The Canadian investment fund industry has been the subject of various regulatory developments in the third quarter of 2015. This bulletin provides a summary of certain key takeaways that will be useful for investment fund and industry professionals to stay abreast of recent changes.
1. Amendments to the Toronto Stock Exchange (“TSX”) Company Manual related to Non-Corporate Issuers
On September 17, 2015, the TSX Company Manual was amended to include additional requirements for Exchange Traded Products (“ETPs”), Structured Products and Closed-end Funds. (collectively, “Non-Corporate Issuers”). Certain amendments include:
- Minimum market capitalization - To be listed on the TSX, Non-Corporate Issuers must satisfy the following market capitalization minimums:
- Exchange Traded Product - $1,000,000;
- Structured Product - $1,000,000; and
- Closed-end Fund - $10,000,000.
- Net asset value - Non-Corporate Issuers must calculate net asset value with the following frequency and maintain a publicly accessible website displaying same:
- Exchange Traded Product - at least daily;
- Structured Product - weekly; and
- Closed-end Fund - as required under applicable securities laws.
The amendments, located on the Ontario Securities Commission website, also codify the existing TSX practices in respect of Non-Corporate Issuers related to capital structure, including the issuance of securities as well as additional and supplemental listings, among others.
2. The Montreal Exchange and ICE Futures Canada receive direct access to the US Commodity Futures Trading Commission (“CFTC”)
On August 26, 2015, the CFTC issued Orders of Registration (“Orders”) to the Montreal Exchange, Inc. (“MX”) and ICE Futures Canada, Inc. (“ICEFC”), Canada’s leading derivatives exchange and agricultural derivatives platform, respectively. As a result of the Orders, the MX and the ICEFC are able to provide their identified members or other participants located in the US with direct access to their electronic order entry and trade matching system.
The ICEFC will offer direct access for futures and options contracts on milling wheat, canola, durum wheat, and barley. The MX will offer direct access for futures contracts on interest rates and certain broad-based security indices as well as options on futures contracts based on the Canadian overnight repo rate average and on ten-year Government of Canada bonds.
3. Mutual Fund Dealers Association of Canada (“MFDA”) proposes proficiency requirements for selling ETFs
On July 22, 2015, the MFDA published Bulletin #0653-P, which outlines proposed proficiency requirements for Approved Persons selling exchange-traded mutual funds (“ETFs”). The MFDA noted that there are important differences between ETFs and conventional mutual funds, and that the existing courses and examinations do not sufficiently address the sale of ETFs under National Instrument 31-103Registration Requirements, Exemptions and Ongoing Registrant Obligations to sell conventional mutual funds.
4. Use of “index” in investment fund names and objectives
On July 9, 2015, Ontario Securities Commission (“OSC”) staff published OSC Staff Notice 81-728 Use of “Index” in Investment Fund Names and Objectives, which sets out guidance for investment funds whose investment objectives are to replicate the performance of an index, and which include the word “index” in their names (“Index Tracking Funds”).
OSC staff noted that in order to make use of, and to refer to, “index” in the Index Tracking Fund’s name and prospectus disclosure, the index whose performance is being replicated (the “Methodology”) should:
(i) be absent of material discretion by the index provider or any others involved in the administration of the index; and
(ii) the index must be transparent (e.g. akin to the Methodology or the constituents of the index available to the public).
Where discretion and transparency do not exist, the Methodology aligns more with an active investment strategy, and not an index.
5. OSC releases July 2015 edition of The Investment Funds Practitioner (“Practitioner”)
The Practitioner is an overview of topical issues arising from applications for discretionary relief, prospectuses, and continuous disclosure documents filed by investment funds with the OSC. The following are certain notable items from the July edition:
- Prospectus disclosure - In connection with prospectus reviews, OSC staff will continue to focus on fees, expenses and investment objectives/strategy disclosure as noted in an earlier November 2013 edition, and will now also place greater emphasis on reviewing disclosure relating to the different classes or series of securities offered by investment funds.
