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) and (c) 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.
Relief also granted from sections 2.3(f), 2.3(h), 2.5(2)(a) and 2.5(2)(c) of National Instrument 81-102 Mutual Funds to permit a mutual fund to use ETFs to invest up to 10 percent of its net assets, in aggregate, in gold and other physical commodities provided that no more than 2.5 percent of the mutual fund’s net assets may be invested in any one commodity sector, other than gold and silver – ETFs will be traded on a Canadian or U.S. stock exchange – subject to 10 percent exposure to physical commodities, in aggregate, and certain conditions.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.1(1), 2.2(1)(a), 2.3(f), 2.3(h), 2.5(2)(a) and (c), 19.1.
December 8, 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
MD FINANCIAL MANAGEMENT INC.
The principal regulator in the Jurisdiction has received an application from the Filer, on behalf of mutual funds managed by the Filer, including any other future fund that may be established by the Filer (the Funds) for a decision (the Exemption Sought) under the securities legislation of the principal regulator (the Legislation):
(a) revoking and replacing the Previous Decisions (defined below), and
(b) exempting each Fund from the following provisions of National Instrument 81-102 Investment Funds (NI 81-102):
a. subsection 2.1(1) (the Concentration Restriction) to permit each Fund to purchase securities of a Canadian Underlying ETF or enter into a specified derivatives transaction with respect to a Canadian 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 Canadian Underlying ETF (the Concentration Relief);
b. paragraph 2.2(1)(a) (the Control Restriction) to permit each Fund to purchase securities of a Canadian or U.S. Underlying ETF even though, immediately after the purchase, the Fund would hold securities representing more than 10% of (i) the votes attaching to the outstanding voting securities of the Canadian or U.S. Underlying ETF, or (ii) the outstanding equity securities of the Canadian or U.S. Underlying ETF (the Control Relief);
c. subsections 2.3(f) and (h) of NI 81-102 to permit the Funds to invest indirectly in physical commodities (in addition to gold which is permitted by subsection 2.3(e) of NI 81-102) through investments in Commodity ETFs (the Commodity ETF Relief);
d. paragraph 2.5(2)(a) to permit each Fund to invest in 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; and
e. paragraph 2.5 (2)(c) to permit each Fund to invest in securities of U.S. Underlying ETFs and Commodity ETFs.
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission is the principal regulator for the 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 provinces and territories of Canada other than the Jurisdiction (together with the Jurisdiction, the Jurisdictions).
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. In addition, the following terms as used in this decision have the following meanings:
Canadian Underlying ETF means an Underlying ETF that is, or will be, a reporting issuer in the provinces and territories of Canada in which its securities are, or will be, distributed, and that is not a Commodity ETF.
Commodity ETF means an Underlying ETF that is a Gold/Silver ETF or an Other Physical Commodity ETF.
Gold/Silver ETF means an Underlying ETF that has exposure to gold or silver, whether on an unlevered basis (Unlevered Gold/Silver ETF) or based on a multiple of 200% (Leveraged Gold/Silver ETF).
Other Physical Commodity ETF means an Underlying ETF that has exposure to one or more physical commodities other than gold or silver, on an unlevered basis.
U.S. Underlying ETF means an Underlying ETF that is not, or will not be, a reporting issuer in the provinces and territories of Canada and that is not a Commodity ETF.
Underlying ETF means an exchange-traded fund that is not an index participation unit (as that term is defined in NI 81-102) and that is traded on a stock exchange in Canada or the United States.
This decision is based on the following facts represented by the Filer:
1. MD Financial is registered as a portfolio manager in each of the provinces and territories of Canada and is registered in Ontario in the category of exempt market dealer, commodity trading manager and investment fund manager. MD Financial is also registered as an investment fund manager in the provinces of Quebec and Newfoundland and Labrador. The head office of MD Financial is located in Ontario.
2. MD Financial manages two families of mutual funds that are each offered by simplified prospectus – being the MD family of mutual funds (primarily distributed by MD Management Limited) and the MDPIM family of mutual funds, which are available to discretionary managed account clients of MD Financial through its division known as MD Private Investment Counsel (MDPIC). It may establish new mutual funds in the future, and the existing mutual funds in each such fund family, as well as any new mutual funds established by the Filer will be referred to herein as the Funds.
