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First National Mortgage Investment Fund and Stone Asset Management Limited
Headnote
National Policy 11-203 Process for Exemptive Relief applications in Multiple Jurisdictions -- non-redeemable investment fund granted temporary relief from certain restrictions in National Instrument 81-102 Investment Funds regarding securities lending transactions, including (i) the 50% limit on lending; (ii) the requirement to use the fund's custodian or sub-custodian as lending agent; (iii) the requirement to receive only cash or qualified securities as collateral; and (iv) the requirement to hold the collateral during the course of the transaction -- investment fund invest its assets in a basket of Canadian equity securities that are pledged to a Counterparty for performance of the fund's obligations under forward contracts giving the fund exposure to underlying interests -- investments fund wishes to lend 100% of the basket of Canadian equity securities -- not practical for custodian to act as securities lending agent as it does not have control over the Canadian equity securities -- counterparty must release its security interest in the Canadian equity securities in order to allow the fund to lend such securities, provided the fund grants the Counterparty a securities interest in the collateral held by the fund for the loaned securities -- National Instrument 81-102 Investment Funds.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.12(1)1, 2.12(1)2, 2.12(1)6, 2.12(1)12, 2.12(3), 2.15, 2.16, 6.8(5), 19.1.
September 18, 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 FIRST NATIONAL MORTGAGE INVESTMENT FUND AND IN THE MATTER OF STONE ASSET MANAGEMENT LIMITED (the Filer)
DECISION
Background
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") for exemptive relief for First National Mortgage Investment Fund (the "Fund") which is a non-redeemable investment fund managed by the Filer in respect of which the representations set out below are applicable, from the following provisions of National Instrument 81-102 -- Investment Funds ("NI 81-102"):
1. paragraph 2.12(1)1 to permit the Fund to maintain its current securities lending arrangement that will not otherwise fully comply with all the requirements of sections 2.15 and 2.16 of NI 81-102;
2. paragraph 2.12(1)2 to permit the Fund to maintain its current securities lending arrangement that will not fully comply with all the requirements of section 2.12 of NI 81-102;
3. paragraph 2.12(1)6 to permit the Fund, during the term of its current securities lending arrangement, to accept, as all or part of the collateral deliverable by the securities borrowers, equity securities listed on the Toronto Stock Exchange which are included in the S&P/TSX 60 Index;
4. paragraph 2.12(1)12 to permit the Fund to maintain its current securities lending arrangement in which the aggregate market value of securities loaned by the Fund exceeds 50% of the net asset value of the Fund;
5. subsection 2.12(3) to permit the Fund, during the term of its current securities lending arrangement to deliver collateral received in connection with its current securities lending arrangement to its Forward Counterparty as collateral for the Fund's obligations under its Forward Contract (as such terms are defined below);
6. section 2.15 to permit the Fund to continue lending securities through an agent (an "Agent") that is not the custodian or sub-custodian of the Fund;
7. section 2.16 to the extent this section contemplates that securities lending transactions be entered into through an agent appointed under section 2.15 of NI 81-102; and
8. subsection 6.8(5) in connection with its current securities lending arrangement to deliver collateral received in connection with its current securities lending arrangement to its Forward Counterparty as collateral for the Fund's obligations under its Forward Contract (as such terms are defined below),
such relief to apply for the Fund until the earlier of (a) the currently scheduled termination date of the Forward Contract (as defined below) for the Fund and (b) the actual termination date of the Forward Contract for the Fund (the "Termination Date").
Paragraphs 1 through 8 are collectively referred to as the "Exemption Sought".
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(i) the Ontario Securities Commission is the principal regulator for this application; and
(ii) 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 (collectively, with Ontario, the "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.
1. The Filer is a corporation incorporated under the laws of Ontario.
2. The registered office of the Filer is located at 36 Toronto Street, Suite 710, Toronto, Ontario, M5C 2C5.
3. The Filer is registered as an adviser for securities in the category of portfolio manager, as a dealer in the category of restricted dealer and an investment fund manager, under the Securities Act (Ontario).
