The Investment Funds and Structured Products Branch of the OSC just released the latest edition of its Investment Funds Practitioner (the Practitioner), which provides an overview of recent issues arising from applications for discretionary relief, prospectuses, and continuous disclosure documents that investment funds file with the OSC.
We have highlighted the following key issues from the Practitioner for your convenience.
Prospectuses - Investment Funds Offering Currency Hedged Class or Series
The OSC is currently reviewing and monitoring developments relating to currency hedging strategies used by investment funds and is considering whether additional guidance or rule-making is needed. OSC Staff is particularly concerned about whether a class or series of an investment fund established for the purpose of using currency hedging strategies (a Hedged Series) should be a separate investment fund. This concern is based on subsection 1.3(1) of NI 81-102 – Investment Funds, which states that each class or series of an investment fund that is referable to a separate portfolio of assets is considered to be a separate fund.
Filers are encouraged to consult with OSC Staff in structuring a Hedged Series. Filers should also expect additional questions with respect to their Hedged Series, in particular for a class or series where a portfolio manager hedges anywhere from 0% to 100% of the Hedged Series’ foreign currency exposure. Though historically OSC Staff has been comfortable with the hedging of all or substantially all of the foreign currency exposure for a Hedged Series, the deviation to a more variable hedging approach has resulted in their questioning of how to treat these variable Hedged Series, and whether such classes should be their own investment fund.
OSC Staff will also request as part of their prospectus review that a fund with a Hedged Series include in its prospectus disclosure that the prior approval of security holders will be obtained before the currency hedging strategy of the Hedged Series is changed.
Continuous Disclosure - Review of Fund-of Funds Disclosure of Fees and Expenses
OSC Staff conducted an issue-oriented continuous disclosure review of the disclosure of fees and expenses for fund-of-funds. Of note, OSC Staff emphasized that:
- Fund managers have to “look-through” expenses in fund-of-fund structures when calculating the management expense ratio (MER) and total expense ratio (TER) for top funds, including top funds that invest in third party conventional mutual funds and exchange traded funds (ETFs). Fund managers should use reasonable estimates when determining the expenses of underlying funds managed by third parties. The OSC has found that a number of top funds that invested in underlying ETFs did not include the expenses of the ETFs in the calculation of the MER and TER. Many of those funds disclosed MER and TER which were materially understated and were required to refile.
- Management fee disclosure provided by top funds, particularly for new funds without historical MERs, may be misleading if there is no prospectus disclosure explaining that the underlying funds may have higher management fees. OSC Staff expects the top fund to provide sufficient disclosure to clearly explain the impact of the expected management fees of the underlying funds on the top fund’s MER. Staff has found that funds with the investment objective to invest in underlying funds often disclose only the management fee at the top fund level, even if the underlying fund(s) have higher management fees.
Independent Review Committees (IRCs) - IRC Reporting Under Section 4.5 of NI 81-107
OSC Staff affirmed its view is that there is no materiality threshold when applying the IRC’s reporting requirement under section 4.5 of NI 81-107. This provision requires an IRC to provide written notice to the principal regulator when the IRC becomes aware of any instance in which the fund manager acted in certain conflict of interest matters, namely (i) interfund trading, (ii) purchases of securities of a related issuer, or (iii) investment in securities offerings underwritten by a related party; but did not comply with a condition imposed by securities legislation, or any IRC approval or exemptive relief decisions.