National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief from certain specified derivatives and custodial requirements to permit mutual funds to enter into swap transactions that are cleared through a clearing corporation as contemplated under U.S. and European requirements -- decision treats cleared swaps similar to other cleared derivatives.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.7(1) and (4), 6.1(1), 19.1.
April 27, 2018
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 VANGUARD INVESTMENTS CANADA INC. (the Filer), VANGUARD GLOBAL BALANCED FUND, VANGUARD GLOBAL DIVIDEND FUND, VANGUARD WINDSOR U.S. VALUE FUND, VANGUARD INTERNATIONAL GROWTH FUND (the Proposed Funds)
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 the Proposed Funds and the existing and future mutual funds, including exchange-traded funds, managed, or that will be managed, by the Filer (together with the Proposed Funds, the Funds) from the following requirements to permit each Fund to enter into cleared swaps as further described below (the Requested Relief):
(a) 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) the requirement 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) the requirement in subsection 6.1(1) of NI 81-102 that all portfolio assets of an investment fund be held under the custodianship of one custodian in order to permit each Fund to deposit cash and other portfolio assets as margin directly with a Futures Commission Merchant (as defined below) and indirectly with a Clearing Corporation (as defined below), in connection with entering into the cleared Swaps, as further described below.
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 (each, an Other Jurisdiction and collectively with the Jurisdiction, 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. The following terms used in this decision have the following meanings:
CFTC means the U.S. Commodity Futures Trading Commission
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 permitted to operate in the Jurisdiction (being recognized or exempt from recognition in the Jurisdiction) or the Other Jurisdiction, as the case may be, where the Fund is located
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
OTC means over-the-counter
Portfolio Advisor means each of the Filer, each affiliate of the Filer and each third party portfolio manager or sub-adviser retained from time to time by the Filer to manage the investment portfolio of one or more Funds.
SEC means the U.S. Securities and Exchange Commission
Swaps 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
U.S. Person has the meaning attributed thereto by the CFTC
VGI means The Vanguard Group, Inc.
This decision is based on the following facts represented by the Filer:
The Filer and the Funds
1. The Filer is a corporation incorporated under the laws of Canada with its head office located in Toronto. The Filer is a wholly-owned indirect subsidiary of VGI, which is a registered investment adviser in the United States with offices based in Valley Forge, Pennsylvania.
2. The Filer is registered as: (i) an investment fund manager in Ontario, Québec and Newfoundland and Labrador; (ii) an adviser (portfolio manager) and a commodity trading manager in Ontario; and (iii) an exempt market dealer in each of the provinces in Canada.
3. Each of the Funds is or will be an investment fund established as a trust, partnership or corporation under the laws of the Jurisdiction or an Other Jurisdiction and is or will be a reporting issuer in one or more of the Jurisdictions.
4. The Filer acts or will act as the manager, trustee, and portfolio manager for each Fund.
5. Securities of each of the Funds are or will be qualified for distribution in the Jurisdictions pursuant to a simplified prospectus, annual information form and a Fund Facts document, or a prospectus and an ETF Facts document, as applicable. Each of the Funds is or will be subject to NI 81-102.
6. Neither the Filer nor any existing Fund is in default of the requirements of securities legislation in any of the Jurisdictions.
7. The investment objective and investment strategies of each Fund permits or will permit such Fund to enter into derivative transactions, including Swaps. The Portfolio Advisor for the Funds considers Swaps to be an important investment tool to properly manage each Fund's portfolio.
8. Dodd-Frank requires that certain OTC derivatives be cleared through a Futures Commission Merchant at a Clearing Corporation, as recognized by the CFTC. Generally, where one party to a Swap is a U.S. Person, that Swap must be cleared.
9. 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.
10. 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.
11. In order to benefit from both the pricing benefits and reduced trading costs that a Portfolio Advisor may be able to achieve through its trade execution practices for its advised investment funds and other accounts and from the reduced costs associated with cleared OTC derivatives as compared to other OTC trades, the Filer wishes to have the Funds enter into cleared Swaps.
12. In the absence of the Cleared Swaps Relief, each Portfolio Advisor will need to structure the Swaps entered into by the Funds so as to avoid the clearing requirements of the CFTC and under EMIR, as applicable. The Filer respectfully submits that this would not be in the best interest of the Funds and their investors for a number of reasons, as set out below.
13. The Filer believes that 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.
14. In its role as a fiduciary for the Funds, the Filer has determined that central clearing represents the best choice for the investors in the Funds to mitigate the legal, operational and back office risks faced by investors in the global swap markets.
15. Each Portfolio Advisor may use the same trade execution practices for all of its advised investment funds and other accounts, including the Funds. An example of these trade execution practices is block trading, where large numbers of securities are purchased or sold or large derivative trades are entered into on behalf of a number of investment funds and other accounts advised by one Portfolio Advisor. These practices include the use of cleared Swaps. If the Funds are unable to employ these trade execution practices, then each affected Portfolio Advisor will have to create separate trade execution practices only for the Funds and will have to execute trades for the Funds on a separate basis. This will increase the operational risk for the Funds, as separate execution procedures will need to be established and followed only for the Funds. In addition, the Funds will no longer be able to enjoy the possible price benefits and reduction in trading costs that a Portfolio Advisor may be able to achieve through a common practice for its advised investment funds and other 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 Swaps on a cleared basis.
16. 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 Filer respectfully submits that 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.
17. The Cleared Swaps Relief is analogous to the treatment currently afforded under NI 81-102 to other types of derivatives that are cleared, such as clearing corporation options, options on futures and standardized futures. This demonstrates that, from a policy perspective, the Cleared Swaps Relief is consistent with the views of the Canadian securities authorities in respect of cleared derivative trades.
18. For the reasons provided above, the Filer submits that it would not be prejudicial to the public interest to grant the Cleared Swaps Relief.
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 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 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.
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.