On June 19, 2014, the Canadian Securities Administrators (CSA) released, in final form, amendments to National Instrument 81-102 Mutual Funds (NI 81-102) and other securities legislation (Phase 2 amendments) that will have a variety of impacts on closed-end funds and mutual funds[1]. The proposed changes were first published for comments in March 2013[2] (2013 proposals) and received extensive critical comments. Many of the investment restrictions for closed-end funds contained in the 2013 proposals have been deferred and will be revisited in the future when a new regime for alternative funds is published by the CSA for comments.
The Phase 2 amendments are too lengthy to be summarized in full in this Bulletin. Industry participants should consult the more detailed provisions of the Phase 2 amendments before determining what actions are required in response to these changes.
Changes for Closed-End Funds
Unless otherwise stated, the changes described below will apply to any closed-end fund that is a reporting issuer anywhere in Canada. This includes TSX-listed funds with or without annual redemption rights at net asset value and flow-through limited partnerships. They also will apply to any underlying fund of a TSX-listed fund as a result of the new fund-on-fund investing rules described below.
Investment restrictions
Fund-on-fund
A closed-end fund will be permitted to invest in another fund (directly or through derivative exposure) only if the underlying fund complies with the provisions of NI 81-102 applicable to closed-end funds (either voluntarily or because it actually is subject to the Instrument) and is a reporting issuer in Canada[3]. In most cases, existing fund-on-fund structures will comply with these requirements because the underlying fund is a reporting issuer and voluntarily complies with the relevant provisions of NI 81-102. However, in a small number of cases (such as where multiple underlying funds are used, or where the underlying fund is a U.S. mutual fund), the underlying fund(s) has not previously file a non-offering prospectus and therefore is not a permitted underlying fund. These funds will need to seek exemptive relief.
Closed-end funds also will be prohibited from using three-tiered (or more) structures unless (i) the middle fund is a "clone fund" of its underlying fund, or (ii) the bottom fund is a money market fund or index participation unit (IPU). Though three-tiered structures are uncommon among closed-end funds, any which do exist are likely to be non-compliant with these new restrictions.
Closed-end funds will have the same limited exceptions for fund-on-fund investments as mutual funds, such as the ability to invest in Canadian and U.S.-traded IPUs. However, closed-end fund managers should note that Ontario Securities Commission (OSC) staff takes a limited view on the types of listed funds which qualify as IPUs[4]. In their view, a fund is not an IPU if it either tracks a commodity price or tracks an index on a leveraged or inverse basis. The reason for this position is that it could enable a mutual fund to obtain investment exposure indirectly through the IPU that the mutual fund could not obtain directly. However, the same policy concerns do not apply to closed-end funds since they are not subject to restrictions on investing in commodities or using leverage. It is not clear to what extent (if any) OSC staff may attempt to limit the scope of permissible IPU investments by closed-end funds.
Existing funds are grandfathered from the new fund-on-fund requirements until March 21, 2016.
10% control restriction
Like mutual funds, closed-end funds will be prohibited from purchasing securities of an issuer that result in the closed-end fund owning more than 10% of the issuer's outstanding voting or equity securities[5]. Look-through rules apply to special warrants and American depositary receipts held by the closed-end fund. The Phase 2 amendments permit the limit to be exceeded to the extent the holding is through derivative exposure for hedging purposes[6]. However, the reason for this exception is unclear since exposure to an issuer through derivatives is not included in a fund's holdings for these purposes. Prepaid forward transaction are not captured by this prohibition since the forward agreement is not a voting or equity security.
Managers of closed-end funds should note that the term "purchase" has an extended meaning in the companion policy to NI 81-102 (Companion Policy) and includes actions not considered a "purchase" in the conventional sense of the word (such as voting in favour of a proposal that will result in the issuer issuing securities to the fund). Managers may need to modify their proxy voting procedures to identify these potential circumstances. Where a closed-end fund acquires securities other than through a "purchase" and crosses the 10% threshold, the fund will be obligated to reduce its position below 10%.
Illiquid investments
The CSA did not impose any prescribed limits on illiquid investments held by closed-end funds. However, the CSA have added a statement in the Companion Policy[7] to the effect that managers should maintain appropriate internal limits on illiquid investments, having regard for the fund's redemption obligations and other cash needs. The CSA also stated that they expect to express valuation concerns in the future when commenting on the prospectuses and continuous disclosure of closed-end funds that have significant portions of their assets in illiquid investments. Their concern is that illiquid investments provide managers with the opportunity to fair value those assets at inflated amounts in order to increase the management fees payable to the manager. Accordingly, to the extent they have not already done so, managers should consider developing internal guidelines regarding illiquid investments to address these concerns.
