Headnote National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Relief granted from sections 2.3(f) and (h), 2.5(2)(a) and (c) of National Instrument 81-102 Mutual Funds to permit actively managed exchange-traded mutual funds to invest in gold ETFs, silver ETFs, gold/silver ETFs and silver, subject to a limit of 10% exposure in gold and silver, and certain conditions.
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – s. 19.1 of National Instrument 81-102 Mutual Funds – exemption from sections 2.8(1)(d) and (f)(i) NI 81-102 to permit actively managed exchange-traded mutual 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 actively managed exchange-traded mutual funds are entitled to receive payments under the interest rate swap, to use as cover, an option to sell an equivalent quantity of the underlying interest of the standardized future, forward or swap – the relief will enhance returns to investors while still providing adequate safeguards.
Applicable Legislative Provisions
National Instrument 81-102 – Mutual Funds, paragraph 2.3(f) and (h), 2.5(2)(a) and (c), 2.8(1)(d), 2.8(1)(f)(i) and section 19.1.
August 3, 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 Invesco CANADA Ltd. (the "Filer")
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") for an exemption, pursuant to 19.1 of National Instrument 81-102 Mutual Funds ("NI 81-102") from:
(a) sections 2.3(f), 2.3(h), 2.5(2)(a) and 2.5(2)(c) of NI 81-102 (the "Gold/Silver Exemption Sought") to permit PowerShares Tactical Bond ETF and any future actively-managed exchange-traded funds managed by the Filer that are subject to National Instrument 81-102 – Mutual Funds ("NI 81-102") other than money market funds as defined in NI 81-102 (together with the PowerShares Tactical Bond ETF, the "PowerShares ETFs") to invest up to 10% in the aggregate of each PowerShares ETF's net assets in:
(i) securities of exchange-traded funds ("ETFs") that seek to replicate (1) the performance of gold on an unlevered basis; or (2) the value of a specified derivative the underlying interest of which is gold on an unlevered basis ("Gold ETFs");
(ii) silver, Permitted Silver Certificates (as defined below) and specified derivatives the underlying interest of which is silver on an unlevered basis (collectively, "Silver");
(iii) securities of ETFs that seek to replicate (1) the performance of silver on an unlevered basis; or (2) the value of a specified derivative the underlying interest of which is silver on an unlevered basis ("Silver ETFs");
(iv) securities of ETFs that seek to replicate (1) the performance of gold and silver on an unlevered basis; or (2) the value of specified derivatives the underlying interest of which are gold and silver on an unlevered basis ("Gold/Silver ETFs") and
(b) Sections 2.8(1)(d) and 2.8(1)(f)(i) of NI 81-102 (the "Derivatives Exemption Sought") to permit the PowerShares ETFs when they:
(i) open or maintain 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) enter into or maintain a swap position and during the periods when the PowerShares ETF 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.
Under the Process for Exemptive Relief Applications in 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, Saskatchewan, Manitoba, Quebec, New Brunswick, Nova Scotia, Newfoundland and Labrador, Prince Edward Island, Northwest Territories, Nunavut and Yukon (the "Other Jurisdictions").
Interpretation
Defined terms contained 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
This decision is based on the following facts represented by the Filer:
The PowerShares ETFs
(a) The PowerShares ETFs are exchange-traded mutual funds established in Ontario for which the Filer is or will be the manager. The investment manager is or will be either the Filer or another entity appointed by the Filer as sub-advisor. The head office of the Filer is located in Toronto, Ontario.
(b) Invesco Advisers, Inc. ("IAI") and Invesco PowerShares Capital Management LLC, both affiliates of the Filer, will be the sub-advisors for PowerShares Tactical Bond ETF. IAI determines the allocations among asset classes and makes investment decisions for PowerShares Tactical Bond ETF.
(c) The investment objective and investment strategies of PowerShares Tactical Bond ETF are set out in its preliminary prospectus.
(d) In some cases, hedging of risk is permitted, including currency risks, whether the currency risk relates to income or equity securities or other securities.
(e) Each of the PowerShares ETFs is or will be (i) an open-end mutual fund established under the laws of Ontario; (ii) a reporting issuer under the securities laws of each of the provinces and territories of Canada; (iii) qualified for distribution in all provinces and territories of Canada; and (iv) not in default of securities legislation in any province or territory of Canada.
Gold/Silver Exemption Sought
(f) In connection with the Gold/Silver Exemption Sought each PowerShares ETF that includes, as part of its investment strategy, investments in gold and/or silver, will be permitted in accordance with its investment objectives and investment strategies to invest in Gold ETFs, Silver, Silver ETFs and Gold/Silver ETFs. The Gold ETFs, Silver ETFs and Gold/Silver ETFs are referred to herein collectively as the "Underlying ETFs".
