Headnote National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions –Two-tier fund structure with conversion feature – the top fund is a closed-end fund that holds forward contract for tax efficient exposure to bottom fund – the bottom fund is a mutual fund – relief granted to bottom fund to short sell up to 20% of net assets subject to certain conditions. Applicable Legislative Provisions National Instrument 81-102 Mutual Funds, sections 2.6(a), 2.6(c), 6.1(1) and 19.1(2).
January 17, 2012
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 MANULIFE ASSET MANAGEMENT LIMITED (the Filer), MANULIFE STRATEGIC INCOME OPPORTUNITIES FUND (the Income Opportunities Fund) and MANULIFE STRATEGIC INCOME TRUST (the Strategic Fund, together with the Income Opportunities Fund, the Funds)
DECISION
Background
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) exempting the Strategic Fund from subsections 2.6(a), 2.6(c) and 6.1(1) of National Instrument 81-102 Mutual Funds (NI 81-102) to permit the Strategic Fund, on the terms and conditions set out in this decision: (a) to sell securities short, including index participation units, as defined in NI 81-102 (IPUs), of fixed income exchange-traded funds (ETFs); (b) to provide a security interest over the Strategic Fund’s assets in connection with the short sales; and (c) to deposit its assets with a dealer as security in connection with the short sales (the Requested Relief).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
the Ontario Securities Commission is the principal regulator for this application; and
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 all provinces and territories of Canada, except Ontario.
Interpretation
Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.
Representations
This decision is based on the following facts represented by the Filer and the Funds:
The Filer and the Funds
The Filer is the manager, trustee and portfolio advisor of the Funds. The Filer is a corporation governed under the Business Corporations Act (Ontario) and has its head office located in Toronto, Ontario. The Filer is an indirect wholly-owed subsidiary of Manulife Financial Corporation (MFC).
The Filer is registered in the categories of portfolio manager, investment fund manager, exempt market dealer, mutual fund dealer and commodity trading manager.
The Filer and the Funds are not in default of securities legislation in any jurisdiction.
Manulife Asset Management (US) LLC (the Sub-Advisor) has been retained by the Filer to provide portfolio sub-advisory services to each of the Funds. The Sub-Advisor is also an indirect wholly-owned subsidiary of MFC.
The Income Opportunities Fund completed an offering of its units to the public (the Offering) pursuant to a final long form prospectus prepared in accordance with Form 41-101F2 dated May 27, 2011. The units of the Income Opportunities Fund are listed and posted for trading on the Toronto Stock Exchange.
The Income Opportunities Fund’s investment objectives are: (a) to provide its unitholders with monthly tax-advantaged distributions; and (b) to preserve capital while providing the opportunity for long-term capital appreciation for its unitholders. The Income Opportunities Fund has been created to provide exposure, on a tax-advantaged basis, to an actively managed portfolio (the Portfolio) comprised primarily of fixed-income securities of global issuers, including corporate bonds (investment grade and high yield) and government bonds (developed and emerging markets). The Income Opportunities Fund obtains economic exposure to the Portfolio through a forward agreement (the Forward Agreement) entered into with a Canadian chartered bank (the Counterparty). The return to the Income Opportunities Fund is, by virtue of the Forward Agreement, based on the performance of the Strategic Fund, which acquired and holds the Portfolio.
The Income Opportunities Fund will de-list its units and convert from a closed-end investment fund into an open-end mutual fund in June of 2013 (the Conversion).
The Strategic Fund filed a final long form prospectus prepared in accordance with Form 41-101F2 dated May 27, 2011 to become a reporting issuer under the Securities Act (Ontario) and the Securities Act (Québec) and issued one unit to the Filer under its final long form prospectus such that the Strategic Fund is subject to NI 81-102.
After the closing of the Offering, the Strategic Fund issued units to the Counterparty with an aggregate value approximately equal to the net proceeds of the Offering, which proceeds the Strategic Fund used to acquire the Portfolio. Units of the Strategic Fund were issued to the Counterparty in reliance on exemptions from prospectus and registration requirements contained in securities legislation.
