Securities Law & Instruments

Headnote

 

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Relief granted to exchange-traded mutual funds from certain mutual fund requirements and restrictions on borrowing from custodian and, if necessary, provision of a security interest to the custodian to fund distributions payable under the fund’s distribution policy – Relief granted to allow mutual funds to invest in ETFs under common management or managed by an affiliate, and to allow the top funds to pay brokerage commissions for the purchase and sale of the securities of ETFs – Underlying ETFs are subject to NI 81-102, are not commodity pools under NI 81-104 – Relief subject to terms and conditions as set out in the decision document.

 

Applicable Legislative Provisions

 

National Instrument 81-102 Investment Funds, ss. 2.1(1), 2.2(1)(a), 2.5(2)(a), 2.5(2)(e), 2.6(a) , 19.1.

 

April 18, 2017

 

IN THE MATTER OF

THE SECURITIES LEGISLATION OF

ONTARIO

(the Jurisdiction)

 

AND

 

IN THE MATTER OF

THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS

IN MULTIPLE JURISDICTIONS

 

AND

 

IN THE MATTER OF

FRANKLIN TEMPLETON INVESTMENTS CORP.

(the Filer)

 

AND

 

IN THE MATTER OF

FRANKLIN LIBERTY CANADIAN INVESTMENT GRADE CORPORATE ETF AND

FRANKLIN LIBERTY RISK MANAGED CANADIAN EQUITY ETF

(the Proposed ETFs)

 

DECISION

 

Background

 

The principal regulator in the Jurisdiction has received an application from the Filer:

 

1.             on behalf of the Proposed ETFs and any additional exchange-traded mutual funds (the Future ETFs, and, together with the Proposed ETFs, the ETFs and individually, an ETF) established now or in the future for which the Filer or an affiliate of the Filer is or may be the manager, for a decision under the securities legislation of the principal regulator (the Legislation) that permits each ETF to borrow cash from the custodian of the ETF (the Custodian) and, if required by the Custodian, to provide a security interest over any of its portfolio assets as a temporary measure to fund the portion of any distribution payable to Securityholders (as defined below) that represents, in the aggregate, amounts that are owing to, but not yet been received by, the ETF (the Borrowing Requirement);

 

2.             on behalf of existing non-exchange traded mutual funds managed by the Filer or an affiliate of the Filer (the Existing Top Funds) and any additional mutual funds, including ETFs, established now or in the future for which the Filer or an affiliate of the Filer is or may be the manager (together with the Existing Top Funds, the Top Funds) for a decision under the Legislation that:

 

(a)           permits each Top Fund to purchase a security of, or enter into a specified derivatives transaction with respect to, an ETF the securities of which are not “index participation units” (IPUs), as such term is defined in National Instrument 81-102 Investment Funds (NI 81-102) (collectively, the Underlying ETFs) even though, immediately after the transaction, more than 10% of the net asset value of the Top Fund would be invested, directly or indirectly, in securities of the Underlying ETF (the Concentration Restriction);

 

(b)           permits each Top Fund to purchase a security of an Underlying ETF such that, after the purchase, the Top Fund would hold securities representing more than 10% of:

 

(i)            the votes attaching to the outstanding voting securities of the Underlying ETF; or

 

(ii)           the outstanding equity securities of the Underlying ETF (the Control Restriction);

 

(c)           permits each Top Fund to purchase and hold a security of an Underlying ETF that is not offered under a simplified prospectus prepared in accordance with National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81-101) (the Fund of Fund Restriction); and

 

(d)           permits each Top Fund to pay brokerage commissions in relation to its purchase and sale on a recognized exchange (as defined in the Securities Act (Ontario)) in Canada of securities of the Underlying ETFs (the Payment of Fees Restrictions)

 

(collectively, the Top Fund Exemptions, and together with the Borrowing Requirement, the Exemption Sought).

 

Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):

 

(a)           the Ontario Securities Commission is the principal regulator for this application; and

 

(b)           the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in all of the provinces and territories of Canada other than the Jurisdiction (together with the Jurisdiction, the Jurisdictions).

 

Interpretation

 

Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.

 

Prescribed Number of Listed Securities means the number of Listed Securities of an ETF determined by the Filer from time to time for the purpose of subscription orders, exchanges, redemptions or for other purposes.

 

Securityholders means beneficial or registered holders of Listed Securities or Unlisted Securities, as applicable.

 

TSX means the Toronto Stock Exchange.

 

Representations

 

This decision is based on the following facts represented by the Filer:

 

The Filer

 

1.             The Filer is a corporation amalgamated under the laws of the Province of Ontario, with its head office located at 200 King Street West, Suite 1500, Toronto, Ontario. The Filer is not in default of securities legislation in any of the Jurisdictions.

