Headnote NP 11-203 – Process for Exemptive Relief Application in Multiple Jurisdictions
Relief granted to commodity pools from concentration, control and fund-on-fund restrictions in sections 2.1(1), 2.2(1), 2.5(2)(a) and (c) of National Instrument 81-102 Mutual Funds to permit certain commodity pools to gain exposure to US commodity ETFs tracking the performance of physical commodities, subject to certain conditions.
Relief granted to commodity pools from fund-on-fund restrictions in section 2.5(2)(e) and (f) of National Instrument 81-102 Mutual Funds to permit commodity pools to pay brokerage commissions incurred for the purchase or sale of securities of US commodity ETFs.
Relief granted from section 3.2(2)(a) of National Instrument 81-104 Commodity Pool to permit manager to redeem seed investment in commodity pools provided pools have received subscriptions from investors totalling at least $5 million and provided the manager maintains working capital as required for investment fund managers under National Instrument 31-103 Registration Requirements and Exemptions.
Applicable Legislative Provisions National Instrument 81-102 Mutual Funds, sections 2.1(1), 2.2(1), 2.5(2)(a), 2.5(2)(c), 2.5(2)(e) and 2.5(2)(f) and section 19.1.
National Instrument 81-104 Commodity Pools, sections 3.2(2)(a) and section 10.1.
August 22, 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)
AND
In the Matter of
POWERSHARES DB COMMODITY (CAD HEDGED) INDEX ETF and
POWERSHARES DB AGRICULTURE (CAD HEDGED) INDEX ETF
(the Proposed Commodity Pools)
Decision
Background
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of the Proposed Commodity Pools and any similar exchange-traded commodity pools that the Filer or an affiliate of the Filer may create and manage in the future (the Future Commodity Pools and, together with the Proposed Commodity Pools, the Commodity Pools) for exemptive relief from the following provisions of National Instrument 81-102 Mutual Funds (NI 81-102) for the following purposes, which relief is referred to below as the Exemption Sought:
(a) subsections 2.1(1) and 2.2(1) and paragraphs 2.5(2)(a) and 2.5(2)(c) to permit the Commodity Pools to invest directly, or indirectly through one or more derivative instruments which will not be prepaid forward agreements, and in excess of the concentration and control restrictions in subsections 2.1(1) and 2.2(1) respectively, in Commodity Participation Units (CPUs), as defined below, traded on a stock exchange in the United States (the US) and issued by mutual funds (the US Commodity ETFs); and
(b) paragraphs 2.5(2)(e) and 2.5(2)(f) to permit the Commodity Pools to pay brokerage commissions incurred for the purchase or sale of securities of the US Commodity ETFs.
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 Subsection 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in each of British Columbia, Alberta, Saskatchewan, Manitoba, Quebec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Northwest Territories, Nunavut and Yukon (with Ontario, the Jurisdictions).
Interpretation
Terms defined in MI 11-102, National Instrument 14-101 Definitions and NI 81-102 have the same meanings if used in this decision unless otherwise defined.
Representations
This decision is based on the following facts represented by the Filer:
The Filer and the Commodity Pools
The Filer is a corporation amalgamated under the laws of Ontario and its head office is located in Toronto, Ontario.
The Filer will be the trustee, manager and portfolio manager of the Proposed Commodity Pools. The Filer or an affiliate of the Filer will be the trustee, manager and portfolio manager of the Future Commodity Pools. The Filer is registered as a portfolio manager and mutual fund dealer in certain of the provinces and territories of Canada and is registered in Ontario as an investment fund manager and under the Commodity Futures Act (Ontario) in the category of commodity trading manager.
The Filer is not in default of securities legislation in any province or territory of Canada.
Each Commodity Pool will be: (a) an open-end mutual fund trust established under the laws of Ontario; (b) governed by the provisions of NI 81-102 as modified by any exemptions as may be granted by the securities regulatory authorities and those exceptions relating to commodity pools outlined in National Instrument 81-104 Commodity Pools (NI 81-104); (c) qualified for distribution in some or all of the provinces and territories of Canada under a prospectus prepared in accordance with National Instrument 41-101 General Prospectus Requirements that will be filed with and receipted by the securities regulators in the applicable Jurisdiction(s); and (d) once receipted, a reporting issuer under the securities laws of some or all of the provinces and territories of Canada.
Each Commodity Pool will be a “commodity pool”, as such term is defined in subsection 1.1(1) of NI 81-104, in that each Commodity Pool will adopt investment objectives that permit that Commodity Pool to invest directly, or indirectly through one or more derivative instruments, in physical commodities in a manner that is not permitted under NI 81-102.
Each Commodity Pool and its units (the Units) will be listed on the Toronto Stock Exchange (the TSX). The Filer will not file a final prospectus for a Commodity Pool unless the TSX has conditionally approved the listing of Units of the Commodity Pool.
