(a) hold the securities that are included in a permitted index or permitted indices of the mutual fund in substantially the same proportion as those securities are reflected in that permitted index or permitted indices or
(2) This definition includes only mutual funds whose entire portfolio is invested in accordance with one or more permitted indices. The Canadian securities regulatory authorities recognize that there may be mutual funds that invest part of their portfolio in accordance with a permitted index or indices, with a remaining part of the portfolio being actively managed. Those mutual funds cannot avail themselves of the relief provided by subsection 2.1(5) of the instrument, which provides relief from the “10% rule” contained in subsection 2.1(1) of the Instrument, because they are not “index mutual funds”. The Canadian securities regulatory authorities acknowledge that there may be circumstances in which the principles behind the relief contained in subsection 2.1(5) of the instrument is also applicable to “partially-indexed” mutual funds. Therefore, the Canadian securities regulatory authorities will consider applications from those types of mutual funds for relief analogous to that provided by subsectionof the instrument is also applicable to “partially-indexed” mutual funds. Therefore, the Canadian securities regulatory authorities will consider applications from those types of mutual funds for relief analogous to that provided by subsection 2.1(5) of the Instrument.
(3) It is noted that the manager of an index mutual fund may make a decision to base all or some of the investments of the mutual fund on a different permitted index than a permitted index previously used. This decision might be made for investment reasons or because that index no longer satisfies the definition of “permitted index” in the Instrument. It is noted that this decision by the manager will be considered by the Canadian securities regulatory authorities generally to constitute a change of fundamental investment objectives, thereby requiring securityholder approval under paragraph 5.1(1)(c) of the Instrument. In addition, this decision would also constitute a material change for the mutual fund, thereby requiring an amendment to the prospectus of the mutual fund and the issuing of a press release under Part 11 of National Instrument 81- 106 Investment Fund Continuous Disclosure.
An investment fund generally holds a passive stake in the businesses in which it invests that is, an investment fund generally does not seek to obtain control of, or become involved in, the management of investee companies. This key restriction on the type of investment activities that may be undertaken by an investment fund is codified in section 2.2 of the instrument. Exceptions to this are labour sponsored or venture capital funds, where some degree of involvement in the management of the investees is generally an integral part of the investment strategy. In determining whether an investment fund exercises control over, or is involved in the management of, an investee company, for the purposes of compliance with section 2.2 of the instrument, the Canadian securities regulatory authorities will generally consider indicators, including the following:
The Canadian securities regulatory authorities will take the above factors into consideration when considering the nature of an investment fund’s investment in an issuer to determine whether the investment fund is in compliance with section 2.2 of the Instrument. The Canadian securities regulatory authorities will also refer to the applicable accounting standards in determining whether an investment fund is exercising control over an issuer.
An investment fund is required by subsection 2.2(3) of the Instrument to assume the conversion of each special warrant it holds. This requirement is imposed because the nature of a special warrant is such that there is a high degree of likelihood that its conversion feature will be exercised shortly after its issuance, once a prospectus relating to the underlying security has been filed.
(1) The Canadian securities regulatory authorities expect the manager of an investment fund (whether a mutual fund or a non-redeemable investment fund) to establish an effective liquidity risk management policy that considers the liquidity of the types of assets in which the investment fund will be invested, and the fund’s obligations and other liabilities (for example, meeting redemption requests, or margin calls from derivative counterparties). Appropriate internal limits for the investment fund’s liquidity needs, in line with its investment strategies, should be established.
(2) As portfolio assets may become illiquid when market conditions change, the Canadian securities regulatory authorities are of the view that the manager should regularly measure, monitor and manage the liquidity of the investment fund’s portfolio assets, keeping in mind the time to liquidate each portfolio asset, the price the asset may be sold at and the pattern of redemption requests.
(3) Furthermore, the Canadian securities regulatory authorities are of the view that illiquid assets are generally more difficult to value, for the purposes of calculating an investment fund’s net asset value, than assets which are liquid. As a result, where a non-redeemable investment fund has a large proportion of its assets invested in illiquid assets, this raises concerns about the accuracy of the fund’s net asset value and the amount of any fees calculated with reference to net asset value. Accordingly, staff of the Canadian securities regulatory authorities may raise comments or questions in the course of their reviews of the prospectuses or continuous disclosure documents of non-redeemable investment funds where such funds have a significant proportion of their assets invested in illiquid assets.