Real property and mortgages
Closed-end funds will be prohibited from purchasing real property and from purchasing any mortgage, other than a government guaranteed mortgage[8]. These new restrictions will effectively prohibit the creation of any further mortgage investment entities as public investment funds. Existing mortgage investment entities are grandfathered provided certain conditions are met.
Loan participations
Closed-end funds will be prohibited from purchasing any interest in a loan syndication or loan participation if the fund would be required to assume any responsibilities for administering the loan[9].
Securities lending, etc.
As a result of the Phase 2 amendments, closed-end funds will become subject to the same requirements relating to securities lending, repurchase transactions and reverse repurchase transactions as mutual funds including:
- the fund must use its custodian or sub-custodian as its agent
- the fund must hold specified collateral with a daily marked-to-market value not less than 102% of the market value of the securities loaned or sold
- in the case of reverse repurchase transactions, only certain types of securities may be purchased by the fund under the transaction and the daily marked-to-market value of such securities must be not less than 102% of the cash paid by the fund under the transaction
- the aggregate outstanding market value of all securities loaned or sold by the fund under securities loans and repurchase transactions cannot exceed 50% of the fund's net asset value. (There is no equivalent limit on reverse repurchase transactions.)
Typically, closed-end funds already comply with equivalent self-imposed restrictions. However, closed-end funds which have outstanding forward sale transactions for income recharacterization purposes will become prohibited from continuing to lend out 100% of their common share portfolio after these changes come into effect on September 21, 2015. This will reduce the fund's securities lending revenue from September 21, 2015 until its forward transaction is terminated under the Budget legislation (generally, the earlier of the transaction's maturity date and March 21, 2018). Some mutual funds in equivalent circumstances have obtained exemptive relief to permit all of their common share portfolios to be loaned (including relief to permit the counterparty's IIROC affiliate rather than the mutual fund's custodian to act as the mutual fund's securities lending agent). Closed-end funds in similar situations should consider whether their current securities lending arrangements will comply with the new requirements after September 21, 2015 and, if not, seek equivalent exemptive relief.
Other investment practices
Like mutual funds, closed-end funds also will be prohibited from[10]:
- purchasing securities subject to future calls (such as instalment receipts and partially paid shares) other than obligations under derivatives
- lending cash (e.g., making direct loans). For greater certainty, this does not prohibit a closed-end fund from investing in fixed income securities, or purchasing permitted loan participations as described above
- lending other portfolio assets, other than securities lending in compliance with NI 81-102
Prohibition against dilutive offerings and all warrant offerings
The Phase 2 amendments prohibit all investment funds from issuing units at an issue price less than their net asset value.[11]. Related guidance from the CSA[12] suggests that funds should seek to achieve net proceeds as close as possible to net asset value per unit, but does not prohibit net proceeds being less than net asset value per unit due to offering expenses (including agents' commission). This is more favourable than the self-imposed restrictions of many closed-end funds which require that net proceeds be not less than net asset value per unit.
The Phase 2 amendments also prohibit all investment funds from issuing warrants[13]. Though not an issue for mutual funds, warrant offerings to existing unitholders of closed-end funds generally have been the only means for closed-end funds to raise additional capital as an exception to their self-imposed anti-dilution restrictions. This will no longer be permitted under the Phase 2 amendments, even if the strike price is out-of-the-money when the warrants are issued.
Mergers and reorganizations
Conversion to a mutual fund
A new requirement under the Phase 2 amendments is that every conversion of a closed-end fund to a mutual fund must be approved by its unitholders[14]. No exception is provided for closed-end funds that were launched with a "built-in conversion feature" such that the conversion was part of the structure of the fund at the time unitholders made their decision to invest in the fund. This is curious since the conversion typically is considered a benefit for unitholders. Instead, conversion now will be subject to unitholder approval at a meeting, the cost of which must be borne by the manager (as discussed below).
