National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Exemptive relief granted to permit an existing non-redeemable investment fund to continue to invest in a Chilean bottom fund -- The Fund's return has been continuously linked to the returns of the bottom fund since its initial public offering in 2011 -- terms and conditions at the time of the initial public offering continue to apply -- National Instrument 81-102 Investment Funds.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.5(2)(a.1) and (c.1), 19.1.
June 23, 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 SCOTIA MANAGED COMPANIES ADMINISTRATION INC. (THE FILER) AND IN THE MATTER OF MONEDA LATAM CORPORATE BOND FUND (THE FUND)
The principal regulator in the Jurisdiction has received an application from the Filer for a decision under the securities legislation of the Jurisdiction (the Legislation) pursuant to section 19.1 of National Instrument 81-102 Investment Funds (NI 81-102) exempting the Fund from paragraphs 2.5(2)(a.1) and 2.5(2)(c.1) of NI 81-102 to permit the Fund to invest in securities of Moneda Deuda Latinoamericana Fondo de Inversion (the Moneda Fund) (the Requested Relief).
Under National Policy 11-203 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 pursuant to section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) that the Requested Relief is intended to be relied upon in each province and territory of Canada, other than Québec, (together with Ontario, the Applicable Jurisdictions).
Defined terms contained in National Instrument 14-101 Definitions and MI 11-102 have the same meaning in this decision unless they are otherwise defined in this decision.
The decision is based on the following facts represented by the Filer:
1. The Filer is a corporation incorporated under the laws of the Province of Ontario with its head office located in Toronto, Ontario. The Filer is registered under the securities legislation of Ontario, Québec, and Newfoundland and Labrador as an investment fund manager.
2. The Filer is not in default of securities legislation in any Applicable Jurisdiction.
3. The Fund is a trust that was created under the laws of the Province of Ontario by a declaration of trust dated October 26, 2011. The Fund is a non-redeemable investment fund and is a reporting issuer (or the equivalent) under the securities legislation of each Applicable Jurisdiction. The Class A units of the Fund are listed for trading on the Toronto Stock Exchange under the symbol "MLD.UN".
4. The portfolio manager (the Portfolio Manager) to the Fund currently is Scotia Capital Inc.
5. Except as described herein, the Fund is not in default of securities legislation in any Applicable Jurisdiction.
6. The Fund completed its initial public offering of securities (the IPO) in all the Applicable Jurisdictions on November 3, 2011 pursuant to a prospectus dated October 26, 2011.
7. At the time of the IPO, the investment objectives of the Fund were to (i) preserve and enhance the net asset value of the Fund, and (ii) provide unitholders with quarterly tax-advantaged distributions consisting primarily of returns of capital, in each case through exposure by virtue of a forward purchase agreement (the Forward Agreement) to the total return performance of the Moneda Fund.
8. Through the use of the Forward Agreement, the Fund was able to provide tax-advantaged distributions to its unitholders because the Fund's positive returns from the Forward Agreement were realized as capital gains, rather than receiving ordinary income from investing directly in securities of the Moneda Fund (a character conversion transaction). Ordinary income is subject to tax at a higher rate in Canada than capital gains.
9. The Forward Agreement terminated at the end of its term on November 3, 2016 (the Effective Date). Due to amendments to the Income Tax Act (Canada) (the ITA) in December 2013 regarding character conversion transactions (the Tax Changes), the tax-advantaged treatment of the Forward Agreement was eliminated and the Fund was precluded by the Tax Changes from entering into a replacement character conversion transaction.
10. The Filer determined that, as a result of the Tax Changes, it would be more efficient and less costly for the Fund to seek to achieve its investment objectives after the Effective Date by investing its assets using the same, or substantially the same, investment strategies as it then employed, namely through exposure to the Moneda Fund. As a result, the Filer determined that, upon the termination of the Forward Agreement, the Fund should invest directly in the securities of the Moneda Fund.
11. Shortly before the Effective Date, the Filer revised the investment objectives of the Fund to remove all references to the use of the Forward Agreement and to delete references to "tax-advantaged" distributions (the Objective Change). As a result, the investment objectives of the Fund became the following:
"The Fund's investment objectives are to (i) preserve and enhance the net asset value of the Fund, and (ii) provide unitholders with quarterly distributions through direct investment in the Moneda Fund."
12. Pursuant to a decision dated September 8, 2016 (the Objective Change Relief), the Filer received an exemption from the requirement in paragraph 5.1(1)(c) of NI 81-102 to obtain the approval of the unitholders of the Fund before making the Objective Change.
13. The Filer complied with the timely disclosure requirements set out in Part 11 of National Instrument 81-106 Investment Fund Continuous Disclosure (NI 81-106) in connection with the Filer's decision to make the Objective Change by issuing a press release on July 25, 2016 regarding the Objective Change and filing the press release with a related material change report on SEDAR on August 3, 2016.