(2) Subsection 2.5(7) of the Instrument provides that certain investment restrictions and reporting requirements do not apply to investments in other investment funds made in accordance with section 2.5 of the Instrument. In some cases, an investment fund’s investments in other investment funds will be exempt from the requirements of section 2.5 of the Instrument because of an exemption granted by the regulator or securities regulatory authority. In these cases, assuming the investment fund complies with the terms of the exemption, its investments in other investment funds would be considered to have been made in accordance with section 2.5 of the Instrument. It is also noted that subsection 2.5(7) of the Instrument applies only with respect to an investment fund’s investments in other investment funds, and not for any other investment or transaction.
Paragraph 2.6(d) of the Instrument prohibits an investment fund from purchasing a security, other than a specified derivative, that by its terms may require the investment fund to make a contribution in addition to the payment of the purchase price. This prohibition does not extend to the purchase of securities that are paid for on an instalment basis in which the total purchase price and the amounts of all instalments are fixed at the time the first instalment is made.
Paragraph 2.6(f) of the Instrument prohibits an investment fund from lending either cash or a portfolio asset other than cash. The Canadian securities regulatory authorities are of the view that the purchase of an evidence of indebtedness, such as a bond or debenture, a loan participation or loan syndication as permitted by paragraph 2.3(1)(i) or (2)(c) of the Instrument, or the purchase of a preferred share that is treated as debt for accounting purposes, does not constitute the lending of cash or a portfolio asset.
Subsection 2.6(2) of the Instrument permits an alternative mutual fund or non-redeemable investment fund to borrow cash for investment purposes (including investing on margin) from an entity that meets the criteria of a fund custodian or subcustodian under section 6.2 or 6.3, and can include the fund’s own custodian or subcustodian. This provision also permits a fund to borrow cash from a lender that is an affiliate or associate of the fund’s investment fund manager provided independent review committee approval is granted.
(1) Section 2.12, 2.13 and 2.14 of the instrument each contains a number of conditions that must be satisfied in order that an investment fund may enter into a securities lending, repurchase or reverse repurchase transaction in compliance with the Instrument. It is expected that, in addition to satisfying these conditions, the manager on behalf of the investment fund, in co-ordination with an agent, will ensure that the documentation evidencing these types of transactions contains customary provisions to protect the investment fund and to document the transaction properly. Among other things, these provisions would normally include
(a) a definition of an “event of default” under the agreement, which would include failure to deliver cash or securities, or to promptly pay to the investment fund amounts equal to dividends and interest paid, and distributions made, on loaned or sold securities, as required by the agreement
(b) provisions giving non-defaulting parties rights of termination, rights to sell the collateral, rights to purchase identical securities to replace the loaned securities and legal rights of set-off in connection with their obligations if an event of default occurs and
(c) provisions that deal with, if an event of default occurs, how the value of collateral or securities held by the non-defaulting party that is in excess of the amount owed by the defaulting party will be treated.
(2) Section 2.12, 2.13 and 2.14 of the instrument each imposes a requirement that an investment fund that has entered into a securities lending, repurchase or reverse repurchase transaction hold cash or securities of at least 102% of the market value of the securities or cash held by the investment fund’s counterparty under the transaction. It is noted that the 102% requirement is a minimum requirement, and that it may be appropriate for the manager of an investment fund, or the agent acting on behalf of the investment fund, to negotiate the holding of a greater amount of cash or securities if necessary to protect the interests of the investment fund in a particular transaction, having regard to the level of risk for the investment fund in the transaction. In addition, if the recognized best practices for a particular type of transaction in a particular market calls for a higher level of collateralization than 102%, it is expected that, absent special circumstances, the manager or the agent would ensure that its arrangements reflect the relevant best practices for that transaction.
(3) Paragraph 3 of subsection 2.12(1) of the Instrument refers to securities lending transactions in terms of securities that are “loaned” by an investment fund in exchange for collateral. Some securities lending transactions are documented so that title to the “loaned” securities is transferred from the “lender” to the “borrower”. The Canadian securities regulatory authorities do not consider this fact as sufficient to disqualify those transactions as securities loan transactions within the meaning of the Instrument, so long as the transaction is in fact substantively a loan. References throughout the Instrument to “loaned” securities, and similar references, should be read to include securities “transferred” under a securities lending transaction.