Merger with another investment fund
The Phase 2 amendments also will require that any merger of a closed-end fund into another investment fund must be approved by its unitholders unless the merger meets conditions for pre-approval similar to those for pre-approved mutual fund mergers[15]. Where a merger is not pre-approved, it also must be approved by the CSA. Mergers also will need to be approved by unitholders of the continuing fund if the merger would be a material change for the continuing fund. The CSA presume that any merger of a larger fund into a smaller fund constitutes a material change for the continuing fund, thereby requiring approval by its unitholders[16].
An exception to the above rules is provided to permit flow-through limited partnerships to merge into mutual fund corporations without further unitholder approval, subject to various conditions including that certain disclosure be included in each fund's prospectus. Some existing flow-through limited partnerships may not have included such disclosure in their previous prospectuses and therefore may need to seek exemptive relief to complete their "rollover" merger without a unitholder vote.
Reorganization to non-investment fund status
Another new requirement is that any reorganization whereby a closed-end fund ceases to be an "investment fund" must be approved by its unitholders[17]. These types of reorganizations are extremely rare since managers of closed-end funds typically do not manage non-investment fund businesses. However, several such reorganizations were recently completed by mortgage investment corporations following the OSC's announcement that it would not issue a receipt for the prospectus of an investment fund that invests mainly in mortgages originated by its manager (or an affiliate)[18]. Accordingly, this new requirement may be a reaction to those recent reorganizations. It also may be in anticipation of reorganizations that may occur in the future as the regulation of closed-end funds increases under the fund modernization proposals.
Termination of a closed-end fund
Under the Phase 2 amendments, the termination of a closed-end fund must be announced in a press release, and the termination must be completed no earlier than 15 days and no later than 90 days following the press release. According to the CSA, the new minimum notice requirement is intended to give investors time to consider the consequences of the termination. However, there does not seem to be anything for investors to consider since a termination results in investors receiving back their cash. The 90-day completion deadline is to address concerns that secondary market liquidity may decline significantly after the proposed termination is announced.
Costs of conversions, mergers and reorganizations
Perhaps of greater concern to managers will be the new requirement that all costs associated with converting a closed-end fund into a mutual fund, merging a closed-end fund into another investment fund, or reorganizing a closed-end fund into a non-investment fund cannot be charged to the fund, thereby effectively requiring that the costs be borne by the fund's manager[19]. These include, for example, unitholder meeting costs and the costs of the fund's first prospectus as a mutual fund. An exception is provided for the costs associated with merging a flow-through limited partnership into a mutual fund corporation.
This new requirement seems excessive since most investment fund conversions and reorganizations produce a significant benefit for unitholders. Merely because the manager retains the assets under management following the conversion or reorganization should not, by itself, be considered sufficient reason for unitholders to receive a "free" conversion or reorganization. This new requirement also creates a disincentive for managers to recommend such transactions, even if the transaction would be in the best interests of unitholders. It would be prudent for managers to add disclosure in their management contracts and prospectuses clarifying that the manager is under no obligation to recommend any conversion, merger or reorganization where the manager would be required to bear the costs of the transaction.
Sale of the business of a closed-end fund manager
As a result of the Phase 2 amendments, the sale of a manager's closed-end fund business will require CSA approval and, if structured as a change of manager (such as through the sale of management contracts), approval by the fund's unitholders as well[20].
The Phase 2 amendments regarding a change of manager through a sale of management contracts are not likely to have a material impact since most closed-end funds have self-imposed requirements to obtain unitholder approval for a change of manager. The more significant impact will be on transactions involving a change of control of the manager. Though CSA approval of a change of control currently is required under section 11.10 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, the CSA's review for NI 81-102 purposes typically is more rigorous and increases the likelihood that unitholder approval will be required. This is due to the OSC's position that a change of control of a manager can, in certain circumstances, be tantamount to a change of manager and therefore should be submitted to unitholders for approval[21]. This will increase the costs and delay the timing of M&A transactions involving closed-end fund managers where a post-closing reorganization or consolidation of the acquired business is desired.
Unitholder and IRC approvals
Like mutual funds, closed-end funds now will be required to seek unitholder approval before:
- changing the basis on which fees and expenses are charged to the fund or its unitholders in a manner that could result in an increase
- changing the fund's investment objective
This is in addition to the unitholder approval requirements for converting, merging or reorganizing a fund or changing its manager, as described above.
Most closed-end funds already have equivalent self-imposed requirements to obtain unitholder approval for these changes and, therefore, should not be materially impacted by these changes.
