September 14, 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 INVESCO CANADA LTD. (the Filer)
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Filer on its behalf and on behalf of Invesco Intactive Strategic Capital Yield Portfolio Class (the “Invesco Top Fund”), a mutual fund managed by the Filer, for an exemption from section 2.7(4) of National Instrument 81-102 Investment Funds (“NI 81-102”) pursuant to section 19.1 of NI 81-102 (the “Exemption Sought”) to permit the Invesco Top Fund to maintain the Forward (as defined below) where the mark-to-market exposure of the Invesco Top Fund under the Forward with the Counterparty (as defined below) exceeds, for a period of 30 days or more, 10% of the net asset value of the Invesco Top Fund.
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;
b. the Filer has provided notice that section 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, Quebec, New Brunswick, Nova Scotia, Newfoundland and Labrador, Prince Edward Island, Northwest Territories, Nunavut and Yukon.
Interpretation
Defined terms contained in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision unless they are defined in this decision. The following additional terms shall have the following meanings:
“Counterparty” means the counterparty to the forward contract with the Invesco Top Fund.
“ICCI” means Invesco Corporate Class Inc.
“ITA” means Income Tax Act (Canada).
“Reference Fund” means Invesco Intactive Strategic Yield Portfolio.
Representations
The head office of the Filer is located in Toronto, Ontario.
The Filer is the manager of the Invesco Top Fund and the Reference Fund.
The Filer is not in default of securities legislation in any jurisdiction in Canada.
Pursuant to the October 30, 2014 decision In the Matter of Invesco Canada Ltd. (the “Prior Relief”), the Filer obtained relief on behalf of PowerShares Tactical Bond Capital Yield Class and the Invesco Top Fund from section 2.7(4) of NI 81-102 to permit each of PowerShares Tactical Bond Capital Yield Class and the Invesco Top Fund (collectively, the “Top Funds”) to maintain a Forward (as defined below) where the mark-to-market exposure of the Top Fund under the Forward with the Counterparty exceeds, for a period of 30 days or more, 10% but is no more than 20% of the net asset value of the Top Fund.
As of August 7, 2015, PowerShares Tactical Bond Capital Yield Class merged into PowerShares Tactical Bond Fund.
As of the date of this decision, the Filer will no longer rely on the Prior Relief.
The Invesco Top Fund is (a) an open-ended mutual fund that is a class of shares of ICCI, a corporation amalgamated under the laws of the Province of Ontario; (b) a reporting issuer in every jurisdiction in Canada but no longer offers it securities for sale to the general public; and (c) not in default of securities legislation in any jurisdiction in Canada.
The investment objectives of the Invesco Top Fund seek to provide returns (before fees and expenses) similar to those of the Reference Fund on a tax-efficient basis.
The Invesco Top Fund seeks to achieve its investment objective by investing primarily in Canadian equity securities (the “Equity Basket”) and by entering into a forward contract (the “Forward”) with the Counterparty pursuant to which on the settlement date the Counterparty will deliver the investment return of a notional number of securities of the Reference Fund less the cost of the Forward and any hedging costs incurred by the Counterparty (collectively, the “Forward Fee”) and the Invesco Top Fund will deliver the Equity Basket. The Invesco Top Fund may also invest directly in securities of the Reference Fund.
The Reference Fund is: (a) an open-ended mutual fund trust established under the laws of the Province of Ontario whose securities are offered for sale to the general public under a simplified prospectus filed in every jurisdiction in Canada; (b) a reporting issuer in every jurisdiction in Canada; and (c) not in default of any securities legislation in any jurisdiction of Canada.
The Counterparty may but is not obliged to hedge its obligations under the Forward by purchasing securities of the Reference Fund.
The investment of the Invesco Top Fund in the Reference Fund (either through the Forward or by directly purchasing securities of the Reference Fund) complies with the requirements of section 2.5 of NI 81-102 as amended by relief obtained by the Invesco Top Fund.
The Forward has a 5 year term. The maturity date for the Forward of the Invesco Top Fund is May 17, 2017. The terms of the Forward provides that it may be partially settled prior to its maturity. If there is a partial pre-settlement, the Invesco Top Fund will deliver a portion of the Equity Basket to the Counterparty who will deliver an amount equal to the return on a notional number of securities of the Reference Fund less the Forward Fees. This partial pre-settlement will result in the Invesco Top Fund realizing a capital gain or a capital loss for tax purposes on the sale of a portion of the Equity Basket.
The Forward is entered into by the Invesco Top Fund in accordance with the requirements of NI 81-102, including in particular sections 2.7 and 2.8 thereof.
Since the Invesco Top Fund began offering its securities to the public, it has solely used the Counterparty as the counterparty to the Forward.
