In the Matter of BMO Asset Management Inc., 2020 CanLII 87636

October 2, 2020

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 BMO Asset Management Inc. (BMOAM), BMO Canadian MBS Index ETF (the MBS Index ETF) and each future investment fund managed by BMOAM or an affiliate (collectively, the Filer) whose investment objective is to seek to replicate the performance of a mortgage-backed securities (MBS) index that is a “permitted index” as contemplated in National Instrument 81-102 Investment Funds (NI 81-102) (the fund’s MBS Index) (together with the MBS Index ETF, the MBS Index Funds)

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 (the Legislation) for an exemption from the following restrictions to permit each MBS Index Fund to invest in BMO MBS (defined below) bought on a primary offering (each, a Related Issuer MBS Investment) up to the representation of the BMO MBS in the fund’s MBS Index:

a) the restrictions in securities legislation, in Ontario under subsections 111(2)(a) and (c) of the Securities Act (Ontario) (the Act) (described below), that prohibit an investment fund from knowingly making or holding an investment in (i) any person or company who is a substantial securityholder of the investment fund, its management company or its distribution company (each, a substantial securityholder) or (ii) an issuer in which any officer or director of the investment fund, its management company or distribution company or an associate of any of them, or a substantial securityholder has a significant interest (the Act Relief);

b) the restriction contained in subsection 13.5(2)(a) of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) (described below) (the 31-103 Relief); and

c) the restriction contained in subsection 4.1(2) of NI 81-102 (described below) (the 81-102 Relief);

(the Act Relief, the 31-103 Relief and the 81-102 Relief, collectively, 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,

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 provinces and territories of Canada, other than Ontario (together with Ontario, the Jurisdictions).

Interpretation

Terms defined in MI 11-102, National Instrument 14-101 Definitions, NI 81-102, National Instrument 81-107 Independent Review Committee for Investment Funds (NI 81-107) and NI 31-103 have the same meaning if used in this decision, unless otherwise defined. Additionally:

“Mortgage-backed securities” or “MBS” means debt securities backed by a pool, brought together by an issuer, of loans that are secured by mortgages against real property.

“BMO MBS” means MBS issued by Bank of Montreal (BMO) or a subsidiary otherwise further described in representation 13 below.

Representations

This decision is based on the following facts represented by the Filer:

The Filer and the MBS Index Funds

1. BMOAM is a corporation incorporated under the laws of the Province of Ontario, an indirect wholly-owned subsidiary of BMO and an affiliate of various registered dealers, including BMO Nesbitt Burns Inc. The head office of BMOAM is located in Toronto, Ontario.

2. BMOAM is registered as a portfolio manager and exempt market dealer in each of the Jurisdictions, as an investment fund manager in Ontario, Quebec and Newfoundland and Labrador and as commodity trading manager in Ontario.

3. BMOAM is the manager and portfolio manager of the MBS Index ETF. The Filer may be the manager of future MBS Index Funds and may be the portfolio manager of future MBS Index Funds.

4. The MBS Index Funds are or will be “dealer managed investment funds” as the term is used in NI 81-102 because the Filer, the portfolio manager of the MBS Index Funds, is or will be controlled by BMO, which is a principal shareholder of a specified dealer.

5. Each of the MBS Index Funds is, or will be, a reporting issuer in one or more Jurisdictions and the securities of each MBS Index Fund are, or will be, qualified for distribution in one or more of the Jurisdictions pursuant to a prospectus prepared and filed in accordance with securities legislation.

6. The Filer and the MBS Index ETF are not in default of securities legislation in the Jurisdictions.

MBS Index ETF and FTSE MBS Index

7. The investment objective of the MBS Index ETF is, and the investment objective of future MBS Index Funds will be, to seek to replicate the performance of a MBS Index, net of expenses. Currently, the MBS Index ETF seeks to replicate the performance of the FTSE Canada NHA MBS 975 Index (FTSE MBS Index).

8. A MBS Index is composed of MBS. The FTSE MBS Index is composed of MBS that are issued by Canadian banks. The FTSE MBS Index includes MBS issues as constituents in the index based on FTSE’s calculation of the market share of such issues.

9. The FTSE MBS Index is calculated and administered by FTSE International Limited (FTSE). FTSE is an organization that is independent of the Filer and that specializes in creating index offerings for the global financial markets. FTSE is a wholly-owned subsidiary of London Stock Exchange Group.

10. The FTSE MBS Index is designed to reflect the performance of the fixed-rate 975 Pool of the Canadian National Housing Act Mortgage Backed Securities market, denominated in Canadian dollars. Each security is weighted by its relative market capitalization and rebalanced on a monthly basis.

BMO and MBS Market

11. BMO is the third largest issuer of MBS in Canada. Currently, approximately 15% of the constituents of the FTSE MBS Index are BMO MBS.