The Phase 2 amendments also will require that a change of auditor of a closed-end fund be approved by its independent review committee. This too does not represent a significant new requirement since managers already are referring such a change to the fund's independent review committee as a conflict of interest matter under National Instrument 81-107 Independent Review Committee for Investment Funds.
Distributions by affiliated dealers
Closed-end funds will become subject to certain related underwriting restrictions that currently apply only to public mutual funds[22]. These restrictions will prohibit the fund from purchasing securities of an issuer during, or within 60 days after, a distribution of that class of securities (whether by public offering or private placement) where an affiliate of the manager acted as an underwriter for the distribution. (Note that under securities legislation, an "underwriter" includes a selling agent on a "best efforts" basis.) This long-standing restriction on mutual funds is intended to address the potential conflict over whether the manager's purchase decision is motivated by a desire to assist its affiliated dealer with the distribution, rather than based solely on the merits of the investment.
There are several important exceptions to this prohibition:
- it does not apply to the purchase of any securities issued or guaranteed by the Canadian government or a province
- it does not apply to the purchase of debt securities with a designated credit rating
- it does not apply to a purchase of equity securities over an exchange if the equity securities were distributed by prospectus (but the securities cannot be purchased under the prospectus offering itself)
- it does not apply if the affiliated dealer acted solely as a selling group member and sold not more than 5% of the offering.
The second and third exceptions above are also subject to receiving independent review committee approval.
Managers of closed-end funds with affiliated IIROC dealers may need to modify their internal procedures to avoid purchases of securities by their closed-end funds that will be prohibited under these restrictions.
Redemption rights
There are several new requirements relating to the redemption rights of unitholders in closed-end funds.
First, the ability of a closed-end fund to suspend redemptions will be limited to the same circumstances as mutual funds[23]. Though not likely to be an issue in most cases, some closed-end funds currently have greater flexibility to suspend redemptions to reflect the liquidity of their underlying assets.
Second, all redemption proceeds must be paid within 15 business days following the valuation date used for the redemption[24]. While most closed-end funds already pay redemption proceeds this quickly, there are a number of funds which do not (again, typically related to the liquidity of their underlying assets). Those funds will need to modify their redemption payment procedures or seek exemptive relief.
Third, the manager must provide unitholders annually with a description of how they may exercise their redemption rights[25]. This annual notification requirement will not take effect until January 1, 2015.
Sales communications
Closed-end funds will become subject to the same sales communications (e.g., advertising) restrictions that currently apply to mutual funds[26]. These rules are too detailed to summarize in this Bulletin. Suffice it to say, they include the following:
- a prescribed method for calculating past performance
- a requirement to include past performance for prescribed periods (e.g., 1, 3, 5 and 10 years) if performance information is included in the communication
- a prohibition against citing past performance if the fund has been a reporting issuer for less than one year
- a requirement to describe the impact of material changes to the fund on its past performance
- restrictions on references to ratings and rankings
- prescribed warnings and disclaimers for all sales communications (even if no past performance information is included).
Any communication to an existing unitholder is a "sales communication" unless it is contained in certain mandatory documents under securities legislation (such as financial statements and management reports of fund performance). A communication also is a "sales communication" if it is made to potential investors to induce the purchase of securities of the investment fund. This includes website postings and advertising in print and other media.
The scope of regulated communications was defined many years ago in the context of mutual funds in continuous distribution. These rules assumed that any purchase would be made as part of the mutual fund's distribution and thereby increase the assets under management of its manager. Where a mutual fund is no longer in continuous distribution, a communication is not considered an inducement to purchase securities of the fund (and therefore not a "sales communication") since the securities are no longer available for purchase.
According to OSC staff, a communication (such as a website posting) may be considered a "sales communication" for a closed-end fund not in distribution if it is made to induce secondary market purchases. These circumstances are unlikely, which leaves room for various communications to not constitute sales communications. However, the prudent approach would be to treat all such communications as sales communications and ensure that their content complies with these requirements.
Administrative requirements
A number of administrative requirements currently applicable to mutual funds will now apply to closed-end funds. These include:
- certain additional rules relating to fund-on-fund holdings (such as transaction costs and voting rights)
- certain specific requirements relating to contractual relationships between the fund and its manager and other service providers[27]
- a requirement that certain rights and obligations be documented where a closed-end fund receives advice from a non-resident adviser concerning options or futures[28].