The Strategic Fund will not otherwise offer its units by way of a prospectus or otherwise.
Prior to the Conversion, the Income Opportunities Fund will file a simplified prospectus (SP) and annual information form (AIF) under National Instrument 81-101 Mutual Fund Distributions (NI 81-101) to qualify its units for new sales. The Strategic Fund has undertaken that, prior to Conversion, it will also file a SP and AIF under NI 81-101.
Short-Selling
The Filer proposes that the Strategic Fund be authorized to engage in a limited, prudent and disciplined amount of short selling. The Filer is of the view that the implementation and execution by the Strategic Fund of a controlled and limited short selling strategy could assist the Funds in seeking to achieve their investment objectives.
The final long form prospectuses for the Funds disclosed a description of: (i) short selling; (ii) the Strategic Fund’s proposed short selling activities; (ii) the risks associated with short selling; and (iii) in the Investment Strategy section, the Strategic Fund’s short selling strategy, subject to obtaining this relief, and this relief, which the Strategic Fund had applied for. Specifically, the long form prospectuses disclosed that, subject to obtaining this relief, the Strategic Fund may short sell units of fixed income ETFs, up to 20% of the Strategic Fund’s net assets, to hedge (as defined in NI 81-102) interest rate risk.
Prior to the Strategic Fund conducting any short sales, each Fund will issue a press release indicating that the Requested Relief has been granted.
In order to effect a short sale, the Strategic Fund will borrow securities from either its custodian or a dealer (in either case, the Borrowing Agent), which Borrowing Agent may be acting either as principal for its own account or as agent for other lenders of securities. The Strategic Fund will be under an obligation to return the borrowed securities to the Borrowing Agent at a future date. The Strategic Fund also will be required to pay the Borrowing Agent any distributions declared on the borrowed securities, together with any securities borrowing fees. To return the borrowed securities, the Strategic Fund will purchase these same securities at a later date, with the result that the Strategic Fund will generally make a gain on the short sale if the price of the securities has declined by such date.
The Strategic Fund will implement the following controls when conducting a short sale:
a. securities will be sold short for cash only;
b. all short sales will be effected through market facilities through which the securities sold short are normally bought and sold, within normal trade settlement periods for the market in which the short sales are effected, and otherwise effected in accordance with market conventions governing the short sales;
c. the securities sold short will not include securities of an investment fund, unless the securities are index participation units, as defined in NI 81-102;
d. the securities sold short will not be “illiquid assets” as such term is defined in NI 81-102, and will be securities that are either:
i. listed and posted for trading on a stock exchange, and
A. the issuer of which has a market capitalization of not less than CDN $100 million, or the equivalent thereof, at the time the short sale is effected, or
B. that the Sub-Advisor has pre-arranged to borrow for the purpose of such sale; or
ii. bonds, debentures or other evidences of indebtedness of, or guaranteed by, any issuer.
e. the aggregate market value of all securities of an issuer sold short by the Strategic Fund does not exceed 5% of the net assets of the Strategic Fund on a daily marked-to-market basis;
f. the aggregate market value of all securities sold short by the Strategic Fund does not exceed 20% of the net assets of the Strategic Fund on a daily marked-to-market basis;
g. the Strategic Fund holds “cash cover” (as defined in NI 81-102) in an amount, including the Strategic Fund’s assets deposited with the Borrowing Agent as security in connection with short sale transactions, that is at least 150% of the aggregate market value of all securities sold short by the Strategic Fund on a daily marked-to-market basis;
h. the Strategic Fund will deposit Strategic Fund’s assets with the Borrowing Agent as collateral in connection with the short sale transaction;
i. the Strategic Fund will keep proper books and records of all short sales and the Strategic Fund’s assets deposited with the Borrowing Agent as collateral; and
j. the Strategic Fund will develop and maintain written policies and procedures and risk management controls for the conduct of short sales prior to conducting any short sales.