(4) Subparagraph 6(d) of subsection 2.12(1) permits the use of irrevocable letters of credit as collateral in securities lending transactions. The Canadian securities regulatory authorities believe that, at a minimum, the prudent use of letters of credit will involve the following arrangements:
(a) the investment fund should be allowed to draw down any amount of the letter of credit at any time by presenting its sight draft and certifying that the borrower is in default of its obligations under the securities lending agreement, and the amount capable of being drawn down would represent the current market value of the outstanding loaned securities or the amount required to cure any other borrower default; and
(b) the letter of credit should be structured so that the lender may draw down, on the date immediately preceding its expiration date, an amount equal to the current market value of all outstanding loaned securities on that date.
(5) Paragraph 9 of subsection 2.12(1) and paragraph 8 of subsection 2.13(1) of the Instrument each provides that the agreement under which an investment fund enters into a securities lending or repurchase transaction include a provision requiring the investment fund’s counterparty to promptly pay to the investment fund, among other things, distributions made on the securities loaned or sold in the transaction. In this context, the term “distributions” should be read broadly to include all payments or distributions of any type made on the underlying securities, including, without limitation, distributions of
(6) Sections 2.12, 2.13 and 2.14 of the Instrument each make reference to the “delivery” and “holding” of securities or collateral by the investment fund. The Canadian securities regulatory authorities note that these terms will include the delivery or holding by an agent for an investment fund. In addition, the Canadian securities regulatory authorities recognize that under ordinary market practice, agents pool collateral for securities lending/repurchase clients; this pooling of itself is not considered a violation of the Instrument.
(7) Sections 2.12, 2.13 and 2.14 of the Instrument each require that the securities involved in a securities lending, repurchase or reverse repurchase transaction be marked to market daily and adjusted as required daily. It is recognized that market practice often involves an agent marking to market a portfolio at the end of a business day, and effecting the necessary adjustments to a portfolio on the next business day. So long as each action occurs on each business day, as required by the Instrument, this market practice is not a breach of the Instrument.
(8) As noted in subsection (7), the Instrument requires the daily marking to market of the securities involved in a securities lending, repurchase or reverse repurchase transaction. The valuation principles used in this marking to market may be those generally used by the agent acting for the investment fund, even if those principles deviate from the principles that are used by the investment fund in valuing its portfolio assets for the purposes of calculating net asset value.
(9) Paragraph 6 of subsection 2.13(1) of the Instrument imposes a requirement concerning the delivery of sales proceeds to the investment fund equal to 102% of the market value of the securities sold in the transaction. It is noted that accrued interest on the sold securities should be included in the calculation of the market value of those securities.
(10) Section 2.15 of the Instrument imposes the obligation on a manager of an investment fund to appoint an agent or agents to administer its securities lending and repurchase transactions, and makes optional the ability of a manager to appoint an agent or agents to administer its reverse repurchase transactions. A manager that appoints more than one agent to carry out these functions may allocate responsibility as it considers best. For instance, it may be appropriate that one agent be responsible for domestic transactions, with one or more agents responsible for offshore transactions. Managers should ensure that the various requirements of sections 2.15 and 2.16 of the Instrument are satisfied for all agents.
(11) It is noted that the responsibilities of an agent appointed under section 2.15 of the Instrument include all aspects of acting on behalf of an investment fund in connection with securities lending, repurchase or reverse repurchase agreements. This includes acting in connection with the reinvestment of collateral or securities held during the life of a transaction.
(12) Subsection 2.15(3) of the Instrument requires that an agent appointed by an investment fund to administer its securities lending, repurchase or reverse repurchase transactions shall be a custodian or sub-custodian of the investment fund. It is noted that the provisions of Part 6 of the Instrument generally apply to the agent in connection with its activities relating to securities lending, repurchase or reverse repurchase transactions. The agent must have been appointed as custodian or sub- custodian in accordance with section 6.1, and must satisfy the other requirements of Part 6 in carrying out its responsibilities.