 

2.             The Filer is, or will be, the investment fund manager of the Top Funds and the Underlying ETFs and is, or will be, the trustee of the Top Funds and the Underlying ETFs where the Top Fund or the ETF is a trust. The Filer or an affiliate of the Filer is, or will be, the portfolio manager of the Top Funds and the Underlying ETFs.

 

3.             The Filer is registered as an investment fund manager in Ontario, Québec, Alberta, British Columbia, Manitoba, Nova Scotia, and Newfoundland and Labrador, as a mutual fund dealer, portfolio manager and exempt market dealer in each province of Canada and the Yukon, and as a commodity trading manager in Ontario.

 

The Top Funds

 

4.             The Top Funds are, or will be, open-ended mutual funds, including exchange-traded funds, organized and governed by the laws of a Jurisdiction or the laws of Canada.

 

5.             The Top Funds are, or will be, governed by the provisions of NI 81-102, subject to any exemption therefrom that has been, or may be, granted by the securities regulatory authorities.

 

6.             Each Top Fund distributes, or will distribute, some or all of its securities pursuant to a simplified prospectus prepared pursuant to NI 81-101 and Form 81-101F1 or a long form prospectus prepared pursuant to National Instrument 41-101 General Prospectus Requirements (NI 41-101) and Form 41-101F2.

 

7.             The Top Funds are, or will be, reporting issuers in the provinces and territories of Canada in which their securities are distributed.

 

8.             Each Top Fund wishes to have the ability to invest up to 100% of its net asset value in any one or more Underlying ETFs.

 

9.             Each investment by a Top Fund in securities of an Underlying ETF will be made in accordance with the investment objectives of the Top Fund and will represent the business judgement of responsible persons uninfluenced by considerations other than the best interest of the Top Fund.

 

10.          The Top Funds do not, and will not, sell short securities of any Underlying ETF.

 

The ETFs and Underlying ETFs

 

11.          Each Proposed ETF will be a trust governed by the laws of the Province of Ontario. The Future ETFs will be either trusts or corporations or classes thereof governed by the laws of a Jurisdiction of Canada.

 

12.          Each Underlying ETF will be an open-ended mutual fund subject to NI 81-102, subject to any exemption therefrom that has been, or may be, granted by the securities regulatory authorities.

 

13.          Each ETF may issue more than one series of securities, including, but not limited to:

 

(a)           a series of securities that will be distributed pursuant to a long form prospectus prepared pursuant to NI 41-101 and Form 41-101F2 that is listed on the Toronto Stock Exchange or another “recognized exchange” in Canada, as that term is defined in securities legislation (Listed Securities); and

 

(b)           a series of securities that will be offered only on a private placement basis pursuant to available prospectus exemptions, including the accredited investor exemption, under securities laws (Unlisted Securities).

 

14.          The Filer has filed, or will file, a long form prospectus prepared in accordance with NI 41-101 in respect of the Listed Securities of the ETFs, subject to any exemptions that may be granted by the applicable securities regulatory authorities.

 

15.          Because the Listed Securities will be distributed pursuant to a long form prospectus prepared pursuant to NI 41-101 and NI 41-101F2, each ETF will be a reporting issuer in the provinces and territories of Canada in which its securities are distributed.

 

16.          The Listed Securities will be listed on the TSX or another recognised exchange in Canada.

 

17.          The net asset value per Listed Security will be calculated on any day when there is a trading session on the TSX or other marketplace and will be made available daily on the Filer’s website.

 

18.          A holder of Listed Securities may:

 

(a)           sell such securities on the TSX;

 

(b)           redeem such securities in any number at a redemption price equal to 95% of the closing price for security on the TSX on the effective day of redemption; or

 

(c)           if such holder is a designated broker or dealer or has the consent of the Filer, exchange a Prescribed Number of Listed Securities (and any additional multiple thereof) of the ETF for cash or securities and cash, the exchange price being equal to the net asset value of the securities of the ETF tendered for exchange on the effective day of the exchange request.

 

19.          No Underlying ETF is, or will be, a commodity pool governed by National Instrument 81-104 Commodity Pools (NI 81-104) or any successor instrument.


20.          No Underlying ETF has, or will have, a net market exposure greater than 100% of its net asset value.

 

Borrowing Requirement

 

21.          Each ETF will make distributions on a monthly or quarterly basis or at such frequency as the Filer may, in its discretion, determine appropriate, may make additional distributions and, in each taxation year, will distribute sufficient net income and net realized capital gains so that it will not be liable to pay income tax under Part I of the Income Tax Act (Canada) (collectively, the Distribution Policy).

 

22.          Amounts included in the calculation of net income and net realized capital gains of an ETF for a taxation year that must be distributed in accordance with the Distribution Policy sometimes include amounts that are owing to but have not actually been received by the ETF from the issuers of securities held in the ETF’s portfolio (Issuers).