4. The investment fund manager of the Fund is the Filer.
5. The Fund is a reporting issuer under the securities laws of each of the provinces and territories of Canada.
6. The Filer and the Fund are not in default of securities legislation in any of the Jurisdictions.
7. The Fund (a) is a non-redeemable investment fund established under the laws of Ontario that has adopted fundamental investment objectives to permit it to invest in mortgages and has a prospectus for which receipt was issued before September 22, 2014; (b) has issued securities qualified for distribution in all provinces and territories of Canada pursuant to a prospectus prepared and filed in accordance with the securities legislation of Ontario; (c) is a non-redeemable investment fund to which NI 81-102 applies and in particular from September 21, 2015, sections 2.12, 2.15 and 2.16 of NI 81-102 will apply to the Fund due to the expiry of the transition period which currently provides that certain non-redeemable investment funds are not subject to these provisions.
8. The Fund obtains economic exposure to the returns of a managed portfolio of securities held by an investment fund also managed by the Filer (the "Bottom Fund") through the use of a forward contract. In particular, to achieve the Fund's investment objectives: (a) the Fund has invested its assets in Canadian equity securities (an "Equity Portfolio") which is generally a static portfolio that is not actively managed and its composition varies only in limited circumstances and (b) the Fund has also entered into a forward contract (a "Forward Contract") with a Canadian Schedule I bank with a designated rating (as defined in NI 81-102) (a "Counterparty") to effectively replace the economic return on its Equity Portfolio with the economic return on an investment in the related Bottom Fund.
9. The Fund has pledged and delivered its Equity Portfolio to its Counterparty or an affiliate thereof as collateral security for performance of the Fund's obligations under its Forward Contract with that Counterparty. The Equity Portfolio is held by the Counterparty or its affiliate pursuant to the Forward Contract prior to the commencement of securities lending.
10. The Fund's current securities lending arrangement involves securities loans of up to 100% of the securities owned by the Fund in order to earn additional returns for the Fund and offset costs of the Forward Contract, and the Fund proposes to continue lending up to 100% of the securities owned by the Fund after September 21, 2015. The Filer proposes to continue to permit up to 100% of the Equity Portfolio for the Fund to be lent to one or more borrowers through the existing Agent for the Fund, which Agent is not the Fund's custodian or sub-custodian.
11. Under the current securities lending arrangement of the Fund, the Agent is considered acceptable to the Fund and Counterparty and is either the Canadian financial institution that is the Counterparty or an affiliate of such Canadian financial institution. It is not commercially practical for a Fund's custodian to act as Agent with respect to the Fund's securities lending transactions since the custodian will not have control over the Fund's Equity Portfolio that has been delivered by way of a pledge to the Counterparty.
12. The Filer has ensured that the Agent through which the Fund lends securities maintains appropriate internal controls, procedures, and records for securities lending transactions as prescribed in subsection 2.16(2) of NI 81-102.
13. A Counterparty must release its security interest in the securities in the Equity Portfolio of a Fund in order to allow the Fund to lend such securities, but will generally only do so provided that the Fund grants the Counterparty a security interest in, and delivers into its control, the collateral received by the Fund for the loaned securities.
14. Securities in the Equity Portfolio have been loaned only to borrowers that have been considered acceptable to the Fund and the Counterparty as contemplated by subsection 2.16(2) of NI 81-102.
15. To facilitate the Counterparty's perfection by control of its security interest in the collateral received by the Fund for the loaned securities, the Filer has ensured that the received collateral for each loan is delivered to the Counterparty which is a Canadian chartered bank or to an affiliate of the Counterparty which is a registered dealer and a member of the Investment Industry Regulatory Organization of Canada ("IIROC").
