Copyright 2012, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Securities Regulation, February 2012
CSA announces adoption of Amendments to complete first phase of its Modernization Project. Upon coming into force, the Amendments:
- introduce new provisions to address the unique features of ETFs by amending certain purchase and redemption processes and other operational requirements
- introduce additional investment restrictions for money market funds, including liquidity requirements and a new dollar-weighted average term to maturity limit
- permit mutual funds to engage in short-selling subject to compliance with standard restrictions contained in exemptive relief routinely granted by the CSA
- expand the definition of "cash cover" to include
securities of money market funds and certain floating rate
On February 9, 2012, the Canadian Securities Administrators (CSA) released the final form of amendments (the Amendments) to National Instrument 81-102 Mutual Funds (NI 81-102) and related instruments. Subject to ministerial approval requirements, the Amendments come into force on April 30, 2012.
Upon coming into force, the Amendments will complete the first phase of the CSA's project to modernize product regulation of publicly offered investment funds by codifying exemptive relief that has been frequently granted to mutual funds and exchange-traded funds under NI 81-102, creating additional operational requirements for money market funds and including other changes intended to make investment fund rules "more effective and relevant in today's diverse and increasingly innovative retail fund marketplace."
The Amendments were initially published for comment on June 25, 2010 and have been revised to reflect certain comments received by the CSA.
Responding to the unique features of exchange-traded mutual funds (ETFs), both those in continuous distribution and those not in continuous distribution, the Amendments eliminate the need for new ETF providers to obtain exemptive relief from certain prescribed purchase and redemption processes and also from other operational requirements that generally apply to more conventional mutual funds that are bought and sold through the mutual fund dealer network. These include permitting ETFs not in continuous distribution to charge fund formation costs to the fund, and providing such funds with an exemption from the compliance reporting requirements in Part 12 of NI 81-102. The Amendments benefit ETF providers and their investors by eliminating the regulatory costs and potential delays associated with obtaining exemptive relief which was routinely being granted by the regulators to these types of funds.
Money Market Funds
The Amendments codify frequently granted exemptive relief to permit money market funds to invest in other money market funds. The Amendments also introduce the following new requirements:
- Liquidity: A money market fund must have at
least 5% of its assets in cash or readily convertible into cash
within one day and 15% of its assets in cash or readily convertible
into cash within one week. Assets readily convertible into cash
within a day or week are assets that can be sold within those time
periods at prices which approximate the values assigned to such
assets by the fund in calculating its net asset value (NAV).
- Dollar-weighted average term to maturity
limit: A money market fund is required to maintain a
dollar-weighted average term to maturity not exceeding 180 days
calculated based on the actual term to maturity of all securities
in its portfolio (in addition to the current requirement to
maintain a dollar-weighted average term to maturity not exceeding
90 days calculated on the basis that the term of a floating rate
obligation is the period to the date of the next rate reset). A
money market fund's investments in other money market funds are
ignored for the purpose of these term-to-maturity
- Derivatives and short sales: A money market
fund is restricted from using specified derivatives or engaging in
The CSA has adopted these new requirements in response to the 2008/09 credit crisis and to keep pace with similar regulatory changes implemented for money market funds in other major markets. Under the Amendments, money market funds have been granted a six-month transition period to realign their portfolios as necessary to comply with the new requirements.
The Amendments permit mutual funds to engage in short-selling, subject to a cap on the aggregate value of shorted securities equal to 20% of the fund's NAV and a cap on the value of shorted securities of a single issuer equal to 5% of the fund's NAV. Also, mutual funds are required to maintain cash cover for short positions with a value equal to 150% of the aggregate market value of shorted securities. Mutual funds short-selling securities for the first time will be required to comply with the applicable notice and prospectus disclosure requirements prescribed under the Amendments. However, mutual funds that already engage in short-selling, or that have sent prior written notice to securityholders of their intention to engage in short-selling in accordance with the terms of exemptive relief granted under NI 81-102, will not be required to provide additional notice. The Amendments further require that an investment fund that short sells securities must calculate and publish its NAV on a daily basis. Again, these Amendments codify exemptive relief that is currently generally available to mutual funds.
The Amendments provide mutual funds with more flexibility in their use of specified derivatives by expanding what qualifies as cash cover (as discussed below) and by removing term limits on specified derivatives.
Cash Cover Definition
Cash cover must be held by mutual funds in respect of certain options, futures and specified derivatives positions held by the fund, as well as in respect of short positions (as referred to above). By requiring mutual funds to hold cash cover equal to their unhedged short exposures plus their long exposures that are obtained synthetically through call options and derivatives, NI 81‑102 restricts the ability of mutual funds to use leverage or have uncovered short positions. The expanded definition of cash cover provided in the Amendments will now include securities of money market funds and certain floating rate notes. This amendment is intended to allow mutual funds to effectively manage their cash cover by enabling them to hold additional instruments that are diversified, cost-effective and that potentially have a higher yield.
Funds of Funds
The Amendments permit mutual funds to continue to invest in other mutual funds even if the underlying fund ceases to offer its securities in the local jurisdiction, provided that the underlying fund remains a reporting issuer in that jurisdiction.
Mutual Fund Dealers
The Amendments exempt principal distributors and participating dealers that are members of the Mutual Fund Dealers Association of Canada, as well as mutual fund dealers in Quebec, from certain requirements of NI 81-102 with respect to the establishment of trust accounts for cash received for investment in, on the redemption of, or for the payment of distributions by, mutual funds and from the preparation and filing of certain compliance reports. Such exemptions were previously only available to IIROC dealers.
The Amendments have been designed to ensure that mutual fund ratings and rankings included in sales communications are objective, accurate and accompanied by certain prescribed disclosure. Such rankings must be prepared by an independent third party (referred to as a mutual fund rating agency in the Amendments) using an objective methodology that rates funds by published fund categories.
In order to increase the transparency of fund performance, pursuant to the Amendments to National Instrument 81‑106, investment funds will be required to make the fund's NAV and NAV per security readily available to the public at no cost.
Upon coming into force, the Amendments will complete the first phase of the CSA's two-phase Modernization Project. The mandate of the Modernization Project is to review the product regulation of publicly offered investment funds and to consider whether the current regulatory approach sufficiently addresses product and market developments in the Canadian investment fund industry, and continues to adequately protect investors.
The second phase of the Modernization Project will seek to address any issues relating to market efficiency, investor protection or fairness resulting from the differing regulatory regimes that currently apply to the various types of publicly offered investment funds. The CSA intend to propose new restrictions and operational requirements for non-redeemable investment funds (such as closed-end funds), that are similar to existing requirements for mutual funds and ETFs under NI 81‑102.
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