Canada: CSA Release Proposals Under Phase 2 Of Fund Modernization Project – Implications For Closed End Funds And Alternative Funds

Last Updated: June 12 2013
Article by Pierre-Yves Châtillon, Tracy L. Hooey and Daniel Fuke

Introduction

In the course of their ongoing review of publicly offered investment funds, the Canadian Securities Administrators (CSA) published on March 27, 2013 a Notice and Request for Comments on amendments to National Instrument 81-102 Mutual Funds (NI 81-102) and consequential amendments to National Instrument 41-101 General Prospectus Requirements (NI 41-101) and its Form 41 102F2 (the 81-102 Proposals).  These amendments introduce core operational requirements for publicly offered non-redeemable "closed-end" investment funds (CEFs) (other than scholarship funds) and related disclosure changes.  Comments on the 81-102 Proposals are due on or before June 25, 2013.

This review is part of the Fund Modernization Project, a mandate of the CSA to consider whether product and market developments in the Canadian investment fund industry are being adequately addressed by the current regulatory regime.

Phase 1 of the Fund Modernization Project is completed and addressed primarily publicly offered mutual funds by amending NI 81-102 and National Instrument 81-106 Investment Funds Continuous Disclosure (NI 81 106).

The CSA have now initiated Phase 2 of the Fund Modernization Project which attempts to harmonize regulatory regimes governing various forms of investment funds and addresses issues of market efficiency and uneven investor protection and fairness among these products.

This Notice and Request for Comments focusses on CEFs.  It proposes core operational requirements similar to those applicable to publicly offered mutual funds including in particular investment restrictions, conflict of interest requirements and securityholder approval for fundamental changes.

The CSA's proposal is based on the premise that the structural differences between conventional mutual funds and CEFs are not significant enough to justify from a policy standpoint the absence of investment restrictions for publicly offered CEFs.

In order that CEFs may continue to operate in a manner that offers a wide range of investment choices to investors, the CSA propose that CEFs either (i) comply with the new NI 81-102 requirements (this would accommodate funds with more passive investment strategies), or (ii) in order to accommodate CEFs with more complex or alternative investment strategies, comply instead with an expanded National Instrument 81-104 Commodity Pools (NI 81-104) for "Alternative Funds", as that term is introduced in the Notice.  Draft amendments to NI 81-104 were not proposed in the Notice.

Nature of Changes Applying to CEFs

Pursuant to the 81-102 Proposals, the CSA have proposed making CEFs (other than Alternative Funds) subject to NI 81-102.  For the most part, NI 81-102 would apply equally to mutual funds and CEFs, but the CSA recognize that the inherent differences between the two types of investment funds warrants distinct regulation in certain circumstances.  Below we have described certain of the significant changes to CEFs that would result if the 81-102 Proposals were adopted. 

  • Investments in Physical Commodities - CEFs would be restricted in making direct or indirect investments in physical commodities to 10% of NAV at the time of purchase.
  • Leverage and Fund of Fund Structures - The 81-102 Proposals would allow CEFs to borrow up to 30% of their NAV (greater than the 5% of NAV limitation to which mutual funds are subject).  However, CEFs would only be permitted to borrow from certain Canadian financial institutions. As a result, CEFs would be prohibited from investing in other CEFs but could, however, invest in mutual funds subject to the same conditions currently prescribed for mutual funds.
  • Conflicts of Interest - CEFs would be subject to the rules relating to conflicts of interest that currently apply to mutual funds, including restrictions on investing in securities of related issuers and restrictions on purchasing securities from related parties.
  • Organizational Costs - Investment fund managers would be prohibited from passing on the organizational costs of a CEF to the fund itself.  The CSA have proposed, however, that underwriting or agency fees in connection with a CEF's initial public offering would not be considered organizational costs for this purpose.
  • Securityholder and Regulatory Approvals - CEFs would be required to obtain securityholder approval in respect of certain material events, including an increase in fees and a change in fundamental investment objectives, similar to the current rules applicable to mutual funds.  The 81-102 Proposals would also require securityholder approval in respect of a conversion from a mutual fund to a CEF or vice versa, as well as in respect of an investment fund changing to an issuer that is not an investment fund.  Conventional flow-through limited partnerships and CEFs that are formed with the intention of converting to a mutual fund upon the occurrence of a specified event would be exempt from the requirement to obtain securityholder approval. In addition, the rules applicable to mutual funds in respect of securities regulatory authority approval for certain material events would extend to CEFs. 
  • Incentive Fees - Incentive fees of CEFs would be required to be based on the total cumulative return of the fund as compared to a specific benchmark or index.
  • Issuance/Redemptions at NAV - The issuance and redemption of CEF securities could be effected at a price no greater than or less than NAV, respectively, in order to prevent dilution to securityholders.  This requirement would mean that CEFs could no longer undertake rights or warrant offerings. 
  • Sales Communications - The 81-102 Proposals would make CEFs subject to the rules applicable to mutual funds in respect of sales communications, including requirements in respect of disclaimer, fee and performance history disclosure.  CEFs would continue to be subject to the restrictions on sales communications during the prospectus waiting period set out in NI 41-101.

