Companion Policy to NI 81-102 Investment Funds

Part 2 Comments on Definitions Contained in the instrument

(1) This term replaced the term “commodity pool” that was previously defined under the National Instrument 81-104 Commodity Pool (NI 81-104). Mutual funds that were commodity pools under NI 81-104 are deemed to be alternative mutual funds under this Instrument.

(2) The definition of “alternative mutual fund” contemplates that the fund’s fundamental investment objectives will reflect those features that distinguish the alternative mutual fund from more conventional mutual funds. Therefore if an existing mutual were to convert to a an alternative mutual fund, we would expect such a change to necessitate changes to the mutual fund’s investment objectives that would require securityholder approval under Part 5 of the Instrument.

(3) The Instrument does not mandate a naming convention for mutual funds. However, it is our view that a mutual fund with the word “alternative” in its name could be misleading or cause confusion in the marketplace if that mutual fund is not an alternative mutual fund. We would generally expect that the only mutual funds that would use that term in their name would be alternative mutual funds.

The definition of “asset allocation service” in the Instrument includes only specific administrative services in which an investment in mutual funds subject to the Instrument is an integral part. The Canadian securities regulatory authorities do not view this definition as including general investment services such as discretionary portfolio management that may, but are not required to, invest in mutual funds subject to this Instrument.

The definition of “cash equivalent” in the Instrument includes certain evidences of indebtedness of Canadian financial institutions. This includes banker’s acceptances.

The definition of “clearing corporation” in the Instrument includes both incorporated and unincorporated organizations, which may, but need not, be part of an options or futures exchange.

The definition of “cleared specified derivative” is intended to apply to derivatives transactions that take place through the facilities of a “regulated clearing agency” as defined in National Instrument 94-101 Mandatory Central Clearing of Derivatives. The Instrument provides exemptions from certain of the provisions governing the use of cleared specified derivatives by investment funds. These exemptions are intended to facilitate the use of the clearing infrastructure in compliance with global requirements for mandatory clearing of derivatives, although the exemptions also apply in respect of cleared specified derivatives that are not subject to mandatory clearing obligations.

Paragraph (b) of the definition of “debt-like security” in the Instrument provides that the value of the component of an instrument that is not linked to the underlying interest of the instrument must account for less than 80% of the aggregate value of the instrument in order that the instrument be considered a debt-like security. The Canadian securities regulatory authorities have structured this provision in this manner to emphasize what they consider the most appropriate manner to value these instruments. That is, one should first value the component of the instrument that is not linked to the underlying interest, as this is often much easier to value than the component that is linked to the underlying interest. The Canadian securities regulatory authorities recognize the valuation difficulties that can arise if one attempts to value, by itself, the component of an instrument that is linked to the underlying interest.

The Canadian securities regulatory authorities recognize there are existing contracts that use the predecessor terms “approved credit rating”, “approved rating” and “approved credit rating organization”. The content of the new definitions “designated rating” and “designated rating organization” is substantially the same as the content of their respective predecessor terms, only the terminology has changed. Therefore, it is reasonable to interpret the predecessor terms as having the same meaning as the definition of “designated rating” and “designated rating organization” in the Instrument, as applicable.

(1) The definition of “fundamental investment objectives” is relevant in connection with paragraph 5.1(1)(c) of the Instrument, which requires that the approval of securityholders of an investment fund be obtained before any change is made to the fundamental investment objectives of the investment fund. The fundamental investment objectives of an investment fund are required to be disclosed in a prospectus under Part B of Form 81-101F1 Contents of Simplified Prospectus or under the requirements of Form 41-101F2 Information Required in an Investment Fund Prospectus. The definition of “fundamental investment objectives” contained in the Instrument uses the language contained in the disclosure requirements of Form 81-101F1 and Form 41-101F2, and the definition should be read to include the matters that would have to be disclosed under the Item of the applicable form concerning “Fundamental Investment Objectives”. Accordingly, any change to the investment fund requiring a change to that disclosure would trigger the requirement for securityholder approval under paragraph 5.1(1)(c) of the Instrument.

(2) Form 41-101F2 and Part B of Form 81-101F1 set out, among other things, the obligation that an investment fund disclose in a prospectus both its fundamental investment objectives and its investment strategies. The matters required to be disclosed under the Item of the applicable form relating to “Investment Strategies” are not “fundamental investment objectives” under the Instrument.

(3) Generally speaking, the “fundamental investment objectives” of an investment fund are those attributes that define its fundamental nature. For example, investment funds that are guaranteed or insured, or that pursue a highly specific investment approach such as index funds or derivative funds, may be defined by those attributes. Often the manner in which an investment fund is marketed will provide evidence as to its fundamental nature; an investment fund whose advertisements emphasize, for instance, that investments are guaranteed likely will have the existence of a guarantee as a “fundamental investment objective”.

