General introduction to the regulatory framework
Outside the specific rules that apply to the regulation of the management of insurance and pension fund assets (described briefly below), the overriding regulatory framework applicable to asset management in Canada is that contained in securities laws. In Canada, securities regulation is a matter of provincial and territorial jurisdiction. Each of the 10 provinces and three territories has its own securities laws, policies and rules that are administered by a local securities regulatory authority. However, in many areas, including in respect of the distribution of securities to sophisticated parties and the registration of market participants in the asset management arena, the rules have been largely harmonised among the jurisdictions so that compliance with the harmonised national rules will generally result in compliance with the rules in all jurisdictions.i Prospectus requirements and exemptions
Asset managers purchasing securities for funds that they manage or offering securities in those funds to Canadian investors must do so on the basis of a prospectus or in reliance on a prospectus exemption. The exemption most frequently used among the capital-raising exemptions in Canada is the accredited investor exemption. This exemption is available in respect of sales of securities to qualified entities and individuals that are deemed sufficiently sophisticated that they do not require the protection that prospectus disclosures are intended to provide. Included among the qualified entities – many of which are advised by asset managers – are certain types of banks and other financial institutions, trust companies, pension funds, registered charities, investment funds, domestic and international governmental bodies, and entities other than individuals or investment funds with net assets of C$5 million or more. An individual may also qualify as an accredited investor if he or she, alone or with a spouse, owns financial assets having an aggregate net realisable value over C$1 million; has net assets of at least C$5 million; or has net income before taxes in excess of C$200,000 alone, or C$300,000 together with his or her spouse. Canadian securities authorities have stated that it is not sufficient to rely on a bare representation of a purchaser's status as an 'accredited investor' and, where necessary, further inquiries must be made of investors to verify the eligibility represented by an investor under a specific category.
The offering of a security by way of prospectus exemption, such as the accredited investor exemption, does not require that a written document describing the business and affairs of an issuer be provided to prospective purchasers. However, if any written document is provided, it may constitute an offering memorandum under the securities legislation of some provinces in Canada, which is required to include certain prescribed disclosure, including disclosure relating to purchaser statutory rights of action for damages or rescission where the offering memorandum contains a misrepresentation, and disclosure relating to certain conflicts of interest. Issuers of eligible foreign securities may avail themselves of exemptions from the requirement to disclose some of this information provided that certain conditions are met, including that distributions be limited to qualified 'permitted clients'.
It should be noted that securities purchased pursuant to a prospectus exemption are subject to resale restrictions or hold periods. For a private fund with securities that are never listed on a Canadian stock exchange, this effectively means that its securities will never be freely tradeable in the Canadian market. However, leaving aside contractual restrictions in a fund's formation documents, such securities can be traded or transferred pursuant to a further prospectus exemption (e.g., to another accredited investor). In addition, when securities are issued from treasury pursuant to certain private placement exemptions, the issuer is required to file a report of trade with the securities regulators in each Canadian jurisdiction in which the securities are sold, generally within 10 days of the distribution. The form required to report private placements was amended in the summer of 2016 to impose enhanced disclosures, including (as applicable) net proceeds by jurisdiction, most recent net asset value and the type of investment fund issuer. In most jurisdictions, the filing of the report is also subject to the payment of a regulatory filing fee, and a copy of any offering memorandum that is delivered to investors must also be delivered to the local regulator. Finally, the issuer must retain a copy of a completed risk acknowledgement form signed by individual accredited investors other than those with financial assets in excess of C$5 million.ii Registration requirements
Asset managers, and those distributing securities to asset managers, may be subject to several types of registration under Canadian securities law. The registration requirements and ongoing registrant obligations are stringent and comprehensive.
National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) establishes registration requirements and exemptions, and sets out the categories of registration; the proficiency, capital, insurance and other basic requirements for registration; and the ongoing requirements regarding internal controls and systems, financial condition and reporting, custody, dealing with clients and handling client accounts. Pending regulatory proposals previously published by the Canadian Securities Administrators (CSA) for comment (the 'client first' amendments) would, if adopted, introduce significant amendments in the area of conflicts of interest management and registrant business conduct. Under Canadian securities laws, firms generally must register if they are in the business of trading, in the business of advising, holding themselves out as being in the business of trading or advising, or if they act as an investment fund manager. If a firm engages in more than one of these registrable activities, then (unless it is otherwise exempt) the firm must register in all applicable categories.Dealer registration
Persons who are in the business of trading in securities are required to be registered as a dealer in each Canadian jurisdiction where purchasers reside. Trading is broadly defined under Canadian securities laws to include not only the sale or disposition of a security for valuable consideration, but also any act, solicitation or conduct that is directly or indirectly in furtherance of the sale or disposition of a security. Accordingly, an asset manager that is not registered as a dealer is generally not permitted to contact and deal directly with prospective clients. Any such contact would generally be considered an act in furtherance of a trade and may accordingly trigger the dealer registration requirement. There are limited exemptions. This means that an asset manager wishing to distribute securities in Canada of a fund that it manages, or a Canadian asset manager wishing to purchase securities for portfolios that it manages, must generally do so through an appropriately registered dealer.
Where securities are being privately placed, the dealer registration requirement may be satisfied through the use of an exempt market dealer (EMD). An EMD is permitted to trade in the exempt market in securities being distributed under a prospectus exemption, or with persons or companies to whom a security may be distributed under a prospectus exemption (e.g., trading with an accredited investor). Under recent amendments, EMDs are now expressly prohibited from engaging in brokerage activities, including trading securities listed on an exchange in foreign or Canadian markets, or participating in prospectus offerings.
