Securities Law & Instruments

Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Relief granted from subsection 2.1(1) and paragraphs 2.2(1)(a), 2.5(2)(a), (b), (c) and (e) of National Instrument 81-102 Investment Funds to allow mutual funds to invest in ETFs in Canada and the United States, and to allow the top funds to pay brokerage commissions for the purchase and sale of the securities of the underlying ETFs – Underlying ETFs are subject to NI 81-102 or the United States Investment Company Act of 1940 – Investments in U.S. ETFs limited to 10% of net asset value – Relief subject to terms and conditions based on investment restrictions of NI 81-102 such that top funds cannot do indirectly via investment in underlying ETFs what they cannot do directly under NI 81-102.

Applicable Legislative Provisions

National Instrument 81-102 Investment Funds, ss. 2.1(1), 2.2(1)(a), 2.5(2)(a), (b), (c) and (e), 19.1.

May 27, 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
TD ASSET MANAGEMENT INC.
(“TDAM”)

DECISION

Background

The principal regulator in the Jurisdiction has received an application (the “Application”) from TDAM under the securities legislation of the principal regulator (the “Legislation”) on behalf of mutual funds subject to National Instrument 81-102 Investment Funds (“NI 81-102”) that it currently manages (the “Existing Funds”) and such mutual funds as may be managed by TDAM in the future (the “Future Funds”, and together with the Existing Funds, the “Funds” and each individually, a “Fund”) for a decision providing an exemption (the “Requested Relief”) from the following provisions of NI 81-102 in order to permit the Funds to invest in securities of exchange-traded funds that are not index participation units (the “Underlying ETFs”):

(a)           subsection 2.1(1) of NI 81-102 (the “Concentration Restriction”) to permit each Fund to purchase securities of an Underlying ETF or enter into a specified derivatives transaction with respect to an Underlying ETF even though, immediately after the transaction, more than 10% of the net asset value (“NAV”) of the Fund would be invested, directly or indirectly, in securities of the Underlying ETF (the “Concentration Relief”);

(b)           paragraph 2.2(1)(a) of NI 81-102 (the “Control Restriction”) to permit each Fund to purchase securities of an Underlying ETF such that, after the purchase, the Fund would hold securities representing more than 10% of:

(i)            the votes attaching to the outstanding voting securities of the Underlying ETF; or

(ii)           the outstanding equity securities of the Underlying ETF (the “Control Relief”);

(c)           paragraph 2.5(2)(a) of NI 81-102 to permit each Fund to invest in securities of Underlying ETFs that do not offer securities under a simplified prospectus in accordance with National Instrument 81-101 Mutual Fund Prospectus Disclosure (“NI 81-101”) and that may not be subject to NI 81-102;

(d)           paragraph 2.5(2)(b) of NI 81-102 to permit each Fund to invest in securities of an Underlying ETF which may be structured as a fund-of-fund (the “Three-Tier Relief”);

(e)           paragraph 2.5(2)(c) of NI 81-102 to permit each Fund to invest in securities of U.S. Underlying ETFs (as defined below); and

(f)            paragraph 2.5(2)(e) of NI 81-102 to permit each Fund to pay brokerage fees in relation to its purchase and sale of securities of a Related Underlying ETF (defined below) (the “Brokerage Fee Relief”).

Under the Process for Exemptive Relief Applications in Multiple Jurisdictions:

(a)           the Ontario Securities Commission is the principal regulator for the Application, and

(b)           TDAM 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 British Columbia, Alberta, Saskatchewan, Manitoba, Quebec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Yukon, Northwest Territories and Nunavut (together with Ontario, the “Jurisdictions” and individually a “Jurisdiction”).

Interpretation

Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.

In addition, the terms below have the following meanings:

“Canadian Underlying ETF” means an Underlying ETF whose securities are listed for trading on a stock exchange in Canada.

“Related Underlying ETF” means an Underlying ETF that is managed by TDAM, or an affiliate or associate of TDAM.

“U.S. Underlying ETF” means an Underlying ETF whose securities are listed for trading on a stock exchange in the United States.

Representations

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

1.             TDAM is a wholly-owned subsidiary of The Toronto-Dominion Bank and is registered under the Securities Act (Ontario) in the categories of investment fund manager, portfolio manager, exempt market dealer and, under the Commodity Futures Act (Ontario), in the category of commodity trading manager. In Jurisdictions other than Ontario, TDAM is registered as follows: (i) as a portfolio manager and exempt market dealer in such Jurisdictions; and (ii) as an investment fund manager in Newfoundland and Quebec. TDAM's head office is in Toronto, Ontario.

