81-106 to Apply to All Underlying Funds
The OSC recently indicated that they will be imposing new conditions for investment fund managers seeking fund-of-fund relief from the prohibited investment provisions applicable to investment funds in s.111 of the Securities Act (Ontario) (the “OSA”). Fund-of-fund relief is obtained from the OSC in relation to provisions that prohibit certain investments by investment funds, including the prohibition against an investment fund owning 20% or more of another investment fund.
One key new condition establishes that “a Top Fund will not invest in an Underlying Fund, unless the Underlying Fund complies with the provisions of NI 81-106 that apply to a “mutual fund in Ontario” as defined in the OSA”.
Going forward, this condition will require that all underlying funds for structures where fund-of-fund relief is obtained comply with the rules around the preparation of annual audited and interim financial statements in NI 81-106. Previous to this new condition, if the local jurisdiction of an underlying fund did not require audited annual financial statements as required by NI 81-106, there was no obligation to prepare them.
There has been no indication regarding how the OSC will deal with existing fund-of-fund structures where relief was granted by the OSC in the past and did not impose the new conditions. We will be watching for developments very closely.
Custodial Considerations for Fund on Fund Structures
In order for a firm to act as its own trustee of a fund, it will often need to apply for an approval under the Loan and Trust Corporations Act (Ontario). In recent OSC audits, we have seen OSC Staff take the view that the commonly used wording in the LTCA approval setting out that assets must be custodied with an appropriate custodian includes assets such as a book based share registry.
This view has implications for fund-of-fund structures, where often the only “asset” of a top fund is a book based register of investors who ultimately invest in a bottom fund (that holds all the investment assets). Some firms consider retaining a custodian only for the bottom fund that contains the investment assets. The view we have seen expressed by OSC Staff would mean that the book based share registry must also be custodied and thus the top fund must also retain a custodian for that purpose. This could have practical not to mention cost considerations.