Changes Not Made to Closed-End Funds
The 2013 proposals included a number of investment restrictions that would have made closed-end funds more similar to mutual funds, such as:
- a 10% concentration limit
- limits on leverage
- restrictions on short selling
- restrictions on the use of derivatives
- limits on illiquid investments
The original intention was that closed-end funds which did not comply with these mutual fund-type investment restrictions would fall into a new category for "alternative funds" and would be subject to different regulations. Since the CSA have yet to publish their proposed regime for alternative funds, the additional investment restrictions described above have been deferred. They will be revisited at a later date when the alternative funds regime is published for comments.
The CSA also have deferred their proposal that closed-end funds not pay for certain start-up costs, including offering expenses.
Changes for Mutual Funds
Though the focus of the Phase 2 amendments is on closed-end funds, a number of changes were made that will impact mutual funds.
Investing in closed-end funds
Current restrictions in NI 81-102 regulate only fund-on-fund investments in other mutual funds. There is no restriction on the ability of a mutual fund to invest in securities of a closed-end fund, other than the same restrictions that apply to any other investment (such as concentration, control and illiquidity limits). The Phase 2 amendments will prohibit all investments by mutual funds in closed-end funds[29].
Sales communication following conversion from a closed-end fund structure
Previously, a mutual fund resulting from the conversion of a closed-end fund could not cite its past performance from the period it was a closed-end fund unless exemptive relief was obtained. The Phase 2 amendments reverse this position and will require that such mutual funds start their performance measurement from the date the fund first was a reporting issuer as a closed-end fund[30]. The Phase 2 amendments also will change the "start date" of such funds to the date the closed-end fund became a reporting issuer[31]. Managers of mutual funds which did not previously obtain such relief will need to recalculate their funds' past performance over the longer performance measurement period. This could impact the fund's ratings and rankings. Further, this information will need to be updated at all relevant locations (such as websites and with third party information providers) by the time the new requirements come into effect on September 22, 2014. According to OSC staff, existing funds are not expected to amend and refile their fund facts merely to include the longer past performance record.
The CSA also have stated their view that any such conversion will require additional discussion under section 15.9(1) of NI 81-102 of the potential impact of the conversion on the fund's past performance[32]. However, there will be nothing to disclose if the fund has been compliant with NI 81-102 since inception and the conversion only changes the redemption rights attached to its units.
Securities lending disclosure
The Phase 2 amendments include amendments to National Instrument 81-106 Investment Fund Continuous Disclosure that will require all investment funds to disclose in the notes to their financial statements a reconciliation between the gross revenues generated for the fund from securities lending activity (including returns from investing the collateral held by the fund for such transactions) and the net income retained by the fund after compensating its lending agent. This disclosure must include the names of the parties who received compensation, the amount each party received, and the aggregate compensation paid as a percentage of the gross securities lending revenue. The new requirement applies to financial years beginning on or after January 1, 2016. As well, investment funds will be required to disclose in their prospectuses specific details of their relationships with their securities lending agent starting September 22, 2014.
Other changes
The Phase 2 amendments include a number of other changes which are not significant. These include:
- making the custodian requirements in NI 81-102 apply to closed-end funds. The equivalent requirements were not deleted from Part 14 of National Instrument 41-101 General Prospectus Requirements, even though they will remain relevant only to scholarship plans
- stylistic changes for greater "plain language" drafting.
Transition and Implementation Period
Except as described below, the Phase 2 amendments are scheduled to take effect on September 22, 2014.
- The requirements relating to securities lending, repurchase transactions and reverse repurchase transactions will not come into effect for existing closed-end funds until September 21, 2015.
- The new investment restrictions relating to control, purchasing real property, mortgages, loan participations and fund-on-fund investments will not come into effect for existing closed-end funds until March 21, 2016.
- The new investment restriction prohibiting a mutual fund from investing in a closed-end fund will not apply to existing mutual funds until March 21, 2016.
Note, however, that the changes described above will apply immediately to any closed-end fund or mutual fund that files its first final prospectus after September 22, 2014.
The requirement to provide annual notice to unitholders of closed-end funds of their redemption rights will not come into effect until January 1, 2015.
Issues with the Phase 2 amendments
Technical and/or policy flaws
As described above, the Phase 2 amendments contain several provisions which are either difficult to interpret or apply, or lack a policy rationale.
