Canada: CSA Proposals Will Require Mutual Funds And ETFs To Use Standard Deviation To Disclose Risk

On December 10, 2015, the Canadian Securities Administrators (CSA) published draft rule amendments that, if adopted, would require publicly offered mutual funds and exchange-traded funds (ETFs) to use standard deviation to measure risk and to disclose that risk in Fund Facts and ETF Facts documents according to a specified five-band risk classification scale. These proposed rule amendments have been published for comment, with a deadline for comments of March 9, 2016.

The CSA Notice and Request for Comment CSA Mutual Fund Risk Classification Methodology for Use in Fund Facts and ETF Facts — Proposed Amendments to NI 81-102 Investment Funds and Related Consequential Amendments includes draft rule amendments to:

  • National Instrument 81-102 Investment Funds, including a new Appendix F entitled Investment Risk Classification Methodology
  • National Instrument 81-101 Mutual Fund Prospectus Disclosure, with proposed amendments to the Fund Facts disclosure form
  • National Instrument 41-101 General Prospectus Requirements, with proposed amendments to the ETF Facts disclosure form that was first published for comment in June 20151.

The new CSA proposals follow on from CSA Notice 81-324 Proposed CSA Mutual Fund Risk Classification Methodology for Use in Fund Facts which was published for comment in December 20132. The CSA have taken into account the many comments received on that publication, including those from Borden Ladner Gervais LLP3, in developing the draft rule amendments and have made significant improvements to the 2013 proposals, but have also further developed the proposed requirements after additional research and review. Some of the most important changes to the 2013 proposals include:

  • An alignment of the proposed mandatory risk classification scale with the five-category scale found in the voluntary guidelines for fund volatility risk classification developed and regularly updated by The Investment Funds Institute of Canada (IFIC)
  • Extension of the risk classification methodology and disclosure requirements to ETFs
  • The ability for fund managers to increase the investment risk level for a fund if doing so is reasonable in the circumstances, although the CSA remain adamant that there is no other discretion available for fund managers
  • Requirements to calculate standard deviation at least annually at the time of refiling Fund Facts or ETF Facts documents.

Features of the Proposed Methodology

The primary features of the proposed CSA risk classification methodology are as follows:

  • Risk Indicator. The CSA propose that all mutual funds, including ETFs, calculate risk using standard deviation. Standard deviation is considered to measure how returns vary over time (or deviate) from the average return and hence, measures the volatility of investment returns.
  • Calculation of Standard Deviation. Annualized standard deviation must be calculated for a mutual fund, including an ETF, using the monthly total returns (i.e. reinvesting all income and capital gains distributions) of the fund over the past 10 years. ETFs will be required to use NAV, in the same way as other mutual funds, to calculate standard deviation. The CSA's proposed methodology allows fund managers to use discretion to increase the risk level of a fund if it is reasonable to do so, but otherwise will not permit any other form of discretion. This differs from the current IFIC guidelines, which provides that a fund manager's discretion should be used, and qualitative factors should be applied, where appropriate, in the interest of ensuring full, true and plain disclosure.
  • For new or young funds (i.e. those with less than 10 years of performance history), the fund manager will be required to use the monthly returns of a reference index to fill out the return history for the fund. The proposed methodology suggests various principles that must be considered in choosing a reference index. The appropriateness of the reference index would need to be monitored at least on an annual basis and the reference index itself will be disclosed in the fund's prospectus.
  • Calculation of standard deviation after fundamental changes. Where there has been a fund merger or other fund reorganization or a change to fundamental investment objectives, the CSA propose (for the former) that the standard deviation for the continuing fund continue to be provided (apparently without regard to the merger) and (for the latter) that a fund calculate standard deviation starting from the effective date of the investment objective change (and not using past history of the fund).
  • Standard deviation would be shown for the fund as a whole. The CSA propose that a fund would calculate standard deviation based on the total returns of its oldest series. Fund managers will not need to calculate standard deviation for each series of a fund, unless an attribute of a particular series would result in a materially different level of volatility risk for that series, in which case the fund manager would use the total returns of that particular series to calculate the standard deviation for that series.
  • Disclosure of risk in Fund Facts and ETF Facts. The CSA propose that a fund's risk be disclosed by identifying where the fund's standard deviation fits on a five-category volatility risk scale that is consistent with the ranges in the IFIC guidelines and that is widely used today by mutual funds. This will be new disclosure for ETFs, although some ETFs have already begun to include this type of disclosure on a voluntary basis.
  • Required monitoring of standard deviation. The CSA propose that fund managers calculate standard deviation of each of their funds on each filing of Fund Facts or ETF Facts documents and, in any case, at least annually. Fund managers may determine standard deviation more frequently, and the CSA expect that fund managers will monitor when the current disclosure of risk is no longer reasonable in the circumstances. If standard deviation for a fund changes, such that the fund falls within a different risk band (either higher or lower), the CSA indicate that they would consider this to be a material change for the fund, which will necessitate a press release and an amendment to the various disclosure documents, as well as a material change report, to be filed within ten days. We consider that an annual calculation of standard deviation and monitoring of disclosure should be sufficient and will urge the CSA to drop the requirement to calculate standard deviation every time a Fund Facts or ETF Facts document (for example, on an amendment to the fund's prospectus) is filed. The fund manager's process in calculating and monitoring of standard deviation will be expected to be established in the fund manager's written policies and procedures manual.
  • Records of standard deviation. Fund managers will be required to maintain records relating to risk disclosure for seven years, consistent with the requirements generally to maintain records.

Proposed Transition

The CSA plan to finalize the draft amendments by fall 2016, with the amended rules coming into force by late 2016 or early 2017. They suggest that the new methodology would be required to be followed by fund managers of mutual funds and ETFs at the time of the next filing of the applicable Fund Facts or ETF Facts. We assume that the risk classification amendments as they apply to ETFs will only apply once the June 2015 proposals for ETF Facts documents are finalized and come into force, but this is not clearly explained by the CSA.

We note also that the CSA clarify that they do not propose at this time to expand the risk methodology and the disclosure requirements to other investment funds, such as closed-end funds and structured products, but say they will consider this "if the disclosure requirements" for these funds change.


1. Please see Marrying the Rules for ETFs and Mutual Funds? Canadian Securities Administrators Propose New "ETF Facts" to be Delivered to Investors Post-Trade Investment Management Bulletin Borden Ladner Gervais LLP June 2015.

2. Please see Canadian Regulators Propose Standard Deviation as the Mandatory Risk Measurement for Canadian Investment Funds Investment Management Bulletin Borden Ladner Gervais LLP January 2014.

3. Comment letter of Borden Ladner Gervais LLP dated March 12, 2014

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