14. Pursuant to the Objective Change Relief, the Filer was required to send to each unitholder of the Fund at least 30 days before the Objective Change a written notice (the Objective Change Notice) that set out the change to the investment objective, the reasons for such change, and a statement that the Fund would no longer distribute gains under forward contracts that are treated as capital gains for tax purposes. The Objective Change Notice was sent as required by the Objective Change Relief.
15. The Moneda Fund is a Chilean listed investment fund established in 2000 which is actively managed by Moneda S.A. Administradora de Fondos de Inversion (Moneda). Moneda is at arm's length from the Filer. As of March 31, 2017, the Moneda Fund had a net asset value of approximately US$ 1.412 billion.
16. The fundamental investment objective of the Moneda Fund is to seek capital appreciation and income from the investment in a diversified portfolio of high yield fixed income securities of companies located in, or with significant operations in, Latin America (including the Caribbean), primarily denominated in U.S. dollars.
17. The Moneda Fund adheres to investment restrictions and practices (the Moneda Fund Investment Restrictions) which are stipulated in its by-law. The Moneda Fund Investment Restrictions include restrictions which generally require, among other matters, that the Moneda Fund:
(a) maintain a diversified portfolio based on restrictions on the amount of assets of the Moneda Fund which may be invested in certain types of instruments and by issuer;
(b) not invest more than 5% of its total assets in equity securities;
(c) not invest in securities issued by Moneda or persons related to Moneda;
(d) adhere to limits relating to borrowing, short selling and securities lending; and
(e) maintain a liquidity reserve not less than 5% of the Moneda Fund's assets.
18. The custodian of substantially all of the Moneda Fund's asset is J.P. Morgan and such custodian arrangements substantially meet the same standards required of custodians as set out in Part 14 of National Instrument 41-101 General Prospectus Requirements.
The Fund's investments in the Moneda Fund
19. Since the completion of the IPO, the Fund's returns have been continuously linked to the returns of the Moneda Fund. Prior to the Objective Change, the linkage existed under the Forward Agreement. Since the Objective Change, the linkage exists through the Fund's direct holding of securities of the Moneda Fund.
20. At the time of the IPO, there were no requirements in Canadian securities legislation specific to investments by non-redeemable investment funds in other investment funds. Nonetheless, it had been the general expectation of staff at certain Canadian securities regulators (principally the Autorité des marchés financiers and, at times, the OSC) that a non-redeemable investment fund (the Top CEF) wishing to invest substantially all of its assets (directly or through derivatives exposure) in another investment fund (the Bottom Fund) required that the Bottom Fund be a reporting issuer in at least one jurisdiction of Canada. The reason for this expectation was to provide transparency of information regarding the Bottom Fund by making the Bottom Fund subject to the continuous and timely disclosure requirements set out in NI 81-106. Where the Bottom Fund was created and managed by the manager of the Top CEF (which typically was the case), this expectation was easily addressed by causing the Bottom Fund to file a non-offering prospectus in at least one jurisdiction.
21. The Moneda Fund was in existence long before the Fund's IPO and was not created for the purpose of becoming the Bottom Fund for the Fund. The manager of the Moneda Fund was, and remains, at arm's length to the Filer. For these reasons, it was not practical to require that the Moneda Fund become a reporting issuer in a local jurisdiction. Instead, as part of reviewing the Fund's preliminary prospectus for its IPO, OSC staff extensively analyzed and commented upon the merits of permitting the Fund to invest, through the Forward Agreement, in securities of the Moneda Fund without requiring that the Moneda Fund become a reporting issuer in a local jurisdiction. Such review included consideration of the following issues:
(a) whether the IPO should be considered an indirect offering in Canada by the Moneda Fund;
(b) the continuous and timely disclosure requirements of the Moneda Fund under its local laws mandated by the Superintendencia Valores y Seguros (the SVS), including a comparison of the disclosure by the Moneda Fund to those mandated by NI 81-106;
(c) whether the Filer would be able to meet its timely disclosure obligations under NI 81-106, including how the Filer would disclose any material changes received from Moneda;
(d) how the Moneda Fund manages conflicts of interest;
(e) the duty of care owed by Moneda to investors in the Moneda Fund and the Fund;
(f) whether the custodial arrangements of the Moneda Fund met substantially the same requirements as those applicable to non-redeemable investment funds in Canada;
(g) the auditor of the Moneda Fund;
(h) the financial year-end of the Moneda Fund;
(i) the controls and processes of the Filer and the Portfolio Manager to monitor the underlying investment of the Fund and Moneda's activities as the portfolio manager of the Moneda Fund, including the parameters used to determine when to exercise the Fund's option to terminate the Forward Agreement early to end the Fund's exposure to the Moneda Fund or whether to pre-settle the Forward Agreement to reduce the Fund's exposure to the Moneda Fund; and
(j) risk factor disclosure regarding the status of the Moneda Fund and Moneda in Canada.
