Headnote National Policy 11-203 – Process for Exemptive Relief applications in Multiple Jurisdictions – Mutual funds granted relief from certain restrictions in National Instrument 81-102 Mutual Funds on securities lending transactions, including (i) the 50% limit on lending; (ii) the requirement to use the fund’s custodian or sub-custodian as lending agent; and (iii) the requirement to hold the collateral during the course of the transaction – Mutual funds invest their assets in a basket of Canadian equity securities that are pledged to a Counterparty for performance of the funds’ obligations under forward contracts giving the funds exposure to underlying interests – Mutual funds wanting to lend 100% of the basket of Canadian equity securities – not practical for custodian to act as securities lending agent as it does not have possession of, or control over, the Canadian equity securities – counterparties must release its security interest in the Canadian equity securities in order to allow the funds to lend such securities, provided the funds grant the Counterparties a securities interest in the collateral held by the fund for the loaned securities – National Instrument 81-102 Mutual Funds.
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, section 2.12(1)1, 2.12(1)2, 2.12(1)12, 2.12(3), 2.15, 2.16, 6.8(5) and 19.1.
September 19, 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 Excel Funds Management Inc. (the “Filer”)
and
Excel EM Capital Income Fund (the “Present Fund”)
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 exemptive relief for the Present Fund, together with all other mutual funds now or in the future managed by the Filer in respect of which the representations set out below are applicable (collectively, the “Funds” and each a “Fund”), from the following provisions of National Instrument 81-102 Mutual Funds (“NI 81-102”):
subsection 2.12(1)1 of NI 81-102 to permit each Fund to enter into securities lending transactions that will not be administered in compliance with all the requirements of sections 2.15 and 2.16 of NI 81-102;
subsection 2.12(1)2 of NI 81-102 to permit each Fund to enter into securities lending transactions that do not fully comply with all the requirements of section 2.12 of NI 81-102;
subsection 2.12(1)12 of NI 81-102 to permit each Fund to enter into securities lending transactions in which the aggregate market value of securities loaned by the Fund exceeds 50% of the total assets of the Fund;
subsection 2.12(3) of NI 81-102 to permit each Fund, during the term of a securities lending transaction, to not hold or to dispose of any non-cash collateral delivered to it as collateral in the transaction;
section 2.15 of NI 81-102 to permit each Fund to appoint an agent, other than the custodian or sub-custodian of the Fund, as agent for administering the securities lending transactions entered into by the Fund (“Agent”);
section 2.16 of NI 81-102 to the extent this section contemplates that securities lending transactions be entered into through an agent appointed under section 2.15 of NI 81-102; and
subsection 6.8(5) of NI 81-102 to permit the collateral delivered to each Fund in connection with a securities lending transaction not to be held under the custodianship of a custodian or a sub-custodian of the Fund.
Paragraphs 1 through 7 are collectively referred to as the Exemption Sought.
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for passport applications):
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 to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Yukon, Northwest Territories and Nunavut.
Defined Terms
Terms defined in NI 81-102, National Instrument 14-101 – Definitions and MI 11-102 have the same meaning in this Decision unless they are defined in this Decision.
Representations
This Decision is based on the following facts represented by the Filer on behalf of each Fund:
Facts
The Filer is a corporation incorporated under the laws of Ontario and is registered in the category of Investment Fund Manager in Ontario. The Filer’s head office is in Mississauga, Ontario.
The Filer is the manager, trustee and promoter of the Fund and is not in default of the Legislation.
Each Fund is a mutual fund to which NI 81-102 applies. Securities of Series A and F of the Present Fund are currently qualified for sale by fund facts, simplified prospectus and annual information form dated September 30, 2011 that has been prepared and filed and receipted in all Jurisdictions.
Each Fund is or will be a reporting issuer in all of the Jurisdictions and is not in default under the securities legislation in force in any Jurisdiction.
The Present Fund’s investment objective is to achieve returns that are similar to an emerging market bond fund that invests primarily in fixed and floating-rate debt securities issued by corporations, governments, or government related entities of developing or emerging nations, less transactions and hedging costs. The Present Fund’s investment objectives state that it may use specified derivatives to seek to provide these returns.
Each Fund’s investment objective will be to achieve returns that are similar to another mutual fund and each Fund may use specified derivatives to seek to provide these returns.
Each Fund invests its assets in equity securities of Canadian public issuers (“Equity Portfolio”) that are Canadian securities for the purposes of the Income Tax Act (Canada). The Equity Portfolio is a static portfolio that is not actively managed except in limited circumstances. Each Fund also enters into forward contracts with one or more financial institutions (each a “Counterparty”) to effectively replace the economic return on its Equity Portfolio with the economic return on another mutual fund (the “Reference Fund”) to achieve the Fund’s investment objective.
Each Fund pledges its Equity Portfolio to the Counterparty (or the portion thereof that is subject to the relevant forward contract with that Counterparty) as collateral security for performance of the Fund’s obligations under its forward contract with that Counterparty. The Equity Portfolio (or that portion thereof) is held by the Counterparty as security for the Fund’s obligations pursuant to that applicable forward contract.
