Headnote
National Policy 11-203 – Process for Exemptive Relief Applications in Multiple Jurisdictions – relief granted to enable current and future mutual funds managed by the filer to enter into prepaid forward contracts, with a counterparty that is a Canadian chartered bank, to gain exposure to an underlying mutual fund managed by the filer - relief granted from the following restrictions: the concentration restriction, the illiquid investments restriction and the limit on mark-to-market exposure to a counterparty for a period longer than 30 days – relief is conditional on weekly mark-to-market valuation of the forward contract and weekly adjustment of collateral to ensure that the market value of the collateral equals the mark-to-market value of the forward contract – relief conditional on collateral being free and clear of all liens and adverse claims other than those of the funds and that each fund will maintain a first-priority perfected security interest in such collateral.
Applicable Legislative Provisions
National Instrument 81-102 – Mutual Funds ss. 2.1(1), 2.4 and 2.7(4).
November 26, 2008
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
NEXGEN FINANCIAL LIMITED PARTNERSHIP
(the "Filer" or “NexGen”)
AND
IN THE MATTER OF
NexGen Canadian Cash Tax Managed Fund AND NexGen Canadian Bond TAX Managed Fund
(the "Existing Funds")
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Filer, on behalf of the Existing Funds and each fixed income, open-end NexGen Tax Managed mutual fund hereafter created and managed by the Filer (the "Future Funds" and together with the Existing Funds, the "Funds") for a decision under the securities legislation of the Jurisdiction of the principal regulator (the "Legislation") exempting the Funds from the following requirements of the Legislation, subject to certain terms and conditions:
the requirements of section 2.1(1) of Part 2 of National Instrument 81-102 (“NI 81-102”) relating to the ability of the Funds to invest more than 10% of their assets in the securities of one issuer;
the requirements of sections 2.4(1), 2.4(2) and 2.4(3) of Part 2 of NI 81-102 relating to the ability of the Funds to purchase and hold illiquid assets; and
the requirements of section 2.7(4) of Part 2 of NI 81-102 relating to the ability of the Funds to enter into a forward contract.
Paragraphs 1), 2) and 3) together are referred to as the "Requested Relief".
Under the Process for Exemptive Relief Applications for Multiple Jurisdictions:
(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 and Quebec.
Interpretation
Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision unless they are defined in this decision.
Representations
NexGen is a limited partnership formed under the laws of the Province of Ontario having its head office in Toronto, Ontario. NexGen is registered in Ontario as an adviser in the categories of investment counsel and portfolio manager and as a dealer in the categories of mutual fund dealer and limited market dealer and commodity trading manager.
NexGen is the manager of the Funds, including the Existing Funds whose securities are currently qualified for sale in the Provinces of British Columbia, Alberta, Ontario and Quebec (the "Jurisdictions") pursuant to a simplified prospectus and annual information form dated May 16, 2008.
Each of the Funds is, or will be, an open-end fixed income investment portfolio within NexGen Investment Corporation, a mutual fund corporation or another mutual fund corporation established under the laws of the Province of Ontario in respect of which the Filer is or will be the manager.
Each of the Funds is, or will be, a reporting issuer in the provinces of, Ontario, British Columbia, Alberta and Quebec, and distributes or will distribute securities under a simplified prospectus and annual information form and be otherwise subject to NI 81-102.
With the exception of specific exemptions granted by the applicable securities regulatory authorities, the investment practices of each of the Funds will comply in all respects with the requirements of Part 2 of NI 81-102.
The NexGen Canadian Cash Tax Managed Fund proposes to, and each of the NexGen Canadian Bond Tax Managed Fund and the Future Funds may, enter into a prepaid forward share purchase contract (each a “Prepaid Forward”) with The Bank of Nova Scotia or another Canadian chartered bank (the “Counterparty”) having a term of 5 years or less with a right to eliminate its exposure under the Prepaid Forward after 3 years.
In each case, the Prepaid Forward will provide the Fund that acquires such Prepaid Forward with an investment return similar to that of the underlying NexGen registered fund that is, or will be, an open-end mutual fund trust established under the laws of the Province of Ontario of which the Filer is or will be the manager (the “Registered Funds”). The investment returns of a Fund holding a Prepaid Forward and the underlying Registered Fund are anticipated to differ primarily due to the cost of the derivative.