(13) Subsection 2.15(4) of the Instrument provides that the manager of an investment fund must not authorize an agent to enter into securities lending, repurchase or, if applicable, reverse repurchase transactions on behalf of the investment fund unless there is a written agreement between the agent, the manager and the investment fund that deals with certain prescribed matters. Subsection (4) requires that the manager and the investment fund, in the agreement, provide instructions to the agent on the parameters to be followed in entering into the type of transaction to which the agreement pertains. The parameters would normally include
(a) details on the types of transactions that may be entered into by the investment fund;
(b) types of portfolio assets of the investment fund to be used in the transaction;
(c) specification of maximum transaction size, or aggregate amount of assets that may be committed to transactions at any one time;
(d) specification of permitted counterparties;
(e) any specific requirements regarding collateralization, including minimum requirements as to amount and diversification of collateralization, and details on the nature of the collateral that may be accepted by the investment fund;
(f) directions and an outline of responsibilities for the reinvestment of cash collateral received by the investment fund under the program to ensure that proper levels of liquidity are maintained at all times; and
(g) duties and obligations on the agent to take action to obtain payment by a borrower of any amounts owed by the borrower.
(14) The definition of “cash cover” contained in section 1.1 of the Instrument requires that the portfolio assets used for cash cover not be “allocated for specific purposes”. Securities loaned by a mutual fund in a securities lending transaction have been allocated for specific purposes and therefore cannot be used as cash cover by the mutual fund for its specified derivatives obligations.
(15) An investment fund sometimes needs to vote securities held by it in order to protect its interests in connection with corporate transactions or developments relating to the issuers of the securities. The manager and the portfolio adviser of an investment fund, or the agent of the investment fund administering a securities lending program on behalf of the investment fund, should monitor corporate developments relating to securities that are loaned by the investment fund in securities lending transactions, and take all necessary
(16) As part of the prudent management of a securities lending, repurchase or reverse repurchase program, managers of investment funds, together with their agents, should ensure that transfers of securities in connection with those programs are effected in a secure manner over an organized market or settlement system. For foreign securities, this may entail ensuring that securities are cleared through central depositories. Investment funds and their agents should pay close attention to settlement arrangements when entering into securities lending, repurchase and reverse repurchase transactions.
Section 2.18 of the instrument imposes daily and weekly liquidity requirements on money market funds. Specifically, money market funds must keep 5% of their assets invested in cash or readily convertible into cash within one day, and 15% of their assets invested in cash or readily convertible into cash within one week. Assets that are “readily convertible to cash” would generally be short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Such assets can be sold in the ordinary course of business within one business day (in the case of the daily liquidity requirement) or within five business days (in the case of the weekly liquidity requirement) at approximately the value ascribed to them by the money market fund. The Canadian securities regulatory authorities note that the securities do not have to mature within the one and five business day periods. For example, direct obligations of the Canadian or U.S. government, or of a provincial government, that mature after one or five business days but that can be readily converted to cash within one or five business days, would likely be eligible for the 5% and 15% liquidity requirements.
(1) Subsection 4.1(4) of the Instrument permits a dealer managed investment fund to make an investment otherwise prohibited by subsection 4.1(1) of the instrument and the corresponding provisions in securities legislation referred to in Appendix C to the Instrument if the independent review committee of the dealer managed investment fund has approved the transaction under section 5.2(2) of National Instrument 81-107 Independent Review Committee for Investment Funds (“NI 81-107”). The Canadian securities regulatory authorities expect the independent review committee may contemplate giving its approval as a standing instruction, as contemplated in section 5.4 of NI 81-107.
(2) Subsection 4.3(2) of the instrument permits an investment fund to purchase a class of debt securities from, or sell a class of debt securities to, another investment fund managed by the same manager or an affiliate of the manager where the price payable for the security is not publicly available, if the independent review committee of the investment fund has approved the transaction under section 5.2(2) of NI 81-107 and the requirements in section 6.1 of NI 81-107 have been met. The Canadian securities regulatory authorities expect the independent review committee may contemplate giving its approval as a standing instruction, as contemplated in section 5.4 of NI 81-107.
(3) In providing its approval under paragraph 4.3(2) of the Instrument, the Canadian securities regulatory authorities expect the independent review committee to have satisfied itself that the price of the security is fair. It may do this by considering the price quoted on a marketplace (e.g., CanPx or TRACE), or by obtaining a quote from an independent, arm’s-length purchaser or seller, immediately before the purchase or sale.