A second dealer category is that of an investment dealer that, unlike an EMD, may trade in virtually any security with any client, including retail clients, provided that the securities offered are covered by a prospectus (subject to know-your-client and trade suitability requirements).
A non-Canadian dealer that is appropriately registered or licensed in its home jurisdiction may make a filing to rely on the international dealer exemption in a Canadian jurisdiction, which would allow it to place foreign securities (i.e., securities issued by issuers established outside of Canada) to permitted clients (a subset of accredited investors), provided a number of other conditions are met.
Firms registered in the category of restricted dealer (which is subject to firm-specific business restrictions) may also be appropriately registered to intermediate a private placement of fund securities.Adviser registration
Canadian securities laws require a person or company engaging in, or holding itself out as engaging in, the business of advising others in respect of the buying, selling or investing in securities to be registered as an adviser in the local jurisdiction where advice is received. Again, there are limited exemptions to this requirement. A non-Canadian firm that is registered or exempt from registration in its home jurisdiction may make a filing to rely on the international adviser exemption provided, among other conditions, that it acts as an adviser to permitted clients (that are not registered as advisers or dealers in a Canadian jurisdiction) and does not advise on securities of Canadian issuers unless that advice is incidental to its advice on a foreign security. The provision of general advice not purporting to be tailored to the needs of the recipient of the advice may also be exempt, subject to disclosure and other conditions. An exemption is also available for unregistered foreign advisers entering into written sub-advisory agreements with a registered adviser or dealer, subject to certain terms and conditions. Significantly, certain Canadian securities regulators once took the view that advice provided outside of Canada to a non-Canadian investment fund flows through to Canadian investors in the fund. That position, however, has been discontinued, and non-Canadian advisers to funds established outside Canada are no longer subject to adviser registration solely as a result of the issuance of securities of the investment fund to Canadian-resident investors.Investment fund manager registration
Canadian securities laws require a person who directs or manages the business, operations or affairs of an investment fund to be registered as an investment fund manager (IFM) in the province or territory in which its head office is located. A non-resident IFM is required to register in Ontario, Quebec, and Newfoundland and Labrador if the fund the IFM manages has security holders that are resident in those jurisdictions, and the IFM or the fund it manages has actively solicited local residents to purchase securities of the fund after the effective date of the rule. There is an exemption from this requirement to the extent that, among other conditions, the securities of the fund that the IFM manages are distributed only to permitted clients and certain other filings are made with the applicable securities regulators. Non-resident IFMs are generally not subject to registration in other Canadian jurisdictions unless fund management activities are conducted on the ground in the local jurisdiction.iii Derivatives regulation
Unlike the regulation of securities, the regulation of exchange-traded and over-the-counter (OTC) derivative instruments in Canada has not been harmonised, and the applicable rules and regulatory approaches vary considerably across all Canadian jurisdictions. Direct derivatives-related asset management activities in a separately managed account format and indirect activities through certain types of commingled vehicles are subject to the application of these rules in the Canadian jurisdiction in which a managed account client is located or the fund is managed. Depending on the jurisdiction, non-Canadian asset managers may rely on certain very limited regulatory exemptions, but may also be required to register or seek discretionary relief to provide derivatives-related advice. In the aftermath of the global financial crisis, the CSA published a series of consultation papers in connection with the implementation of G20 reforms relating to dealer and adviser registration and derivatives execution facilities. Final rules have now been adopted on the recognition of trade repositories and derivatives data reporting, the central clearing of OTC derivatives, which generally apply to direct clearing participants (and their affiliates) and major swap market participants (month-end gross notional above C$500 billion), and on segregation and porting for customer collateral in cleared derivatives. In addition, OTC derivatives transactions with federally regulated financial institutions are now subject to new margin requirements for non-centrally cleared derivatives. The CSA is working on a revised registration and business conduct framework in response to significant industry comments on proposals issued for comment in 2018. In general, the CSA has expressed its intention to maintain consistency with the rule-making approaches in the United States and Europe, with necessary adjustments to accommodate the size and specificities of the Canadian OTC derivatives market.iv Early warning, insider reporting and takeover bid requirements
Canadian and foreign asset managers are subject to reporting requirements governing significant Canadian or inter-listed equity positions under management. The acquisition of beneficial ownership of, or control or direction over, 10 per cent or more of any class of voting or equity securities of a reporting issuer in Canada (i.e., a Canadian public company) (or 5 per cent where the issuer is the subject of a current takeover bid or tender offer) is a significant event under Canadian securities laws, and triggers a number of reporting and other compliance obligations under Canadian early warning, insider reporting and, in certain cases, takeover bid rules.v Other areas of regulation
In addition to the sector-specific regulation and tax rules described below, the management of assets of Canadian-resident investors may also be subject to detailed regulation in the areas of trading (e.g., registration, best execution, short selling, institutional trade matching, insider trading), brokerage and soft dollars, bank regulation, privacy, anti-spam, unsolicited telecommunication rules and lobbying. Quebec's Charter of the French Language establishes French as the official language of the Province of Quebec, and imposes (absent an exemption) French-language requirements with respect to such matters as the language of contracts, business names and commercial advertising on entities doing business in Quebec. Canadian anti-money laundering and terrorist-financing legislation also applies to domestic and non-Canadian asset managers doing business in Canada, although the application of these rules in the context of cross-border asset management arrangements is an area of some difficulty.