A Prepaid Forward is an attractive investment for the NexGen Canadian Cash Tax Managed Fund because it will materially reduce the costs associated with the conventional forward share purchase contract that it currently holds (the “Conventional Forward”). In the case of the NexGen Canadian Bond Tax Managed Fund and the Future Funds, a Prepaid Forward is an attractive investment both for its cost relative to the cost of a conventional forward and for income conversion purposes generally.
Initially, each of the Funds will obtain exposure to the underlying Registered Fund by selling a portion of its assets, which in the case of the NexGen Canadian Cash Tax Managed Fund are currently subject to the Conventional Forward, and using the proceeds to prepay its purchase obligations under the Prepaid Forward. From time to time, as subscriptions for shares accumulate, each Fund will be permitted to increase the amount of its obligations under the Prepaid Forward by increments of not less than $1 million.
Pursuant to the terms of the Prepaid Forward, each Fund will receive on or before its maturity date (the “Maturity Date”) a specified portfolio consisting of securities (“Canadian Securities”) of Canadian public issuers that are Canadian Securities for the purposes of the Income Tax Act (Canada) with a value equal to an amount determined based on the economic return generated by the underlying Registered Fund.
The terms of each Prepaid Forward will provide that it may be partially settled in order to fund distributions, redemptions of shares and expenses and other liabilities of the applicable Fund. In connection with a requested partial settlement the Counterparty will deliver to the Fund Canadian Securities with an aggregate value based on the partial settlement amount. The Fund will then sell such securities into the market in order to fund distribution, redemption or other expenses or liabilities of such Fund.
A Fund will be able to settle any Prepaid Forward in whole by providing notice to the Counterparty at least five business days prior to the proposed valuation date designated by the Fund with the settlement date occurring three business days following such valuation date.
The obligations of the Counterparty under a Prepaid Forward will be secured by a pledge of securities by the Counterparty to and in favour of the Fund (the “Collateral”). The Collateral will consist of Toronto Stock Exchange listed common shares and will meet the diversification requirements under NI 81-102.
The Counterparty will represent to the Filer and each Fund that the Counterparty will own such Collateral free and clear of all liens and adverse claims, other than the lien and security interest granted to the Fund, and that such Fund will have a first-priority perfected security interest in such Collateral and the proceeds thereof.
The Collateral will be held in an account in the name of the Counterparty by Scotia Capital Inc. (the “Dealer”), an investment dealer that is an affiliate of the Counterparty. Each Fund, the Counterparty and the Dealer will enter into a control agreement (the “Control Agreement”) that will make such Fund an entitlement holder with respect to the Collateral as described in the Securities Transfer Act (Ontario).
In the event the Counterparty defaults with respect to a Prepaid Forward or if the Counterparty becomes insolvent, the Dealer would be obligated under the Control Agreement to deliver the Collateral to the applicable Fund.
The Collateral and the corresponding Prepaid Forward will be marked to market on a weekly basis. The amount of Collateral will be adjusted each week to ensure that the market value of the Collateral will be equal to the mark-to-market value of the corresponding Prepaid Forward and that the Collateral meets the diversification requirements under NI 81-102.
It is expected that on or before the Maturity Date, the applicable Fund and the Counterparty, or alternatively, one or more other counterparties, will enter into comparable prepaid forward share purchase arrangements in order to provide for the continuing exposure of the such Fund to the investment return of the corresponding Registered Fund.
Decision
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 in respect of each Fund:
(a) the Collateral and the corresponding Prepaid Forward will be marked to market on a weekly basis and the amount of Collateral will be adjusted each week to ensure that the market value of the Collateral will be equal to the mark-to-market value of the corresponding Prepaid Forward; and
(b) the Collateral will be free and clear of all liens and adverse claims, other than those of the Funds, and each Fund will maintain a first-priority perfected security interest in such Collateral.
“Vera Nunes”
Assistant Manager, Investment Funds Branch Ontario Securities Commission
SEDAR Project No. 1283568