16. The collateral received by the Fund in respect of a securities lending transaction, and in which the Counterparty has a security interest, is in the form of cash, qualified securities and/or other collateral permitted by NI 81-102.
17. The collateral received by the Fund in respect of a securities lending transaction, and in which the Counterparty has a security interest, is not re-invested in any other types of investment products (but to the extent cash collateral is received it will be deposited with the Counterparty or the relevant affiliate thereof).
18. The prospectus and current annual information form of the Fund has disclosed that the Fund may enter into securities lending transactions.
19. Other than as set forth herein, any securities lending transactions on behalf of the Fund is currently being conducted in accordance with the provisions of NI 81-102 except that pursuant to the Fund's securities loans, permitted collateral includes equities listed on the Toronto Stock Exchange which are included in the S&P/TSX 60 Index which equity securities collateral is and will be valued at 100% of its market value for collateral posting purposes.
22. It would not be practicable or economical for the Fund to transition the securities lending arrangement given the costs and time required to negotiate and implement a new securities lending arrangement and the limited remaining term of the Forward Contract.
23. The Fund's Forward Contract is set to terminate on December 19, 2017 and will not be renewed. Upon or prior to termination of the Forward Contract, the foregoing securities lending transactions will be terminated and the Fund will no longer rely on the Exemption Sought in respect of any securities lending transactions entered into by the Fund.
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:
(a) with respect to the exemption from paragraph 2.12(1)12 of NI 81-102, the Fund has entered into a Forward Contract with an applicable Counterparty and has granted that Counterparty a security interest in the securities subject to that Forward Contract and, in connection with a securities lending transaction relative to those securities,
(1) receives the collateral that
(A) is prescribed by paragraphs 2.12(1)3 to 6 of NI 81-102, other than collateral described in subsection 2.12(1)6(d) or in paragraph (b) of the definition of "qualified security", except that the Fund may also accept as collateral equities listed on the Toronto Stock Exchange which are included in the S&P/TSX 60 Index; and
(B) is marked to market on each business day in accordance with paragraph 2.12(1)7 of NI 81-102;
(2) has the rights set forth in paragraphs 2.12(1)8, 2.12(1)9 and 2.12(1)11 of NI 81-102;
(3) complies with paragraph 2.12(1)10 of NI 81-102; and
(4) lends its securities only to borrowers that are acceptable to the Fund and the Counterparty;
(b) with respect to the exemption from subsection 2.12(3) of NI 81-102, the Fund has provided a security interest to the applicable Counterparty in the collateral delivered to it as collateral pursuant to a securities lending transaction as described in representation 13;
(c) with respect to the exemption from section 2.15 of NI 81-102:
(1) the Fund has entered into a written agreement with an Agent that complies with each of the requirements set forth in subsection 2.15(4) of NI 81-102, except as set out herein; and
(2) the Agent administering the securities lending transaction of the Fund:
(A) is in compliance with the standard of care prescribed in subsection 2.15(5) of NI 81-102; and
(B) shall be acceptable to the Fund and Counterparty and shall be a financial institution that is permitted to act as custodian of the Fund pursuant to section 6.2 of NI 81-102;
(d) with respect to the exemption from section 2.16 of NI 81-102, the Filer and the Fund comply with the requirements of section 2.16 of NI 81-102 as if the Agent appointed by the Filer were the agent contemplated in that section; and
(e) with respect to the exemption from subsection 6.8(5) of NI 81-102, the Fund:
(1) provides a security interest to the applicable Counterparty in the collateral delivered to it as collateral pursuant to a securities lending transaction as described in representation 13; and
(2) the collateral delivered to the Fund pursuant to the securities lending transaction is held by the Counterparty or an affiliate of the Counterparty, which will be a registered dealer and a member of IIROC, as described in representation 15.
This decision expires on the Fund's Termination Date. In any event, this decision expires no later than December 19, 2017.
"Raymond Chan"
Manager
Investment Funds and Structured Products
Ontario Securities Commission