Securities Law & Instruments


Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Existing and future mutual funds granted relief to invest in specified ETFs whose securities would meet the definition of index participation unit under NI 81-102 but for the fact that they are listed on the London Stock Exchange (London ETFs) – relief is subject to certain conditions and requirements including that none of the London ETFs are synthetic ETFs and that each top fund will not invest more than 10% of its net asset value in any single London ETF and will not invest more than 20% in London ETFs in the aggregate

Applicable Legislative Provisions

National Instrument 81-102 Investment Funds, ss. 2.5(2)(a) and (c), 19.1.

April 28, 2017

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
EXCEL FUNDS MANAGEMENT INC.
(THE FILER)

DECISION

BACKGROUND

The principal regulator in the Jurisdiction has received an application from the Filer on behalf of each of the investment funds (the Funds) for which the Filer or an affiliate acts as manager that are subject to National Instrument 81-102 Investment Funds (NI 81-102), for a decision under the securities legislation of the jurisdiction of the principal regulator (the Legislation) providing an exemption from paragraphs 2.5(2)(a) and (c) of NI 81-102 to permit the Funds to invest in securities of exchange traded funds listed on the London Stock Exchange (the London ETFs) that, but for the fact that they are listed on a stock exchange in London and not on a stock exchange in Canada or the United States, would otherwise qualify as “index participation units” (IPU) as defined in NI 81-102 (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 subsection 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in all of the other provinces and territories of Canada (together with the Jurisdiction, the Jurisdictions).

INTERPRETATION

Terms defined in National Instrument 14-101 Definitions, MI 11-102 and NI 81-102 have the same meaning if used in this decision, unless otherwise defined.

REPRESENTATIONS

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

The Filer and the Funds

1.             The Filer is a corporation organized under the laws of Ontario with a head office in Mississauga, Ontario.

2.             The Filer is registered as an investment fund manager in Newfoundland and Labrador, Ontario and Quebec.

3.             The Filer or an affiliate acts, or will act, as manager of each of the Funds.

4.             Each Fund is, or will be, an investment fund under the laws of a Jurisdiction of Canada and a reporting issuer under the laws of some or all of the Jurisdictions.

5.             Each Fund is, or will be, governed by NI 81-102, subject to any relief therefrom granted by the securities regulatory authorities.

6.             The securities of each Fund are, or will be, qualified for distribution in some or all of the Jurisdictions under a prospectus or simplified prospectus.

7.             Neither the Filer nor the existing Funds are in default of securities legislation in any of the Jurisdictions.

The London ETFs

8.             Each Fund proposes, from time to time, to invest up to 10% of its net asset value in securities issued by a single London ETF. At no time will a Fund invest more than 20% of its net asset value in securities issued by London ETFs in aggregate.

9.             Each London ETF is a portfolio, with segregated liability, of an umbrella open-ended investment company with variable capital. An investment company is incorporated with limited liability in Ireland and is authorized by the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations, 2003, as amended (the UCITS Regulations). Each London ETF is therefore a “UCITS” and will therefore comply with UCITS requirements.

10.          The investment objective of a London ETF is to provide investors with a total return, taking into account both capital and income returns, which reflects the return of the applicable index which would be a “permitted index” within the meaning of NI 81-102.

11.          Securities of each London ETF are listed on the London Stock Exchange (the LSE). The securities of a London ETF may also be listed on one or more additional stock exchanges.

12.          The UK Financial Conduct Authority, in its role as the UK Listing Authority (UKLA), is the regulator for the LSE. The UKLA has the responsibility for overseeing the admission process to the LSE.

13.          The LSE is subject to substantially equivalent regulatory oversight to securities exchanges in Canada and the requirements to be complied with by the London ETFs in order to be admitted to trading on the LSE are consistent with the Toronto Stock Exchange listing requirements.

14.          Each London ETF is an “investment fund” and a “mutual fund” within the meaning of applicable Canadian securities legislation.

15.          Securities of each London ETF would be IPUs within the meaning of NI 81-102, but for the fact that they are not traded on a stock exchange in Canada or the United States.

16.          Each London ETF either: (a) holds securities that are included in a specified widely­quoted market index in substantially the same proportion as those securities are reflected in that index; or (b) invests in a manner that causes the issuer to replicate the performance of that index.