12. There may not be a sufficient supply of BMO MBS in the secondary market for the MBS Index ETF or a future MBS Index Fund to meet its investment objective. BMO MBS, as well as most other bank MBS, are issued in the primary market and currently bought exclusively by, or issued directly to, bank treasuries and the Canada Mortgage and Housing Corporation, making it difficult for investors, such as the MBS Index Funds, to access MBS in the secondary market.

13. The BMO MBS (i) are non-exchange-traded debt securities, (ii) have a term to maturity of 365 days or more, (iii) have been given and continue to have, at the time of purchase by the MBS Index Fund, a “designated rating” by a “designated rating organization” within the meaning of those terms in NI 44-101 Short Form Prospectus Distributions (NI 44-101), and (iv) will be purchased in a primary offering where the terms, such as the size and the pricing, will be a matter of public record as evidenced in a prospectus, offering memorandum, press release or other public document.

[Subsections 111(2)](https://www.canlii.org/en/on/laws/stat/rso-1990-c-s5/latest/rso-1990-c-s5.html#sec111subsec2_smooth) and [111(4)](https://www.canlii.org/en/on/laws/stat/rso-1990-c-s5/latest/rso-1990-c-s5.html#sec111subsec4_smooth) of the [Act](https://www.canlii.org/en/on/laws/stat/rso-1990-c-s5/latest/rso-1990-c-s5.html)

14. Subsection 111(2)(a) of the Act prohibits an investment fund from knowingly making an investment in any person or company who is a substantial securityholder of the investment fund, its management company or its distribution company.

15. Subsection 111(2)(c)(ii) of the Act prohibits an investment fund from knowingly making an investment in an issuer in which any person or company who is a substantial securityholder of the investment fund, its management company or its distribution company has a significant interest.

16. Subsection 111(4) of the Act prohibits an investment fund from holding an investment prohibited under any other subsection of section 111 of the Act.

17. The issuer of the BMO MBS, BMO or a subsidiary, will be either: (i) a company that is a substantial securityholder of the management company or distribution company of the MBS Index Funds or (ii) an issuer in which a company who is a substantial securityholder of the management company or distribution company of the MBS Index Funds has a significant interest. As a result, the MBS Index Funds are prohibited from investing in the BMO MBS.

Subsection 13.5(2)(a) of NI 31-103

18. Subsection 13.5(2)(a) of NI 31-103 prohibits a registered adviser from knowingly causing an investment portfolio managed by it (including the MBS Index ETF and future MBS Index Funds) to purchase a security of an issuer in which a responsible person, or an associate of a responsible person (including an officer or director of the Filer) is a partner, officer or director, unless: (i) this fact is disclosed to the client, and (ii) the written consent of the client to the purchase is obtained before the purchase.

19. While there are currently no directors or officers of the Filer who are also officers or directors of an issuer of BMO MBS, the Filer anticipates that there may, in the future, be officers and/or directors of the Filer who are also officers and/or directors of the issuers of BMO MBS.

20. Pursuant to the Companion Policy to NI 31-103, disclosure of the relationship between an issuer of BMO MBS and the Filer, and consent to make a Related Issuer MBS Investment, must be made to, and obtained from, each investor in the MBS Index Funds. Due to the widely-held nature of a publicly qualified investment fund, and the fact that, in the case of an exchange-traded fund, the manager does not have knowledge of the beneficial owners of the fund, it is impracticable for the Filer to obtain consent from each investor in a MBS Index Fund to make a Related Issuer MBS Investment.

Subsection 4.1(2) of NI 81-102

21. Subsection 4.1(2) of NI 81-102 prohibits a dealer managed investment fund from knowingly making an investment in a class of securities of an issuer of which a partner, director, officer or employee of the dealer manager of the investment fund, or a partner, director, officer or employee of an affiliate or associate of the dealer manager, is a partner, director or officer, unless the partner, director, officer or employee: (a) does not participate in the formulation of investment decisions made on behalf of the dealer managed investment fund; (b) does not have access before implementation to information concerning investment decisions made on behalf of the dealer managed investment fund; and (c) does not influence, other than through research, statistical and other reports generally available to clients, the investment decisions made on behalf of the dealer managed investment fund.

22. The MBS Index Funds are or will be “dealer managed investment funds” as the term is used in NI 81-102, as the portfolio manager of the MBS Index Funds is or will be wholly owned by BMO, which is a principal shareholder of various specified dealers, including BMO Nesbitt Burns Inc.

23. While there are currently no directors or officers of the Filer who are also officers or directors of an issuer of the BMO MBS, the Filer anticipates that there may, in the future, be officers and/or directors of the Filer who are also officers and/or directors of the issuers of BMO MBS.

Section 6.2 of NI 81-107

24. The Filer cannot rely on the exemption codified under section 6.2 of NI 81-107 for Related Issuer MBS Investments because, under NI 81-107, such investments must be made on an exchange.

