Headnote
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – relief from certain specified derivatives and custodial requirements to permit mutual funds to enter into swap transactions that are cleared through a clearing corporation – relief required because of new U.S. requirements to clear over-the-counter derivatives including swaps - decision treats cleared swaps similar to other cleared derivatives – National Instrument 81-102 Mutual Funds
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, ss. 2.7(1) and (4), 6.8(1), 19.1
June 7, 2013
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
PIMCO CANADA CORP.
(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), pursuant to section 19.1 of National Instrument 81-102 Mutual Funds (NI 81-102), exempting each Existing PIMCO Fund (as defined below) and all current and future mutual funds managed by the Filer that enter into Swaps (as defined below) in the future (each, a Future PIMCO Fund and, together with the Existing PIMCO Funds, each, a PIMCO Fund and, collectively, the PIMCO Funds):
(i) from the requirement in subsection 2.7(1) of NI 81-102 that a mutual fund must not purchase an option or a debt-like security or enter into a swap or a forward contract unless, at the time of the transaction, the option, debt-like security, swap or contract has an approved credit rating or the equivalent debt of the counterparty, or of a person or company that has fully and unconditionally guaranteed the obligations of the counterparty in respect of the option, debt-like security, swap or contract, has an approved credit rating;
(ii) from the limitation in subsection 2.7(4) of NI 81-102 that the mark-to-market value of the exposure of a mutual fund under its specified derivatives positions with any one counterparty other than an acceptable clearing corporation or a clearing corporation that settles transactions made on a futures exchange listed in Appendix A to NI 81-102 shall not exceed, for a period of 30 days or more, 10 percent of the net asset value of the mutual fund; and
(iii) from the requirement in subsection 6.1(1) of NI 81-102 to hold all portfolio assets of a mutual fund under the custodianship of one custodian in order to permit each PIMCO Fund to deposit cash and portfolio assets directly with a Futures Commission Merchant (as defined below) and indirectly with a Clearing Corporation (as defined below) as margin,
in each case, with respect to cleared Swaps (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 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 the other provinces and territories of Canada (the Other Jurisdictions).
Interpretation
Terms defined in NI 81-102, National Instrument 14-101 Definitions, and MI 11-102 have the same meaning if used in this decision, unless otherwise defined. Capitalized terms used in this decision have the following meanings:
“CFTC” means the U.S. Commodity Futures Trading Commission
“Clearing Corporation” means any of the Chicago Mercantile Exchange Inc., ICE Clear Credit LLC, LCH.Clearnet Limited and any other clearing organization that is permitted to operate in the Jurisdiction or the Other Jurisdiction, as the case may be, where the PIMCO Fund is located
“Dodd-Frank” means the Dodd-Frank Wall Street Reform and Consumer Protection Act
“Existing PIMCO Funds” means any of PIMCO Canadian Short Term Bond Fund, PIMCO Canadian Total Return Bond Fund, PIMCO Canadian Long Term Bond Fund, PIMCO Canadian Real Return Bond Fund, PIMCO Monthly Income Fund (Canada), PIMCO Global Advantage Strategy Bond Fund (Canada), PIMCO Global Balanced Fund (Canada) and PIMCO EqS Pathfinder Fund^TM^ (Canada)
“Futures Commission Merchant” means any futures commission merchant that is registered with the CFTC and is a member of a Clearing Corporation
“OTC” means over-the-counter
“PIMCO” means the global PIMCO group of companies, including the Filer, Allianz Asset Management of America L.P., Pacific Investment Management Company LLC, PIMCO Europe Ltd. and their affiliates
“Swaps” means the swaps that are, or will become, subject to a clearing determination issued by the CFTC, including fixed-to-floating interest rate swaps, basis swaps, forward rate agreements in U.S. dollars, the Euro, Pounds Sterling or the Japanese Yen, overnight index swaps in U.S. dollars, the Euro and Pounds Sterling and untranched credit default swaps on certain North American indices (CDX.NA.IG and CDX.NA.HY) and European indices (iTraxx Europe, iTraxx Europe Crossover and iTraxx Europe HiVol) at various tenors
“U.S. Person” has the meaning attributed thereto by the CFTC
Representations
This decision is based on the following facts represented by the Filer:
The Filer is, or will be, the investment fund manager of each PIMCO Fund. The Filer is registered as an investment fund manager in the Provinces of Ontario, Québec and Newfoundland and Labrador and is registered as a portfolio manager and exempt market dealer in the Provinces of Ontario, Alberta, British Columbia, Manitoba, Nova Scotia, Québec and Saskatchewan. The Filer is also registered under the Commodity Futures Act (Ontario) in the category of commodity trading manager in the Province of Ontario, as a derivatives portfolio manager in the Province of Québec and as an adviser in the Province of Manitoba. The head office of the Filer is in Toronto, Ontario.
The Filer is, or will be, the portfolio manager to the PIMCO Funds and one of the PIMCO companies, each of which is an affiliate of the Filer, is, or will be, the sub-advisor to the PIMCO Funds.
Each PIMCO Fund is, or will be, a mutual fund created under the laws of the Province of Ontario and is, or will be, subject to the provisions of NI 81-102.
Neither the Filer nor the PIMCO Funds are, or will be, in default of securities legislation in any Jurisdiction.
