June 5, 2015
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 Investment 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 a designated 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 a designated 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 an investment 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 clearing organization registered with the CFTC or central counterparty authorized by ESMA, as the case may be, that, in either case, is also 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
EMIR means the European Market Infrastructure Regulation
ESMA means the European Securities and Markets Authority
European Economic Area means all of the European Union countries and also Iceland, Liechtenstein and Norway
Existing PIMCO Funds means each mutual fund managed by PIMCO that is relying on the Previous Relief on the date of this decision
Futures Commission Merchant means any futures commission merchant that is registered with the CFTC and/or clearing member for purposes of EMIR, as applicable, 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 or a clearing obligation issued by the CFTC or ESMA, as the case may be, 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 and the PIMCO Funds
1The 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.
2The 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.
3Each 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.
4Neither the Filer nor the PIMCO Funds are, or will be, in default of securities legislation in any Jurisdiction.
5The 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 Previous Cleared Swaps Relief
6In a decision document dated June 7, 2013, the PIMCO Funds were granted relief from the requirements in subsections 2.7(1), 2.7(4) and 6.1(1) to permit the PIMCO Funds to enter into cleared swaps that are, or will be, subject to a clearing determination issued by the CFTC (the “Previous Relief”). The Previous Relief, in accordance with its terms, terminates on June 7, 2015.
7The Filer is seeking the Requested Relief in this new decision to extend the term of the Previous Relief and to vary the Previous Relief by permitting the PIMCO Funds to also enter into cleared swaps that become subject to a clearing obligation under EMIR.
Cleared Swaps
8The 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.
9Dodd-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, that Swap must be cleared, absent an available exception.
10EMIR will also require that certain OTC derivatives be cleared through a central counterparty authorized to provide clearing services for purposes of EMIR. Generally, where one party to a Swap is a financial counterparty or a non-financial counterparty whose OTC derivative trading activity exceeds a certain threshold, in each case established in a state that is a participant in the European Economic Area, that Swap will be required to be cleared. As at the date of this decision, no clearing obligation has been issued under EMIR; the first clearing directive is expected to be issued in the third quarter of 2015 and will be phased-in based on the category of both parties to the trade.
11In 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 wishes to enter into cleared Swaps on behalf of the PIMCO Funds.
12In 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 and under EMIR, as applicable. 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.
13The Filer strongly believes that it is in the best interests of the PIMCO Funds and their investors to continue to execute OTC derivatives with global counterparties, including U.S. and European swap dealers.
14In 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.
15PIMCO 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 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.
16As 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 and under EMIR by granting them the Requested Relief.
17The 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.
18For 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 when any rules applicable to customer clearing of OTC derivatives enter into force, the Clearing Corporation is permitted to offer customer clearing of OTC derivatives in the Jurisdiction or the Other Jurisdiction, as the case may be, where the PIMCO Fund is located and provided further 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 coming into force of any revisions to the provisions of NI 81-102 that address the clearing of OTC derivatives.
“Darren McKall”
Darren McKall, Manager
Investment Funds and Structured Products Branch
Ontario Securities Commission
SEDAR Project #2336882
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. and European requirements to clear over-the-counter derivatives including swaps – decision treats cleared swaps similar to other cleared derivatives – National Instrument 81-102 Investment Funds
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.7(1) and (4), 6.8(1), 19.1