November 18, 2019
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 Guardian Capital LP (the Filer)
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of Guardian Strategic Income Fund (GSIF), any alternative mutual fund established in the future and managed by the Filer or an affiliate of the Filer (together with GSIF, the Alternative Mutual Funds) and any current or future mutual fund, other than an Alternative Mutual Fund, managed by the Filer or an affiliate of the Filer (each, a Mutual Fund and, together with the Alternative Mutual Funds, the Funds) for a decision under the securities legislation of the principal regulator (the Legislation) exempting the Funds from the requirement set out in subsection 6.1(1) of National Instrument 81-102 Investment Funds (NI 81-102) that provides that, except as provided in section 6.8, 6.8.1 and 6.9 of NI 81-102, all portfolio assets of an investment fund must be held under the custodianship of one custodian that satisfies the requirements of section 6.2, in order to permit a Fund to deposit portfolio assets with a borrowing agent that is not the Fund’s custodian or sub-custodian in connection with a short sale of securities, if the aggregate market value of the portfolio assets held by the borrowing agent after such deposit, excluding the aggregate market value of the proceeds from outstanding short sales of securities held by the borrowing agent, does not:
(a) in the case of each Mutual Fund, exceed 10% of the net asset value (NAV) of the Mutual Fund at the time of deposit; and
(b) in the case of each Alternative Mutual Fund, exceed 25% of the NAV of the Alternative Mutual Fund at the time of deposit,
(the Exemption Sought).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission is the principal regulator for the 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 all of the provinces and territories of Canada other than the Jurisdiction (together with the Jurisdiction, the Jurisdictions).
Interpretation
Terms defined in National Instrument 14-101 Definitions, MI 11-102 and NI 81-102 have the same meaning if used in this decision, unless otherwise defined.
Prime Broker means any entity that acts as, among other things, a borrowing agent to one or more investments funds.
Representations
This decision is based on the following facts represented by the Filer:
The Filer is a limited partnership established under the laws of the Province of Ontario. The general partner of the Filer is Guardian Capital Inc., a corporation incorporated under the laws of the Province of Ontario. The Filer’s head office is located in Toronto, Ontario.
The Filer is registered as a portfolio manager and exempt market dealer in each province of Canada and as an investment fund manager in each of Ontario, Québec and Newfoundland and Labrador. The Filer is also registered as a commodity trading counsel and commodity trading manager in Ontario.
The Filer or an affiliate of the Filer is, or will be, the investment fund manager of each of the Funds.
Since May 27, 2013, the series A, series F, series I and series X units of GSIF have been distributed to investors on a prospectus-exempt basis in accordance with National Instrument 45-106 Prospectus Exemptions (NI 45-106) in each Jurisdiction.
The Filer has filed a simplified prospectus, annual information form and fund facts (the Disclosure Documents) with respect to the series A, series F and series I units (the Units) of GSIF under which GSIF will distribute Units to the public, thereby becoming a reporting issuer under the securities legislation of the Jurisdictions except for Québec. In addition, GSIF will become subject to the requirements of NI 81-102 that relate to alternative mutual funds and to the requirements of NI 81-106 that apply to investment funds that are reporting issuers. The series X units of GSIF will continue to be offered only on a prospectus-exempt basis.
Each Fund is, or will be, a reporting issuer in one or more Jurisdictions and distributes its units to the public pursuant to disclosure documents prepared and filed in accordance with National Instrument 81-101 Mutual Fund Prospectus Disclosure or National Instrument 41-101 General Prospectus Requirements.
None of the Filer, GSIF, or an existing Fund is in default of securities legislation in any Jurisdiction.
In connection with, among other things, the short sale of securities that the Funds will or may engage in, each Fund is permitted to grant a security interest in favour of, and deposit pledged portfolio assets with, the entity that acts as, among other things, a Prime Broker to it, whether the Fund is an Alternative Mutual Fund or a Mutual Fund.
Effective as of January 3, 2019, NI 81-102 was amended to include alternative mutual funds. The ability of alternative mutual funds to borrow cash and to sell short securities more extensively than other investment funds governed by NI 81-102 has led to the increased involvement of Prime Brokers in the operations of these alternative mutual funds. While the prime brokerage model works well in the exempt investment fund space, the prime brokerage community and investment fund managers are experiencing greater difficulties in applying that model to alternative mutual funds and other investment funds under NI 81-102.
Under section 6.8.1 of NI 81-102, if a Mutual Fund engages as its Prime Broker an entity that is not its custodian or sub-custodian, then it may only deliver to its Prime Broker portfolio assets having a market value, in the aggregate, of not more than 10% of the NAV of the Mutual Fund at the time of deposit. If an Alternative Mutual Fund engages as its Prime Broker an entity that is not its custodian or sub-custodian, then it may only deliver to its Prime Broker portfolio assets having a market value, in the aggregate, of not more than 25% of the NAV of the Alternative Mutual Fund at the time of deposit.
A Prime Broker may not wish to act as borrowing agent for a Mutual Fund that wants to sell short securities having an aggregate market value of up to 20% of the Mutual Fund’s NAV if the Prime Broker is only permitted to hold as security for such transactions portfolio assets, including the proceeds from the short sale, having an aggregate market value that is not in excess of 10% of the NAV of the Mutual Fund.
The issue is even greater in the context of an Alternative Mutual Fund, as a Prime Broker will not want to act as borrowing agent for an Alternative Mutual Fund that wants to sell short securities having an aggregate market value of up to 50% of the Alternative Mutual Fund’s NAV if the Prime Broker is only permitted to hold as security for such transactions portfolio assets, including the proceeds from the short sale, having an aggregate market value that is not in excess of 25% of the NAV of the Alternative Mutual Fund.
The prime brokerage operational and pricing models in the context of short selling are premised on the ability of the Prime Broker to retain, as collateral for the obligations of the applicable Fund, the proceeds from the short sales, whether such proceeds are cash or are used by the Fund to purchase other portfolio assets. These models are also based on the ability of the Prime Broker to hold additional assets of the Fund as collateral for those obligations.
Many Prime Brokers are not appointed as custodians or sub-custodians under NI 81-102, as it can be operationally challenging to appoint them to act in that capacity.
Given the collateral requirements that Prime Brokers impose on their customers that engage in the short sale of securities, if the 10% and 25% of NAV limitations set out in section 6.8.1 of NI 81-102 apply, then the Funds will need to retain two or more Prime Brokers in order to sell short securities to the extent permitted under section 2.6.1 of NI 81-102. This will result in inefficiencies for the Funds, increase their costs of operations, reduce returns and negatively impact investors.
While the collateral limits for the short sale of securities is currently topical in the context of alternative mutual funds, the Filer submits that there is no policy reason to differentiate between Alternative Mutual Funds and Mutual Funds to the extent that Mutual Funds also engage in the short selling of securities.
The Filer submits that it is not prejudicial to the public interest to grant the Exemption Sought.
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 the Funds otherwise comply with subsections 6.8.1(2) and (3) of NI 81-102.
“Darren McKall”
Darren McKall, Manager, Investment Funds and Structured Products Branch Ontario Securities Commission
Application No. 2019/0546
SEDAR Project No. 2983497