The securities of each PIMCO Fund are, or will be, qualified for distribution pursuant to a prospectus that was, or will be, prepared and filed in accordance with the securities legislation of the Jurisdictions. Accordingly, each PIMCO Fund is, or will be, a reporting issuer or the equivalent in each Jurisdiction.
The investment objective and investment strategies of each PIMCO Fund permit, or will permit, the PIMCO Fund to enter into derivative transactions, including Swaps. The portfolio management team of the Existing PIMCO Funds consider Swaps to be an important investment tool that is available to it to properly manage each PIMCO Fund’s portfolio. As at the end of April, 2013, the Existing PIMCO Funds have entered into foreign exchange swaps, interest rate swaps and credit default swaps on single names and indices that had an aggregate absolute notional value of approximately $4.8 billion.
Dodd-Frank requires that certain OTC derivatives be cleared through a Futures Commission Merchant at a Clearing Corporation. Generally, where one party to a Swap is a U.S. Person and the other party to the Swap is a mutual fund, such as a PIMCO Fund, that Swap must be cleared, absent an available exception, beginning on June 10, 2013. With respect to entities such as the PIMCO Funds, the compliance date for the clearing of iTraxx CDS indices is July 25, 2013.
Currently, the PIMCO Funds enter into Swaps on an OTC basis with a number of Canadian, U.S. and other international counterparties. These OTC Swaps are entered into in compliance with the derivative provisions of NI 81-102.
In order to benefit from both the pricing benefits and reduced trading costs that PIMCO is often able to achieve through its trade execution practices for its managed investments funds and from the reduced costs associated with cleared OTC derivatives as compared to other OTC trades, PIMCO has started to enter into cleared Swaps on behalf of the PIMCO Funds in compliance with NI 81-102 and wishes to be able to deliver margin to Futures Commission Merchants.
In the absence of the Requested Relief, PIMCO may need to structure certain Swaps entered into by the PIMCO Funds so as to avoid the clearing requirements of the CFTC. The Filer respectfully submits that this would not be in the best interests of the PIMCO Funds and their investors for a number of reasons, as set out below.
The Filer strongly believes that it is in the best interests of the PIMCO Funds and their investors to continue to execute OTC derivatives with U.S. Persons, including U.S. swap dealers, after June 10, 2013.
In its role as a fiduciary for the PIMCO Funds, the Filer has determined that central clearing represents the best choice for the investors in the PIMCO Funds to mitigate the legal, operational and back office risks faced by investors in the global swap markets.
PIMCO currently uses the same trade execution practices for all of its managed funds, including the PIMCO Funds. An example of these trade execution practices is block trading, where large number of securities are purchased or sold or large derivative trades are entered into on behalf of a number of investment funds advised by PIMCO. These practices include the use of cleared Swaps if such trades are executed with a U.S. swap dealer. If the PIMCO Funds are unable to employ these trade execution practices, then PIMCO will have to create separate trade execution practices only for the PIMCO Funds and will have to execute trades for the PIMCO Funds on a separate basis. This will increase the operational risk for the PIMCO Funds, as separate execution procedures will need to be established and followed only for the PIMCO Funds. In addition, the PIMCO Funds may no longer be able to enjoy the possible price benefits and reduction in trading costs that PIMCO may be able to achieve through a common practice for its family of investment funds. In PIMCO’s opinion, best execution and maximum certainty can best be achieved through common trade execution practices, which, in the case of OTC derivatives, involve the execution of Swaps on a cleared basis.
As a member of the G20 and a participant in the September 2009 commitment of G20 nations to improve transparency and mitigate risk in derivatives markets, Canada has expressly recognized the systemic benefits that clearing OTC derivatives offers to market participants, such as the PIMCO Funds. The Filer respectfully submits that the PIMCO Funds should be encouraged to comply with the robust clearing requirements established by the CFTC by granting them the Requested Relief.
The Requested Relief is analogous to the treatment currently afforded under NI 81-102 to other types of derivatives that are cleared, such as clearing corporation options, options on futures and standardized futures. This demonstrates that, from a policy perspective, the Requested Relief is consistent with the views of the Canadian securities authorities in respect of cleared derivative trades.
For the reasons provided above, the Filer submits that it would not be prejudicial to the public interest to grant the Requested Relief.
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, in respect of the deposit of cash and portfolio assets as margin:
(a) in Canada,
(i) the Futures Commission Merchant is a member of a SRO that is a participating member of CIPF; and
(ii) the amount of margin deposited and maintained with the Futures Commission Merchant does not, when aggregated with the amount of margin already held by the Futures Commission Merchant, exceed 10 percent of the net asset value of the PIMCO Fund as at the time of deposit; and
(b) outside of Canada,
(i) the Futures Commission Merchant is a member of a Clearing Corporation and, as a result, is subject to a regulatory audit;
(ii) the Futures Commission Merchant has a net worth, determined from its most recent audited financial statements that have been made public or from other publicly available financial information, in excess of the equivalent of $50 million; and
(iii) the amount of margin deposited and maintained with the Futures Commission Merchant does not, when aggregated with the amount of margin already held by the Futures Commission Merchant, exceed 10 percent of the net asset value of the PIMCO Fund as at the time of deposit.
This decision will terminate on the earlier of (i) the coming into force of any revisions to the provisions of NI 81-102 that address the clearing of OTC derivatives, and (ii) two years from the date of this decision.
“Darren McKall”
Darren McKall
Manager, Investment Funds Branch
Ontario Securities Commission