(4) [Deleted]

(5) One component of the definition of “fundamental investment objectives” is that those objectives distinguish an investment fund from other investment funds. This component does not imply that the fundamental investment objectives for each investment fund must be unique. Two or more investment funds can have identical fundamental investment objectives.

A mortgage insured under the National Housing Act (Canada) or similar provincial statutes is a “guaranteed mortgage” for the purposes of the Instrument.

(1) One component of the definition of “hedging” is the requirement that hedging transactions result in a “high degree of negative correlation between changes in the value of the investment or position, or group of investments or positions, being hedged and changes in the value of the instrument or instruments with which the investment or position is hedged”. The Canadian securities regulatory authorities are of the view that there need not be complete congruence between the hedging instrument or instruments and the position or positions being hedged if it is reasonable to regard the one as a hedging instrument for the other, taking into account the closeness of the relationship between fluctuations in the price of the two and the availability and pricing of hedging instruments.

(2) The definition of “hedging” includes a reference to the “maintaining” of the position resulting from a hedging transaction or series of hedging transactions. The inclusion of this component in the definition requires an investment fund to ensure that a transaction continues to offset specific risks of the investment fund in order that the transaction be considered a “hedging” transaction under the Instrument; if the “hedging” position ceases to provide an offset to an existing risk of an investment fund, then that position is no longer a hedging position under the Instrument, and can be held by the investment fund only in compliance with the specified derivatives rules of the Instrument that apply to non-hedging positions. The component of the definition that requires the “maintaining” of a hedge position does not mean that an investment fund is locked into a specified derivatives position; it simply means that the specified derivatives position must continue to satisfy the definition of “hedging” in order to receive hedging treatment under the Instrument.

(3) Paragraph (b) of the definition of “hedging” has been included to ensure that currency cross hedging continues to be permitted under the Instrument. Currency cross hedging is the substitution of currency risk associated with one currency for currency risk associated with another currency, if neither currency is a currency in which the investment fund determines its net asset value per security and the aggregate amount of currency risk to which the investment fund is exposed is not increased by the substitution. Currency cross hedging is to be distinguished from currency hedging, as that term is ordinarily used. Ordinary currency hedging, in the context of investment funds, would involve replacing the investment fund’s exposure to a “non-net asset value” currency with exposure to a currency in which the investment fund calculates its net asset value per security. That type of currency hedging is subject to paragraph (a) of the definition of “hedging”.

A portfolio asset of a mutual fund that meets the definition of “illiquid asset” will be an illiquid asset even if a person or company, including the manager or the portfolio adviser of a mutual fund or a partner, director or officer of the manager or portfolio adviser of a mutual fund or any of their respective associates or affiliates, has agreed to purchase the asset from the mutual fund. That type of agreement does not affect the words of the definition, which defines “illiquid asset” in terms of whether that asset cannot be readily disposed of through market facilities on which public quotations in common use are widely available.

The definition of “manager” under the Instrument only applies to the person or company that actually directs the business of the investment fund, and does not apply to others, such as trustees, that do not actually carry out this function. Also, a “manager” would not include a person or company whose duties are limited to acting as a service provider to the investment fund, such as a portfolio adviser.

The term “performance data” includes data on an aspect of the investment performance of an investment fund, an asset allocation service, security, index or benchmark. This could include data concerning return, volatility or yield. The Canadian securities regulatory authorities note that the term “performance data” would not include a rating prepared by an independent organization reflecting the credit quality, rather than the performance, of, for instance, an investment fund’s portfolio or the participating funds of an asset allocation service.

An “advertisement” is defined in the Instrument to mean a sales communication that is published or designed for use on or through a “public medium”.

(1) The definition of a “purchase”, in connection with the acquisition of a portfolio asset by an investment fund, means an acquisition that is the result of a decision made and action taken by the investment fund.

(2) The Canadian securities regulatory authorities consider that the following types of transactions would generally be purchases of a security by an investment fund under the definition:

1. The investment fund effects an ordinary purchase of the security, or, at its option, exercises, converts or exchanges a convertible security held by it.

2. The investment fund receives the security as consideration for a security tendered by the investment fund into a take-over bid.

3. The investment fund receives the security as the result of a merger, amalgamation, plan of arrangement or other reorganization for which the investment fund voted in favour.

4. The investment fund receives the security as a result of the automatic exercise of an exchange or conversion right attached to another security held by the investment fund in accordance with the terms of that other security or the exercise of that exchange or conversion right at the option of the investment fund.

