Headnote National Policy 11-203 Process For Exemptive Relief Applications in Multiple Jurisdictions - exemption from sections 2.8(1)(d) and (f)(i) NI 81-102 to permit the funds when they open or maintain a long position in a standardized future or forward contract or when they enter into or maintain an interest rate swap position and during the periods when the Funds are entitled to receive payments under the swap, to use as cover, an option to sell an equivalent quantity of the underlying interest of the standardized future, forward or swap. Applicable Legislative Provisions National Instrument 81-102 - Mutual Funds, Subsection 2.8(1) and Section 19.1
June 20, 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
CIBC ASSET MANAGEMENT INC.
(the "Manager")
AND
IN THE MATTER OF
FRONTIERS CANADIAN FIXED INCOME POOL
(the "Pool" together with the Manager, the "Filers")
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Filers for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for an exemption relieving the Pool from the sections of NI 81-102 as follows:
the requirement in sections 2.8(1)(d) and 2.8(1)(f)(i) of NI 81-102 in order to permit the Pool when it
(i) opens or maintains a long position in a debt-like security that has a component that is a long position in a forward contract or in a standardized future or forward contract, or
(ii) enters into or maintains a swap position and during the periods when the Pool is entitled to receive payments under the swap,
to use as cover, a right or obligation to sell an equivalent quantity of the underlying interest of the standardized future, forward or swap.
(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 Filers have provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, Quebec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Yukon, Northwest Territories and Nunavut (the Passport Jurisdictions)
(The Jurisdiction and the Passport Jurisdictions are collectively, the Jurisdictions).
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 Filers:
CIBC Asset Management Inc.
1The Manager is the manager, portfolio advisor and trustee of the Pool. The Manager is a corporation incorporated under the laws of Canada and has its head office located in Toronto, Ontario.
2The Manager is registered in the categories of portfolio manager in all Jurisdictions and as an investment fund manager and a commodity trading manager in the Province of Ontario.
3PIMCO Canada Corp. (PIMCO) is registered as an adviser in the category of portfolio manager and commodity trading manager in the Province of Ontario. PIMCO's head office is in Toronto, Ontario.
4Under its agreement with the Pool, the Manager is authorized to, and will appoint, PIMCO as sub-advisor to the Pool.
5The Filers and PIMCO are not in default of securities legislation in any of the Jurisdictions.
The Pool
6The Pool is a reporting issuer and is subject to the requirements of NI 81-102.
7The investment objective and strategies of the Pool are set out in the Pool's simplified prospectus.
8The Pool is currently permitted to use specified derivatives to hedge against losses caused by changes in securities prices, interest rates, exchange rates and/or other risks. The Pool may also use specified derivatives for non-hedging purposes under its investment strategies in order to invest indirectly in securities or financial markets or to gain exposure to other currencies, provided the use of specified derivatives is consistent with the Pool's investment objective. When specified derivatives are used for non-hedging purposes, the Pool is subject to the cover requirements of NI 81-102.
Cover in the form of Put Options for Long Positions in Futures, Forwards and Swaps
9Sections 2.8(1)(d) and 2.8(1)(f)(i) of NI 81-102 do not permit covering the position in long positions in futures and forwards and long positions in swaps for a period when a fund is entitled to receive payments under the swap, in whole or in part with a right or obligation to sell an equivalent quantity of the underlying interest of the future, forward or swap. In other words, those sections of NI 81-102 do not permit the use of put options or short future positions to cover long future, forward or swap positions.
10Regulatory regimes in other countries recognize the hedging properties of options for all categories of derivatives, including long positions evidenced by standardized futures or forwards or in respect of swaps where a fund is entitled to receive payments from the counterparty, provided they are covered by an amount equal to the difference between the market price of a holding and the strike price of the option that was bought or sold to hedge it. NI 81-102 effectively imposes the requirement to overcollateralize, since the maximum liability to the fund under the scenario described is equal to the difference between the market value of the long and the exercise price of the option and as a result overcollateralization imposes a cost on a fund.
11Section 2.8(1)(c) of NI 81-102 permits a mutual fund to write a put option and cover it with a put option on an equivalent quantity of the underlying interest of the written put option. This position has similar risks as a long position in a future, forward or swap and therefore, the Manager submits, that the Pool should be permitted to cover a long position in a future, forward or swap with a put option or short future position.
