Canada: CSA Proposes Amended Risk Disclosure For Mutual Funds And ETFs

Last Updated: December 23 2015
Article by Jason A. Chertin and Vlad Duta

On December 10, 2015, the Canadian Securities Administrators ("CSA") published proposed amendments1 (the "Current Proposed Amendments") to risk disclosure requirements for mutual funds and exchange-traded mutual funds ("ETFs"). The Current Proposed Amendments will require mutual funds and ETFs to use a standard deviation measure of risk when disclosing investment risk levels in existing Fund Facts documents and in proposed ETF Facts documents, respectively. These amendments are expected to be proclaimed into force in late 2016 or early 2017.

Background

Currently, the Fund Facts document requires a mutual fund to provide its investment risk level based on a risk classification methodology of the fund manager's own choosing. While there is presently no disclosure document similar to a Funds Facts document required for ETFs, the CSA has proposed a document called "ETF Facts" that would serve the same purpose – see our previous bulletin on ETF Facts here.

In response to stakeholder feedback that a standardized risk classification methodology would be more useful to investors, the CSA began researching alternatives to the existing risk disclosure framework. On December 12, 2013, the CSA published an initial version of the risk disclosure amendments in which they first proposed using standard deviation as the sole indicator of risk (the "2013 Proposed Amendments").

The 2013 Proposed Amendments generated 56 comment letters, which were generally supportive of the proposal. The Current Proposed Amendments are largely similar to the 2013 Proposed Amendments. However, based on feedback received, the CSA made the following key changes:

  • ETF Facts. The application of the amendments was extended to the proposed ETF Facts document.
  • Risk level categories. The six-category risk level scale was abandoned in favour of the five-category scale currently prescribed in Fund Facts documents.2
  • Discretion to increase risk level. The investment risk level of a fund may be increased (but not decreased) if doing so is reasonable in the circumstances.
  • Required updates to risk level. The frequency of required updates to risk level disclosure was decreased.3
  • Reference index guidance. The 2013 Proposed Amendments contained a list of criteria for a reference index to be considered appropriate. This list of criteria was removed, but the list of reference index principles was retained and amended.
  • Fund reorganization or change in objective. Where there has been a reorganization or transfer of assets of a mutual fund4 (including a fund merger), a requirement was added to calculate standard deviation based on the returns of the continuing mutual fund. Similarly, where there has been a change to the fundamental investment objectives of a mutual fund,5 a requirement was added to calculate standard deviation based on the returns of the fund starting from the date of the change.
  • Record-keeping. The requirement to maintain records of the risk disclosure methodology for ten years was removed in favour of the already existing requirement in securities legislation to maintain records for seven years from the date the records were created.6

Summary of New Risk Disclosure Requirements

Disclosing Risk Level

The Current Proposed Amendments would require all mutual funds, and eventually ETFs, to calculate their standard deviation using monthly returns on a 10-year historical basis.7 This standard deviation number would be used to place the fund into one of five investment risk levels from "Low" to "High"8 and this risk level would be disclosed in the Fund Facts or ETF Facts document. Records must be maintained of how the risk level of a mutual fund or ETF was determined. A fund may increase (but not decrease) its risk level if doing so is reasonable in the circumstances.

Risk level disclosure must occur at least annually, and within 60 days from the filing of a Fund Facts or ETF Facts document, or whenever the current risk level is no longer reasonable in the circumstances. The CSA would generally consider a change to the fund's risk level disclosed on the most recently filed Fund Facts or ETF Facts document to be a material change under securities legislation.

The Current Proposed Amendments do not require that risk level be determined for each series or class of securities of a fund unless a series or class of securities possesses an attribute that could result in a different risk level than that of the fund (eg. a series or class that is offered in a foreign currency or employs currency hedging may be subject to different risks).

Using a Reference Index

For mutual funds and ETFs that do not have the sufficient 10-year history, a reference index can be used as a proxy. The reference index chosen must comply with certain principles proposed by the CSA including, among others,9 the following: the index returns are highly correlated with the returns of the fund, the index has a systemic risk profile highly similar to the fund, and the index reflects market sectors in which the fund is investing. In response to comments received by the CSA, the Current Proposed Amendments have removed the requirement that the reference index be "widely recognized" and "publically available" in all instances. A mutual fund or ETF must monitor the reasonableness of the reference index annually or more frequently if necessary.

