Canada: Modernization Of Investment Fund Product Regulation (Phase 2) Is Here – Immediate Impact On Closed-End Funds

Last Updated: June 20 2014
Article by Kimberly Poster and Jason A. Chertin

The long-awaited final amendments relating to the Canadian Securities Administrators ("CSA") project to modernize the regulation of publicly offered investment funds was published on June 19, 2014. The stated purpose of Phase 2 is, in part, to address market efficiency and investor protection issues that arise out of different rules for publicly offered mutual funds and non-redeemable investment funds including closed-end funds ("CEFs") and exchange traded funds.

This bulletin focuses on the immediate impact of the new operational requirements and investment restrictions for CEFs. In the CSA's view, these new requirements provide baseline protections to investors that purchase investment fund products. While not the focus of this bulletin, we note that many of the amendments will have an impact on mutual funds as well.

These amendments impact National Instrument 81-102 Mutual Funds ("NI 81-102") and Companion Policy 81-102CP, National Instrument 81-106 Investment Fund Continuous Disclosure ("NI 81-106") and Companion Policy 81-106CP, National Instrument 81-101 Mutual Fund Prospectus Disclosure ("NI 81-101") and National Instrument 41-101 General Prospectus Requirements ("NI 41-101").

As described in more detail below, after reviewing the comments received, the CSA has deferred the implementation of certain provisions that were published in their 2013 proposal, including:

  • investment restrictions relating to physical commodities, specified derivatives, borrowing and short sales;
  • parameters on payment of incentive fees;
  • concentration restrictions;
  • restrictions on investment in illiquid assets; and
  • prohibition on paying organizational costs.

Investment Restrictions

Control Restriction

CEFs will now be restricted by NI 81-102 from purchasing more than 10% of the outstanding equity securities of an issuer, or from purchasing a security for the purpose of exercising control over the issuer of the security. Such restrictions are intended to restrict investments which are deemed to be inconsistent with the fundamental characteristics of an investment fund, which, unlike venture capital / private equity funds, do not become actively involved in the management of investee companies.

A transition period will apply to existing CEFs from these requirements until March 21, 2016. Other than for the restrictions on investing in mortgages discussed below, existing CEFs will not be grandfathered from the new requirements.

Investments in Real Property and Loan Syndications

New restrictions will prohibit CEFs from purchasing real property, or an interest in certain loan syndications or loan participations, which again are intended to limit activities to those which are not typically performed by publicly offered investment funds. Similar to the new control restrictions, there is a transition period for existing non-redeemable investment funds to March 21, 2016.

Investments in Mortgages

A CEF will be prohibited from investing in a mortgage, other than a guaranteed mortgage, which the CSA views as engaging in a lending business and once again, outside the scope of activities typical of an investment fund. Generally, a guaranteed mortgage is one that is fully and unconditionally guaranteed by a government or a government agency. Of importance to existing CEFs, these amendments will not apply to funds that have received a receipt for their prospectus on or before September 22, 2014, and which have adopted investing in mortgages as a fundamental investment objective. Originally the CSA had proposed a 24 month transition period for these funds to divest themselves of prohibited holdings or transition to the regulatory regime for public issuers that are not investment funds, but amended the prohibition as a result of industry concerns.

Fund of Fund Structures

CEFs will be permitted to invest in other investment funds, provided the new conditions set out in NI 81-102 are met. NI 81-102 already contains rules governing mutual funds that invest solely or primarily in other mutual funds. New conditions include that the underlying fund must itself be subject to NI 81-102, and must be a reporting issuer in at least one Canadian jurisdiction in which the "top fund" is a reporting issuer. This represents a change from the original proposal, which would have required the underlying fund to be a reporting issuer in every jurisdiction in which the top fund is a reporting issuer. There is a transition period for existing funds until March 21, 2016.

With respect to CEFs that may invest in foreign investment funds, the CSA is willing to consider applications for exemptive relief on a case-by-case basis.

Consistent with the 2013 proposal, NI 81-102 has also been amended to clarify that a mutual fund is not permitted to invest in a non-redeemable investment fund, but the notice indicates the CSA will consider applications for exemptive relief on a case-by-case basis for funds that currently hold such investments.

Securities Lending

The same investment restrictions relating to securities lending, repurchase and reverse repurchase transactions currently applicable to mutual funds will now apply to CEFs. These requirements govern documentation, supervision, controls and records and prescribe who is permitted to act as a fund's securities lending agent, the value of cash or other collateral a fund must hold to support such activities, and the permitted aggregate value of such transactions. The provisions of NI 81-102 mandate the appointment of a securities lending agent to administer a securities lending or repurchase transaction, but it is not strictly required for reverse repurchases.