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:
the aggregate market value of all securities sold short by the Strategic Fund does not exceed 20% of the net assets of the Strategic Fund on a daily marked-to-market basis;
any short sale made by the Strategic Fund is subject to compliance with the investment objective of the Strategic Fund;
all short sales will be effected through market facilities through which the securities sold short are normally bought and sold;
securities will be sold short for cash only;
the aggregate market value of all securities of an issuer sold short by the Strategic Fund does not exceed 5% of the net assets of the Strategic Fund on a daily marked-to-market basis;
the Strategic Fund maintains appropriate internal controls regarding its short sales, including written policies and procedures, risk management controls and proper books and records;
the Strategic Fund holds “cash cover” (as defined in NI 81-102) in an amount, including the Strategic Fund’s assets deposited with the Borrowing Agent as security in connection with short sale transactions, that is at least 150% of the aggregate market value of all securities sold short by the Strategic Fund on a daily marked-to-market basis;
no proceeds from the short sales by the Strategic Fund are used by the Strategic Fund to purchase long positions in securities other than cash cover;
for short sale transactions in Canada, every dealer that holds the Strategic Fund’s assets as collateral in connection with short sale transactions by the Strategic Fund shall be a registered dealer in Canada and a member of a self-regulatory organization that is a participating member of the Canadian Investor Protection Fund;
for short sale transactions outside of Canada, every dealer that holds the Strategic Fund’s assets as collateral in connection with short sale transactions by the Strategic Fund is a member of a stock exchange and, as a result, subject to a regulatory audit and has a net worth in excess of the equivalent of $50 million determined from its most recent audited financial statements that have been made public;
except where the Borrowing Agent is the Strategic Fund’s custodian, when the Strategic Fund deposits the Strategic Fund’s assets with a Borrowing Agent as security in connection with a short sale transaction, the amount of the Strategic Fund’s assets deposited with the Borrowing Agent does not, when aggregated with the amount of the Strategic Fund’s assets already held by the Borrowing Agent as security for outstanding short sale transactions of the Strategic Fund, exceed 10% of the net assets of the Strategic Fund, taken at market value at the time of the deposit;
the security interest provided by the Strategic Fund over any of its assets that is required to enable the Strategic Fund to effect short sale transactions is made in accordance with industry practice for that type of transaction and relates only to obligations arising under such short sale transactions;
before the Strategic Fund conducts any short sales, each Fund will include in the press release referred to in representation 14 above, the following information, which will also be included in the AIFs filed for the Funds before Conversion:
a. that there are written policies and procedures in place that set out the objectives and goals for short selling and the risk management procedures applicable to short selling;
b. who is responsible for setting and reviewing the policies and procedures referred to in the preceding paragraph, how often the policies and procedures are reviewed, and the extent and nature of the involvement of the board of directors of the Filer in the risk management process;
c. the trading limits or other controls on short selling in place and who is responsible for authorizing the trading and placing limits or other controls on the trading;
d. whether there are individuals or groups that monitor the risks independent of those who trade; and
e. whether risk measurement procedures or simulations are used to test the portfolio under stress conditions;
- before the Strategic Fund conducts any short sales in connection with any new distribution of its units after Conversion:
(a) the SPs for the Funds disclose, a description of: (i) short selling; (ii) how the Strategic Fund intends to engage in short selling; (iii) the risks associated with short selling; and (iv) in the Investment Strategy section, the Strategic Fund’s short selling strategy and this relief; and
(b) the AIFs for the Funds include the disclosure outlined in condition 13 above; and
- the Requested Relief shall terminate upon the coming into force of any legislation or rule of the securities regulatory authorities dealing with the matters referred to in subsections 2.6(a), 2.6(c) and 6.1(1) of NI 81-102.
"Darren McKall"
Name: Darren McKall Title: Manager, Investment Funds Ontario Securities Commission