Canada’s second most eagerly anticipated legalization of a product line was announced on October 4, when the Canadian Securities Administrators (CSA) published their Notice of Amendments – Modernization of Investment Fund Product Regulation – Alternative Mutual Funds (Alternative Mutual Fund Rules). When these amendments come into force on January 3, 2019, investment fund managers will be able to develop and market non-traditional funds to a wider client base that includes retail investors.
What’s changing: The Alternative Mutual Fund Rules will replace most of the current rules for commodity pools set out in National Instrument 81-104 Commodity Pools (NI 81-104) with a more comprehensive and tailored regulatory framework that is integrated into the existing regime for mutual funds.
Proposed vs final rules: The final Alternative Mutual Fund Rules are not significantly different than the proposed rules published in September 2016 (“Proposed Rules”). We have highlighted two differences below:
- The CSA changed the name of these funds from “alternative funds” to “alternative mutual funds” to emphasize that these new funds will be subject to the full suite of regulations applicable to traditional mutual funds, except for specific exceptions spelled out in the rules.
§ As expected and hoped for, the aggregate notional value of specified derivatives transactions that are “hedging transactions”, as defined in National Instrument 81-102 Investment Funds (NI 81-102), will be excluded from the calculation of the combined limit on cash borrowing, short selling and specified derivatives transactions.
Proficiency requirements for alternative mutual funds remain in NI 81-104, for now: Currently, individuals who sell commodity pool securities, other than dealing representatives of Investment Industry Regulatory Organization of Canada (IIROC) member firms, must meet proficiency standards in NI 81-104 that go beyond the minimum requirements to be registered as a dealing representative of a mutual fund dealer. For now, the CSA has retained these proficiency requirements in NI 81-104 (and changed the name of NI 81-104 from “Commodity Pools” to “Alternative Mutual Funds”) until it completes a larger project to review and update registrant proficiency standards generally.
Performance fees permitted: Consistent with the old rules for commodity pools, alternative mutual funds will be able to charge performance-related fees, but:
- Payment of that fee must be based on the cumulative total return of the alternative mutual fund for the period that began immediately after the last period for which the performance fee was paid; and
§ The method of calculating the fee must be disclosed in the alternative mutual fund’s prospectus.
Pooled fund performance data can’t be used: Several commenters on the Proposed Rules asked for a limited exemption from the rules so that existing pooled funds that convert to alternative mutual funds could use their pre-conversion historical performance data in sales communications for their alternative mutual funds. The CSA declined to make the requested change, noting that the restriction exists in part because funds sold in the exempt market aren’t subject to the same investment restrictions as funds sold under NI 81-102. According to the CSA, disclosure of performance history on this basis could be misleading to investors.
Transition/grandfathering: For existing commodity pools that have filed and received a receipt for a prospectus before January 2, 2019, the Alternative Mutual Fund Rules will not apply until July 4, 2019. Also, any non-redeemable investment fund established prior to October 4, 2018 will be exempted from some of the investment restrictions, unless the fund files a prospectus for which a receipt is issued after October 4, 2018.