For example, there is no policy rationale for requiring a unitholder vote on converting a closed-end fund to a mutual fund when the conversion feature is included in the fund since its inception and described to investors in the fund's prospectus. Similarly, it is unfair to impose on a manager the costs of such a conversion, or of merging a flow-through limited partnership into a mutual fund corporation, when the conversion or merger is a feature of the fund since its inception and described to investors in the fund's prospectus. The result will be a windfall for investors in these funds.
Similarly, there is no compelling policy reason for the additional securities lending disclosure contained in the Phase 2 amendments. Securities lending is a voluntary activity not required to be undertaken by any particular fund and typically not a material part of any fund's investment strategies. The revenues generated from securities lending usually comprise only a small part of the fund's overall return. Most of the additional information for prospectus disclosure results directly from securities legislation: the fund's lending agent must be its custodian or sub-custodian, the minimum collateral is 102% on a marked to market basis, and the permitted scope of indemnities is governed by section 4.4(3) of NI 81-102. The additional prospectus information seems excessive, particularly when compared to the equivalent disclosure made of the relationships with the same parties as custodians and sub-custodians.
The CSA's rationale for some of this disclosure is a concern over a conflict of interest where the fund's lending agent is affiliated with its manager. However, no such concern exists when the lending agent is arm's length from the manager. For that reason, the additional disclosure should be limited only to circumstances where the lending agent is affiliated with the manager. To the extent that the CSA also are seeking transparency of the costs associated with securities lending, this can be achieved in a more meaningful manner through each fund's management expense ratio and trading expense ratio.
More generally, following the publication of the 2013 proposals, the CSA received comments requesting an articulation of the policy rationale behind these changes in order to enable industry participants to provide more meaningful comments. The CSA have yet to articulate their policy rationale beyond seeking fairness and a level the playing field between mutual funds and closed-end funds. The CSA have not provided information to support whether there is any harm to investors resulting from the current differences between mutual funds and closed-end funds. Instead, the Phase 2 amendments merely seek to standardize the regulation without taking into account the different classes of investors and advisors who utilize closed-end funds.
Absence of a meaningful cost-benefit analysis
A critical condition on the ability of the CSA to create new regulations is the requirement to provide a meaningful cost-benefit analysis[33]. Without it, there is a reduction of both the ability of market participants to comment on the merits of proposed new securities legislation, as well as the accountability of the CSA in making such proposals.
The CSA have not provided a meaningful costs-benefit analysis concerning the Phase 2 amendments. The CSA have only stated a number of assumptions and conclusions regarding the anticipated costs of benefits without detailing or quantifying those costs and benefits. There is, for example, no information provided by the CSA to justify their statement that:
"Overall, we think the potential benefits of the Proposed Amendments are proportionate to their costs."[34]
The CSA have instead reversed the onus of the cost-benefit analysis by inviting commentators to provide specific data concerning anticipated costs. This "reverse onus" does not satisfy the obligation of the CSA to provide a meaningful description of the anticipated costs and benefits of the Phase 2 amendments.
No further opportunity for comments
The changes contained in the 2013 proposals were so extensive that it was difficult for industry participants to exhaustively comment on them[35]. The 2013 proposals indicated that closed-end funds which could not comply with the new restrictions could continue as "alternative funds" under a separate alternative funds regime. However, that regime was not included in either the 2013 proposals or the Phase 2 amendments, with the result that closed-end funds now have no option but to comply with the Phase 2 amendments. The 2013 proposals and the Phase 2 amendments also failed to identify and address a number of ambiguities and unintended consequences that will lead to confusion and exemptive relief applications.
For these reasons, Faskens has written to OSC staff to state our view that the Phase 2 amendments should be published for further comments before being finalized and implemented. Failure to provide an opportunity to comment on the Phase 2 amendments impairs the ability of the CSA to make the best regulation possible, and is inconsistent with the spirit and intent of public consultation as part of the rule-making process.
Failure to address matters of benefit to the industry
The CSA have moved quickly when introducing new restrictions on the industry, but proceeded noticeably more slowly concerning changes that could benefit the industry. For example, routine exemptive relief in a number of areas (such as investing in leveraged ETFs or commodities in certain circumstances) has yet to be codified, thereby requiring that each fund incur the cost of seeking its exemptive relief. The CSA also have not expressed any views to facilitate the response by mutual funds to the Federal Budget's elimination of income recharacterization transactions.
