Ba1/BB+ or below) or a similar rating by a designated rating organization (as defined in NI 81-102), with a secondary investment objective of capital appreciation. Securities may also be non-rated but considered to be of comparable credit quality to other below investment grade securities. FHY may also invest opportunistically in senior floating rate loans, investment grade debt securities and convertible bonds. The fund's aggregate exposure to senior floating rate loans is limited to 40% of its net asset value. The weighted average duration of FHY's portfolio securities may not exceed 3 years.

11. Units of each of FSD and FHY are qualified investments under the Income Tax Act (Canada) (the "Tax Act") for registered retirement savings plans, registered retirement income funds, tax-free savings accounts, registered education savings plans, deferred profit sharing plans and registered disability savings plans.

The Conversion of FSD

12. Prior to implementation of the Merger, the Filer is proposing to convert FSD from a closed-end investment fund to an ETF (the "Conversion"). The Conversion was approved by the unitholders of FSD at a meeting of unitholders. If the Conversion is implemented, the Class A units and Class F units of FSD will be redesignated as advisor class units and common units, respectively, and the name of FSD will be changed to First Trust Short Duration High Yield Bond ETF II, as the Continuing Fund. The Filer will also apply to list the common units of FSD (formerly the Class F units) on the TSX.

13. In connection with the Conversion:

(a) the investment objectives and investment strategies of FSD will be changed so that they align with the investment objectives and investment strategies of FHY (while maintaining FSD's forward agreement structure for as long as FSD may derive benefits from it under Canadian tax laws);

(b) the Filer will remain as manager of FSD and the Portfolio Trust and will become the trustee of FSD, replacing Computershare Trust Company of Canada;

(c) First Trust Advisors L.P. (the "Portfolio Advisor") will remain as advisor to FSD and the Portfolio Trust, and will manage the portfolio investments held by the Portfolio Trust instead of continuing the existing sub-advisor relationship with First Western Capital Management Company;

(d) CIBC Mellon Trust Company and CIBC Mellon Global Securities Services Company will assume the roles of custodian and valuation agent of FSD, respectively. They now perform those roles for the other ETFs managed by the Filer;

(e) Equity Financial Trust Company will assume the role of the registrar and transfer agent, and distribution reinvestment plan agent for the advisor class units and common units of FSD. It now performs these roles for the other ETFs managed by the Filer; and

(f) the Independent Review Committee of FSD will remain the same.

14. As a result of the Conversion:

(a) the investment objective of each of FSD and FHY will be to provide unitholders with a high level of current income by investing primarily in a diversified portfolio of below investment grade debt securities as rated by Moody's Investor Services, Inc., and Standard & Poors (Ba1/BB+ or below) or a similar rating by a designated rating organization (as defined in NI 81-102), and a secondary objective will be to seek capital appreciation;

(b) FSD and FHY will have substantially similar valuation procedures and the same management fee structure;

(c) each of FSD and FHY will be subject to the investment restrictions and practices contained in Canadian securities law, including NI 81-102, and will be managed in accordance with these restrictions and practices; and

(d) each of FSD and FHY will be governed by the master declaration of that applies to all of the ETFs managed by the Filer, which (i) provides for the ongoing issuance of units at net asset value per unit to designated brokers and dealers; (ii) provides exchange and redemption rights to unitholders as well as secondary market trading; and (iii) enables the fund to distribute its units continuously.

The Merger

15. Under the Merger, the Terminating Fund will transfer all or substantially all of its net assets to FSD in consideration for the issuance by FSD to FHY of a number of FSD advisor class units and FSD common units determined based on an exchange ratio established as of the close of trading on the business day immediately preceding the effective date of the Merger (the "Exchange Ratios").

16. The Exchange Ratios will be calculated based on the relative net asset values of the FSD Units and the FHY Units.

17. Immediately following the transfer of assets of FHY to FSD and the issuance of FSD Units to FHY, all the FHY Units will be automatically redeemed. Each FHY unitholder will receive such number of FSD Units as is equal to the number of FHY Units of a class held multiplied by the Exchange Ratio of the units of the relevant class.

18. As soon as reasonably possible following the Merger, the Terminating Fund will be wound up and the Continuing Fund will continue as an ETF existing under the laws of Ontario.

19. Unitholders of FHY approved the Merger at a special meeting of unitholders that was held on August 10, 2015, as required pursuant to NI 81-102. In approving the Merger, unitholders of FHY have, in effect, indicated their acceptance of the fundamental investment objective of the Continuing Fund which will be the same as FHY.