(g) In the absence of the Gold/Silver Exemption Sought, an investment by the PowerShares ETFs in securities of the Underlying ETFs would be contrary to section 2.5(2)(a) of NI 81-102 as the securities of the Underlying ETFs are not subject to NI 81-102 and NI 81-101.
(h) In the absence of the Gold/Silver Exemption Sought, an investment by the PowerShares ETFs in securities of the Underlying ETFs would be contrary to section 2.5(2)(c) of NI 81-102 as the Underlying ETFs are not reporting issuers in the local jurisdiction.
(i) In the absence of the Gold/Silver Exemption Sought, an investment by the PowerShares ETFs in Silver would be contrary to sections 2.3(f) and 2.3(h) of NI 81-102 as those sections only stipulate gold as a permissible commodity to be held directly or as an underlying interest of a specified derivative.
(j) The market for silver is highly liquid, and there are no liquidity concerns that should lead to a conclusion that investments in silver need to be prohibited.
(k) The Underlying ETFs and Silver are attractive investments for the PowerShares ETFs as they provide an efficient and cost effective means of achieving diversification in addition to any investment in gold.
(l) The PowerShares ETFs will invest in Silver from time to time when the Filer determines that it is desirable to do so following a valuation of assets, a determination of the effect of monetary policy and economic environment on assets prices and assessing historic price movements on likely future returns.
(m) An investment by a PowerShares ETF in the securities of the Underlying ETFs and/or Silver represent the business judgment of responsible persons uninfluenced by considerations other than the best interest of the PowerShares ETF.
(n) Any investment in a PowerShares ETF will be made in compliance with the custodian requirements in Part 6 of NI 81-102.
(o) the prospectus of each PowerShares ETF will disclose under the sections entitled:
(i) "Investment strategies", the PowerShares ETF's ability to invest in Silver and in the Underlying ETFs;
(ii) "Risk Factors", the risks associated with the PowerShares ETF's exposure to silver and gold;
(p) The silver certificates ("Permitted Silver Certificates") that the PowerShares ETFs invest in will be certificates that represent silver that is:
(i) available for delivery in Canada, free of charge, to or to the order of the holder of the certificate;
(ii) of a minimum fineness of 999 parts per 1,000;
(iii) held in Canada;
(iv) in the form of either bars or wafers; and
(v) if not purchased from a bank listed in Schedule I, II or III of the Bank Act (Canada), fully insured against loss and bankruptcy by an insurance company licensed under the laws of Canada or a province or territory of Canada
Derivatives Exemption Sought
(q) As part of its investment strategies, PowerShares Tactical Bond ETF may use specified derivatives in order to gain synthetic exposure to an issuer or class of issuers or to gain exposure to commodities.
(r) When specified derivatives are used for non-hedging purposes, the PowerShares ETFs will be subject to the cover requirements of NI 81-102.
(s) Sections 2.8(1)(d) and 2.8(1)(f)(i) of NI 81-102 do not permit covering 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, forward or swap positions to cover long future, forward or swap positions.
(t) Regulatory 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 derivative holding and the strike price of the option that was bought or sold to hedge that derivative position. NI 81-102 effectively imposes the requirement to overcollateralize, since the maximum liability to a fund under the scenario described is equal to the difference between the market value of the long derivative position and the exercise price of the option. Overcollateralization imposes a cost on a mutual fund.
(u) Section 2.8(1)(c) of NI 81-102 permits a mutual fund to write a put option and to cover it by holding a right or obligation to sell 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. Therefore, the Filer submits that the PowerShares ETFs should be permitted to cover a long position in a future, forward or swap with a put option or a short future position.
(v) The Filer has written policies and procedures relating to the use of derivatives by the PowerShares ETFs. The policies and procedures are reviewed annually by personnel in the Legal and Compliance departments. The Chief Compliance Officer of the Filer is responsible for maintaining the policies and procedures, oversight of the derivative strategies used by the PowerShares ETFs and monitoring and assessing compliance with all applicable legislation. The Chief Compliance Officer reports to the board of directors of the Filer on his compliance assessments. Limits and controls on the use of derivatives are part of the Filer's fund compliance regime and include reviews by analysts who ensure that the derivative positions of the PowerShares ETFs are within applicable policies.
(w) The derivative contracts entered into by the Filer or a sub-advisor on behalf of the PowerShares ETFs must be in accordance with the investment objectives and strategies of each of the PowerShares ETFs. The Filer and sub-advisors are also required to adhere to NI 81-102. The Filer sets and reviews the investment policies of the PowerShares ETFs which also allow the trading in derivatives.
(x) Without the Derivatives Exemption Sought, the PowerShares ETFs will not have the flexibility to enhance yield and to manage more effectively its exposure under specified derivatives.