The Counterparty is a foreign entity whose obligations are fully guaranteed by a Canadian financial institution.
The Canadian financial institution is a Schedule I bank under the Bank Act (Canada) which currently has a designated rating by a designated rating organization.
The Counterparty is not an acceptable clearing corporation or a clearing corporation that clears and settles transactions made on a futures exchange listed in Appendix A of NI 81-102.
Pursuant to section 2.7(4) of NI 81-102, the mark-to market exposure of a mutual fund under a specified derivative with a counterparty may not exceed 10% of the net asset value of the fund (the “Maximum Exposure”) for a period of 30 days or more.
The mark-to market exposure of the Invesco Top Fund to the Counterparty has on several occasions exceeded the Maximum Exposure for a period exceeding 30 days since the granting of the Prior Relief.
In light of the current Canadian equity market volatility, there is a possibility that the Invesco Top Fund’s exposure to its Counterparty will continue to exceed the Maximum Exposure for 30 days or more.
Under normal conditions, the Invesco Top Fund would partially pre-settle its Forward with the Counterparty to reduce the mark-to-market exposure to the Counterparty and would have the flexibility in the future to upsize or increase the size of the Forward when the mark-to-market exposure of the Counterparty improved.
The 2013 federal budget introduced section 12(1)(z.7)(ii) of the ITA which provision requires all profits from a derivative forward contract to be treated on account of income rather than capital. Under the transitional rules, section 12(1)(z.7)(ii) of the ITA generally only applies to the proceeds of forward contracts that were entered into after March 20, 2013.
As a result of the introduction of section 12(1)(z.7)(ii) of the ITA, it is not possible for the Invesco Top Fund to:
i) enter into any new forward contract with a counterparty where the profits from that forward contract will be treated on account of capital on maturity of that forward contract;
ii) extend the term of the existing Forward under any circumstances; or
iii) upsize or increase the size of the existing Forward except under limited circumstances, namely where the Invesco Top Fund holds cash as of March 20, 2013 which cash was committed to be used to upsize or increase the size of the existing Forward.
- Accordingly, while it is possible for the Invesco Top Fund to partially pre-settle the Forward to reduce its counterparty exposure, it is not desirable to do so as it will not be able to upsize or increase the size of the Forward or enter into a comparable forward contract with the Counterparty or another counterparty in the future as:
i) any such upsizing or increasing the size of the Forward would taint the entire Forward, namely, all profits from the Forward on maturity (not only the portion upsized or increased) would be treated on account of income rather than capital; and
ii) entering into a new forward contract with the Counterparty or another counterparty will result in the profits of that forward contract on maturity being treated on account of income rather than capital.
In both instances, this would be contrary to the investment objectives of the Invesco Top Fund, namely to provide tax efficient returns.
The Filer has considered a direct investment in the Reference Fund by the Invesco Top Fund. However, this is not desirable as the Reference Fund will distribute income to the Invesco Top Fund. As the Invesco Top Fund is part of ICCI, each year all income of the Invesco Top Fund together with all other funds that are classes of ICCI (the “ICCI Classes”) are aggregated and deducted against (i) all expenses of the ICCI Classes, and (ii) any non-capital loss carryforwards of ICCI. To the extent that the income exceeds expenses and loss carryforwards, ICCI will become taxable. Accordingly, any direct investment by the Invesco Top Fund in the Reference Fund should only be considered as a last resort measure to ensure the Invesco Top Fund meet its investment objectives until the maturity date of the Forward.
At the time of applying for the Prior Relief and at the time of applying for the Exemption Sought, the Filer also considered several other alternatives to the Exemption Sought, but has determined that such other alternatives were at that point and are at this point neither desirable nor in the best interests of the securityholders of the Invesco Top Fund.
The Exemption Sought is in the best interests of the Invesco Top Fund.
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 is that the Exemption Sought is granted provided that:
(a) the mark-to-market value of the exposure of the Invesco Top Fund to the Counterparty under the Forward does not exceed, for a period of 30 days or more, 20% of the net asset value of the Invesco Top Fund;
(b) the Forward for the Invesco Top Fund mature on May 17, 2017 and that the terms of such Forward is not extended;
(c) the Counterparty’s obligations under the Forward continue to be guaranteed by a Canadian financial institution which financial institution is a Schedule I bank under the Bank Act (Canada) which has a designated rating by a designated rating organization; and
(d) securities of the Invesco Top Fund are not, and will not be made, available for sale to investors.
This decision will terminate on May 17, 2017.
“Stephen Paglia”
Stephen Paglia
Acting Manager, Investment Funds and Structured Products
Ontario Securities Commission
SEDAR Project No. 2381739