Headnote National Policy 11-203 Process For Exemptive Relief Applications in Multiple Jurisdictions - exemption from sections sections 2.8(1)(d) and (f)(i) of National Instrument 81-102 – Mutual Funds 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, a right or obligation 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, ss. 2.8(1) and s. 19.1
September 24, 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
MACKENZIE FINANCIAL CORPORATION
(the Filer)
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of all existing and future mutual 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 (the Fund(s)), for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for an exemption, pursuant to section 19.1 of NI 81-102, from sections 2.8(1)(d) and 2.8(1)(f)(i) of NI 81-102 (the Exemption Sought), when:
(i) a Fund 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) a Fund enters into or maintains a swap position and during the periods when the Fund is entitled to receive payments under the swap,
to permit the Fund 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 (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 British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, the Northwest Territories, Nunavut and Yukon (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.
Representations
This decision is based on the following facts represented by the Filer:
The Filer
The Filer is a corporation governed by the laws of Ontario and is registered as a portfolio manager and exempt market dealer in all of the provinces and territories of Canada. The Filer is also registered as a commodity trading manager in Ontario and as an investment fund manager in each of Ontario, Québec and Newfoundland.
The Filer is, or will be, the manager and the portfolio manager of the Funds. As portfolio manager, the Filer manages, or will manage, the derivatives strategies of the Funds or appoints, or will appoint, a sub-advisor to manage such derivatives strategies.
The Funds
Each Fund is, or will be, an open-ended mutual fund established under the laws of Ontario.
Units of each Fund are, or will be, offered by a simplified prospectus filed in each province and territory of Canada and, accordingly, each Fund is, or will be, a reporting issuer in each province and territory of Canada.
The Filer and the existing Funds are not in default of securities legislation in any jurisdiction of Canada.
The investment objective and investment strategies of each Fund are, or will be, set out in the Fund’s simplified prospectus. As part of its investment strategies, each Fund may invest in specified derivatives in order to seek exposure to securities or markets. The Fund may also use derivatives to hedge against potential loss.
When specified derivatives are used for non-hedging purposes, each Fund is, or will be, subject to the cover requirements of NI 81-102.
Exemption Sought
Sections 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, forward or swap positions to cover long future, forward or swap positions.
Regulatory regimes in other countries and common investment practices 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 the 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.
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 Funds should be permitted to cover a long position in a future, forward or swap with a put option or a short future position.
The Filer has written policies and procedures relating to the use of derivatives by the Funds. The Filer’s Fund Services Department records, values, monitors and reports on derivative transactions that are entered into by the Funds. A monthly derivative trading report is prepared on a fund-by-fund basis identifying derivative activity, credit rating analysis, concentration levels and compliance with regulatory requirements. Copies of these monthly reports are provided to the designated Senior Vice-President, Investments, the Chief Financial Officer, Funds and the Compliance Department of the Filer. A summary of the reports and analysis of the overall use of derivatives by the Funds is reviewed by the Fund Oversight Committee of the Board of Directors of the Filer at least annually.
The annual information form of the Funds discloses, or will disclose, the internal controls and risk management processes of the Filer regarding the use of derivatives. The simplified prospectus and annual information form, upon renewal, will include disclosure of the nature of the Exemption Sought.
Without the Exemption Sought, the Funds will not have the flexibility to enhance yield and to manage more effectively any exposure they may have 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 the decision.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that:
(a) when a Fund enters into or maintains a swap position for periods when the Fund would be entitled to receive fixed payments under the swap, the Fund 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 Fund under the swap less the obligations of the Fund 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 Fund, to enable the Fund to satisfy its obligations under the swap;
(b) when a Fund 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 Fund 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 market 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 Fund, to enable the Fund to acquire the underlying interest of the future or forward contract;
(c) a Fund 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) or (f) of NI 81-102 if, immediately after the purchase or writing of such option, more than 10% of the net asset value of the Fund 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 Fund for purposes other than hedging, or (B) options used to cover any position under section 2.8(1)(b), (c), (d), (e) or (f) of NI 81-102;
(d) on the date that is the earlier of (i) the date when an amendment to the annual information form of a Fund is filed for reasons other than the Exemption Sought and (ii) the date that the renewal annual information form of a Fund is receipted, the Fund shall:
(i) disclose the nature and terms of the Exemption Sought in the annual information form of the Fund; and
(ii) include a summary of the nature and terms of the Exemption Sought in the simplified prospectus of the Fund under the Investment Strategies section or in the introduction to Part B of the simplified prospectus with a cross reference thereto under the Investment Strategies section for the Fund; and
(e) this decision 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.
“Vera Nunes”
Vera Nunes, Manager
Investment Funds Branch
Headnote
National Policy 11-203 Process For Exemptive Relief Applications in Multiple Jurisdictions - exemption from sections sections 2.8(1)(d) and (f)(i) of National Instrument 81-102 – Mutual Funds 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, a right or obligation 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, ss. 2.8(1) and s. 19.1