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.
Relief also provided to a mutual fund subject to NI 81-102 to invest up to 10% of net assets in aggregate in underlying Luxembourg fund subject to UCITS rules.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.5(2)(a), 2.5(2)(c), 2.7(1), 2.7(4), 6.1 and 19.1.
August 25, 2017
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
CAPITAL INTERNATIONAL ASSET MANAGEMENT (CANADA), 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:
(i) Capital Group World Bond Fund (Canada) (the Capital Fund) from the requirements that an investment fund must not purchase or hold a security of another investment fund unless: the other investment fund is a mutual fund that is subject to NI 81-102 and offers or has offered securities under a simplified prospectus in accordance with National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81-101); and the investment fund and the other investment fund are reporting issuers in the local jurisdiction (collectively, the Underlying Fund Requirements) in order to permit the Capital Fund to invest up to 10 percent of its net assets in Capital Group Global High Income Opportunities (LUX) (the Underlying Fund) (the Underlying Fund Relief);
(ii) (a) each of the Capital Fund and all other 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 Fund and, together with the Capital Fund, each, a Fund and, collectively, the Funds) 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;
(b) each Fund 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
(c) each Fund 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 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 (as defined below) (collectively, the Cleared Swaps Relief)
collectively, the Requested Relief.
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:
Advisors means each of the Filer, Capital Guardian Trust Company, CRMC and their affiliates, and each third party portfolio manager retained from time to time by the Fund or the Filer to manage the investment portfolio of one or more Funds as an advisor or sub-advisor
CFTC means the U.S. Commodity Futures Trading Commission
CIF means Capital International Fund, an umbrella fund with eighteen sub-funds, including the Underlying Fund, organized as a SICAV with UCITS status (as defined below) under the laws of Luxembourg and managed by an affiliate of the Filer
CIMC means Capital International Management Company Sàrl
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
CRMC means Capital Research and Management Company
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
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
SICAV means Société d’Investissement à Capital Variable, an open-ended investment company
UCITS means Undertakings for Collective Investment in Transferable Securities and refers to the investment funds authorized by the European Union as investment funds suitable to be distributed in more than one country of the European Union
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 Funds
1. The Filer is, or will be, the investment fund manager of each Fund. The Filer is registered as an investment fund manager in Ontario, Québec and Newfoundland and Labrador, as an adviser in the category of portfolio manager in Ontario, and as a dealer in the category of exempt market dealer in Alberta, British Columbia, Nova Scotia, Ontario and Québec. The head office of the Filer is in Toronto, Ontario.
2. The Filer is a wholly-owned subsidiary of Capital International Asset Management, Inc., a company based in Los Angeles, California, which is wholly-owned by Capital Group. Capital Group is a global investment management firm founded in 1931, which through its affiliated companies manages stock and bond portfolios for institutional and retail clients around the world. Capital Group is one of the largest and oldest investment management organizations in the United States. In addition to Canada, Capital Group and its subsidiaries maintain offices in the United States, Switzerland, England, Hong Kong, Japan and Singapore.
3. The Filer is, or will be, the portfolio manager to all or a portion of the portfolios of the Funds. CRMC will be the portfolio manager to the futures contracts and futures options portfolio of the Capital Fund and will be the sub-advisor to the remaining portfolio of the Capital Fund. One of the Advisors is, or will be, the sub-advisor to the other Funds.
4. Each 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.
5. Neither the Filer nor the Funds are, or will be, in default of securities legislation in the Jurisdictions.
6. The securities of each 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 Jurisdictions. Accordingly, each Fund is, or will be, a reporting issuer or the equivalent in each Jurisdiction.
Underlying Fund Relief
7. The investment objective of the Capital Fund will be to seek to provide, over the long term, a high level of total return consistent with prudent investment management through investments primarily in bonds and other debt securities of global issuers. Total return comprises the income generated by the Capital Fund and the changes in the market value of the Capital Fund’s investments.
8. A wholly-owned subsidiary of Capital Group, Capital Group International, Inc., is the parent company of the Luxembourg-based subsidiary, CIMC. As of June 30, 2017, CIMC managed more than USD 11 billion, USD 5.7 billion of which was invested in eighteen investment funds, which are all sub-funds of CIF. CIF includes the Underlying Fund. As of June 30, 2017, the Underlying Fund had USD 672.9 million of assets under management.
9. The Underlying Fund is distributed in several European countries pursuant to the European Union regulations of collective investment schemes, known as the UCITS Directives, which permit the distribution of UCITS in more than one country provided the UCITS Directives are followed. As SICAVs organized under Part I of the Luxembourg law on collective investment vehicles, CIF and all of its sub-funds including the Underlying Fund, qualify as UCITS.
10. The Underlying Fund has filed a prospectus with Luxembourg’s financial sector regulator, Commission de Surveillance du Secteur Financier, that contains disclosure regarding the Underlying Fund. The Underlying Fund is a conventional mutual fund and would not be considered a hedge fund. The Underlying Fund does not invest more than 10% of its net asset value in other investment funds.