The investment objective of each Commodity Pool will be to seek to replicate, to the extent reasonably possible and before fees and expenses, the performance of a specified commodity index, which index will track the price of one or more physical commodities. In the case of PowerShares DB Commodity (CAD Hedged) Index ETF and as at the date of this decision, the index will be the DBIQ Optimum Yield Diversified Commodity Index Excess Return Hedged CAD. In the case of PowerShares DB Agriculture Fund and as at the date of this decision, the index will be the DBIQ Diversified Agriculture Index Excess Return Hedged CAD.
Each Commodity Pool will be subject to the restrictions concerning illiquid assets in section 2.4 of NI 81-102, and will be subject to the Filer’s internal policies governing liquidity requirements.
Fund on Fund Strategy
In accordance with its investment strategies, as stated in its prospectus, to seek to achieve its investment objective, each Commodity Pool may invest directly, or indirectly through one or more derivative instruments, in securities issued by a specified US Commodity ETF.
PowerShares DB Commodity (CAD Hedged) Index ETF will invest directly, or indirectly through one or more derivative instruments, in the PowerShares DB Commodity Index Tracking Fund, a US Commodity ETF which tracks the performance of the DBIQ Optimum Yield Diversified Commodity Index Excess Return. PowerShares DB Agriculture (CAD Hedged) Index ETF will invest directly, or indirectly through one or more derivative instruments, in the PowerShares DB Agriculture Fund, a US Commodity ETF which tracks the performance of the DBIQ Diversified Agriculture Index Excess Return.
The US Commodity ETFs that the Proposed Commodity Pools will invest in, namely, PowerShares DB Commodity Index Tracking Fund and PowerShares DB Agriculture Fund, are managed by DB Commodity Services LLC, an affiliate of Deutsche Bank AG. US Commodity ETFs that the Future Commodity Pools may invest in could include US Commodity ETFs managed by an affiliate of the Filer or by a third party.
As at the date of this decision, the Filer expects that each Commodity Pool will typically invest almost 100% of its non-cash assets in the US Commodity ETF specified in its prospectus.
In this Decision, a Commodity Participation Unit (CPU), is defined as a security that is issued by an issuer, the only purpose of which is to:
(a) hold a physical commodity as defined in NI 81-102 (a Physical Commodity) or more than one Physical Commodity;
(b) hold commodity futures that are widely quoted or used as the benchmark for pricing the future price of a Physical Commodity or more than one Physical Commodity; or
(c) invest in a manner that causes the issuer to replicate the performance of a Physical Commodity or more than one Physical Commodity, or commodity futures, referred to in subparagraphs 13(a) and 13(b).
The securities of the US Commodity ETFs are CPUs.
Each US Commodity ETF and its securities will be listed on a stock exchange in the United States.
Each US Commodity ETF has signed agreements with parties referred to as “authorized participants”. Each authorized participant is a registered broker-dealer in the United States or a financial institution authorized to engage in securities transactions. Only authorized participants are permitted to subscribe for and buy newly-created shares of that US Commodity ETF directly from the US Commodity ETF, which shares are then sold into the marketplace, and to redeem shares of that US Commodity ETF. Through their ability to subscribe for and redeem shares of the US Commodity ETF, authorized participants provide additional liquidity for the US Commodity ETF.
As each US Commodity ETF tracks a commodity index, which is not considered to be a market index, the securities of the US Commodity ETFs do not meet the definition of “index participation unit” (IPU) in NI 81-102.
An investment by each Commodity Pool, either directly or indirectly through one or more derivative instruments, in securities of a US Commodity ETF, will represent the business judgment of responsible persons uninfluenced by considerations other than the best interest of the Commodity Pool.
A US Commodity ETF that refers to more than one category of Physical Commodity or commodity future will state in its current public offering document that it seeks to replicate the performance of an index of widely quoted or used benchmarks for physical commodities or categories of physical commodities. The index that the US Commodity ETF will seek to replicate will employ an empirical, rules based allocation methodology.
The Commodity Pools will invest directly, or indirectly through one or more derivative instruments, in securities of US Commodity ETFs that provide indirect exposure to physical commodities that, in accordance with NI 81-104, a Commodity Pool could acquire directly and in concentrations that it could accumulate directly.
In the absence of the Exemption Sought, an investment by the Commodity Pools, whether directly or indirectly through one or more derivative instruments, in the securities of the US Commodity ETFs would be contrary to paragraphs 2.5(2)(a) and 2.5(2)(c) of NI 81-102, as the securities of the US Commodity ETFs will not be subject to NI 81-102, will not offer or ever have offered securities under a simplified prospectus in accordance with NI 81-101 Mutual Fund Distributions and will not be reporting issuers in any Jurisdiction.
