National Policy 11-203 Process for Exemptive Relief Appli-cations in Multiple Jurisdictions – relief granted to RP Strategic Income Plus Fund to increase short-selling issuer concentration limits under to subparagraph 2.6.1(1)(c)(ii) for short sales of “government securities” as defined in NI 81-102 – relief sought to allow fund to better implement strategy to short sell government bonds as a hedge against interest rate risk of corporate bond portfolio – fund can short sell “government securities” from a single issuer up to 20% of NAV – other short-selling restrictions in NI 81-102, including overall limit of 20% of NAV, and provisions concerning cash cover, use of short-sale proceeds, and limits on exposure to any one borrowing agent will continue to apply to all short sales by the fund.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.6.1(1)(c)(ii), 19.1.
May 18, 2018
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
RP INVESTMENT ADVISORS LP
IN THE MATTER OF
RP STRATEGIC INCOME PLUS FUND
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of the Fund for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for an exemption from paragraph 2.6.1(1)(c)(ii) of NI 81-102 to permit the Fund to increase the limit on aggregate short sale exposure to any single issuer that is a “government security” (as defined in NI 81-102) to 20% of the net asset value (NAV) of the Fund (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 section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in each of British Columbia, Alberta, Saskatchewan, Mani-toba, Quebec, New Brunswick, Nova Scotia, Prince Edward Island, Newfound-land and Labrador, Northwest Territories, Yukon and Nunavut (the Other Juris-dictions and with Ontario, the Juris-dictions).
Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.
The decision is based on the following facts represented by the Filer on behalf of itself and the Fund:
1. The Filer is a limited partnership established under the laws of the Province of Ontario. The general partner of the Filer is RP Investment Advisors GP Inc. (the General Partner), a corporation incor-porated under the laws of the Province of Ontario. The Filer’s head office is located in Toronto, Ontario.
2. The Filer is the manager, trustee and portfolio manager of the Fund and is the manager and portfolio manager of certain other investment funds, the securities of which are sold pursuant to exemptions from the prospectus requirement (the Pooled Funds).
3. The Filer is registered as an investment fund manager in Ontario, Quebec and Newfoundland and Labrador, as a portfolio manager in Ontario, Quebec and British Columbia, as an exempt market dealer in each of the Jurisdictions and as a commodity trading manager in Ontario.
4. The Filer is not in default of applicable securities legislation in any of the Jurisdictions.
The Fund and the Pooled Funds
5. The Fund is an open-ended public mutual fund governed by NI 81-102.
6. The Fund is organized as a trust established under the laws of the Province of Ontario.
7. The Fund is a reporting issuer in each of the Jurisdictions and distributes its units in each of the Jurisdictions pursuant to disclosure documents filed under National Instrument 81-101 Mutual Fund Prospectus Disclosure.
8. The Fund is not in default of applicable securities legislation in any of the Jurisdictions.
9. The Fund’s investment objective is to generate stable risk-adjusted absolute returns consisting of dividend, interest income and capital gains by investing primarily in investment grade corporate debt and debt-like securities, with a focus on capital preservation.
Short Selling Hedging Strategy
10. The investments of the Pooled Funds are similar to the investments of the Fund in that each invests in fixed income instruments and seeks to hedge its interest rate exposure by using a short selling hedging strategy.
11. In order to hedge against interest rate risk in the investment portfolios of the Pooled Funds, the Filer short sells highly liquid government fixed income securities at the same time that the Pooled Funds invest in corporate fixed income securities. This strategy has proven to be highly successful with the Pooled Funds.
12. The Filer currently uses a similar strategy of short selling government fixed income securities for the Fund, but to a more limited extent than the Pooled Funds, in accordance with the 5% single issuer restriction in NI 81-102.
13. Paragraph 2.6.1(1)(c)(ii) of NI 81-102 restricts the Filer from short selling more than 5% of the NAV of the Fund in respect of any one issuer. As a result, the Fund is prevented from short selling Canadian government bonds by more than 5% of its NAV and similarly prevented from short selling U.S. government bonds by more than 5% of its NAV, resulting in the Fund only being able to hedge its interest rate exposure using this short selling strategy to a maximum of 10% of NAV.
14. The Filer is of the view that the Fund could benefit further from this hedging strategy if it were able to short sell “government securities” (as defined in NI 81-102) for hedging purposes in an amount greater than 5% of the Fund’s NAV per issuer for the following reasons:
(a) The Filer believes that short-selling government securities will reduce interest rate risk across the Fund’s portfolio of fixed income securities, as the underlying interest rate characteristics of the cor-porate fixed income securities held by the Fund trade relative to federal government securities.
(b) The most effective interest rate hedge is where the government debt securities selected by the Filer most closely correlate to the underlying interest rate characteristics of the particular corporate fixed income securities held by the Fund and thus the Filer cannot remain within the 5% single issuer restriction by using different government debt securities and still achieve an optimal hedge for the Fund.
(c) The market for government securities is highly liquid and debt securities issued by the federal governments of Canada and the U.S. and the Canadian provinces and/or territories generally exhibit greater liquidity than high-quality corporate issues.
(d) While derivatives can be used to manage interest rate risk, the use of a derivatives hedging strategy is more inefficient, more complex, and risker than the Filer’s strategy of short-selling government securities.
15. The Fund implements the following controls when conducting a short sale:
(a) the Fund assumes the obligation to return to the Borrowing Agent (as defined in NI 81-102) the securities borrowed to effect the short sale;
(b) the Fund receives cash for the securities sold short within normal trading settle-ment periods for the market in which the short sale is effected;
(c) the Filer monitors the short positions of the Fund at least as frequently as daily;
(d) the security interest provided by the Fund over any of its assets that is required to enable the Fund to effect a short sale transaction is made in accordance with industry practice for that type of trans-action and relates only to obligations arising under such short sale trans-actions;
(e) the Fund maintains appropriate internal controls regarding short sales, including written policies and procedures for the conduct of short sales, risk management controls and proper books and records; and
(f) The Filer and the Fund keep proper books and records of short sales and all of its assets deposited with Borrowing Agents as security.
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:
1. Each short sale made by the Fund will comply with all of the short sale requirements in section 2.6.1 of NI 81-102, other than the restriction that the aggregate market value of all securities of the issuer of the securities sold sort by the Fund does not exceed 5% of the NAV of the Fund.
2. The only securities which the Fund will sell short in an amount that exceeds 5% of the NAV of the Fund will be securities which meet the definition of “government security”, being an evidence of indebtedness issued, or fully and unconditionally guaranteed as to principal and interest, by and of the government of Canada, the government of a Jurisdiction or the government of the United States of America.
3. Each short sale will be made consistent with the Fund’s investment objectives and investment strategies.
4. The simplified prospectus of the Fund will disclose, at the next renewal, that the Fund is able to short sell “government securities” (as defined in NI 81-102) for hedging purposes in an amount greater than 5% of the Fund’s NAV per issuer.“Darren McKall”
Manager, Investment Funds and Structured Products Branch
Ontario Securities Commission