The amount of securities loaned or sold in securities lending, repurchase and reverse repurchase transactions will be limited to 50% of the NAV of the fund, rather than the current limit which is 50% of the total assets of the fund. The impact of these proposed amendments may be considerable for CEFs as the changes will reduce the amount of securities available to be loaned or sold by the liabilities (including leverage) of the fund. Existing CEFs must comply with these new rules by September 21, 2015.

Operational Restrictions

Conflicts of Interest

As widely expected, the conflicts of interest provisions of NI 81-102 are being extended to CEFs, a proposal that was broadly supported by commentators. The CSA views these provisions as extending key protections to security holders. We do not believe that this change represents a departure from the current practices of many CEFs.

Fundamental Changes

The CSA is extending the provisions of NI 81-102 relating to fundamental changes to CEFs. These requirements include detailed rules regarding matters that require security holder approval, the process to obtain such approval (including the mechanics surrounding security holder meetings) and circumstances in which the approval of securities regulators is required. While many CEFs already adhere to investor voting rights that are similar to those in NI 81-102 in their constating documents, the CSA view is again that these provisions extend key protection to security holders.

A new provision will require that prior security holder approval be obtained in order to implement a change to the nature or structure of an investment fund, specifically, any change that would convert a mutual fund into a non-redeemable investment fund (or vise versa) or an investment fund into an issuer that is not an investment fund. The costs and expenses associated with such a merger, reorganization or restructuring (including the costs of obtaining security holder approval and, if applicable, the costs of filing a simplified prospectus to commence a continuous distribution) may not be borne by the fund. Originally, the CSA had proposed an exemption for CEFs structured from inception to convert to a mutual fund, but have determined that security holder approval cannot be replaced with prospectus disclosure and have not adopted the exemption.

Certain funds which have a limited term and that do not list or trade their securities, such as flow-through investment funds, will be exempted from some of the security holder and regulatory approval requirements for fund mergers in the specified circumstances, which include additional prospectus disclosure.

For pre-approved fund mergers, a new requirement relating to CEFs is that the CEF must permit security holders to redeem their securities at a price equal to the net asset value of those securities at a date before the effective date of the merger. In addition, the consideration offered to security holders in connection with a pre-approved merger must have a value that is equal to the net asset value of the fund. Managers should keep these new requirements in mind if mergers are intended to be effected in reliance on the exemption from prior approval contained in section 5.6 of NI 81-102.

Finally, the CSA will now require CEFs to terminate the fund not less than 15 days before and not more than 90 days after disclosing an intended termination (the original proposal limited the termination to within 30 days of filing a press release disclosing the intended termination).

Custodianship Requirements

The CSA have adopted their original proposal to extend the custodianship requirements of NI 81-102 to CEFs. This was generally seen as a non-controversial proposition as these provisions are for the most part the same as the current requirements applicable to CEFs that file a prospectus under NI 41-101.

Sale of Securities

Under NI 81-102, mutual funds are required to issue securities at NAV. The amendments will also require that the issuance of securities of an exchange-traded mutual fund (that is not in continuous distribution) or a CEF not cause dilution to existing security holders.

Warrant Offerings

One proposal resisted by some commentators that is being adopted relates to the prohibition on warrant offerings or of any rights or other specified derivatives where the underlying interest is a security of the fund. The CSA view such offerings as being dilutive to the value of the securities held by investors who do not exercise such warrants. The CSA also view the issuance of warrants as coercive by obligating security holders to exercise and make an additional investment or face the risk of dilution.


Recognizing the differences between mutual funds and CEFs, a few of the provisions of NI 81-102 relating to redemptions will be extended to CEFs. CEFs will be required to send investors an annual reminder regarding their redemption rights and how they may be exercised. To facilitate the timely processing of redemptions, proceeds will have to be paid no more than 15 business days after the redemption date. To avoid dilution to remaining security holders, CEFs will not be permitted to redeem securities at an amount that is greater than the NAV per security on the redemption date.

In addition, CEFs will only be permitted to suspend redemptions if trading is suspended on an exchange, if the securities or specified derivatives listed or traded on such exchange represent more than 50% of the total assets or underlying market exposure of the CEF and no other exchange that represents a reasonably practical alternative.