The Filer is of the view that each US Commodity ETF will not be an “illiquid asset” as defined in NI 81-102, provided that (i) the particular US Commodity ETF is listed for trading on an exchange, (ii) the US Commodity ETF has an agreement in place with one or more authorized participants, and (iii) normal trading has not been suspended on the stock exchange on which the US Commodity ETF is listed and traded or, if applicable, on the futures exchange where the futures purchased and sold by the US Commodity ETF are traded.
In the absence of the Exemption Sought, an investment by a Commodity Pool, whether directly or indirectly through one or more derivative instruments, in the securities of a US Commodity ETF would be contrary to subsection 2.1(1) and may be contrary to subsection 2.1(2) of NI 81-102 as, immediately after the transaction, more than 10 percent of the net asset value of the Commodity Pool will be invested in securities of the US Commodity ETF and the Commodity Pool may hold more than 10 percent of the outstanding securities of the US Commodity ETF.
All investments by the Commodity Pools in securities of the US Commodity ETFs will be made in compliance with the requirements set forth in section 2.5 of NI 81-102, with the exception of sections 2.5(2)(a), 2.5(2)(c), 2.5(2)(e) and 2.5(2)(f) of NI 81-102 pursuant to the grant of the Exemption Sought.
The Filer believes that it is in the best interests of the Commodity Pools for investments to be made, either directly or indirectly through the use of derivative instruments, in the US Commodity ETFs. Investing directly or indirectly in the US Commodity ETFs is expected to be a lower cost investment alternative for the Commodity Pools than investing directly in the physical commodities held in the applicable commodity index or in separate derivative instruments the underlying interests of which are the physical commodities held in such commodity index.
Brokerage Fees
The majority of trading in securities of the US Commodity ETFs occurs in the secondary market.
As is the case with the purchase or sale of any other equity security made on an exchange, brokers are typically paid a commission in connection with trading in securities of exchange-traded funds, such as the US Commodity ETFs.
Securities may only be directly purchased or redeemed from a US Commodity ETF in large blocks. It is anticipated that many of the trades conducted by the Commodity Pools would not be the size necessary for a Commodity Pool to be eligible to purchase securities directly from the US Commodity ETFs. Furthermore, the Commodity Pools are not authorized participants and have not entered into any agreement that would permit them to purchase and redeem securities directly from the US Commodity ETFs.
It is proposed that the Commodity Pools will purchase and sell securities of the US Commodity ETFs on the applicable US exchange and pay commissions to brokers in connection with the purchase and sale of such securities.
Subsection 2.5(5) of NI 81-102 provides that the prohibition against the duplication of sales and redemption fees in paragraphs 2.5(2)(e) and (f) does not apply to brokerage fees incurred by a mutual fund for the purchase or sale of an IPU issued by a mutual fund. However, as securities of the US Commodity ETFs are not IPUs, the Commodity Pools cannot rely on subsection 2.5(5) of NI 81-102.
In the absence of the Exemption Sought, when a Future Commodity Pool trades securities of a US Commodity ETF managed by an affiliate of the Filer, paragraph 2.5(2)(e) would not permit the Commodity Pool to pay any brokerage fees incurred in connection with the trade. In addition, in the absence of the Exemption Sought, when a Commodity Pool trades securities of a US Commodity ETF, paragraph 2.5(2)(f) of NI 81-102 would not permit the Commodity Pool to pay any brokerage fees incurred in connection with the trade.
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 Exemption Sought is granted provided that:
(a) the Commodity Pool’s investment, either directly or indirectly through one or more derivative instruments, in securities of a US Commodity ETF, is in accordance with the investment objective of the Commodity Pool, which investment objective, as set out in its prospectus, specifies the name of the commodity index that the Commodity Pool seeks to replicate and describes the nature of that index;
(b) the Commodity Pool’s investment strategies, as set out in its prospectus, specify that the Commodity Pool is exposed to physical commodities and commodity futures through investment, directly or indirectly through derivative instruments, in securities of a US Commodity ETF that invests in physical commodities and commodity futures;
(c) the prospectus for each Commodity Pool will state that the Commodity Pool has obtained the Exemption Sought and provide disclosure regarding the risks associated with investing in the US Commodity ETFs;
(d) the securities of the US Commodity ETFs are listed on a US stock exchange;
(e) the Commodity Pool will only invest in securities of a US Commodity ETF pursuant to internal policies and procedures governing liquidity that have been established or will be established by the Filer or an affiliate of the Filer for the Commodity Pool as its manager; and
(f) the relief from paragraphs 2.5(2)(e) and 2.5(2)(f) will only apply to brokerage fees incurred for the purchase or sale of securities of the US Commodity ETFs by the Commodity Pools.
“Raymond Chan”
Raymond Chan
Manager, Investment Funds
Ontario Securities Commission