3. Neither the Filer nor the Funds are in default of any requirement of securities legislation in any Canadian jurisdiction.
4. Clients of MD Financial and MD Management Limited must be “qualified eligible clients”, which is defined primarily as physicians and their families who are members of the Canadian Medical Association, or clients who are sponsored by such members.
5. The Funds are or will be open-end mutual fund trusts or mutual fund corporations that are organized and governed by the laws of the Province of Ontario. 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) and is governed by the 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 each of the Jurisdictions.
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 in accordance with the investment objectives.
9. The Filer is the investment fund manager to the Funds and may also be the portfolio adviser. The Filer engages third party portfolio managers for the Funds in its discretion.
10. The Filer obtained previous exemptions from the Jurisdictions in Decisions dated January 28, 2013 (the 2013 Decision) and February 3, 2014 (the February 2014 Decision), which exempt certain of the Funds from subsections 2.3(f) and (h) of NI 81-102 to permit the Funds to invest indirectly in physical commodities (in addition to gold which is permitted by subsection 2.3(e) of NI 81-102) through investments in Commodity ETFs. The Filer was also granted relief from paragraphs 2.5(2)(a) and (c) of NI 81-102 to permit those certain Funds to invest in Commodity ETFs traded on a stock exchange in Canada or the United States.
11. The Filer also obtained a decision dated April 29, 2014 (the April 2014 Decision and together with the 2013 Decision and February 2014 Decision, the Previous Decisions) exempting the above-noted specified Funds from paragraphs 2.5(2)(a) and (c) of NI 81-102 to permit each of them to invest in three specified U.S. exchange traded funds.
12. Each of the Previous Decisions was granted on conditions that have been incorporated into this Decision in all material respects, with the changes inherent in the Exemption Sought regarding investments in Canadian Underlying ETFs and U.S. Underlying ETFs and to allow for all of the Funds to make such investments if the Filer or any portfolio manager of the Funds considers such investments are appropriate for the Funds.
The Underlying ETFs
13. The securities of an Underlying ETF will not meet the definition of index participation unit (IPU) in NI 81-102 because the only purpose of the Underlying ETF will not be to:
(i) hold the securities that are included in a specified widely quoted index in substantially the same proportion as those securities are reflected in that index; or
(ii) invest in a manner that causes the Underlying ETF to replicate the performance of that index.
14. 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, the Filer 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.
15. No Underlying ETF will hold more than 10% of its NAV in securities of another investment fund unless (i) the Underlying ETF is a clone fund, as defined in NI 81-102, (ii) the other investment fund is a money market fund, as defined in NI 81-102, or (iii) securities of the other investment fund are IPUs.
16. No Fund will pay management or incentive fees which to a reasonable person would duplicate a fee payable by an Underlying ETF for the same service.
17. Absent the Exemption Sought, an investment by a Fund in an Underlying ETF would be prohibited by paragraph 2.5(2)(a) of NI 81-102 because the Underlying ETFs do not offer securities under a simplified prospectus in accordance with NI 81-101, and in the case of the U.S. Underlying ETFs, are not subject to NI 81-102. 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.
18. The Filer has concluded that it may not currently gain exposure for the Funds to applicable asset classes, sectors and/or markets entirely through existing Canadian investment fund alternatives or IPUs.
The Commodity ETFs
19. The Filer wishes to continue to make the investments provided for in the 2013 Decision and the February 2014 Decision in respect of the specified Funds, and wishes for these decisions to be revoked and replaced, to ensure that the relief is consolidated with the more flexible relief regarding investments in other Underlying ETFs and to enable the Filer to continue to rely on the relief on similar conditions to the 2013 Decision and the February 2014 Decision for the specified Funds notwithstanding that the previous decisions did not refer to the Filer being the only investment adviser to the Funds. The Filer wishes to expand the relief provided for in those Decisions to all of the Funds.
The Canadian Underlying Funds
20. 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.
