The April 2015 Investment Funds Practitioner, published by staff of the OSC’s Investment Funds and Structured Products Branch, included an interesting reminder about public investment funds governed by National Instrument 81-102 Investment Funds (NI 81-102).
In response to an inquiry, staff confirmed that portfolio assets deposited by an investment fund as collateral with a counterparty in connection with a specified derivatives transaction (as otherwise permitted by NI 81-102) may not be rehypothecated (i.e., pledged or otherwise encumbered) by the counterparty. Staff’s view is that the ability to deposit portfolio assets as collateral in connection with a particular specified derivatives transaction is a limited carve-out from the general rule that all of a fund’s portfolio assets must be held by its custodian. Since the counterparty in essence replaces the custodian in safeguarding the assets, the fund would be subject to risks not otherwise permitted by NI 81-102 if the assets could then be rehypotecated by the counterparty.
The take-away from the note is that fund managers must ensure that their over-the-counter derivatives documentation does not permit the counterparty to use the collateral, other than for the completion of the original specified derivatives transaction.