20. Subject to necessary regulatory approval, the Merger is expected to occur in September 2015. Implementation of the Merger is also conditional upon approval of the Conversion by unitholders of FSD.

21. A notice of meeting, a management information circular dated June 23, 2015 (the "Circular") and a proxy in connection with the Conversion and Merger has been mailed to the unitholders of FSD and FHY, respectively, in accordance with applicable securities laws. ETF summary documents of the Continuing Fund were not sent to unitholders, as they will not become available until the Continuing Fund converts to an ETF. The Circular provided prospectus level disclosure, including a description of the proposed Conversion and Merger, information about FHY and FSD and the income tax considerations for unitholders of FHY and FSD. The Circular discloses that unitholders of FHY and FSD may obtain at no cost, the most recent annual and, the and the most recent annual management report on fund performance, as well as the current annual information form of FSD and the current prospectus of FHY, by contacting the Filer or by accessing the website of the Filer or the System for Electronic Document Analysis and Retrieval ("SEDAR").

22. The Filer will pay for the costs and expenses associated with the Conversion and the Merger, including the cost of holding the meetings and of soliciting proxies, including costs of mailing the Circular and accompanying materials. FSD and FHY will not bear any of the costs and expenses associated with the Conversion or the Merger.

23. As required by National Instrument 81-107 -- Independent Review Committee, the terms of the Conversion were presented to the independent review committee (the "IRC") of FSD for its review and recommendation. After considering the potential conflict of interest matter related to the Conversion, the IRC provided its positive recommendation for the Conversion.

24. As required by National Instrument 81-107 -- Independent Review Committee, the terms of the Merger were presented to the IRC of FHY for its review and recommendation. After considering the potential conflict of interest matter related to the Merger, the IRC provided its positive recommendation for the Merger.

25. Units of the Terminating Fund will continue to be offered, exchanged and redeemed on a daily basis up to the business day immediately prior to the effective date of the Merger, primarily through the designated brokers and dealers of the Terminating Fund.

26. The management fee of the Continuing Fund will be the same or lower than the Terminating Fund.

27. In addition, unitholders of the Terminating Fund will be able to trade their units on the TSX in the ordinary course at least until the close of business on the business day before the effective date of the Merger.

28. The cash and any other assets of the Terminating Fund acquired by the Continuing Fund in connection with the Merger will be acquired in compliance with NI 81-102.

29. A press release was issued on June 25, 2015 and a material change report was filed on SEDAR by FHY and FSD relating to the proposed Conversion and Merger on June 30, 2015.

30. An amendment dated July 4, 2015 to the long form prospectus of FHY dated June 4, 2015 announcing the Merger proposal and Conversion has been filed on SEDAR.

31. FSD will file a preliminary long form prospectus in order to be able to continuously distribute FSD Units if the Conversion is approved by FSD unitholders.

32. Under section 5.6 of NI 81-102, approval of the Merger by the regulator is not required if all of the criteria for pre-approval listed in paragraphs 5.6(1)(a) through (i) are satisfied.

Submissions

33. The foregoing representations indicate that the Merger will satisfy all the requirements of paragraphs 5.6(1)(a) through (i) of NI 81-102 with the following exceptions:

(a) the Merger will not meet the requirement of paragraph 5.6(1)(a), as it will not be a "qualifying exchange" within the meaning of section 132.2 of the Tax Act or a tax deferred transaction under subsection 85(1), 85.1(1), 86(1) or 87(1) of the Tax Act; and

(b) the Merger will not meet the requirement of paragraph 5.6(1)(f)(ii), as the Manager was unable to deliver the ETF summary document together with the Circular since the document will only be available at later date.

34. The Filer has concluded in respect of the Terminating Fund that the pre-approval under section 5.6 of NI81-102 is not available since paragraphs 5.6(1)(a) and 5.6(1)(f)(ii) have not been satisfied.

35. The Manager believes that the Merger will be beneficial to securityholders of the Terminating Fund for the following reasons:

(a) Unitholders may experience a lower management expense ratio as a result of the larger asset base of the Continuing Fund;

(b) the Continuing Fund has existing non-capital tax losses and will also own portfolio assets directly after the Merger, so the Continuing Fund should be able to use such losses which will benefit all unitholders of the Continuing Fund; and

(c) in the near term, the Continuing Fund provides for a more efficient tax structure by utilising the Forward Agreement.

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 is that the Requested Approval is granted.

"Darren McKall"
Manager, Investment Funds and Structured Products
Ontario Securities Commission