The Filer proposes to engage in securities lending transactions on behalf of each Fund that may represent up to 100% of the net assets of that Fund, in order to earn additional returns for that Fund. The Filer proposes to arrange for the Equity Portfolio to be lent to one or more borrowers indirectly through one or more Agents, other than the Fund’s custodian or sub-custodian.
Each Agent shall be acceptable to the Fund and Counterparty and shall be either a Canadian financial institution (including a Counterparty) or an affiliate of a Canadian financial institution. It is not commercially practical for the Fund’s custodian to act as Agent with respect to the Fund’s securities lending transactions as the custodian will not have control over the Fund’s Equity Portfolio for the reason set out in paragraph 8 above.
The Filer will ensure that any Agent through which a Fund lends securities maintains appropriate internal controls, procedures, and records for securities lending transactions as prescribed in subsection 2.16(2) of NI 81-102.
A Counterparty must release its security interest in the securities in the Equity Portfolio of the Fund in order to allow the Fund to lend such securities, but will only do so provided that the Fund grants the Counterparty a security interest in the collateral held by the Fund pursuant to the security lending transaction.
To facilitate the Counterparty's release of its security interest in the securities of the Equity Portfolio of a Fund, securities in the Equity Portfolio will be loaned only to borrowers that are acceptable to the Fund and the Counterparty, and that have an "approved credit rating" as defined in NI 81-102 or whose obligations are unconditionally guaranteed by persons or companies that have such a credit rating.
A borrower may include an affiliate of the Counterparty. Whether the borrower is an affiliate or not an affiliate of the Counterparty or the Agent will not affect the revenues from securities lending transactions received by the Fund.
To facilitate the Counterparty’s perfection of its security interest in the collateral for the loaned securities, the Filer will ensure that such collateral is held by a registered dealer and member of the Investment Industry Regulatory Organization of Canada (IIROC).
The collateral received by a Fund in respect of a securities lending transaction, and in which the Counterparty will have a security interest, will be in the form of cash, qualified securities and/or other collateral permitted by NI 81-102, other than collateral described in subsection 2.12(1)6(d) or in paragraph (b) of the definition of "qualified security". The non-cash collateral will be held by the Agent in the name of the Fund and will not be reinvested in any other types of investment products.
Revenue generated from a Fund’s securities lending transactions will be paid to such Fund.
The Filer will ensure that the Agent administering the securities lending transaction of each Fund is subject to the standard of care prescribed in subsection 2.15(5) of NI 81-102.
The prospectus of each Fund discloses that the Fund may enter into securities lending transactions. Other than as set forth herein, any securities lending transactions on behalf of the Fund will be conducted in accordance with the provisions of NI 81-102.
Decision
The principal regulator is satisfied that the test contained in the Legislation that provides the principal regulator with the jurisdiction to make the decision has been met.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that:
(a) with respect to the exemption from subsection 2.12(1)12 of NI 81-102, each Fund enters into a forward contract with an applicable Counterparty and grants that Counterparty a security interest in the securities subject to that forward contract and, in connection with a securities lending transaction relative to those securities,
(i) receives the collateral that
(A) is prescribed by subsections 2.12(1)3 to 6 of NI 81-102 other than collateral described in subsection 2.12(1)6(d) or in paragraph (b) of the definition of "qualified security";
(B) is marked to market on each business day in accordance with subsection 2.12(1)7 of NI 81-102;
(ii) has the rights set forth in subsections 2.12(1)8, 2.12(1)9 and 2.12(1)11 of NI 81-102;
(iii) complies with subsection 2.12(1)10 of NI 81-102; and
(iv) lends its securities only to borrowers that are acceptable to the Fund and the Counterparty, and that have an approved credit rating (as defined in NI 81-102) or whose obligations to the Fund are fully and unconditionally guaranteed by persons or companies that have such a credit rating;
(b) with respect to the exemption from subsection 2.12(3) of NI 81-102, the Fund provides a security interest to the applicable Counterparty in the collateral delivered to it as collateral pursuant to a securities lending transaction as described in representation 12;
(c) with respect to the exemption from section 2.15 of NI 81-102:
(i) each Fund enters into a written agreement with an Agent that complies with each of the requirements set forth in subsection 2.15(4) of NI 81-102, except as set out herein;
(ii) the Agent administering the securities lending transaction of each Fund shall be acceptable to the Fund and Counterparty and shall be either a bank or trust company described in paragraph 1 or 2 of section 6.2 of NI 81-102 or the investment bank affiliate of such bank or trust company that is registered as an investment dealer or in an equivalent registration category;
(d) with respect to the exemption from section 2.16 of NI 81-102, the Filer and the Funds comply with the requirements of section 2.16 of NI 81-102 as if references to an "agent appointed under section 2.15" in that section are references to an "agent appointed by the manager"; and
(e) with respect to the exemption from subsection 6.8(5) of NI 81-102, each Fund:
(i) provides a security interest to the applicable Counterparty in the collateral delivered to it as collateral pursuant to a securities lending transaction as described in representation 12; and
(ii) the collateral delivered to the Fund pursuant to the securities lending transaction is held by a registered dealer and member of the IIROC as described in representation 15.
“Darren McKall”
Darren McKall
Manager, Investment Funds Branch
Ontario Securities Commission
SEDAR # 1896028