2.             TDAM is, or will be, the manager of the Funds.

3.             Neither TDAM nor the Existing Funds are in default of securities legislation in any Jurisdiction.

The Funds

4.             The Funds are, or will be, open-ended mutual funds or exchange traded open-ended mutual funds organized and governed by the laws of a jurisdiction of Canada.

5.             Each Fund distributes, or will distribute, its securities pursuant to a simplified prospectus prepared pursuant to NI 81-101 and Form NI 81-101F1 Contents of Simplified Prospectus (“Form 81-101F1”) or a long form prospectus prepared pursuant to National Instrument 41-101 General Prospectus Requirements (“NI 41-101”) and Form 41-101F2 Information Required in an Investment Fund Prospectus (“Form 41-101F2”) and is, or will be, governed by the applicable provisions of NI 81-102, subject to any exemptions therefrom that have been, or may in the future be, granted by the securities regulatory authorities.

6.             The Funds are, or will be, reporting issuers in one or more province and territory of Canada in which their securities are distributed.

7.             Each Fund is, or will be, subject to National Instrument 81-107 Independent Review Committee for Investment Funds ("NI 81-107").


8.             The Funds may, from time to time, wish to invest in Underlying ETFs.

The Underlying ETFs

9.             An Underlying ETF will not meet the definition of index participation unit (“IPU”) as set out in NI 81-102 because it will not:

(a)           hold securities that are included in a specified widely quoted index in substantially the same proportion as those securities are reflected in that index; or

(b)           invest in a manner that causes the Underlying ETF to replicate the performance of that index.

10.          The securities of an Underlying ETF are, or will be, listed on a recognized exchange in Canada or the United States and the market for them is, or will be, liquid because it is, or will be, supported by designated brokers. As a result TDAM expects a Fund to be able to dispose of such securities through market facilities in order to raise cash, including to fund the redemption requests of its securityholders.

11.          Other than as described in paragraphs 30 to 34 below, no Underlying ETF will hold more than 10% of its NAV in securities of another investment fund unless (i) the other investment fund is a clone fund or money market fund, as defined in NI 81-102; or (ii) securities of the other investment fund are IPUs.

12.          No Underlying ETF will pay management or incentive fees which to a reasonable person would duplicate a fee payable by the applicable Fund for the same service.

13.          Absent the Requested Relief, an investment by a Fund in an Underlying ETF would be prohibited by paragraph 2.5(2)(a) of NI 81-102 because such Underlying ETF may not be subject to NI 81-102 and does not offer its securities under a simplified prospectus in accordance with NI 81-101. An investment by a Fund in an Underlying ETF would not qualify for the exception in paragraph 2.5(3)(a) of NI 81-102 because the securities of the Underlying ETF are not IPUs.

The Canadian Underlying ETFs

14.          Each Canadian Underlying ETF is, or will be, an open-ended mutual fund subject to NI 81-102, subject to any exemption therefrom that may be granted by the securities regulatory authorities.

15.          Securities of each Canadian Underlying ETF are, or will be:

(a)           distributed pursuant to a long form prospectus prepared pursuant to NI 41-101 and Form 41-101F2 or a simplified prospectus prepared pursuant to NI 81-101 and Form 81-101F1; and

(b)           listed on the Toronto Stock Exchange (“TSX”) or another “recognized exchange” in Canada, as that term is defined in securities legislation.

16.          Because securities of each Canadian Underlying ETF are, or will be, distributed pursuant to a long form prospectus prepared pursuant to NI 41-101 and Form 41-101F2 or a simplified prospectus pursuant to NI 81-101 and Form 81-101F1, each Canadian Underlying ETF is, or will be, a reporting issuer in the provinces and territories of Canada in which its securities are, or will be, distributed.

17.          Each Canadian Underlying ETF is, or will be, subject to NI 81-107 generally and in respect of conflict of interest matters to which NI 81-107 applies.

18.          TDAM, or an affiliate or associate of TDAM, may qualify for distribution securities of the Related Underlying ETFs whose securities do not meet the definition of IPU, as set out in NI 81-102. The Funds may, from time to time, wish to invest in such Related Underlying ETFs.

