Multilateral Instrument 11-102 Passport System and National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- National Instrument 81-102 Mutual Funds (NI 81-102) -- s. 19.1 -- Specified derivatives relief -- s. 2.7(1) and s. 2.7(4) -- Custodian relief -- s. 6.1(1).
Counterparty Credit Rating Requirement
A group of mutual funds seeks relief from the counterparty credit rating requirement in subsection 2.7(1) of NI 81-102 to permit the mutual funds to enter into certain swaps that are cleared through a clearing corporation -- The mutual fund cannot meet the counterparty credit rating requirement in subsection 2.7(1); the mutual fund will enter into swaps that are cleared through a clearing corporation; the clearing corporation will be the counterparty to the trade.
Counterparty Mark-to-Market Exposure Limit
A group of mutual funds seeks relief from the mark-to-market exposure restrictions in subsection 2.7(4) of NI 81-102 to permit the mutual funds to enter into certain swaps that are cleared through a clearing corporation -- The mutual fund wants to clear swaps through a clearing corporation that is not an "acceptable clearing corporation" and that is not in Appendix A to NI 81-102; the mutual fund will only clear swaps through certain clearing corporations with adequate regulatory and capital requirements.
Custodial Requirements -- Deposit of Margin
A group of mutual funds seeks relief from the custodial requirements in subsection 6.1(1) of NI 81-102 to permit the mutual funds to deposit cash and portfolio assets with a dealer as margin for transactions involving cleared swaps -- The mutual fund wants to deposit portfolio assets with a dealer as margin for cleared swaps; the portfolio assets will be deposited with a dealer meeting conditions in subsections 6.8(1) and 6.8(2) of NI 81-102.
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, ss.19.1, 2.7(1), 2.7(4), 6.1(1).
November 10, 2015
IN THE MATTER OF THE SECURITIES LEGISLATION OF BRITISH COLUMBIA AND ONTARIO (the Jurisdictions) AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF HSBC GLOBAL ASSET MANAGEMENT (CANADA) LIMITED (the Manager) AND IN THE MATTER OF THE MUTUAL FUNDS LISTED ON SCHEDULE "A" (the Existing HSBC Funds and collectively with the Manager, the Filers)
The securities regulatory authority or regulator in each of the Jurisdictions (the Decision Maker) has received an application from the Filers for a decision under the securities legislation of the Jurisdictions (the Legislation), under section 19.1 of National Instrument 81-102 Investment Funds (NI 81-102), exempting each Existing HSBC Fund and all current and future mutual funds managed by the Manager that enter into Swaps (as defined below) in the future (each, a Future HSBC Fund and, together with the Existing HSBC Funds, each, an HSBC Fund and, collectively, the HSBC Funds):
(a) from the requirement in subsection 2.7(1) of NI 81-102 that a mutual 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) from the limitation in subsection 2.7(4) of NI 81-102 that the mark-to-market value of the exposure of a mutual fund under its specified derivatives positions with any one counterparty other than an acceptable clearing corporation or a clearing corporation that 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 mutual fund; and
(c) from the requirement in subsection 6.1(1) of NI 81-102 to hold all portfolio assets of an investment fund under the custodianship of one custodian in order to permit each HSBC 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 Swaps cleared through the facilities of a Clearing Corporation (the Exemption Sought).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a dual application):
(a) the British Columbia Securities Commission is the principal regulator for this application,
(b) the Filers have provided notice that subsection 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Northwest Territories, Yukon Territory and Nunavut, and
(c) the decision is the decision of the principal regulator and evidences the decision of the securities regulatory authority or regulator in Ontario.
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. Capitalized terms used in this decision have the following meanings:
"CFTC" means the U.S. Commodity Futures Trading Commission
"Clearing Corporation" means any clearing agency that acts as counterparty to each party for each Swap for which it provides clearing services and is a clearing organization 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 the jurisdiction of Canada where the HSBC Fund is located
"Dodd-Frank" means the Dodd-Frank Wall Street Reform and Consumer Protection Act
"EMIR" means the European Market Infrastructure Regulation
"ESMA" means the European Securities and Markets Authority
"European Economic Area" means all of the European Union countries and also Iceland, Liechtenstein and Norway
"Existing HSBC Fund" means each mutual fund managed by the Manager that is listed on Schedule "A" to this decision
"Futures Commission Merchant" means any futures commission merchant that is registered with the CFTC and/or is a clearing member for purposes of EMIR, as applicable, and is a member of a Clearing Corporation
"OTC" means over-the-counter
"Portfolio Advisor" means each of the Manager and each affiliate of the Manager and each third party portfolio manager retained from time to time by the Manager to sub-advise the investment portfolio of one or more HSBC Funds
"Swaps" means the 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, including fixed-to-floating interest rate swaps, basis swaps, forward rate agreements in U.S. dollars, the Euro, Pounds Sterling or the Japanese Yen, overnight index swaps in U.S. dollars, the Euro and Pounds Sterling and untranched credit default swaps on certain North American indices (CDX.NA.IG and CDX.NA.HY) and European indices (iTraxx Europe, iTraxx Europe Crossover and iTraxx Europe HiVol) at various tenors
"U.S. Person" has the meaning given to it by the CFTC
This decision is based on the following facts represented by the Filers:
The Manager and the HSBC Funds
1. the Manager is, or will be, the investment fund manager of each HSBC Fund; the Manager is registered as an investment fund manager, a portfolio manager and an exempt market dealer in British Columbia, Ontario, Newfoundland and Labrador and Québec, as a portfolio manager and an exempt market dealer in each of Alberta, Saskatchewan, Manitoba, New Brunswick and Nova Scotia and as an exempt market dealer in the Northwest Territories; the head office of the Manager is in Vancouver, British Columbia;