Additional prospectus disclosure with respect to a CEF's redemption procedures will also be required.

Commingling of Cash

The requirements of NI 81-102 relating to the commingling of cash have been extended to CEFs. These provisions require dealers or service providers in relation to an investment fund to segregate cash received in respect of purchases or redemptions of securities in a trust account (except for CDS).

Sales Communications

The requirements of NI 81-102 governing sales communications will be extended to CEFs. These are guidelines designed to ensure that disclosure for investment funds is relevant, consistent and not misleading. A significant portion of the requirements relate to the use and calculation of performance data, which must be based on actual historical performance and not on hypothetical or back-tested data. Under the amendments, a sales communication pertaining to a CEF must generally not contain performance data of the fund unless the fund has been a reporting issuer in a jurisdiction for at least 12 consecutive months and may not contain performance data from before the fund became a reporting issuer.

Existing CEFs may use sales communications that were printed before the amendments become effective until March 23, 2015. Managers of CEFs should be aware that compliance with these rules is closely monitored by securities regulators.

Securities Lending Disclosure

The financial statements of an investment fund (both CEFs and mutual funds) will now be required to include note disclosure that reconciles the gross amount generated from securities lending transactions to the revenue from securities lending that is otherwise required to be disclosed. Disclosure must include the identity of each person / company entitled to receive payments and the amount each recipient was entitled to receive. The name of the securities lending agent will also have to be disclosed in an investment fund's prospectus, as well as any relationship to the investment fund's manager. In addition, funds will have to disclose (in their prospectuses or AIFs) the essential terms of any agreement with their securities lending agent.

Investment funds will not be required to comply with these amendments for financial years beginning before January 1, 2016.

Original Proposals not Currently Adopted (Future Potential Regulation)

For now, the CSA has deferred their review of the previously published proposal to establish a regime for "alternative funds" that will apply to mutual funds and CEFs that employ alternative investment strategies, as well as investment restrictions that are related to the alternative fund proposals. Some of these investment restrictions relate to investments in physical commodities, the use of specified derivatives, the ability to borrow cash, purchase securities on margin or selling securities short.

The CSA are also deferring the introduction of a concentration restriction for CEFs (which would otherwise have prohibited these funds from purchasing securities of an issuer, entering into specified derivatives transactions or purchasing index participation units if, immediately after the transaction, more than 10% of the fund's net assets would be invested in the securities of such issuer). Similarly, the CSA is deferring the implementation of its proposed restrictions concerning illiquid assets. Notwithstanding such deferral, the CSA reiterated their concern about CEFs investing a large portion of their NAV in illiquid assets, because they believe it will be difficult for such funds to accurately calculate their NAV, as well as manage liquidity risk, and guidance has been added to 81-102CP on this point.

One of the more controversial proposals for CEFs related to the current provision in NI 81-102 that prohibits the organizational costs of a mutual fund to be borne by the mutual fund or its security holders. Such costs include the costs associated with the formation of the mutual fund, as well as the preparation and filing of a prospectus and related documentation. The original proposal included a prohibition on CEFs or security holders from bearing organizational costs, which was a significant departure from market practice relating to the CEF's initial public offering. The CSA is not implementing any prohibition at this time, but remains concerned about funds that are launched as CEFs that shortly convert into a mutual fund, and may publish proposed amendments to NI 81-102 in the future to address this concern.

In addition, the original proposals would have set out parameters for the payment of incentive fees by CEFs. Specifically, performance fees would have been required to be determined with reference to an external benchmark or index that reflects the market sector in which the CEF invests. This proposed change was controversial as the performance fees paid to managers by many CEFs are typically based on the internal cumulative total returns of the fund rather than a benchmark. These proposals relating to incentive fees are being deferred until the alternative funds proposals are published for comment.

Next Steps

The amendments are expected to come into force on September 22, 2014. Prior to such date, investment fund managers with existing funds should review their fund documentation in order to determine whether amendments are required, determine whether or not certain prohibited investments must be sold (and the timing of such sale), and/or whether exemptive relief is required. Sales communications and use of past performance data should also be closely scrutinized. Managers currently preparing a prospectus for a new fund should consider the new disclosure requirements and determine whether additional information is desirable to be included. Your McMillan lawyer or any member of our investment fund and asset management team would be pleased to discuss any such requirements with you in further detail.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2014

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

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

Kimberly Poster
Jason A. Chertin
In association with
Up-coming Events Search
Font Size:
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
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.

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