17.          BlackRock Asset Management Ireland Limited is the manager of the London ETFs and has responsibility for the management and administration and overall oversight of all service providers and other delegates and for the investment and reinvestment of assets of the London ETFs. BlackRock Asset Management Ireland Limited is not an affiliate or associate of the Filer.

18.          BlackRock Advisors (UK) Limited is the investment manager and has responsibility for the investment and reinvestment of assets held by the London ETFs.

19.          The following third parties are also involved in the administration of the London ETFs:

(a)           State Street Fund Services (Ireland) Limited is the administrator and registrar;

(b)           State Street Custodial Services (Ireland) Limited is the depository of the London ETFs; and

(c)           PricewaterhouseCoopers are the auditors and reporting accountant.

20.          The London ETFs are subject to the following regulatory requirements:

(a)           Each London ETF is subject to a robust risk management framework through prescribed rules on governance, risk, regulation of service providers and safekeeping of assets.

(b)           No London ETF is a “synthetic ETF”, meaning that no London ETF will principally rely on an investment strategy that makes use of swaps or other derivatives to gain an indirect financial exposure to the return of an index.

(c)           A London ETF is restricted to investments permitted by the UCITS Regulations and/or authorized by the Central Bank of Ireland.

(d)           A London ETF is subject to investment restrictions generally designed to limit holdings of illiquid securities which are not listed on a stock exchange or regulated market to 15% or less of its net asset value. In addition, a London ETF will hold no more than 10% of its net asset value in securities of other collective investment undertakings.

(e)           Each London ETF is subject to restrictions concerning the use of derivatives, including the types of derivatives in which it may transact, limits on counterparty risk, and limits on increases to overall market risk resulting from the use of derivatives.

(f)            Each London ETF has procedures in place relating to the use of derivatives and risk modelling of derivatives positions.

(g)           No London ETF engages in securities lending activities.

(h)           Each London ETF has a prospectus that discloses material facts and that is similar to the disclosure required to be included in a prospectus or simplified prospectus of a Fund.

(i)            Each London ETF has a product key facts statement which forms part of the prospectus and contains disclosure similar to that required to be included in a fund facts document prepared under National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81-101).

(j)            Each London ETF is subject to continuous disclosure obligations which are similar to the disclosure obligations under National Instrument 81-106 Investment Fund Continuous Disclosure.

(k)           Each London ETF is required to update information of material significance in the prospectus and to prepare unaudited semi-annual reports and audited annual reports.

(l)            Each London ETF has an investment manager that is subject to a governance framework which sets out a duty of care and a standard of care requiring the management board of the investment manager to act in the best interest of unitholders.

21.          The index tracked by each London ETF is transparent, in that the methodology for the selection and weighting of index components is publicly available.

22.          Details of the components of the index tracked by each London ETF, such as issuer name, ISIN and weighting within the index is publicly available and updated from time to time.

23.          The index tracked by a London ETF includes sufficient component securities so as to be broad-based and is distributed and referenced sufficiently so as to be broadly utilized.

24.          Each London ETF makes the net asset value of its holdings available to the public through at least one price information system associated with the LSE and on the website of its manager.

Investment by Funds in London ETFs

25.          The investment objective and strategies of each Fund will be disclosed in each Fund’s prospectus or simplified prospectus.

26.          The Funds will provide all disclosure mandated for investment funds investing in other investment funds.

27.          There will be no duplication of management fees or incentive fees as a result of an investment by a Fund in a London ETF.

28.          The amount of loss that could result from an investment by a Fund in a London ETF will be limited to the amount invested by the Fund in such London ETF.

29.          The majority of trading in securities of the London ETFs occurs in the secondary market rather than by subscribing or redeeming such securities directly from the London ETF.

30.          As is the case with the purchase or sale of any other equity security made on an exchange, brokers are typically paid a commission in connection with trading in securities of exchange-traded funds, such as the London ETFs.

31.          Securities of the London ETFs are typically only directly subscribed or redeemed from a London ETF in large blocks and it is anticipated that many of the trades conducted by the Funds in London ETFs would not be the size necessary for a Fund to be eligible to directly subscribe for securities.

32.          It is proposed that the Funds will purchase and sell securities of the London ETFs on the LSE.

33.          Where a Fund purchases or sells securities of a London ETF in the secondary market it will pay commissions to brokers in connection with the purchase and sale of such securities.

34.          There will be no duplication of fees payable by an investor in a Fund and the Filer will ensure that there are appropriate restrictions on sales fees and redemption charges for any purchase or sale of securities of a London ETF.