22. As a result of that extensive review and comment process, OSC staff agreed to permit the IPO to proceed on the strength of the responses provided by the Filer which included the following:
(a) the Filer and the Portfolio Manager monitor the information which the Moneda Fund is required to file publicly;
(b) the Fund provides enhanced disclosure in its management reports of fund performance (MRFPs) regarding the Moneda Fund including:
(i) a discussion of any related party transactions carried out by the Moneda Fund;
(ii) a summary of the investment portfolio of the Moneda Fund; and
(iii) a detailed look-through management discussion of fund performance for the Moneda Fund including results of operations, recent developments and past performance;
(c) Moneda assists the Filer with the preparation of the MRFPs;
(d) the Filer discloses all material changes received from Moneda to the public upon receipt of such information; where such information is a "material change" as defined in NI 81-106, the Filer discloses this information publicly by a press release;
(e) the Filer provides unitholders of the Fund with the option upon request to receive in respect of the Moneda Fund:
(i) annual audited financial statements within four months of the end of the Moneda Fund's fiscal year;
(ii) semi-annual unaudited financial statements within two months of the end of the Moneda Fund's semi-annual period;
(iii) monthly reports within 30 days of the end of each month;
(iv) reports of any material event involving the Moneda Fund as soon as practicable and in any event within 10 days of the happening of such event, in each case as filed with the SVS; and
(v) the by-laws of the Moneda Fund;
(together, the Moneda Documents);
(f) the Fund, the Filer and Moneda enter into an agreement (the Moneda Agreement) pursuant to which:
(i) Moneda has agreed to exercise the powers and duties of its office honestly, in good faith and in the best interests of the Filer and the Fund and exercise the degree of care, diligence and skill that a reasonably prudent person would exercise in the circumstances;
(ii) Moneda consents to the Fund providing its unitholders with the Moneda Documents;
(iii) Moneda agrees to provide the Filer and the Fund with continuous disclosure in respect of the Moneda Fund on the same basis as such information is generally provided to investors in the Moneda Fund; and
(iv) Moneda agrees to notify the Filer and the Fund promptly in writing of any material changes in respect of the Moneda Fund, as the term "material change" is defined in NI 81-106;
(g) Moneda holds status conference calls quarterly (or more frequently if requested by the Filer) with representatives of the Filer and the Portfolio Manager relating to the Moneda Fund to enable the Filer and the Portfolio Manager to ask questions with respect to the Moneda Fund's disclosure and performance,
(together, the Moneda Requirements).
The Moneda Agreement was filed on SEDAR. The Moneda Requirements remain in effect today.
CEF Fund-on-Fund Requirements
23. On September 22, 2014, NI 81-102 was amended (the Phase 2 Amendments) to, among other matters, introduce certain requirements for non-redeemable investments. The Phase 2 Amendments extended to non-redeemable investments funds the application of certain investment restrictions in NI 81-102 (the CEF Investment Restrictions) and certain other requirements unrelated to investment restrictions (the CEF Operational Requirements). The CEF Investment Restrictions include restrictions (the CEF Fund-on-Fund Requirements) on the ability of a Top CEF to invest in a Bottom Fund, including the introduction of paragraphs 2.5(2)(a.1) and 2.5(2)(c.1) of NI 81-102, which did not become effective until March 21, 2016.
24. Due to personnel changes at the Filer, the impact of the CEF Fund-on-Fund Requirements on the Fund was not identified at that time.
25. Except to the extent the Fund is seeking the Requested Relief, the Fund complies with the CEF Investment Restrictions and CEF Operational Requirements.
26. The Moneda Fund Investment Restrictions do not match the CEF Investment Restrictions. The Moneda Fund complies with operational requirements mandated by the SVS which may or may not be similar to the CEF Operational Requirements.
27. Paragraph 2.5(2)(a.1) of NI 81-102 provides that a Top CEF must not purchase or hold a security of a Bottom Fund unless the Bottom Fund is subject to NI 81-102 or complies with the provisions of NI 81-102 applicable to a non-redeemable investment fund.
28. Paragraph 2.5(2)(c.1) of NI 81-102 provides that a Top CEF must not purchase or hold a security of a Bottom Fund unless the Bottom Fund is a reporting issuer in the local jurisdiction.
29. The Moneda Fund:
(a) is not subject to NI 81-102;
(b) may not comply, from time to time, with some of the CEF Investment Restrictions;
(c) may not comply with the CEF Operational Requirements; and
(d) is not a reporting issuer under the securities legislation of any Applicable Jurisdiction.
Accordingly, absent the Requested Relief, paragraphs 2.5(2)(a.1) and 2.5(2)(c.1) of NI 81-102 prohibit the Fund from purchasing and holding securities of the Moneda Fund.
30. Principally through its quarterly status conference calls with Moneda and review of any material changes to the Moneda Fund of which the Filer is given notice pursuant to the Moneda Agreement, the Portfolio Manager monitors the ongoing suitability of the Moneda Fund as a means for pursuing the Fund's investment objectives in a manner consistent with the risk profile of the Fund. If the Portfolio Manager determines that the Moneda Fund no longer remains a suitable investment for the Fund, the Filer will either:
(a) seek the approval of unitholders of the Fund to change its investment objectives based on advice from the Portfolio Manager; or
(b) commence proceedings to terminate the Fund.
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 the Moneda Requirements continue to be met.