National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Relief to permit a senior loan exchange-traded fund to borrow cash up to an amount equal to 10% of NAV as a temporary measure to accommodate requests for the redemption of units of the fund -- relief needed due to longer settlement times of senior loans -- relief subject to numerous conditions -- National Instrument 81-102 Investment Funds.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.6(a)(i), 19.1.
March 15, 2016
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 SENIOR LOAN ETF (CAD-HEDGED) (the "First Trust ETF" or "FSL")
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of the First Trust ETF for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for relief, pursuant to Section 19.1 of National Instrument 81-102 -- Investment Funds (NI 81-102), from the borrowing restriction in Section 2.6(a)(i) of NI 81-102, in order to allow the First Trust ETF to borrow cash on a temporary basis to accommodate requests for the redemption of its Units (as defined below) while the First Trust ETF settles portfolio transactions initiated to satisfy such redemption requests provided that the outstanding amount of all borrowings of the First Trust ETF does not exceed 10% of its net asset value at the time of borrowing (the Exemption Sought).
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 section 4.7(1) of Multilateral Instrument 11-102 -- Passport System (MI 11-102) is intended to be relied upon in each of the provinces and territories of Canada other than the Jurisdiction (including Ontario, the Jurisdictions).
Terms defined in National Instrument 14-101 -- Definitions (NI 14-101), MI 11-102 or NI 81-102 have the same meaning if used in this decision, unless otherwise defined herein.
"Basket of Securities" means a group of securities determined by the Filer from time to time representing the constituents of the investment portfolio then held by the First Trust ETF.
"Dealers" means registered brokers and dealers that have entered into dealer agreements with the First Trust ETF and that subscribe for and purchase Units from the First Trust ETF, and "Dealer" means any one of them.
"Designated Brokers" means registered brokers and dealers that enter into agreements with the First Trust ETF to perform certain duties in relation to the First Trust ETF, including posting a liquid two-way market for the trading of Units on the TSX or another marketplace.
"Designated Counterparty" means a person or company, or the direct or indirect parent company of such person or company, whose securities have a "designated rating", as defined in National Instrument 44-101 Short Form Prospectus Distributions.
"Prescribed Number of Units" means the number of Units of the First Trust ETF determined by the Manager from time to time for the purpose of subscription orders, exchanges, redemptions or for other purposes.
"Unit" a redeemable, transferable Common Unit or Advisor Class Unit of the First Trust ETF, which represents an equal, undivided interest in the net assets of the First Trust ETF.
"Unitholders" means beneficial and registered holders of Units of the First Trust ETF.
This decision is based on the following facts represented by the Filer on behalf of itself and the First Trust ETF:
1. The Filer is the trustee and manager of the First Trust ETF. The head office of the Filer is located in Toronto, Ontario.
2. First Trust Advisors L.P. (First Trust Advisors or the Portfolio Advisor), which is registered under the Securities Act (Ontario) as a portfolio manager, is the portfolio advisor of the First Trust ETF and an affiliate of the Filer.
3. None of the Manager, First Trust Advisors and the First Trust ETF is in default of securities legislation in any of the Jurisdictions.
4. The First Trust ETF is a reporting issuer all of the provinces and territories of Canada. The First Trust ETF distributes its Units in such jurisdictions under a long form prospectus in the form of Form 41-101F2 -- Information Required in an Investment Fund Prospectus (the Prospectus).
5. The First Trust ETF is an exchange traded mutual funds in continuous distribution that is subject to NI 81-102.
6. The First Trust ETF has issued Units that are listed and posted for trading on the Toronto Stock Exchange.
7. The investment objective of FSL is to seek to provide Unitholders with a high level of current income by investing primarily in a diversified portfolio of senior floating rate loans and debt securities, with capital appreciation as a secondary objective. FSL invests primarily in a portfolio of senior floating rate loans which are generally rated at or below BB+ by Standard & Poors, or Ba1 or less by Moody's Investor Services, Inc., or a similar rating by designated rating organization (as defined in NI 81-102).
8. FSL may invest up to 20% of its net assets in other floating rate debt instruments, including floating rate bonds, floating rate notes, money market instruments, floating rate debentures and tranches of floating rate asset-backed securities, structured notes, made to, or issued by, U.S. and non-U.S. corporations or other business entities, other fixed-rate income producing securities (including, without limitations, U.S. government debt securities, investment grade and below-investment grade corporate debt securities), securities of other investment funds, warrants and equity securities and derivatives. FSL will generally seek to hedge substantially all of its U.S. dollar currency exposure back to the Canadian dollar.
9. The First Trust ETF invests in senior loans that First Trust Advisors believes exhibit the best combination of attractive fundamental credit characteristics and relative value within the senior loan market. First Trust Advisors seeks to assemble a well-diversified portfolios that includes loans of issuers with strong credit metrics, including strong cash flows and effective management teams. Senior loans, compared to equivalently rated unsecured high yield bonds, typically offer a higher recovery rate because of the protection offered by their secured nature and their priority claim relative to other debt instruments.
10. The liquidity of all senior loans investments is assessed prior to each investment. This involves assessing a range of different loan factors including the the bid-offer spread, market depth, data freshness, movers count, quoted size of trades, and directional strength of price movements.
