On March 27, 2013, the Canadian Securities Administrators (CSA) issued a request for comment on the first stage of Phase 2 of their Modernization of Investment Fund Product Regulation Project (the Modernization Project). This stage will focus on amending National Instrument 81-102 Mutual Funds (NI 81-102) in order to extend the requirements of 81-102 to non-redeemable investment funds.
Historically, such operational requirements have not been applied to non-redeemable investment funds although, like mutual funds, they are subject to the continuous disclosure and fund governance requirements set out in National Instrument 81-106 Investment Fund Continuous Disclosure and National Instrument 81-107 Independent Review Committee for Investment Funds, respectively. In addition, this stage will involve creating a more comprehensive alternative fund framework that would govern investment funds that invest in assets, or use investment strategies, that would not be permitted pursuant to the amended NI 81-102. The goal of these proposed amendments is to create a more consistent, fair and functional regulatory regime across the spectrum of publicly offered investment fund products.
Proposed Amendments that will affect public non-redeemable investment funds
The guiding principle behind the proposed amendments to NI 81-102 (Proposed Amendments) is that non-redeemable investment funds are, in many ways, similar to mutual funds and thus should be regulated in a similar fashion. Under securities legislation, the primary purpose of both types of investment funds is to pool money provided by their securityholders. Additionally, both types of investment funds offer professional management services to the public.
However, the CSA also recognizes that non-redeemable investment funds differ from mutual funds in certain key aspects. Unlike conventional mutual funds, non-redeemable investment funds do not offer unlimited securities on a continuous basis and they do not redeem their securities at net asset value (NAV) on a regular basis. Instead, they typically issue a fixed number of securities in an initial public offering, following which the securities are generally listed and traded on an exchange at market prices that may be at a premium or discount to NAV.
Highlights of the Proposed Amendments include implementing the following with respect to publicly offered non-redeemable investment funds:
- a concentration restriction that prohibits more than 10% of NAV being invested in an issuer;
- a limit on investments in physical commodities and specified derivatives the underlying interests of which are physical commodities to, in the aggregate, an amount equal to 10% of NAV at the time of purchase;
- a restriction on investments in illiquid assets, but one that is more generous than that applicable to mutual funds;
- a prohibition on borrowings of cash in excess of 30% of NAV;
- a prohibition on investments in mortgages that are not fully and unconditionally guaranteed by a government or government agency (subject to a 24-month transition period);
- a restriction on investing in other mutual funds and a prohibition on investing in other non-redeemable investment funds;
- restrictions on securities lending, repurchase and reverse repurchase transactions;
- the implementation of various conflict of interest provisions and securityholder and regulatory approval requirements;
- the implementation of custodianship requirements; and
- the adoption of limits on the ability to charge performance fees.
It is currently proposed that certain of the Proposed Amendments will be implemented before others and some will be subject to transition periods to give existing funds sufficient time to align their portfolios with the new requirements. As a general rule, any new non-redeemable investment funds established after the coming-into-force date of such Proposed Amendments would be required to comply with the investment restrictions immediately.
Proposed Amendments that will affect public mutual funds
While Phase 2 generally focuses on introducing operational requirements for non-redeemable investment funds, there are some provisions in the Proposed Amendments that would affect public mutual funds. These provisions include proposed:
- amendments to require an exchange-traded mutual fund that is not in continuous distribution to issue a news release if the fund intends to begin using specified derivatives, short selling and/or entering into securities lending, repurchase and reverse repurchase transactions;
- amendments to limit the amount of securities loaned or sold in repurchase transactions by a mutual fund to 50% of NAV, rather than 50% of total assets, excluding the collateral delivered to the fund;
- prohibition on public mutual funds (including exchange-traded mutual funds) paying for organizational expenses of the mutual fund;
- amendments to broaden the securityholder approval requirements to require securityholder approval for a merger of a mutual fund with any issuer, rather than just a merger with another mutual fund;
- introduction of a requirement for a mutual fund that wishes to restructure the fund into a non-redeemable investment fund or an issuer that is not an investment fund to obtain prior securityholder approval, with the fund prohibited from bearing the costs of the restructuring;
- prohibition on the issuance of warrants and similar instruments by all investment funds;
- provisions to prevent dilutive issuances of securities by an exchange-traded mutual fund that is not in continuous distribution;
- introduction of requirements for an exchange-traded mutual fund that is not in continuous distribution to pay redemption proceeds no more than 15 business days after the redemption is effected; and
- amendments to permit cash received in respect of sales and redemptions of all investment fund securities (and not only mutual fund securities) to be held in one trust account.
Alternative funds framework
The CSA is also considering amendments to National Instrument 81-104 Commodity Pools (NI 81-104) to include both mutual funds and non-redeemable investment funds that focus on alternative asset classes or use alternative investment strategies not permitted by NI 81-102 (as amended by the Proposed Amendments).
Currently, NI 81-104 sets forth a regulatory framework that applies only to specialized mutual funds that are commodity pools by exempting them from certain restrictions in NI 81-102. A proposed redesign of NI 81-104 to include both mutual funds and non-redeemable investment funds is intended to preserve the flexibility for non-redeemable investment funds to use alternative investment strategies that may not be permissible under NI 81-102 (as amended by the Proposed Amendments), and at the same time, create a more comprehensive regulatory framework in NI 81-104 for alternative funds (for both mutual funds and non-redeemable investment funds).
The CSA is considering whether alternative funds should have greater flexibility with respect to, among other items, concentration restrictions, leverage exposure, investments in physical commodities, borrowing, short selling and counterparty credit exposure.
The CSA is also considering whether (i) specified disclosure should have to be included on the cover page of an alternative fund prospectus indicating that the fund may use investment strategies or invest in assets in a different manner than other investment funds and that the risks of investing in the fund may differ significantly from the risks associated with other investment funds and (ii) alternative funds should be permitted to be offered in the same prospectus document with investment funds that are not alternative funds.
All interested parties are invited by the CSA to provide written feedback on the proposals by June 25, 2013.