5. (a) The investment fund has become legally entitled to dispose of the collateral held by it under a securities loan or repurchase agreement and to apply proceeds of realization to satisfy the obligations of the counterparty of the investment fund under the transaction, and

(b) sufficient time has passed after the event described in paragraph (a) to enable the investment fund to sell the collateral in a manner that maintains an orderly market and that permits the preservation of the best value for the investment fund.

(3) The Canadian securities regulatory authorities consider that the following types of transactions would generally not be purchases of a security by an investment fund under the definition:

1. The investment fund receives the security as a result of a compulsory acquisition by an issuer following completion of a successful take-over bid.

2. The investment fund receives the security as a result of a merger, amalgamation, plan of arrangement or other reorganization that the investment fund voted against.

3. The investment fund receives the security as the result of the exercise of an exchange or conversion right attached to a security held by the investment fund made at the discretion of the issuer of the security held by the investment fund.

4. The investment fund declines to tender into an issuer bid, even though its decision is likely to result in an increase in its percentage holdings of a security beyond what the investment fund would be permitted under the Instrument to purchase.

A special warrant is a form of restricted security and, accordingly, the provisions of the Instrument applying to restricted securities apply to special warrants.

(1) The term “sales communication” includes a communication by an investment fund to

(i) a securityholder of the investment fund and

(ii) a person or company that is not a securityholder if the purpose of the communication is to induce the purchase of securities of the investment fund.

A sales communication therefore does not include a communication solely between an investment fund or its promoter, manager, principal distributor or portfolio adviser and a participating dealer, or between the principal distributor or a participating dealer and its registered salespersons, that is indicated to be internal or confidential and that is not designed to be passed on by any principal distributor, participating dealer or registered salesperson to any securityholder of, or potential investor in, the investment fund. In the view of the Canadian securities regulatory authorities, if a communication of that type were so passed on by the principal distributor, participating dealer or registered salesperson, the communication would be a sales communication made by the party passing on the communication if the recipient of the communication were a securityholder of the investment fund or if the intent of the principal distributor, participating dealer or registered salesperson in passing on the communication were to induce the purchase of securities of the investment fund.

(2) The term “sales communication” is defined in the Instrument such that the communication need not be in writing and includes any oral communication. The Canadian securities regulatory authorities are of the view that the requirements in the Instrument pertaining to sales communications would apply to statements made at an investor conference to securityholders or to others to induce the purchase of securities of the investment fund.

(3) The Canadian securities regulatory authorities are of the view that image advertisements that are intended to promote a corporate identity or the expertise of an investment fund manager fall outside the definition of “sales communication”. However, an advertisement or other communication that refers to a specific investment fund or funds or promotes any particular investment portfolio or strategy would be a sales communication and therefore be required to include warnings of the type now described in section 15.4 of the instrument.

(4) In the case of an investment fund, paragraph (b) of the definition of a “sales communication” in the Instrument excludes sales communications contained in certain documents that the investment fund is required to prepare, including audited or unaudited financial statements, statements of account and confirmations of trade. The Canadian securities regulatory authorities are of the view that if information is contained in these types of documents that is not required to be included by securities legislation, any such additional material is not excluded by paragraph (b) of the definition of sales communication and may, therefore, constitute a sales communication if the additional material otherwise falls within the definition of that term in the Instrument.

(1) The term “specified derivative” is defined to mean an instrument, agreement or security, the market price, value or payment obligations of which are derived from, referenced to or based on an underlying interest. Certain instruments, agreements or securities that would otherwise be specified derivatives within the meaning of the definition are then excluded from the definition for purposes of the Instrument.

(2) Because of the broad ambit of the lead-in language to the definition, it is impossible to list every instrument, agreement or security that might be caught by that lead-in language but that is not considered to be a derivative in any normal commercial sense of that term. The Canadian securities regulatory authorities consider conventional floating rate debt instruments, securities of an investment fund, American depositary receipts and instalment receipts generally to be within this category, and generally will not treat those instruments as specified derivatives in administering the Instrument.

(3) However, the Canadian securities regulatory authorities note that these general exclusions may not be applicable in cases in which a mutual fund invests in one of the vehicles described in subsection 2 with the result that the mutual fund obtains or increases exposure to a particular underlying interest in excess of the limit set out in section 2.1 of the instrument. In such circumstances, the Canadian securities regulatory authorities are likely to consider that instrument a specified derivative under the Instrument.

The definition of “standardized future” refers to an agreement traded on a futures exchange. This type of agreement is called a “futures contract” in the legislation of some jurisdictions, and an “exchange contract” in the legislation of some other jurisdictions (such as British Columbia and Alberta). The term “standardized future” is used in the Instrument to refer to these types of contracts, to avoid conflict with existing local definitions.

The Canadian securities regulatory authorities are of the view that the definition of a swap in the Instrument would include conventional interest rate and currency swaps, as well as equity swaps.