Prior Decisions

25. The Filer has exemptive relief from subsection 111(2) of the Act and subsection 13.5(2)(a) of NI 31-103 dated September 23, 2014 and has exemptive relief from subsection 4.1(2) of NI 81-102 dated September 22, 2014, to allow mutual funds and portfolios managed by it to invest in debt securities of a related issuer (2014 Decisions).

26. The Filer cannot rely on the 2014 Decisions for the purposes of Related Issuer MBS Investments up to the representation of the BMO MBS in the fund’s MBS Index because the relief restricts a fund from investing more than 5% of its net asset value in related issuer debt in the primary market.

27. As a result, absent the Requested Relief, a MBS Index Fund will not be able to replicate the performance of its MBS Index in situations where BMO MBS represent more than 5% of the fund’s MBS Index.

IRC Review and Related Issuer MBS Investments

28. The Filer has established, or will establish, an independent review committee (IRC) in respect of each MBS Index Fund in accordance with the requirements of NI 81-107.

29. Any proposed Related Issuer MBS Investments will be referred to the IRC of the MBS Index Funds in accordance with subsection 5.2(1) of NI 81-107 and the Filer, as manager, and the IRC will comply with Section 5.4 of NI 81-107 in respect of any standing instructions the IRC provides in connection with Related Issuer MBS Investments.

30. At the time of a Related Issuer MBS Investment, the Filer, as manager, will have policies and procedures in place to enable the applicable MBS Index Funds to engage in the applicable Related Issuer MBS Investment.

31. If the IRC of a MBS Index Fund becomes aware of an instance where the Filer, as manager of the MBS Index Fund, did not comply with the terms of this decision or a condition imposed by securities legislation or the IRC in its approval, the IRC of the MBS Index Fund will, as soon as practicable, notify in writing the securities regulatory authority or regulator in the jurisdiction under which the MBS Index Fund is organized.

32. Each Related Issuer MBS Investment conducted by an MBS Index Fund will represent the business judgement of responsible persons uninfluenced by considerations other than the best interests of the MBS Index 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 under the Legislation is that the Requested Relief is granted provided that:

a) at the time of purchase and while holding the Related Issuer MBS Investment, the fund’s MBS Index is a “permitted index”, as contemplated by NI 81-102, in that it is a market index that is both (i) administered by an organization that is not affiliated with any of the fund, its manager, its portfolio adviser or its principal distributor, and (ii) available to persons or companies other than the fund;

b) the purchase or holding is consistent with, or is necessary to meet, the investment objective of the MBS Index Fund;

c) at the time of the purchase, the IRC of the MBS Index Fund has approved the Related Issuer MBS Investment in accordance with subsection 5.2(2) of NI 81-107;

d) the manager of the MBS Index Fund complies with section 5.1 of NI 81-107 and the manager and the IRC of the MBS Index Fund comply with section 5.4 of NI 81-107 for any standing instructions the IRC provides in connection with the investment;

e) the BMO MBS has been given and continues at the time of purchase to have a “designated rating”, by a “designated rating organization”, within the meaning of those terms in NI 44-101;

f) the size of the BMO MBS primary offering is at least $100 million;

g) at least two purchasers who are independent and at arm’s-length, which may include an “independent underwriter” (within the meaning of National Instrument 33-105 Underwriting Conflicts), collectively purchase at least 20% of the BMO MBS primary offering;

h) the percentage representation of BMO MBS in the portfolio of the MBS Index Fund will be no higher than the percentage representation of BMO MBS in the fund’s MBS Index;

i) no MBS Index Fund will participate in the BMO MBS primary offering, if following its purchase, the MBS Index Fund, together with other related investment funds under common management with the MBS Index Fund, will hold more than 20% of the securities issued in the same BMO MBS primary offering;

j) the BMO MBS are offered at the same price per security to all purchasers participating in the BMO MBS primary offering such that the price paid for the securities by a MBS Index Fund in the BMO MBS primary offering will not be higher than the price paid by any arm’s length purchaser who participates in the BMO MBS primary offering; and

k) no later than the time the MBS Index Fund files its annual financial statements, and no later than the 90th day after each financial year-end, the Filer, as manager of the MBS Index Fund, files with the securities regulatory authority or regulator the particulars of any Related Issuer MBS Investment.

The 31-103 Relief and the 81-102 Relief

“Darren McKall” Darren McKall Manager, Investment Funds and Structured Products Branch Ontario Securities Commission

The Act Relief

“Mary Anne DeMonte-Whelan” “Heather Zordel” Mary Anne DeMonte-Whelan Heather Zordel Commissioner Commissioner Ontario Securities Commission Ontario Securities Commission

Application #s: 2020/0184 and 2020/0185 SEDAR Project #:03039677