- Default mutual fund distribution selection - Where funds offer fixed rate distribution securities, also known as “T-Series”, the default selection for distributions made to holders of such securities should be set as cash payout, not reinvestment, as the general purpose of T-Series is to provide monthly cash flow to investors.
- Mutual funds to cease holding securities of closed-end funds - In connection with recent amendments to NI 81-102, the Modernization Amendments, mutual funds are prohibited from investing/holding securities of closed-end funds. Mutual funds that filed a prospectus on or before September 22, 2014 have until March 21, 2016 to comply with the requirement unless granted exceptive relief.
- Detailed disclosure of Investment Review Committee Compensation (“IRC”) - Mutual funds must ensure their prospectus contains detailed disclosure of compensation provided to members of the IRC pursuant to National Instrument 81-107 Independent Review Committee for Investment Funds. Disclosure of amounts paid to the entire IRC in the aggregate is insufficient, rather what is required is disclosure of specific amounts paid to individual members and includes any expenses reimbursed by the fund.
- Scope of future-oriented relief for pooled funds investing in related pooled funds - OSC staff will limit relief granted for future fund-on-fund structures (future-oriented relief), to specific facts/structures that trigger the need for the relief in the first instance, and which the filer expects to implement in the near future. This is in contrast to the more broadly framed future-oriented relief previously granted, which included relief for structures not yet actually planned, and which may not have been substantially similar in features and purposes to those structures described in the applications.
- Industry awards in sales communications - Reference to industry awards in sales communications must be discontinued. OSC staff is of the view that while certain awards, (namely those that are based on objective criterion and are prepared by a mutual fund rating entity) are permitted by Part 15 of NI 81-102, industry awards more often include a subjective component and thus are not permitted under NI 81-102.
6. OSC guidance on mutual fund practices and portfolio liquidity
On June 25, 2015, the OSC released Staff Notice 81-727 Report on Staff’s Continuous Disclosure Review of Mutual Fund Practices Relating to Portfolio Liquidity. Following the OSC’s targeted review of 22 funds, consisting of conventional mutual funds and ETFs, the key recommendations include:
Liquidity assessments of fund holdings
- Robust and highly tailored policies and procedures - Funds should have robust written policies and procedures on liquidity assessments at the time of an investment purchase, and on an ongoing basis. Funds’ written policies and procedures, and their liquidity metrics, should be tailored for different asset classes.
- Timely settlement of redemption notice - Funds should consider whether their investment holdings can be readily disposed of and settled in the three day redemption period set out in National Instrument 81-102 Investment Funds (“NI 81-102”). The OSC staff noted that simply being listed on a stock exchange with a quoted price is not generally sufficient to conclude that a particular holding is liquid, and at a price that approximates the amount at which the portfolio asset is valued.
Liquidity stress testing
- Written stress testing policies and procedures - Funds should have written stress testing policies and procedures that speak to the order of asset liquidation. This is to ensure the fund can effectively execute redemption in stressed market conditions while minimizing the impact to the portfolio and the remaining unitholders.
- Redemption scenario analysis - In performing stress testing, funds should incorporate into their scenario analysis redemption rates that exceed past redemption experience, and should consider the impact of market conditions and other scenarios on the portfolio, including geopolitical developments, among others.
- Fair value determination for net asset value - A fair value assessment of an investment based on the quoted market price requires that there be an active market. In assessing whether an investment meets the illiquid asset restrictions under NI 81-102, funds must consider the ‘active market’ guidance provided in International Financial Reporting Standards 13 (“IFRS 13”).
- Additional disclosure for non-active market fair value determinations - Where an investment is not quoted in an active market, the fair value determination, in accordance with NI 81-102, is determined based not on the quoted price but rather a consideration of other inputs. In such cases, additional disclosure is required in respect of such investments in the funds’ financial statements and in accordance with IFRS 13.
Independent review of illiquid asset valuation - In order to manage and limit actual/perceived conflicts of interest in connection with the Investment Fund Manager’s (“IFM”) valuation of illiquid assets, IFMs must have standing instructions from the funds’ independent review committee in regards to its valuation policies and procedures.