2. the Manager is, or will be, the portfolio manager of the HSBC Funds; another Portfolio Advisor is, or will be, the sub-advisor to certain of the HSBC Funds;
3. each HSBC Fund is, or will be, a mutual fund created under the laws of British Columbia and is, or will be, subject to the provisions of NI 81-102;
4. neither the Manager nor the HSBC Funds are, nor will be, in default of securities legislation in any jurisdiction of Canada;
5. the securities of each HSBC Fund are, or will be, qualified for distribution under a prospectus that was, or will be, prepared and filed in accordance with the securities legislation of the Jurisdictions; accordingly, each HSBC Fund is, or will be, a reporting issuer or the equivalent in each jurisdiction of Canada;
The Previous Cleared Swaps Relief
6. in a decision document dated November 11, 2013, the HSBC Funds were granted relief from the requirements in subsections 2.7(1), 2.7(4) and 6.1(1) to permit the HSBC Funds to enter into cleared swaps that are, or will be, subject to a clearing determination issued by the CFTC (the Previous Relief); the Previous Relief, in accordance with its terms, terminates on November 11, 2015;
7. the Filers are seeking the Exemption Sought in this new decision to extend the term of the Previous Relief and to vary the Previous Relief by permitting the HSBC Funds to also enter into cleared swaps that become subject to a clearing obligation under EMIR;
8. the investment objective and investment strategies of each HSBC Fund permit, or will permit, the HSBC Fund to enter into derivative transactions, including Swaps; the Portfolio Advisors of the Existing HSBC Funds consider Swaps to be an important investment tool that is available to them to properly manage each HSBC Fund's portfolio;
9. each of the Existing HSBC Funds have entered into, or intend to enter into, foreign exchange swaps, interest rate swaps and credit default swaps on single names and indices;
10. Dodd-Frank requires that certain OTC derivatives be cleared through a Futures Commission Merchant at a Clearing Corporation recognized by the CFTC; generally, where one party to a Swap is a U.S. Person, that Swap must be cleared;
11. EMIR also requires 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 European Economic Area, that Swap will be required to be cleared; the first clearing directive has been issued in respect of certain interest rate swaps and will be phased-in based on the category of both parties to the trade;
12. in order to benefit from both the pricing benefits and reduced trading costs that a Portfolio Advisor is often able to achieve through its trade execution practices for its advised investments funds and from the reduced costs associated with cleared OTC derivatives as compared to other OTC trades, the Manager wishes to have the HSBC Funds enter into cleared Swaps;
13. in the absence of the Exemption Sought, each Portfolio Advisor will need to structure the Swaps entered into by the HSBC Funds so as to avoid the clearing requirements of the CFTC and under EMIR, as applicable; the Manager respectfully submits that this would not be in the best interests of the HSBC Funds and their investors for a number of reasons, as set out below;
14. the Manager strongly believes that it is in the best interests of the HSBC Funds and their investors to continue to execute OTC derivatives with global counterparties, including U.S. and European swap dealers;
15. in its role as a fiduciary for the HSBC Funds, the Manager has determined that central clearing represents the best choice for the investors in the HSBC Funds to mitigate the legal, operational and back office risks faced by investors in the global swap markets;
16. a Portfolio Advisor currently uses the same trade execution practices for all of its advised funds, including the HSBC Funds; an example of these trade execution practices is block trading, where large number of securities are purchased or sold or large derivative trades are entered into on behalf of a number of investment funds advised by the Portfolio Advisor; these practices include the use of cleared Swaps; if the HSBC Funds are unable to employ these trade execution practices, then the Portfolio Advisor will have to create separate trade execution practices only for the HSBC Funds and will have to execute trades for the HSBC Funds on a separate basis; this will increase the operational risk for the HSBC Funds, as separate execution procedures will need to be established and followed only for the HSBC Funds; in addition, the HSBC Funds will no longer be able to enjoy the possible price benefits and reduction in trading costs that a Portfolio Advisor may be able to achieve through a common practice for its family of investment funds; in the Manager'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 Swaps on a cleared basis;
17. 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 HSBC Funds; and
18. the Exemption Sought 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.
Each of the Decision Makers 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 Makers under the Legislation is that the Exemption Sought is granted provided that when any rules applicable to customer clearing of OTC derivatives come into force, the Clearing Corporation is permitted to offer customer clearing of OTC derivatives in the jurisdictions of Canada where the HSBC Fund is located and provided further that, in respect of the deposit of cash and portfolio assets as margin:
(a) in Canada,
(i) the Futures Commission Merchant is a member of a SRO that is a participating member of CIPF; and
(ii) the amount of margin deposited and maintained with the Futures Commission Merchant does 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 HSBC Fund as at the time of deposit; and
(b) outside of Canada,
(i) the Futures Commission Merchant is a member of a Clearing Corporation and, as a result, is subject to a regulatory audit;
(ii) the Futures Commission Merchant has a net worth, determined from its most recent audited financial statements that have been made public or from other publicly available financial information, in excess of the equivalent of $50 million; and
(iii) the amount of margin deposited and maintained with the Futures Commission Merchant does 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 HSBC 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.