Canada: Proposed Changes To “Fund-On-Fund” And Other Rules For Canadian

The ability of publicly offered mutual funds to invest in other mutual funds will be broadened under proposed amendments that were recently republished for comments by the Quebec Securities Commission, on behalf of Canada’s securities regulators. If adopted, the amendments will permit a mutual fund to invest an unlimited amount in traditional Canadian mutual funds, if duplication of management fees, sales charges and redemption fees is eliminated. Any traditional mutual fund may be an underlying fund if it does not itself invest in other mutual funds (other than money market funds or IPUs) or if it is an RSP clone fund. In a significant change from the July 2002 proposals, traditional mutual funds will now also be able to invest in IPUs of Canadian or U.S. funds, without any limits.

Mutual funds will not be permitted to invest in non-prospectized pooled funds, virtually all foreign mutual funds (other than IPUs), most labour-sponsored venture capital corporations or commodity pools, because the proposed amendments will continue to restrict mutual funds from investing in mutual funds that are not subject to National Instruments 81-101 and 81-102 (other than IPUs). The amendments would replace the current provision that permits mutual funds to invest not more than 10% of its net assets in other mutual funds. The extent to which traditional mutual funds will be permitted to invest in closed-end funds, such as listed structured trusts, income trusts and REITs, will continue to be limited by the 10% control and concentration tests.

Investments in Mutual Funds

The proposed amendments require both the investing mutual fund and the underlying mutual fund to be qualified for distribution in the same jurisdiction, and the underlying mutual fund must be subject to NI81-101. Layering of investments among levels of funds will continue to be prohibited. Under the amendments, a mutual fund may invest any amount in qualifying traditional mutual funds, RSP clone funds, money market funds or IPUs if:

  • no management fees or incentive fees are payable by the investing mutual fund that, to a reasonable person, would duplicate a fee payable by the underlying mutual fund for the same service;
  • no sales fees or redemption fees are payable by the investing mutual fund in relation to its purchases or redemptions of the securities of the underlying mutual fund if the underlying mutual fund is managed by the same manager or by its affiliate or associate;
  • no sales fees or redemption fees are payable by the investing mutual fund in relation to its purchases or redemptions of securities of the underlying fund that, to a reasonable person, would duplicate a fee payable by an investor in the investing mutual fund (other than brokerage fees incurred on the purchase of IPUs);
  • the prospectus for any fund that invests in other mutual funds discloses the process or criteria to select those mutual funds, including the percentage of the fund’s net assets dedicated to these investments; and
  • in any case in which more than 10% of the securities of a mutual fund are held by another mutual fund, the fund discloses that percentage, together with the risks associated with a possible redemption request by that fund.

Mutual fund securities held by another mutual fund may be voted by the manager of the latter fund unless both funds are managed by the same manager or by its affiliate or associate. If both funds are so managed, the manager, at its option, may arrange for securities of the underlying funds to be voted by the securityholders of the investing fund.

Other Proposed Changes

The proposal to allow mutual funds to enter into swaps has been withdrawn, pending further review.

The proposal to require securityholder approval before changing or introducing fees or expenses charged directly to securityholders is continued, but it will now only apply to fees or expenses charged by the mutual fund or its manager and, in the case of a new fee or expense, only if it could result in increased charges.

Service providers for principal distributors and participating dealers will become subject to the existing deadlines for transmitting orders for purchases and redemptions, and the requirement to give disclosure to financial institutions of client trust fund accounts.

Regarding fund mergers, the proposed rules continue to clarify that the prospectus for the continuing fund need only contain financial information about the continuing fund.

Transition and Timing

Securities regulators intend to bring the amendments into force in early August, 2003. To ensure that all mutual funds will comply with the same rules, all previously granted exemptions, waivers or other decisions permitting fund-on-fund investments will be revoked on the first anniversary of the date the amendments come into force.

The deadline for submitting comments on the proposed amendments is July 14, 2003. If you would like to discuss the proposed changes, please call us at 416.865.7500, extension 8500. If you are calling long distance, you may call us toll-free at 1.800.505.TORY (8679) from anywhere in the United States or Canada. Copies of the proposed amendments to NI81-101 and NI81-102 are available on the Quebec Securities Commission’s Web site at

This client memo is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss with you the issues raised by this client memo in the context of your particular circumstances.

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