In response to comments that some actively managed mutual funds are so unique that none of the widely available benchmarks capture their exposure or strategy, the CSA stated that reference index returns should be correlated to the returns of the mutual fund rather than replicate the returns exactly. The Current Proposed Amendments also permit the use of blended indices. In the CSA's view, there are sufficient reference indices available that can serve as a proxy for the risk profile of actively managed funds.

Regarding fund of funds, where the top fund does not have the requisite 10-year history and its strategy is to "clone" the bottom fund, the CSA may allow, through exemptive relief, the use of the underlying fund's standard deviation values to determine the top fund's risk level.

Why Standard Deviation?

In deciding on a standardized measure of risk, the CSA considered 15 different risk indicators before selecting standard deviation. Several benefits of using standard deviation were noted:

  • Its calculation is relatively simple, well-known, and established.
  • It provides a consistent risk evaluation for a broad range of funds.
  • It provides a relatively stable and meaningful risk evaluation when coupled with an appropriate historical period.
  • It is already broadly used in the industry and serves as the basis for the methodologies used by both the Investment Funds Institute of Canada and the Committee of European Securities Regulators.
  • It is easily available from third party data providers, thereby providing a data source that allows oversight and independent verification by both regulators and investors.
  • The implementation costs are expected to be minimal since most fund managers already use standard deviation, at least in part, to determine a fund's risk level.

Purpose

The purpose of the Fund Facts document and the eventual ETF Facts document is to give investors access to key information about mutual funds and ETFs in a language they can understand. The CSA believes that introducing standard deviation as a standardized risk measure will help to achieve this purpose by providing investors with a simple way to measure risk and to make meaningful comparisons between mutual funds and/or ETFs.

The final rules implementing the Current Proposed Amendments are expected to be implemented in the Fall of 2016 and to be in force three months later. The CSA seeks feedback on the Current Proposed Amendments. The deadline for submitting comments to the CSA is March 9, 2016.

Footnotes

1. The proposed amendments are to National Instrument 81-102 Investment Funds ("NI 81-102"), National Instrument 81-101 Mutual Fund Prospectus Disclosure and its related companion policy, and National Instrument 41-101 General Prospectus Requirements and its related companion policy.

2. The standard deviation ranges in each risk category were also changed to make them consistent with the ranges in the risk classification methodology developed by the Investment Funds Institute of Canada.

3. Rather than monthly determinations required under the 2013 Proposed Amendments, the risk levels are now to be determined upon each filing of a Fund Facts or ETF Facts document and at least annually

4. Pursuant to section 5.1(f), (g) or (h)(i) of NI 81-102.

5. Pursuant to section 5.1(c) of NI 81-102.

6. See section 11.6 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations).

7. Standard deviation should be calculated by using net asset value (as opposed to market price).

8. The five risk levels (along with their standard deviation parameters) are as follows: Low (0-6); Low to Medium (6-11); Medium (11-16); Medium to High (16-20); and High (20 or greater).

9. The other principles are that the index: (i) is made up of one or a composite of several market indices that best reflect the returns and volatility of the mutual fund and the portfolio of the mutual fund; (ii) contains a high proportion of the securities represented in the mutual fund's portfolio with similar portfolio allocations; (iii) has security allocations that represent invested position sizes on a similar pro rata basis to the mutual fund's total assets; (iv) is denominated, in or converted into, the same currency as the mutual fund's reported net asset value; (v) has its returns computed on the same basis (e.g., total return, net of withholding taxes, etc.) as the mutual fund's returns; (vi) is based on an index or indices that are each administered by an organization that is not affiliated with the mutual fund, its manager, portfolio manager or principal distributor, unless the index is widely recognized and used; and (vii) is based on an index or indices that have each been adjusted by its index provider to include the reinvestment of all income and capital gains distributions in additional securities of the mutual fund.

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 2015

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
Jason A. Chertin
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