Alternative Funds

As discussed above, the CSA are considering amendments to NI 81-104 to include both mutual funds and CEFs that focus on asset classes or use investment strategies not permitted by the proposed amendments to NI 81-102.  The CSA did not include proposed amendments to NI 81-104 in the Notice but rather only a summary of key elements of a proposed regulatory framework, regarding which they have sought feedback.  Some of the key elements the CSA are considering are listed below.

  • the replacement of the term "commodity pool" with "Alternative Fund", which would include both mutual funds and CEFs;
  • Alternative Funds would be permitted greater concentration limits than funds subject to NI 81-102, but the CSA are seeking feedback on what limit would be appropriate;
  • whether Alternative Funds should be permitted to borrow cash up to a limit of 50% of NAV at the time of borrowing;
  • whether Alternative Funds should be permitted to sell securities short beyond the limits in NI 81-102, including permitting short sales of securities of a single issuer to 10% of NAV at the time of the short sale and permitting the aggregate market value of all securities sold short by an Alternative Fund to be up to 40% of NAV at the time of purchase, as well as an exemption from the cost cover requirements of NI 81-102;
  • restricting Alternative Funds from providing returns of more than two times the existing daily positive or inverse return of an underlying interest;
  • whether the exemption in NI 81-104 from the requirement to comply with the counterparty exposure limits should be repealed for Alternative Funds;
  • limiting total leverage for Alternative Funds (whether through borrowing, short selling, derivatives transactions and investing in underlying funds) at all times to 3:1, as well as considering other methods of measuring leverage;
  • prohibiting the payment by an Alternative Fund of its organizational costs;
  • whether further proficiency requirements should apply to dealing representatives who sell Alternative Fund securities; and
  • the introduction of specific requirements relating to naming, prospectus disclosure, sales communications, continuous disclosure (including text box disclosure on the prospectus cover page and in sales communications), drawdown reporting and maximum and average daily leverage levels.

Timetable

The comment period regarding the 81-102 Proposals and the proposed re-design of NI 81-104 will close June 25, 2013.  The CSA anticipates finalizing certain aspects of the 81-102 Proposals in advance of others, including the proposed conflict of interest provisions, securityholder and regulatory approval requirements and custodianship requirements.  The proposed investment restrictions are inter-related with the re-design of NI 81-104 and accordingly are expected to be considered in conjunction therewith.

The CSA is also asking for feedback on what a reasonable time frame would be to enable CEFs to transition to the new regime of NI 81-102 or the alternative regime of NI 81-104.  

Action by Managers of Non-Redeemable Investment Funds

At this point, CEF  managers may wish to assess how the published proposed changes to NI 81-102 will impact their funds' structure and investment strategies and in particular:

  1. whether or not the fund's investment strategies, such as those involving investing in physical commodities or specified derivatives on physical commodities, fund of fund structures with other CEFs or the use of leverage through specified derivatives, can be achieved in compliance with the proposed NI 81-102; if not, the manager will have to consider, when changes to NI 81-104 are published, if the fund's investment strategies may fit into the proposed Alternative Fund regime;
  2. the fund manager will have to review its fund's constating documents to determine what formalities (including notices to security holders, formalities for security holder approval, preparation of disclosure documents for meetings) have to be met for the fund's structure to comply with the new requirements.  In this regard, managers will need to take into account the new securityholder approval requirements mandated by amended NI 81-102 and NI 81-104, once they come into force,  in addition to those of the fund's constating documents.

A link to the CSA Notice and Request for Comments is provided below:

http://www.osc.gov.on.ca/en/SecuritiesLaw_csa_20130327_81-102_rfc-proposed-amendments.htm

The proposed changes will have a significant impact on how CEFs are operated.  The investment fund industry and investors in general are strongly invited to share their views on the issues the proposed changes to these products raise in the Canadian market.

www.fasken.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Osler, Hoskin & Harcourt LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Osler, Hoskin & Harcourt LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions