On July 27, 2017, the Canadian Securities Administrators (“CSA”) adopted amendments (the “Amendments”) to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”) as well as the companion policy to NI 31-103 (the “CP”). According to the CSA, the Amendments are intended to promote stronger investor protection, clarify certain regulatory requirements and enhance certain market efficiencies. The Amendments come into force December 4th , 2017 with the exception of the custody amendments which come into force June 4, 2018.
We are highlighting below amendments clarifying the activities that may be conducted by exempt market dealers (the “EMD Amendments”) and the amendments enhancing the custody requirements applicable to registered firms (the “Custody Amendments”).
The EMD Amendments are intended to clarify that an exempt market dealer (“EMD”) can only act as a dealer or an underwriter in the “exempt market” (i.e., where the distribution is made in reliance on a prospectus exemption). An EMD may not act as a dealer or underwriter in a distribution that is being made under a prospectus even if the investor would otherwise qualify for a prospectus exemption. An EMD can however participate in a private placement of securities of a reporting issuer. The CP has also been updated to provide further guidance on the activities that can be conducted by EMDs, including when an EMD can participate in a resale of securities.
In addition, the exemption from the dealer registration requirement that is often relied on by portfolio managers who issue securities of investment funds they manage to clients for which the firm has managed accounts, has been expanded. This exemption will now be available to portfolio managers if the investment funds are managed by the adviser or an affiliate of the adviser. Firms relying on this exemption should be aware that they are required to provide written notice of their reliance on this exemption to the regulators.
The Custody Amendments introduce new requirements for registered firms pertaining to custody arrangements. The Custody Amendments generally apply to registered firms that (a) hold or have access to cash or securities of clients of the firm or investment funds managed by the firm; or (b) direct or arrange which custodian will hold the cash or securities of such clients and/or investment funds.
The Custody Amendments do not apply to IIROC or MFDA member firms or to investment funds subject to National Instrument 81-102 -Investment Funds (“NI 81-102”) as these entities are subject to their own specific custodian requirements. However, for other registered firms, the Custody Amendments impose obligations with respect to the entities that are permitted to act as custodian of client and investment fund assets, the due diligence expected to be conducted on custodians and the disclosure of custody arrangements. Each of these items are summarized briefly below.
With some exceptions, the Custody Amendments require registered firms to appoint a "Canadian Custodian" or a “Foreign Custodian” to hold the cash or securities of clients and investment funds they manage. A "Canadian Custodian" generally includes banks listed in Schedule I, II or III of the Bank Act (Canada), Canadian trust companies that meet certain capital requirements, and IIROC firms that are permitted under IIROC rules to hold the cash and securities of a client or investment fund. A registered firm can appoint a "Foreign Custodian" only if using the Foreign Custodian is more beneficial to the client or investment fund than using a Canadian Custodian.
The Custody Amendments permit cash of clients or investment funds to be held at a Canadian financial institution (that may not otherwise be a “Canadian Custodian”) and specify how cash and securities are to be held by the applicable custodian and by the firm (in the limited instances where a firm can self-custody).
Further, in addition to exercising due skill, care and diligence in the selection and appointment of custodians, fund managers are expected to conduct a periodic review of their custodial arrangements for their funds, and to have a written custodial agreement in place.
The Custody Amendments expand the relationship disclosure obligations of registered firms to include disclosure to clients about where and how client assets are held and accessed, including any related risks and benefits. A registered firm that has access to client assets must provide disclosure regarding the manner in which it has access to the assets and the risks and benefits to the client arising from having such access.
The Custody Amendments are intended to codify existing custodial best practices. Accordingly, for a majority of registered firms, no major changes to existing custodial arrangements may be required. However, registrants should take the time to review their existing custodial arrangements as well as the updated guidance in the CP. We would be happy to assist you with ensuring that your policies, procedures and documentation reflect CSA’s expectations for oversight of custodial arrangements and client disclosure obligations.