Decision
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make a decision.
The decision of the principal regulator under the Legislation is as follows.
(a) The Gold/Silver Exemption Sought is granted provided that:
(i) the prospectus of each PowerShares ETF and all subsequent renewals will disclose under the sections entitled:
"Investment strategies", the PowerShares ETF's ability to invest in Silver and in the Underlying ETFs;
"Risk Factors", the risks associated with the PowerShares ETF's exposure to silver and gold;
"Exemptions and Approvals", the nature and terms of the Gold/Silver Exemption Sought;
(ii) the silver certificates that the PowerShares ETFs invest in will be certificates that represent silver that is:
available for delivery in Canada, free of charge, to or to the order of the holder of the certificate;
of a minimum fineness of 999 parts per 1,000;
held in Canada;
in the form of either bars or wafers; and
if not purchased from a bank listed in Schedule I, II or III of the Bank Act (Canada), fully insured against loss and bankruptcy by an insurance company licensed under the laws of Canada or a province or territory of Canada;
(iii) the securities of the Underlying ETFs are traded on a stock exchange in Canada or the United States;
(iv) each PowerShares ETF does not purchase gold, permitted gold certificates, silver, Permitted Silver Certificates, Underlying ETFs or enter into specified derivatives the underlying interest of which is gold or silver if, immediately after the transaction, more than 10% of the net assets of such PowerShares ETF, taken at market value at the time of transaction, would consist of gold, permitted gold certificates, silver, Permitted Silver Certificates, Underlying ETFs and underlying market exposure of specified derivatives linked to gold or silver;
(v) the investment by a PowerShares ETF in securities of an Underlying ETF and/or Silver is in accordance with the fundamental investment objectives of such PowerShares ETF; and
(vi) the securities of the Underlying ETFs are treated as specified derivatives for the purposes of Part 2 of NI 81-102.
(b) The Derivatives Exemption Sought is granted provided that:
(i) the prospectus of each PowerShares ETF and all subsequent renewals will disclose under the sections entitled "Exemptions and Approvals", the nature and terms of the Derivatives Exemption Sought;
(ii) when each of the PowerShares ETFs enters into or maintains a swap position for periods when the PowerShares ETFs would be entitled to receive fixed payments under the swap, the PowerShares ETFs hold:
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;
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 fund under the swap less the obligation of the PowerShares ETFs under such offsetting swap; or
a combination of the positions referred to in subparagraph (1) and (2) that is sufficient, without recourse to the other assets of the PowerShares ETF to enable the PowerShares ETF to satisfy its obligations under the swap;
(iii) when each of the PowerShares ETFs 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 PowerShares ETF holds:
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;
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 aggregate amount, if any, by which the market price of the future or forward contract exceeds the strike price of the right or obligation to sell the underlying interest; or
a combination on the positions referred to in subparagraph (1) and (2) that is sufficient, without recourse to other assets of the PowerShares ETF to enable the PowerShares ETF to acquire the underlying interest of the future or forward contract;
(iv) the PowerShares ETFs 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 position 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 PowerShares ETFs, taken at market value at the time of the transaction, would be made up of (A) purchased debt-like securities that have an option component or purchased options, in each case, held by the PowerShares ETF for purposes other than hedging, or (B) options used to cover any positions under section 2.8(1)(b), (c), (d), (e) and (f) of NI 81-102; and
(v) this decision with respect to the Derivatives Exemption Sought will terminate on the coming into force of any securities legislation relating to the use as cover of a right or obligation to sell an equivalent quantity of the underlying interest of the standardized future, forward or swap in compliance with section 2.8 of NI 81-102.
"Darren McKall"
Darren McKall
Manager, Investment Funds
Ontario Securities Commission
SEDAR #1930116
Headnote
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Relief granted from sections 2.3(f) and (h), 2.5(2)(a) and (c) of National Instrument 81-102 Mutual Funds to permit actively managed exchange-traded mutual funds to invest in gold ETFs, silver ETFs, gold/silver ETFs and silver, subject to a limit of 10% exposure in gold and silver, and certain conditions.
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – s. 19.1 of National Instrument 81-102 Mutual Funds – exemption from sections 2.8(1)(d) and (f)(i) NI 81-102 to permit actively managed exchange-traded mutual 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 actively managed exchange-traded mutual funds are entitled to receive payments under the interest rate swap, to use as cover, an option to sell an equivalent quantity of the underlying interest of the standardized future, forward or swap – the relief will enhance returns to investors while still providing adequate safeguards.
Applicable Legislative Provisions
National Instrument 81-102 – Mutual Funds, paragraph 2.3(f) and (h), 2.5(2)(a) and (c), 2.8(1)(d), 2.8(1)(f)(i) and section 19.1.