Securities Law & Instruments

Headnote

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 U.S. and European 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.

November 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 BRANDES INVESTMENT PARTNERS & CO. (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 of the principal regulator (the Legislation), pursuant to section 19.1 of National Instrument 81-102 Investment Funds (NI 81-102), exempting each Existing Bridgehouse Fund (as defined below) and all current and future mutual funds managed by the Filer that enter into Swaps (as defined below) in the future (each, a Future Bridgehouse Fund and, together with the Existing Bridgehouse Funds, each, a Bridgehouse Fund and, collectively, the Bridgehouse Funds):

(i) 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;

(ii) 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

(iii) 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 Bridgehouse Fund to deposit cash and other 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 (the Requested Relief).

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 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 (the Other Jurisdictions and 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. Capitalized terms used in this decision have the following meanings:

CFTC means the U.S. Commodity Futures Trading Commission

Clearing Corporation means any 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 or the Other Jurisdiction, as the case may be, where the Bridgehouse Fund is located

Dodd-Frank Act 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 Bridgehouse Fund means each mutual fund managed by the Filer that is relying on the Previous Relief on the date of this decision

Futures Commission Merchant means any futures commission merchant that is registered with the CFTC and/or 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 Filer, each affiliate of the Filer and each third party portfolio manager retained from time to time by the Filer as portfolio sub-advisor to manage all or a portion of the investment portfolio of one or more Bridgehouse 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 attributed thereto by the CFTC

Representations

This decision is based on the following facts represented by the Filer:

The Filer and the Bridgehouse Funds

1. The Filer is, or will be, the investment fund manager of each Bridgehouse Fund. The Filer is registered as an investment fund manager, a portfolio manager, an exempt market dealer and a mutual fund dealer in each of the Provinces of Ontario and Newfoundland and Labrador. The Filer is also registered as a portfolio manager and an exempt market dealer in all of the other Jurisdictions, as a mutual fund dealer in all of the other Jurisdictions except the Province of Québec and as an investment fund manager in the Province of Québec. The head office of the Filer is in Toronto, Ontario.

2. The Filer is, or will be, the portfolio manager to the Bridgehouse Funds. Either an affiliate of the Filer or a third party portfolio manager is, or will be, the portfolio sub-advisor to some or all of the Bridgehouse Funds.

3. Each Bridgehouse Fund is, or will be, a mutual fund created under the laws of the Province of Ontario and is, or will be, subject to the provisions of NI 81-102.

4. Neither the Filer nor the Bridgehouse Funds are in default of securities legislation in any Jurisdiction.

5. The securities of each Bridgehouse Fund are, or will be, qualified for distribution pursuant to a prospectus that was, or will be, prepared and filed in accordance with the securities legislation of the Jurisdictions. Accordingly, each Bridgehouse Fund is, or will be, a reporting issuer or the equivalent in each Jurisdiction.

The Previous Cleared Swaps Relief

6. In a decision document dated December 17, 2013, the Bridgehouse Funds were granted relief from the requirements in subsections 2.7(1), 2.7(4) and 6.1(1) to permit the Bridgehouse Funds to enter into cleared Swaps that are, or will be, subject to a clearing determination issued by the CFTC (the Previous Relief).

7. The Previous Relief, in accordance with its terms, terminates on December 17, 2015. Accordingly, the Filer is seeking the Requested Relief on substantially the same terms as the Previous Relief, except that the Requested Relief also permits the Bridgehouse Funds to enter into cleared Swaps that become subject to a clearing obligation under EMIR.

Cleared Swaps

8. The investment strategies of each Bridgehouse Fund permit, or will permit, the Bridgehouse Fund to enter into derivative transactions, including Swaps. Each Portfolio Advisor for the Existing Bridgehouse Funds considers Swaps to be an important investment tool that is available to it to manage each Bridgehouse Fund's portfolio.

9. The Dodd-Frank Act requires that certain OTC derivatives be cleared through a Futures Commission Merchant at a clearing organization recognized by the CFTC. Generally, where one party to a Swap is a U.S. Person, that Swap must be cleared.

10. 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.

11. In order to benefit from both the pricing benefits and reduced trading costs that a Portfolio Advisor may be able to achieve through its trade execution practices for its advised investment funds and other accounts and from the reduced costs associated with cleared OTC derivatives as compared to other OTC trades, the Filer wishes to have the Bridgehouse Funds enter into cleared Swaps.

12. In the absence of the Requested Relief, each Portfolio Advisor will need to structure the Swaps entered into by the Bridgehouse Funds so as to avoid the clearing requirements of the CFTC and under EMIR, as applicable. The Filer respectfully submits that this would not be in the best interests of the Bridgehouse Funds and their investors for a number of reasons, as set out below.

13. The Filer strongly believes that it is in the best interests of the Bridgehouse Funds and their investors to continue to be able to execute OTC derivatives with global counterparties, including U.S. and European swap dealers.

14. In its role as a fiduciary for the Bridgehouse Funds, the Filer has determined that central clearing represents the best choice for the investors in the Bridgehouse Funds to mitigate the legal, operational and back office risks faced by investors in the global swap markets.

15. Each Portfolio Advisor may use the same trade execution practices for all of its advised funds and other accounts, including the Bridgehouse 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 and other accounts advised by one Portfolio Advisor. These practices include the use of cleared Swaps. If the Bridgehouse Funds are unable to employ these trade execution practices, then each affected Portfolio Advisor will have to create separate trade execution practices only for the Bridgehouse Funds and will have to execute trades for the Bridgehouse Funds on a separate basis. This will increase the operational risk for the Bridgehouse Funds, as separate execution procedures will need to be established and followed only for the Bridgehouse Funds. In addition, the Bridgehouse 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 advised 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 Swaps on a cleared basis.

16. 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 Bridgehouse Funds. The Filer respectfully submits that the Bridgehouse Funds should be encouraged to comply with the robust clearing requirements established by the CFTC and under EMIR by granting them the Requested Relief.

17. 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.

18. For the reasons provided above, the Filer submits that it would not be prejudicial to the public interest to grant the Requested Relief.

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 Requested Relief is granted provided that when any rules applicable to customer clearing of OTC derivatives enter into force, the Clearing Corporation is permitted to offer customer clearing of OTC derivatives in the Jurisdiction or the Other Jurisdiction, as the case may be, where the Bridgehouse Fund is located and provided further that, in respect of the deposit of cash and other 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 Bridgehouse 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 Bridgehouse 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.

"Raymond Chan"
Manager, Investment Funds and Structured Products Branch
Ontario Securities Commission