National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – relief from certain specified derivatives and custodian requirements to permit mutual funds to enter into swap transactions that are cleared through a clearing corporation as contemplated under U.S. and European regulatory requirements. Decision treats cleared swaps similar to other cleared derivatives.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.7(1), 2.7(4), 6.1,19.1.
Securities Act, R.S.O. 1990, c. S.5, as am., s. 144.
October 7, 2016
IN THE MATTER OF
THE SECURITIES LEGISLATION OF
IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS
IN MULTIPLE JURISDICTIONS
IN THE MATTER OF
RBC GLOBAL ASSET MANAGEMENT INC.
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 RBC GAM Fund (as defined below) and all current and future mutual funds, including exchange-traded funds, managed by the Filer that enter into Cleared Swaps (as defined below) in the future (each, a Future RBC GAM Fund and, together with the Existing RBC GAM Funds, each, a RBC GAM Fund and, collectively, the RBC GAM 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 clears and 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 RBC GAM 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).
The Filer is also requesting that the Previous Relief (as defined below) be revoked and replaced with the Requested Relief (the Revocation).
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).
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
Cleared Swap means any OTC derivative transaction that can be entered into on a cleared basis, whether or not such derivative is subject to a clearing determination or a clearing obligation issued by the CFTC or ESMA, as the case may be
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 recognized or exempt from recognition in Ontario
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 RBC GAM Funds means the RBC GAM Funds that are relying on the Previous Relief as at 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
LSOC Model means the legally segregated operationally commingled model adopted by the CFTC for Cleared Swaps collateral
OTC means over-the-counter
Sub-Advisors means each of the Filer, RBC Global Asset Management (UK) Limited, RBC Investment Management (Asia) Limited, RBC Global Asset Management (US) Inc., BlueBay Asset Management LLP and their affiliates, and each third party portfolio manager retained from time to time by the Filer to manage the investment portfolio of one or more RBC GAM Funds
U.S. Person has the meaning attributed thereto by the CFTC
This decision is based on the following facts represented by the Filer:
The Filer and the RBC GAM Funds
1. The Filer is, or will be, the investment fund manager of each RBC GAM Fund. The Filer is registered as an adviser in the category of portfolio manager and as a dealer in the category of exempt market dealer under the securities legislation of each of the Jurisdictions, is registered as an investment fund manager in each of British Columbia, Ontario, Québec and Newfoundland and Labrador and is also registered in Ontario as a commodity trading manager. The head office of the Filer is in Toronto, Ontario.
2. The Filer is, or will be, the portfolio manager to the RBC GAM Funds. One of the Sub-Advisors is, or will be, the sub-advisor to the RBC GAM Funds.
3. Each RBC GAM 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 RBC GAM Funds are, or will be, in default of securities legislation in the Jurisdiction or any Other Jurisdiction.
5. The securities of each RBC GAM 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 Jurisdiction and the Other Jurisdictions. Accordingly, each RBC GAM Fund is, or will be, a reporting issuer or the equivalent in each Jurisdiction.
Previous Cleared Swaps Relief
6. In a decision document dated December 18, 2014, the RBC GAM Funds were granted relief from the requirements in subsections 2.7(1), 2.7(4) and 6.1(1) of NI 81-102 to permit the RBC GAM 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 December 18, 2016.
7. The Filer is seeking the Revocation to replace the Previous Relief with the Requested Relief.
8. The investment objective and investment strategies of each RBC GAM Fund permit, or will permit, the RBC GAM Fund to enter into derivative transactions, including Cleared Swaps. Each Sub-Advisor of the Existing RBC GAM Funds considers Cleared Swaps to be an important investment tool that is available to it to properly manage each Existing RBC GAM Fund’s portfolio. Each Existing RBC GAM Fund currently uses or intends to use interest rate swaps and/or credit default swaps in its portfolio.
9. Dodd-Frank requires that certain OTC derivatives be cleared through a Futures Commission Merchant at a Clearing Corporation. Generally, where a U.S. Person is currently party to any of a fixed-to-floating interest rate swap, basis swap, forward rate agreement in U.S. dollars, the Euro, Pounds Sterling or the Japanese Yen, overnight index swap in U.S. dollars, the Euro and Pounds Sterling or untranched credit default swaps on certain North American indices (CDS.NA.IG and CDX.NA.HY) and European indices (iTraxx Europe, iTraxx Europe Crossover and iTraxx Europe HiVol) at various tenors, 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 addition to clearing swaps that are mandated to be cleared under Dodd-Frank and/or EMIR, many of the Clearing Corporations offer clearing services in respect of other types of derivative transactions. Many global derivative end-users enter into Cleared Swaps on both a voluntary and a mandatory basis.
12. In order to benefit from both the pricing benefits and reduced trading costs that each Sub-Advisor is often able to achieve through its trade execution practices for its managed investment funds and accounts and from the reduced costs associated with Cleared Swaps as compared to other OTC trades, the Filer wishes that the RBC GAM Funds have the ability to enter into Cleared Swaps.
13. In the absence of the Requested Relief, each Sub-Advisor will need to structure the derivative transactions entered into by the applicable RBC GAM Funds so as to avoid clearing, including 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 RBC GAM Funds and their investors for a number of reasons, as set out below.
14. The Filer strongly believes that it is in the best interests of the RBC GAM Funds and their investors to continue to be able to execute OTC derivatives with global counterparties, including U.S. and European swap dealers.
15. A Sub-Advisor may use common trade execution practices for all of its accounts, including the RBC GAM Funds. If these practices involve the use of Cleared Swaps and if the RBC GAM Funds are unable to employ these trade execution practices, then the Sub-Advisor would have to create separate trade execution practices only for the RBC GAM Funds and would have to execute trade for the RBC GAM Funds on a separate basis. This would increase the operational risk for the RBC GAM Funds and would prevent the RBC GAM Funds from benefitting from the pricing benefits and reduced trading costs that a Sub-Advisor may be able to achieve through common practices for its advised 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 Cleared Swaps.
16. In its role as a fiduciary for the RBC GAM Funds, the Filer has determined that central clearing represents a good choice for the investors in the RBC GAM Funds to mitigate the legal, operational and back office risks faced by investors in the global swap markets.
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 RBC GAM Funds. The Filer respectfully submits that the RBC GAM Funds should be encouraged to comply with the robust clearing requirements established by the CFTC and under EMIR by granting them the Requested Relief.
18. The Requested Relief is analogous to the treatment currently afforded under NI 81-102 to other types of derivatives that are cleared, i.e., clearing corporation options, options on futures and standardized futures. This demonstrates that, from a policy perspective, such Requested Relief is consistent with the views of the Canadian securities authorities in respect of cleared derivative trades.
19. For the reasons provided above, the Filer submits that it would not be prejudicial to the public interest to grant the Requested Relief to the RBC GAM Funds.
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:
1) the Revocation is granted; and
2) 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 applicable RBC GAM 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 RBC GAM 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 RBC GAM 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.
Manager, Investment Funds and Structured Products
Ontario Securities Commission