Rationale for Investment in London ETFs

35.          A Fund is not permitted to invest in securities of a London ETF unless the requirements of subsection 2.5(2) of NI 81-102 are satisfied.

36.          If securities of a London ETF were IPUs within the meaning of NI 81-102, a Fund would be permitted by subsections 2.5(3), (4) and (5) of NI 81-102 to invest in securities of that London ETF.

37.          Securities of each London ETF would be IPUs, but for the requirement in the definition of IPU that the securities be traded on a stock exchange in Canada or the United States.

38.          The Filer considers that investments in a London ETF provide an efficient and cost effective way for the Funds to achieve diversification and obtain exposure to the markets and asset classes in which the London ETFs invest.

39.          The investment objectives and strategies of each Fund, which contemplate or will contemplate investment in global or international securities, permit or will permit the allocation of assets to global or international securities. As economic conditions change, the Funds may reallocate assets, including on the basis of industrial sector or geographic region. A Fund will invest in the London ETFs to gain exposure to certain unique strategies in global or international markets in circumstances where it would be in the best interests of the Fund to do so through ETFs rather than through investments in individual securities. For example, a Fund will invest in the London ETFs in circumstances where certain investment strategies preferred by the Fund are either not available or not cost effective.

40.          The Filer is not aware of any mutual fund that:

(a)           is subject to NI 81-102;

(b)           issues securities that are traded on Canadian or U.S. stock exchanges; and

(c)           focuses primarily on the European bond market and is able to trade in local UK time (thereby providing for tighter and more relevant execution).

The Filer therefore believes that the London ETFs will be able to provide the Funds with unique exposures.

41.          By investing in the London ETFs, the Funds will obtain the benefits of diversification, which would be more expensive and difficult to replicate using individual securities. This will reduce single issuer risk.

42.          Investment by each Fund in a London ETF meets, or will meet, the investment objectives of such Fund.

43.          An investment by the Funds in securities of each London ETF will represent the business judgment of responsible persons uninfluenced by considerations other than the best interests of the Funds.

44.          In the absence of the Exemption Sought:

(a)           The investment restriction in paragraph 2.5(2)(a) of NI 81-102 would prohibit a Fund that is a mutual fund from purchasing or holding securities of the London ETFs because such London ETFs are not subject to NI 81-102 and neither would such London ETFs offer securities under a simplified prospectus in accordance with NI 81-101. Because IPUs are currently defined to be securities that are traded on a stock exchange in Canada or the United States only, a Fund would not be able to rely on the IPU exemption set forth in paragraph 2.5(3)(a) of NI 81-102 in respect of its investments and holdings of the London ETFs.

(b)           The investment restriction in paragraph 2.5(2)(c) of NI 81-102 would prohibit a Fund that is a mutual fund from purchasing or holding securities of the London ETFs because such London ETFs will not be reporting issuers in the local jurisdiction. Because IPUs are currently defined to be securities that are traded on a stock exchange in Canada or the United States only, a Fund would not be able to rely on the IPU exemption set forth in paragraph 2.5(3)(a) of NI 81-102 for its investments and holdings of London ETFs.

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 is that the Exemption Sought is granted, provided that:

(a)           the investment by a Fund in securities of the London ETFs is in accordance with the fundamental investment objectives of the Fund;

(b)           none of the London ETFs are synthetic ETFs, meaning that they will not principally rely on an investment strategy that makes use of swaps or other derivatives to gain an indirect financial exposure to the return of an index;

(c)           the prospectus of each Fund that is relying on the Exemption Sought discloses the fact that the Fund has obtained relief to invest in the London ETFs and, in the case of a Fund that is a mutual fund, the matters required to be disclosed under NI 81-101 in respect of fund of fund investments, provided that any such Fund that is in existence as of the date of this decision makes the required disclosure no later than the next time the simplified prospectus or prospectus of the Fund is renewed after the date of this decision;

(d)           the investment by a Fund in the London ETFs otherwise complies with section 2.5 of NI 81-102;

(e)           a Fund does not invest more than 10% of its net asset value in securities issued by a single London ETF and does not invest more than 20% of its net asset value in securities issued by London ETFs in aggregate; and

(f)            a Fund shall not acquire any additional securities of a London ETF, and shall dispose of any securities of a London ETF then held, in the event the regulatory regime applicable to the London ETF is changed in any material way.

“Darren McKall”
Manager, Investment Funds and Structured Products Branch