19.          Each Related Underlying ETF will be a Canadian Underlying ETF or U.S. Underlying ETF.

The U.S. Underlying ETFs

20.          Each U.S. Underlying ETF is, or will be, a publicly offered mutual fund subject to the United States Investment Company Act of 1940 (the "Investment Company Act").

21.          TDAM has concluded that it could not currently gain exposure to applicable asset classes, sectors and/or markets entirely through existing Canadian fund alternatives such as Canadian exchange-traded funds. Currently, the U.S. Underlying ETFs provide significantly broader exposure to asset classes, sectors and markets than those available from existing Canadian exchange-traded funds or fund alternatives. As the Canadian market for actively-managed exchange-traded funds and fund alternatives evolves, TDAM may consider such products as a vehicle to achieve the investment objectives of a Fund.

22.          Absent the Requested Relief, an investment by a Fund in a U.S. Underlying ETF would be prohibited by paragraph 2.5(2)(c) of NI 81-102 because such U.S. Underlying ETF is not a reporting issuer in the local jurisdiction.

23.          TDAM submits that having the option to allocate a very limited portion of each Fund’s assets to U.S. Underlying ETFs will increase diversification opportunities and improve a Fund's overall risk/reward profile.

24.          A key benefit of investing in the Underlying ETFs, including the U.S. Underlying ETFs, is improved portfolio diversification and potentially enhanced returns. For example:

(a)           an investment in the Underlying ETFs will provide the Funds with access to specialized knowledge, expertise and/or analytical resources of the investment adviser to the Underlying ETFs;

(b)           the Underlying ETFs provide a potentially better risk profile and improved liquidity/tradability than direct holdings of asset classes to which the Underlying ETFs provide exposure; and

(c)           the investment strategies of the U.S. Underlying ETFs offer significantly broader exposure to asset classes, sectors and markets than those available in the existing Canadian exchange-traded fund market.

The Concentration Relief and Control Relief

25.          An investment in an Underlying ETF by a Fund is an efficient and cost effective alternative to administering one or more investment strategies similar to that of the Underlying ETF.

26.          An investment in an Underlying ETF by a Fund should pose limited investment risk to the Fund because each Underlying ETF will be subject to NI 81-102 or the Investment Company Act, subject to any exemption therefrom that may in the future be granted by the securities regulatory authorities.

27.          Due to the potential size disparity between the Funds and the Underlying ETFs, it is possible that a relatively small investment, on a percentage of NAV basis, by a relatively larger Fund in securities of an Underlying ETF could result in such Fund holding securities representing more than 10% of: (i) the votes attaching to the outstanding voting securities of the Underlying ETF; or (ii) the outstanding equity securities of that Underlying ETF, contrary to the Control Restriction.

28.          Absent the Concentration Relief and the Control Relief, an investment by a Fund in securities of an Underlying ETF will not qualify for the exemptions set out in:

(a)           paragraph 2.1(2)(d) of NI 81-102 from the Concentration Restriction; and

(b)           paragraph 2.2(1.1)(b) of NI 81-102 from the Control Restriction;

because securities of the Underlying ETFs are not IPUs.

29.          The material difference between the securities of an Underlying ETF and the securities of a conventional mutual fund is the method of distribution and disposition.

The Three-Tier Relief

30.          An Underlying ETF may be structured as a “fund-of-fund” to achieve economies of scale. The Underlying ETF may invest in a separate series of a master trust or separate class of a corporation. The master trust or corporation in turn invests in, or obtains exposure to, certain asset classes, sectors and/or markets. Economies of scale may be achieved by centralizing investments at the master trust or corporate level. In the absence of such structure, each series or class would need to attract sufficient assets to invest in, or gain exposure to, applicable investments.

31.          Absent the Three-Tier Relief, an investment by a Fund in an Underlying ETF that invests substantially all of its assets in securities of another investment fund would be prohibited by paragraph 2.5(2)(b) of NI 81-102, as more than 10% of the NAV of the Underlying ETF would be invested in securities of other investment funds.

32.          NI 81-102 defines a “clone fund” to mean an “investment fund that has adopted a fundamental investment objective to track the performance of another investment fund”. An investment by a Fund in an Underlying ETF may not qualify for the exception in paragraph 2.5(4)(a) of NI 81-102, as the Underlying ETF may not meet the strict definition of “clone fund” where such Underlying ETF has not adopted a fundamental investment objective to track the performance of another investment fund.

