National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Exemption granted from the requirements of section 2.8(1)(d) of National Instrument 81-102 Investment Funds to allow mutual funds that are not alternative mutual funds to enter into and maintain a long position in a currency forward contract under which a fund delivers the currency in which it calculates its net asset value and receives another currency in order to substitute the risk to the first currency for the risk to another currency -- aggregate amount of currency risk to which the mutual fund is exposed is not increased by the substitution.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.8(1)(d), 19.1.
April 14, 2020
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 RBC GLOBAL ASSET MANAGEMENT INC. (the Filer)
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of the existing and future mutual funds for which the Filer or an affiliate acts, or will act in the future, as the investment fund manager (the Funds) for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for an exemption under section 19.1 of National Instrument 81-102 Investment Funds (NI 81-102) from the cash cover requirements in section 2.8(1)(d) of NI 81-102 (the Cash Cover Requirements) when a Fund opens or maintains a long position in an FX Forward Contract (as defined below) in order to substitute the risk to the Base Currency for the risk to another currency without increasing the aggregate amount of currency risk to which the Fund is exposed by the substitution (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 section 4.7(1) of Multilateral Instrument 11-102 -- Passport System (MI 11-102) is intended to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, the Northwest Territories, Nunavut and Yukon (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.
This decision is based on the following facts represented by the Filer.
1. The Filer is a corporation formed by amalgamation pursuant to articles of amalgamation dated November 1, 2010 under the federal laws of Canada and its head office is located in Toronto, Ontario.
2. The Filer is an indirect, wholly-owned subsidiary of Royal Bank of Canada.
3. The Filer is registered as an adviser in the category of portfolio manager and as a dealer in the category of exempt market dealer under the securities legislation of each Jurisdiction, is registered as an investment fund manager in each of British Columbia, Ontario, Québec and Newfoundland and Labrador and is also registered in Ontario as a commodity trading manager.
4. The Filer, or an affiliate thereof, is or will be, the investment fund manager and/or portfolio manager of each Fund.
5. The Filer is not in default of securities legislation in any Jurisdiction.
6. Each Fund is, or will be, a conventional mutual fund or an exchange-traded fund established under the laws of the Province of Ontario or the laws of another Jurisdiction.
7. Each Fund is, or will be, subject to NI 81-102, subject to any exemptions therefrom that may be granted by the securities regulatory authorities. Each Fund is not, or will not be, an alternative mutual fund.
8. The securities of the Funds are, or will be, offered either by a simplified prospectus and annual information form or long-form prospectus, as applicable, filed in all of the Jurisdictions and, accordingly, each Fund is, or will be, a reporting issuer in the Jurisdictions.
9. None of the Funds in existence on the date of this decision are in default of securities legislation in any Jurisdiction.
10. Each Fund invests, or will invest, directly or indirectly, in fixed income, equity securities or other assets denominated in the currency in which it determines its net asset value (the Base Currency) and in fixed income, equity securities or other assets denominated in non-Base Currencies in accordance with its investment objectives.
11. The Funds are, or will be, permitted to use specified derivatives to reduce risk by hedging against losses caused by changes in securities prices, foreign currency exposure, interest rates, exchange rates and/or other risks. The Funds may also use specified derivatives for non-hedging purposes pursuant to their investment strategies in order to gain exposure to other currencies, provided the use of specified derivatives is consistent with the Fund's investment objectives.
12. In all cases where the Funds may use derivatives, hedging of risks is permitted, including currency risks, whether the currency risk relates to fixed income or equity securities or otherwise.
13. When specified derivatives are used for non-hedging purposes, the Funds are subject to the Cash Cover Requirements.
14. Any Fund that is not currently permitted to engage in the use of derivatives will only do so in accordance with Section 2.11 of NI 81-102.
15. A Fund that enters into or maintains a currency forward contract in which a Fund delivers its Base Currency and receives another currency (a FX Forward Contract) is required to hold cash cover in accordance with the Cash Cover Requirements.
16. Pursuant to NI 81-102, the Funds are permitted to (a) enter into a currency forward contract pursuant to which a Fund delivers a non-Base Currency and receives another non-Base Currency without being subject to the Cash Cover Requirements because (i) the transaction would be a "currency cross hedge" (as defined in NI 81-102) transaction, and (ii) the definition of "hedging" under NI 81-102 includes a currency cross hedge transaction; (b) enter into a currency forward contract pursuant to which a Fund delivers a non-Base Currency and receives the Base Currency without being subject to the Cash Cover Requirements because the definition of "hedging" under NI 81-102 includes such transactions.
17. The Filer seeks the ability for each Fund to enter into FX Forward Contracts without being subject to the Cash Cover Requirements. The FX Forward Contracts will enable a Fund to substitute the Fund's risk to its Base Currency for a risk to another currency, without increasing the aggregate amount of currency risk to which the Fund is exposed by the substitution. A Fund's currency exposure (calculated in the Fund's Base Currency) will not at any time exceed the net asset value of the Fund.