11. In addition, in order to monitor the Fund's ability to meet unitholder redemptions under stressed market conditions, the liquidity of the First Trust ETF's portfolio of senior loans is actively monitored on an ongoing basis through stress testing. At least once each month, a screen is run on all of the senior loans held by the First Trust ETF and any loans with a high 30 day average liquidity score are flagged. The Portfolio Advisor is then prompted to review the market data and consider whether the loan is illiquid.
12. Generally, orders to purchase Units directly from the First Trust ETF must be placed by Designated Brokers or Dealers in a Prescribed Number of Units (or an integral multiple thereof). Investors are generally expected to purchase and sell Units, directly or indirectly, through dealers executing trades through the facilities of the TSX or another marketplace in Canada. Units may also be issued directly to the First Trust ETF's investors upon the reinvestment of distributions of income or capital gains.
13. Designated Brokers perform certain other functions, which inclue standing in the market with a bid and ask price for Units for the purpose of maintaining liquidity for the Units.
14. Unitholders may redeem Units of the First Trust ETF for cash at a redemption price per Unit equal to the lesser of (a) 95% of the closing price for the Units on the TSX on the effective day of the redemption; and (b) the NAV per Unit. Unitholders of the First Trust ETF (generally Designated Brokers or Dealers) may also exchange the Prescribed Number of Units (or an integral multiple thereof) for Baskets of Securities and/or cash in the discretion of the Manager.
15. The net asset value per Unit of each class of the First Trust ETF is calculated and published daily on the Manager's website at www.firstrust.ca.
16. The Filer believes the senior loan investments made by the First Trust ETF can be liquidated in a timely fashion, however, the settlement time is typically longer than that of equity securities.
17. Senior loans, compared to equivalently rated unsecured high yield bonds, typically offer a higher recovery rate because of the protection offered by their secured nature and their priority claim relative to other debt instruments. This security is generally achieved by security interests on physical or non-physical assets and, even if not realized through liquidation, can greatly increase recovery in a reorganization scenario.
18. The purchaser of a senior loan that will be transacting with the First Trust ETF will always be a dealer that is a Designated Counterparty.
19. The sale of a senior loan between the First Trust ETF and a Designated Counterparty will always be subject to the standard terms and conditions for par/near par trade confirmations published by the Loan Syndications and Trading Association (the "Terms"). The Terms are binding on the parties to the transaction and do not contain any termination provisions for force majeure or the stress or dislocation of the senior loan market.
20. The Filer has determined that it would be prudent for the First Trust ETF to request the Exemption Sought in order to borrow cash on a temporary basis to accommodate requests for the exchange or redemption of its Units while the First Trust ETF settles portfolio transactions initiated to satisfy such requests provided that the outstanding amount of all borrowing of the First Trust ETF does not exceed 10% of its net asset value at the time of borrowing.
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 Decision Maker under the Legislation is that the Exemption Sought is granted provided that:
(a) if trading of the Units on the TSX of a First Trust ETF is suspended for a period exceeding 30 days, the First Trust ETF will begin taking all necessary steps to ensure that all amounts borrowed under the overdraft facility are fully repaid as soon as commercially reasonable, but no later than 90 days from the date of suspension, provided that such repayment need not be completed if the suspension is lifted within 90 days from the date of the suspension;
(b) the First Trust ETF does not make a distribution to its Unitholders where that distribution would impair the ability of such First Trust ETF to repay the funds borrowed under the overdraft facility;
(c) the First Trust ETF's next renewal prospectus or amendment to prospectus to be filed in connection with the continuous distribution of its Units discloses the maximum percentage of assets of the First Trust ETF that the borrowing may represent, the First Trust ETF's intended use of the amounts borrowed under the overdraft facility, the material terms of the overdraft facility, and the risks arising from the borrowing under the overdraft facility;
(d) the First Trust ETF's next renewal prospectus or amendment to prospectus to be filed in connection with the continuous distribution of its Units will have textbox disclosure stating that: (i) the First Trust ETF invests primarily in senior secured loans, which are generally rated below investment grade debt, (ii) settlement periods for senior secured loans may be longer than for other types of debt securities, such as corporate bonds, and (iii) the First Trust ETF is not a substitute for holding money market securities; and
(e) the First Trust ETF may only borrow cash in excess of 5% of its net asset value if all of the following conditions are satisfied:
(i) after giving effect to the borrowing, the outstanding amount of all borrowings of the First Trust ETF does not exceed 10% of its the net asset value of the First Trust ETF;
(ii) the First Trust ETF has entered into a binding agreement with a Designated Counterparty(s) to sell a senior loan(s) in order to satisfy redemption requests, but the settlement period on the senior loan(s) exceeds three days; and
(iii) the amount of cash that the First Trust borrows does not exceed the amount of cash that it will receive in respect of the sale of the senior loan(s) referred to in paragraph (e)(ii) above.
(iv) the First Trust ETF has sold all of the securities in its portfolio, other than senior loan holdings, and has used all of its available cash in order to satisfy redemption requests.
The Exemption Sought expires on the date that is 18 months after the date of this decision.