33.          In such a case, other than the fact that the Underlying ETF’s investment objective does not specifically state that it will track the performance of another investment fund, the Underlying ETF would satisfy the definition of “clone fund”, as it has adopted a fundamental investment objective akin to that of its underlying fund. In this decision, such an Underlying ETF is referred to as a “Technical Clone Fund”.

34.          TDAM submits that to the extent that an Underlying ETF is a Technical Clone Fund a three-tier “fund-on-fund” structure should be permissible.

The Brokerage Fee Relief

35.          The trades conducted by a Fund may not be of the size necessary for the Fund to be eligible to purchase or exchange securities of a Related Underlying ETF directly from the Related Underlying ETF at its NAV per security. Trades in securities of a Related Underlying ETF are therefore likely to be conducted by a Fund in the secondary market through the facilities of a recognized exchange. Absent the Brokerage Fee Relief, paragraph 2.5(2)(e) of NI 81-102 would not permit a Fund to pay brokerage fees incurred in connection with a Related Underlying ETF.

36.          All brokerage fees related to trades in securities of Related Underlying ETFs will be borne by the Funds in the same manner as any other portfolio transactions made on an exchange.

37.          If a Fund trades in securities of a Related Underlying ETF with or through an affiliate or associate of TDAM acting as dealer, TDAM will comply with its obligations under NI 81-107 in respect of any proposed related party transactions. These related party transactions will be disclosed to securityholders of the applicable Fund in its management report of fund performance.

38.          None of the U.S. Underlying ETFs are Related Underlying ETFs.

The Other ETF Decision

39.          The Funds previously received exemptive relief on October 5, 2010 (the “Other ETF Decision”) to permit the Funds to invest in securities of Leveraged ETFs, Inverse ETFs and Leveraged Gold ETFs (as such terms are defined in the Other ETF Decision, collectively, the “Other ETFs”) that are not IPUs.

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:

(a)           the investment by a Fund in securities of an Underlying ETF is in accordance with the investment objectives of the Fund;

(b)           in respect of a Fund’s purchase of securities of Underlying ETFs other than Related Underlying ETFs, a Fund does not purchase securities of such Underlying ETFs if, immediately after the purchase, more than 30% of the NAV of the Fund in aggregate, taken at market value at the time of purchase, would consist of securities of such Underlying ETFs;

(c)           a Fund does not purchase securities of a U.S. Underlying ETF (including a related U.S. Underlying ETF) if, immediately after the purchase, more than 10% of the NAV of the Fund in aggregate, taken at market value at the time of the purchase, would consist of securities of U.S. Underlying ETFs;

(d)           a Fund does not purchase securities of an Underlying ETF if, immediately after the purchase, more than 10% of the NAV of the Fund in aggregate, taken at market value at the time of the purchase, would consist of a combination of securities of Underlying ETFs and Other ETFs that provide leverage exposure, further to the Other ETF Decision;

(e)           a Fund does not short sell securities of an Underlying ETF;


(f)            an Underlying ETF is not a commodity pool as defined in National Instrument 81-104 Commodity Pools or under applicable U.S. laws and its investment adviser is not required to register as a commodity pool operator in the United States in connection with the U.S. Underlying ETFs;

(g)           the Canadian Underlying ETF does not rely on exemptive relief from the requirements of:

(i)            section 2.3 of NI 81-102 regarding the purchase of physical commodities;

(ii)           sections 2.7 and 2.8 of NI 81-102 regarding the purchase, sale or use of specified derivatives; or

(iii)          paragraphs 2.6(a) and 2.6(b) of NI 81-102 with respect to the use of leverage;

(h)           securities of each Underlying ETF are listed on a recognized exchange in Canada or the United States;

(i)            each U.S. Underlying ETF is, immediately before purchase by a Fund of securities of that U.S. Underlying ETF, an investment company subject to the Investment Company Act in good standing with the United States Securities and Exchange Commission;

(j)            in respect of the Three-Tier Relief, the Underlying ETF is a Technical Clone Fund; and

(k) t         he prospectus of each Fund discloses, or will disclose in the next renewal of its prospectus following the date of this decision, in the investment strategy section, the fact that the Fund has obtained the Requested Relief to permit investments in Underlying ETFs on the terms described in this decision.

“Vera Nunes”
Manager, Investment Funds and Structured Products Branch
Ontario Securities Commission