The Phase 2 amendments add to the existing long list of disclosures required to be provided to unitholders. Much of this information is duplicative and the cost of preparing the information typically is charged back to the investment fund, thereby increasing the fund's management expense ratio. As part of other initiatives, the CSA have emphasized the importance of fund facts as the central document upon which investors are expected to base their investment decisions. In the past, the CSA also have stated their willingness to consider changes to reduce duplication in the overall investment fund disclosure regime. However, this willingness has not been mentioned in recent CSA publications. It would be a benefit to the industry and investors if the CSA gave the rationalization of this disclosure the same priority as was afforded the Phase 2 amendments.
Similarly, the CSA have made no recent attempt to modernize the requirements for electronic delivery of documents since the CSA's views on electronic delivery were articulated almost 15 years ago[36]. The CSA recently reiterated in the context of the fund facts regime that, in their view, "access" (e.g., mere website posting) does not equal "delivery", nor is referral to a website sufficient. This position is significantly out-of-date with current internet usage by average Canadians. An overhaul of the CSA's position on electronic delivery is long overdue, particularly in light of the increasing amount of disclosure expected to be made to unitholders.
Additional information
A link to the Phase 2 amendments is provided below.
Fasken Martineau also has prepared a consolidated version of NI 81-102 which incorporates the Phase 2 amendments for ease of reference and can be accessed through the links below.
National Instrument 81-102 Mutual Funds (with Phase 2 Fund Modernization Amendments)
National Instrument 81-102 Mutual Funds (with Phase 2 Fund Modernization Amendments) - Blacklined
[1] CSA Notice of Amendments to National Instrument 81-102 Mutual Funds, National Instrument 81-106 Investment Fund Continuous Disclosure, National Instrument 81-101 Mutual Fund Prospectus Disclosure, National Instrument 41-101 General Prospectus Requirements and Related Consequential Amendments (June 19, 2014).
[2] CSA Notice and Request for Comment: Proposed Amendments to National Instrument 81-102 Mutual Funds, Companion Policy 81-102CP Mutual Funds and Related Consequential Amendments and Other Matters Concerning National Instrument 81-104 Commodity Pools and Securities Lending, Repurchases and Reverse Repurchases by Investment Funds (March 27, 2013).
[3] Sections 2.5(2)(a.1) and 2.5(2)(c.1) of NI 81-102.
[4] See the May 2011 publication of The Investment Funds Practitioner.
[5] Section 2.2 of NI 81-102.
[6] Section 2.9(2) of NI 81-102.
[7] Section 3.3.1 of the Companion Policy.
[8] Sections 2.3(2)(a) and (b) of NI 81-102.
[9] Section 2.3(2)(c) of NI 81-102.
[10] Sections 2.6(d) and (f) of NI 81-102.
[11] Section 9.3(2) of NI 81-102.
[12] Section 9.3(2)(a) of the Companion Policy
[13] Section 9.1.1 of NI 81-102.
[14] Section 5.1(1)(h)(i) of NI 81-102.
[15] Section 5.3 of NI 81-102.
[16] Section 7.3(2) of the Companion Policy.
[17] Section 5.1(1)(h)(iii) of NI 81-102.
[18] See OSC Staff Notice 81-722. The Phase 2 amendments now expressly grandfather any such existing funds, though such funds may face regulatory opposition with future prospectus offerings.
[19] Sections 5.1(2), 5.3(2)(a)(iii) and 5.6(1)(h) of NI 81-102
[20] Sections 5.1(1)(b) and 5.5(1)(a) and 5.5(1)(a.1) of NI 81-102.
[21] See OSC Staff Notice 81-710.
[22] Section 4.1 of NI 81-102.
[23] Section 10.6 of NI 81-102.
[24] Sections 10.4(1.1) and (1.2) of NI 81-102.
[25] Section 10.1(3) of NI 81-102.
[26] Part 15 of NI 81-102.
[27] Section 4.4 of NI 81-102.
[28] Section 2.10 of NI 81-102.
[29] Section 2.5(2)(a) of NI 81-102.
[30] Section 15.6(2) of NI 81-102.
[31] Section 13.2(5) of the Companion Policy.
[32] Section 13.2(1) of the Companion Policy.
[33] See, for example, section 143.2(2)7 of the Securities Act (Ontario).
[34] See the discussion under the heading "Anticipated Costs and Benefits of the Proposed Amendments" in the CSA notice which accompanied the 2013 proposals.
[35] For this reason, the CSA extended the comment period under CSA Staff Notice 11-324 (June 25, 2013).
[36] See National Policy 11-201 Electronic Delivery of Documents