18. The Filer as portfolio adviser takes a deliberate approach towards monitoring and managing the currency exposure and risk in each Fund's portfolios. Moreover, the Filer does not passively accept currency exposure of the securities a Fund holds and seeks to manage foreign currency exposure separately from cash assets.
19. For example, a Fund that has Canadian dollars (CAD) as its Base Currency may have investment objectives and strategies that permit it to invest in both Canadian and U.S. equities (e.g. a North American equity fund). However, this Fund would not be permitted, without complying with the Cash Cover Requirements, to maintain currency exposure that is split evenly between CAD and the U.S. dollar (USD), unless at least half of the Fund is invested in U.S. equities. This does not allow active management of equity exposures without also introducing unmanaged currency risk. For instance, the portfolio manager of the Fund may be bullish on Canadian equities, but also expects that CAD will underperform relative to USD. The portfolio manager is effectively disincentivized from investing in Canadian equities because in doing so the Fund's exposure to USD would be reduced and the desired currency exposure would not be maintained. Conversely, there would be no need to comply with the Cash Cover Requirements if the portfolio manager was bullish on U.S. equities but not USD as it could increase the holdings of U.S. equities and maintain the desired currency exposure by hedging the USD exposure.
20. The ability of a Fund to manage currency risk separately from its portfolio assets represents a more deliberate approach toward managing individual risks in the portfolio. In the example provided in paragraph 19, the Requested Relief would permit the portfolio manager to increase the Fund's Canadian equities exposure to 60%, reduce its U.S. equity exposure to 40%, and maintain the desired 50/50 CAD-USD currency exposure allocation without being required to hold cash cover that would reduce the Fund's equity exposure. It is the Filer's belief that managing all risks in a portfolio rather than accepting some risks passively is an important part of the portfolio construction process and can result in significant benefits for unitholders.
21. The Requested Relief will permit the Filer to adjust a Fund's currency exposure to align with the currency exposures of the Fund's benchmark. In addition, if investors have given the Filer the mandate to deviate from the Fund's benchmark exposure, the Requested Relief will permit the Filer to overlay its active currency views on top of the neutral currency positioning to obtain greater or lower exposure to foreign currencies relative to the Fund's benchmark.
22. Whether a Fund directly holds a foreign security or enters into a FX Forward Contract to obtain foreign currency exposure, the currency exposure is essentially identical. The Filer believes that a Fund's potential incremental risk exposure in entering into a FX Forward Contract compared to the currency exposure embedded within a foreign-currency denominated asset is negligible. Any such differences (operational risks, counterparty risks, cash flow risks etc.) will be adequately monitored and managed.
23. The purpose of the Cash Cover Requirements is to prohibit a mutual fund from obtaining uncovered exposure to portfolio assets when using certain specified derivatives and to ensure that the mutual fund is in a position to meet its obligations on the settlement date.
24. The Filer has developed a number of policies and mechanisms to monitor the use of derivatives by the Funds in order to comply with the requirements in NI 81-102. In addition, the Filer has written control policies and procedures that set out the risk management procedures applicable to derivative transactions in respect of the Funds, including FX Forward Contracts. These policies and procedures set out specific procedures for authorization, documentation, reporting, monitoring (including monitoring the level of a Fund's currency exposure daily to ensure it does not exceed the Fund's net asset value and monitoring the Fund's FX Forward Contracts daily to ensure that the amount of Base Currency to be delivered under the FX Forward Contracts does not exceed the value of the assets held by the Fund that are denominated in its Base Currency) and review of derivative strategies to ensure that these functions are performed by individuals independent of those who trade. Independent personnel employed by the Filer (and any sub-advisor appointed by the Filer, if applicable) review the use of derivatives as part of their ongoing supervision of a Fund's investment practices including exposure thereunder.
25. Permitting the Funds to enter into and maintain FX Forward Contracts without the requirement to comply with the Cash Cover Requirements will provide the Funds with a better opportunity to pursue and achieve their investment objectives.
26. The Filer believes that the Requested Relief is in the best interests of the Funds as it allows active management of portfolio assets in a way that does not create a by-product of unmanaged currency risk.
27. The Filer is seeking the Requested Relief to permit the Funds to engage in strategies in a manner which is not otherwise permitted under NI 81-102.
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 is that the Request Relief is granted provided that:
(a) the use of FX Forward Contracts contemplated by this decision is consistent with the fundamental investment objectives and investment strategies of the applicable Fund;
(b) a Fund must not enter into an FX Forward Contract if, immediately after entering into an FX Forward Contract, the aggregate amount of a Fund's Base Currency to be delivered under all FX Forward Contracts (the "Aggregate Amount") would exceed the value of the assets held by the Fund that are denominated in its Base Currency (the "Base Currency Holdings"); and
(c) if a Fund's Aggregate Amount exceeds at any time the value of its Base Currency Holdings, the Fund must, as quickly as is commercially reasonable, take all necessary steps to reduce the Aggregate Amount to an amount that does not exceed the value of its Base Currency Holdings.