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 BLACKROCK ASSET MANAGEMENT CANADA LIMITED (the Filer)
September 11, 2024
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) for an exemption, pursuant to section 19.1 of National Instrument 81-102 Investment Funds (NI 81-102) permitting all current and future mutual funds, including exchange-traded funds, that are, or will be, managed by the Filer or an affiliate of the Filer and to which NI 81-102 applies (the Funds) to hold as cover, in respect of the requirement under section 2.8(1)(d) of NI 81-102 that a mutual fund must not open or maintain a long position in a standardized future, unless the mutual fund holds 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 (the Cover Requirement), one or more receivables (each, a Receivable) of the Fund arising as a result of a declaration or payment of a distribution, dividend or other payment on one or more Securities (as defined below) held by the Fund in order to equitize the Receivable during the period from the date that the Fund becomes entitled to receive the Receivable until the date that the Receivable is actually received by the Fund (the Entitlement Period), thereby permitting the Fund to seek to track its applicable index in respect of the Receivable or to otherwise invest the amount of the Receivable, as applicable (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 Section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in each of Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, Northwest Territories, Nova Scotia, Nunavut, Prince Edward Island, Québec, Saskatchewan and Yukon (together with Ontario, the Jurisdictions).
Interpretation
Terms defined in 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 is a corporation amalgamated under the laws of Ontario with its head office in Toronto, Ontario.
The Filer is registered as: (i) an investment fund manager in each of the Jurisdictions; (ii) a commodity trading manager in Ontario; (iii) an adviser in Manitoba; (iv) a portfolio manager in each of the Jurisdictions; and (v) an exempt market dealer in each of the Jurisdictions.
The Filer or an affiliate of the Filer is, or will be, the investment fund manager of the Funds and the Filer, an affiliate of the Filer or a third-party portfolio manager retained by the Filer is, or will be, the portfolio manager of the Funds.
Each Fund is, or will be, a mutual fund created under the laws of a Jurisdiction or the laws of Canada.
Each Fund is, or will be, governed by the provisions of NI 81-102, subject to any exemption therefrom that has been, or may be, granted by the securities regulatory authorities.
Neither the Filer nor the Funds are in default of securities legislation in any Jurisdiction.
Each Fund either seeks to track, or will seek to track, to the extent reasonably possible and before fees and expenses, the performance of a market index (an Index) (each, an Index Fund) or seeks to invest, or will seek to invest, its portfolio assets in accordance with its investment objective and investment strategies (each, a Non-Index Fund).
In pursuing its investment objective, each Index Fund seeks to provide long-term capital growth or income by replicating, to the extent possible, the performance of the applicable Index selected at the discretion of the Filer. In the case of each Non-Index Fund, such Non-Index Fund may invest in equity securities, including securities issued by investment funds, fixed income securities, and other financial instruments in accordance with that Non-Index Fund’s investment objective and investment strategies. Each equity security, including each security issued by an investment fund, or other financial instrument, such as a specified derivative, where the underlying interest is an equity security held by a Fund from time to time is referred to herein as a Security.
While a Security is held in the portfolio of a Fund, the issuer of that Security may declare payable, and make or pay, a distribution, a dividend, or another payment, such as in connection with a corporate action, on the Security. Once declared payable, that distribution, dividend or other payment becomes a Receivable of the applicable Fund effective as of the date of entitlement.
Under the rules and methodology that govern each Index, an Index treats each Receivable as an investable asset of the applicable Index and deems the amount of the Receivable to be invested in one or more of the constituent securities of the Index effective as of the date that securityholders of the applicable Security would first become entitled to receive the Receivable.
A mutual fund generally cannot invest or earn interest income on a Receivable during the Entitlement Period. As a result, Receivables dilute a fund’s exposure to market returns. The effect on performance is known as Cash Drag.
In order to meet its investment objective, reduce Cash Drag, and therefore reduce tracking error in respect of the applicable Index, during the Entitlement Period each Index Fund would like to open and maintain a long position in one or more standardized futures, each of which is expected to provide exposure to market returns that is similar to the applicable Index.
Similarly, in order to meet its investment objective and to reduce Cash Drag, each Non-Index Fund would like to open and maintain a long position in one or more standardized futures during the Entitlement Period.
In connection with each futures position held by a Fund, the Fund will hold on a daily mark-to-market basis, the amount of cash cover actually required to be paid by it on settlement of that futures position. The Fund will hold this amount of cash cover such that it is not allocated for specific purposes and is available to satisfy the settlement amount of the futures position.
The Cover Requirement is based on the assumption that on termination or settlement of each futures position, the mutual fund is required to pay a gross amount equal to the mark-to-market value of the entire underlying market exposure of the standardized future. Accordingly, the Cover Requirement requires a mutual fund to hold a combination of cash cover, margin on account for the futures position and the market value of the futures position that has a value that is not less than, on a daily mark-to-market basis, the underlying market exposure of the futures position.
The purpose of the cash cover requirements in NI 81-102 is to prohibit an investment fund from leveraging its assets when using certain specified derivatives and to ensure that the investment fund is in a position to meet its obligations on the settlement date. This is evident from the definition of “cash cover”, which is defined as certain specific portfolio assets of the investment fund that have not been allocated for specific purposes and that are available to satisfy all or part of the obligations arising from a position in specified derivatives held by the investment fund. Currently, the definition of “cash cover” includes eight different categories of portfolio assets, including receivables of the investment fund arising from the disposition of portfolio assets, net of payables arising from the acquisition of portfolio assets.
In addition to the portfolio assets included in the definition of cash cover, each Fund would also like to include any Receivable of the Fund arising as a result of a declaration or a payment of a distribution, dividend or other payment on a Security for purposes of satisfying the Cover Requirement.
The inclusion of Receivables as an acceptable form of cover for purposes of the Cover Requirement will allow the Index Funds to more closely track the applicable Index by reducing tracking error caused by Cash Drag and will allow the non-Index Funds to be more fully invested in accordance with their investment objectives. In each case, this may positively impact the performance of all of the Funds and the economic returns to investors.
Treating Receivables as cover for purposes of the Cover Requirements is consistent with the global market treatment of Receivables. Given the historically low risk of non-payment associated with Receivables and the need for the industry to have a consistent approach to the different market practices regarding the length of the period between entitlement to a Receivable and receipt of that Receivable, Receivables are treated generally as part of the applicable index by relevant index providers and as an asset of the applicable investment fund by industry participants in most developed markets.
As each Fund enters into one or more of the relevant standardized futures in order to equitize one or more Receivables, the notional amount of the standardized futures position or positions will be less than or equal to the dollar value of the applicable Receivables. As an asset of the Fund, each Receivable is available to serve as, and should be able to be used for, cash cover for the related standardized futures position or positions.
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 for each long position in a standardized future that a Fund opens or maintains in order to equitize a Receivable, the Fund holds, on each trading day, a combination of the amount of the Receivable, cash cover and margin or collateral posted by the Fund in connection with its obligation under that futures position that, in the aggregate, has a value that is not less than, on a daily mark-to-market basis, the underlying market exposure of the standardized future.
“Darren McKall”
Darren McKall
Manager, Investment Management Division
Ontario Securities Commission
Application #2024/0499
SEDAR+ Project #6171026