11. The investment objective of the Underlying Fund is to seek a long-term high level of total return through investment primarily in corporate or government high yield bonds that are usually listed or traded on other regulated markets and denominated in various national currencies (including emerging markets currencies) or multinational currencies. Unlisted high yield bonds may also be purchased.
12. In order for the Capital Fund to achieve its investment objective on a diversified basis and obtain broad exposure to the sectors it proposes to invest in, including global high yield exposure, it is desirable that it be permitted to allocate up to 10% of net assets to the Underlying Fund.
13. The Underlying Fund is a low-cost mutual fund whose investment strategy and objective make it a very suitable investment for the Capital Fund. The Underlying Fund is managed by portfolio managers within the Capital Group and, accordingly, the Filer will benefit from understanding its investments and the management style of its portfolio managers, which understanding will benefit the Capital Fund.
14. The Filer believes that it is in the best interests of the Capital Fund for investments to be made in the Underlying Fund. Investing directly in separate securities to allow direct exposure to the type of securities invested in by the Underlying Fund is a less desirable option owing to the increased costs and inefficiencies that are associated with such direct investing.
15. The Capital Fund’s investment in the Underlying Fund is not for the purpose of distributing the Underlying Fund to the Canadian public. The investments by the Capital Fund in the Underlying Fund are proposed not to allow the Underlying Fund to be indirectly distributed in Canada, but to allow the Capital Fund to achieve its investment objective by investing, to a very limited extent, in a unique, suitable and professionally managed lower-cost mutual fund, where the investment style and approach is known to the manager of the Capital Fund.
16. The Underlying Fund is subject to investment restrictions and practices under the laws of Luxembourg that are applicable to mutual funds that are sold to the general public and that are consistent with similar restrictions and practices applicable to mutual funds under NI 81-102.
17. The Capital Fund will otherwise comply fully with section 2.5 of NI 81-102 in investing in the Underlying Fund and will provide all disclosure mandated for mutual funds investing in other mutual funds.
Cleared Swaps Relief
18. The investment objective and investment strategies of each Fund permit, or will permit, the Fund to enter into derivative transactions, including Cleared Swaps. CRMC, the entity that will be the Advisor of the Capital Fund, considers Cleared Swaps to be an important investment tool that is available to it to properly manage the Capital Fund’s portfolio. The Capital Fund intends to use interest rate swaps and/or credit default swaps in its portfolio.
19. Dodd-Frank requires that certain OTC derivatives be cleared through a Futures Commission Merchant at a Clearing Corporation.
20. 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.
21. 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.
22. In order to benefit from both the pricing benefits and reduced trading costs that each 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 Funds have the ability to enter into Cleared Swaps.
23. In the absence of the Cleared Swaps Relief, each Advisor will need to structure the derivative transactions entered into by the applicable Funds so as to avoid clearing, including the clearing requirements of the CFTC and under EMIR, as applicable. This would not be in the best interests of the Funds and their investors for a number of reasons, as set out below.
24. It is in the best interests of the Funds and their investors to continue to be able to execute OTC derivatives with global counterparties, including U.S. and European swap dealers.
25. An Advisor may use common trade execution practices for all of its accounts, including the Funds. If these practices involve the use of Cleared Swaps and if the Funds are unable to employ these trade execution practices, then the Advisor would have to create separate trade execution practices only for the Funds and would have to execute trades for the Funds on a separate basis. This would increase the operational risk for the Funds and would prevent the Funds from benefitting from the pricing benefits and reduced trading costs that an Advisor may be able to achieve through common practices for its advised accounts. 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.
26. In its role as a fiduciary for the Funds, the Filer has determined that central clearing represents a good choice for the investors in the Funds to mitigate the legal, operational and back office risks faced by investors in the global swap markets.
27. 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 Funds. The Funds should be encouraged to comply with the robust clearing requirements established by the CFTC and under EMIR by granting them the Cleared Swaps Relief.
28. The Cleared Swaps 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 Cleared Swaps Relief is consistent with the views of the Canadian securities authorities in respect of cleared derivative trades.
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:
(i) in the case of the Underlying Fund Relief:
(a) the Underlying Fund is subject to investment restrictions and practices under the laws of Luxembourg that are applicable to mutual funds that are sold to the general public and is a regulated investment fund authorized as a UCITS;
(b) the Capital Fund will otherwise comply fully with section 2.5 of NI 81-102 in its investment in the Underlying Fund and will provide all disclosure mandated for investment funds investing in other investment funds;
(c) the Capital Fund will not purchase securities of the Underlying Fund if, immediately after the purchase, more than 10 percent of its net assets would consist of investments in the Underlying Fund; and
(d) if the laws applicable to the Underlying Fund that are, as at the date of this decision, substantially similar to Part 2 of NI 81-102 change in a manner that is materially inconsistent with Part 2 of NI 81-102, the Capital Fund shall not acquire any additional securities of the Underlying Fund, and shall dispose of the securities of the Underlying Fund then held in an orderly and prudent manner;
(ii) in the case of the Cleared Swaps Relief, 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 Jurisdictions where the applicable 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 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 Fund as at the time of deposit.
(c) this decision with respect to the Cleared Swaps Relief 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