21. Securities of each Canadian Underlying ETF are, or will be:
(i) distributed pursuant to a long form prospectus prepared pursuant to NI 41-101 and Form 41-101F2 or, if it has received an exemption to do so, a simplified prospectus prepared pursuant to NI 81-101 and Form 81-101F1; and
(ii) listed on the Toronto Stock Exchange or another “recognized exchange” in Canada, as that term is defined in securities legislation.
22. 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.
The U.S. Underlying ETFs
23. 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), whose securities are listed for trading on a stock exchange in the United States.
24. Absent the Exemption Sought, 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.
25. The Filer submits that having the option to allocate a 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.
26. 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:
(i) 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;
(ii) 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
(iii) 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 the Control Relief
27. An investment in a Canadian or U.S. Underlying ETF by a Fund is an efficient and cost effective alternative to administering one or more investment strategies similar to that of the Canadian or U.S. Underlying ETF.
28. An investment in a Canadian or U.S. Underlying ETF by a Fund should pose limited investment risk to the Fund because each Canadian or U.S. 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.
29. Due to the potential size disparity between the Funds and the Canadian or U.S. Underlying ETFs, it is possible that a relatively small investment, on a percentage of NAV basis, by a relatively larger Fund in securities of a Canadian or U.S. 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 Canadian or U.S. Underlying ETF; or (ii) the outstanding equity securities of that Canadian or U.S. Underlying ETF, contrary to the Control Restrictions.
30. An investment by a Fund in securities of a Canadian or U.S. Underlying ETF will not qualify for the exemptions set out in:
1. Paragraph 2.1(2)(d) of NI 81-102 from the Concentration Restriction; and
2. Paragraph 2.2 (1.1) (b) of NI 81-102 from the Control Restriction;
because the securities of the Underlying Canadian or U.S. ETFs are not IPUs.
31. The material difference between the securities of an Underlying Canadian or U.S. ETF and the securities of a conventional mutual fund is the method of distribution and disposition.
32. Since the Previous Decisions contained restrictive conditions and do not cover all of the Funds, the Filer has requested that the Previous Decisions be revoked and replaced by this decision in order to allow the Filer to have one consolidated decision that, among other things, provides for more flexibility for the Funds to invest in Underlying ETFs.
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 Exemption Sought 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) a Fund does not purchase gold, permitted gold certificates, securities of a Commodity ETF or enter into specified derivatives, the underlying interest of which is gold (the Commodity Products) if, immediately after the purchase, more than 10% of the net assets of the Fund in aggregate, taken at market value at the time of purchase, would consist of Commodity Products;
(c) a Fund does not purchase Commodity Products if, immediately after the transaction, the market value exposure to all physical commodities (whether direct or indirect) through the Commodity Products is more than 10% of the net assets of the Fund in aggregate, taken at market value at the time of purchase;
(d) no more than 2.5% of the net asset value of a Fund may be invested in any one commodity sector, other than gold and/or silver, taken at market value at the time of purchase. For this purpose, the relevant commodity sectors are energy, grains, industrial metals, livestock, precious metals other than gold and silver and softs (e.g., cocoa, cotton, coffee and sugar);
(e) the securities of the Commodity ETFs are treated as specified derivatives for the purposes of Part 2 of NI 81-102;
(f) a Fund does not purchase securities of a U.S. Underlying ETF or a Commodity 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 and Commodity ETFs;
(g) a Fund does not short sell securities of an Underlying ETF;
(h) an Underlying ETF (other than a Commodity 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;
(i) 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;
(j) securities of each Underlying ETF are listed on a recognized exchange in Canada or the United States;
(k) each U.S. Underlying ETF is, immediately before the purchase by a Fund of securities of that U.S. Underlying ETF, an investment company subject to the Investment Company Act; and
(l) the prospectus of each Fund discloses, or will disclose in the next renewal of its prospectus following the date of this decision, (i) in the investment strategy section, the fact that the Fund has obtained the Exemption Sought to permit investments in Underlying ETFs on the terms described in this decision and (ii) the risks associated with the Fund’s investment in securities of the Commodity ETFs.
Manager, Investment Funds and Structured Products Branch
Ontario Securities Commission