Derivative Policies and Risk Management
12The Manager sets and reviews the investment objectives and overall investment policies of the Pool, which will allow for trading in derivatives. The derivative contracts entered into by or on behalf of the Pool must be in accordance with the investment objectives and strategies of each of the Pool and in compliance with NI 81-102.
13Pursuant to its agreement with PIMCO appointing it as the portfolio adviser to the Pool, the Manager will permit PIMCO to use derivatives for the Pool under certain conditions and limitations in order to gain exposure to financial markets or to invest indirectly in securities or other assets. Such agreement will also require PIMCO to use risk management processes to monitor and measure the risks of all portfolio holdings within the Pool, including derivatives positions.
14The Manager, as portfolio advisor, will oversee PIMCO in the use of derivatives as investments within the Pool and will put in place policies and procedures which will set out oversight processes to ensure that the use of derivatives is adequately monitored and derivatives risk is appropriately managed.
15The simplified prospectus and annual information form of the Pool will include disclosure of the nature of the Requested Relief in respect of the Pool.
Decision
The principal regulator is satisfied that the decision meets the test contained 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:
a. when the Pool enters into or maintains a swap position for periods when the Pool would be entitled to receive fixed payments under the swap, the Pool holds:
i. cash cover, in an amount that, together with margin on account for the swap and the market value of the swap, is not less than, on a daily mark-to-market basis, the underlying market exposure of the swap;
ii. a right or obligation to enter into an offsetting swap on an equivalent quantity and with an equivalent term and cash cover that together with margin on account for the position is not less than the aggregate amount, if any, of the obligations of the Pool under the swap less the obligations of the Pool under such offsetting swap; or
iii. a combination of the positions referred to in subparagraphs (i) and (ii) that is sufficient, without recourse to other assets of the Pool, to enable the Pool to satisfy its obligations under the swap; and
b. when the Pool opens or maintains a long position in a debt-like security that has a component that is a long position in a forward contract, or in a standardized future or forward contract, the Pool holds:
i. cash cover, in an amount that, together with margin on account for the specified derivative and the market value of the specified derivative, is not less than, on a daily mark-to-market basis, the underlying market exposure of the specified derivative;
ii. a right or obligation to sell an equivalent quantity of the underlying interest of the future or forward contract, and cash cover that together with margin on account for the position, is not less than the amount, if any, by which the price of the future or forward contract exceeds the strike price of the right or obligation to sell the underlying interest;
or
iii. a combination of the positions referred to in subparagraphs (i) and (ii) that is sufficient, without recourse to other assets of the Pool, to enable the Pool to acquire the underlying interest of the future or forward contract;
c. the Pool will not (i) purchase a debt-like security that has an option component or an option, or (ii) purchase or write an option to cover any positions under section 2.8(1)(b), (c), (d), (e) and (f) of NI 81-102, if immediately after the purchase or writing of such option, more than 10% of the net assets of the Pool, taken at market value at the time of the transaction, would be in the form of (1) purchased debt-like securities that have an option component or purchased options, in each case, held by the Pool for purposes other than hedging, or (2) options used to cover any positions under section 2.8(1)(b), (c), (d), (e) and (f) of NI 81-102;
d. the Pool shall disclose the nature and terms of the Requested Relief in the Pool's simplified prospectus under the investment strategies section and in the Pool's annual information form.
"Sonny Randhawa"
Sonny Randhawa
Manager, Investment Funds Branch
Ontario Securities Commission
Headnote
National Policy 11-203 Process For Exemptive Relief Applications in Multiple Jurisdictions - exemption from sections 2.8(1)(d) and (f)(i) NI 81-102 to permit the funds when they open or maintain a long position in a standardized future or forward contract or when they enter into or maintain an interest rate swap position and during the periods when the Funds are entitled to receive payments under the swap, to use as cover, an option to sell an equivalent quantity of the underlying interest of the standardized future, forward or swap.
Applicable Legislative Provisions
National Instrument 81-102 - Mutual Funds, Subsection 2.8(1) and Section 19.1