 

23.          While it is possible for an ETF to maintain a portion of its assets in cash or to dispose of securities in order to obtain any cash necessary to make a distribution in accordance with the Distribution Policy, maintaining such a cash position or making such a disposition (which would generally be followed, when the cash is actually received from the Issuers, by an acquisition of the same securities) impacts the ETF’s performance. Maintaining assets in cash or disposing of securities means that a portion of the net asset value of the ETF is not invested in accordance with its investment objective.

 

24.          The Filer is of the view that it is in the interests of an ETF to have the ability to borrow cash from the Custodian and, if required by the Custodian, to provide a security interest over its portfolio assets as a temporary measure to fund the portion of any distribution payable to Securityholders that represents, in the aggregate, amounts that are owing to, but have not yet been received by, the ETF from the Issuers. While such borrowing will have a cost, the Filer expects that such costs will be less than the reduction in the ETF’s performance if the ETF had to hold cash instead of securities in order to fund the distribution.

 

Fund of Fund Investments

 

25.          No Underlying ETF will hold more than 10% of its net asset value in securities of another investment fund unless the securities of the other investment fund are securities of a money market fund, as defined in NI 81-102, or are IPUs.

 

26.          No Top Fund will pay management or incentive fees which to a reasonable person would duplicate a fee payable by the applicable Underlying ETF for the same service.

 

27.          The Underlying ETFs will primarily achieve their investment objectives through direct holdings of cash and securities, in accordance with their investment objectives and strategies and the requirements of NI 81-102.

 

28.          All brokerage costs related to trades in Listed Securities will be borne by the Top Funds in the same manner as any other portfolio transactions made on the exchange.

 

29.          The Listed Securities are highly liquid, as the Designated Broker acts as an intermediary between investors and each ETF, standing in the market with bid and ask prices for such securities to maintain a liquid market for them.

 

30.          Holders of Unlisted Securities may redeem Unlisted Securities in any number for cash at a redemption price per Unlisted Security equal to the net asset value per Unlisted Security on the effective day of redemption.

 

31.          Each Top Fund and each Underlying ETF is, or will be, subject to National Instrument 81-107 Independent Review Committee for Investment Funds (NI 81-107) generally and in respect of conflicts of interest matters arising from trades of securities of an Underlying ETF.

 

32.          If a Top Fund makes a trade in securities of an Underlying ETF with or through the Filer or an affiliate of the Filer acting as dealer, the Filer will comply with its obligations under NI 81-107 in respect of any proposed related party transactions. All such related party transactions will be disclosed to securityholders of the relevant Top Fund in its management report of fund performance.

 

Reasons for Exemption Sought

 

Exemption from the Borrowing Requirement

 

33.          Section 2.6(a)(i) of NI 81-102 prevents a mutual fund from borrowing cash or providing a security interest over its portfolio assets unless the transaction is a temporary measure to accommodate redemption requests or to settle portfolio transactions and does not exceed five percent of the net assets of the mutual fund. As a result, an ETF is not permitted under section 2.6(a)(i) to borrow from the Custodian to fund distributions under the Distribution Policy.

 

Top Fund Exemptions

 

34.          An investment in an Underlying ETF by a Top Fund is an efficient and cost effective alternative to administering one or more investment strategies similar to that of the Underlying ETF.

 

35.          An investment in an Underlying ETF by a Top Fund should pose no additional investment risk to the Top Fund because each Underlying ETF will be subject to NI 81-102, subject to any exemption therefrom granted by the securities regulatory authorities.

 

36.          Due to the potential size disparity between the Top Funds and the Underlying ETFs, it is possible that a relatively small investment, on a percentage of net asset value basis, by a relatively larger Top Fund in an Underlying ETF could result in such Top Fund holding securities representing more than 10% of: (i) the votes attaching to the outstanding voting securities of the applicable Underlying ETF; or (ii) the outstanding equity securities of that Underlying ETF, contrary to the Control Restriction.

 

37.          It is anticipated that many of the trades in Listed Securities of an Underlying ETF conducted by a Top Fund will not be of the size necessary for the Top Fund to be eligible to purchase or redeem a Prescribed Number of Listed Securities of an Underlying ETF directly from or to, as the case may be, the Underlying ETF. As such, it is anticipated that many of the trades in Listed Securities by a Top Fund will be conducted in the secondary market through the TSX or another recognized exchange in Canada.

 

38.          As each Underlying ETF is not an IPU, absent the Exemption Sought, an investment by a Top Fund in securities of the Underlying ETF do not qualify for the exemptions set out in:

 

(a)           section 2.1(2)(d) of NI 81-102 from the Concentration Restriction;

 

(b)           section 2.2(1.1)(b) of NI 81-102 from the Control Restriction; and

 

(c)           section 2.5(3) of NI 81-102 from the Fund of Fund Restriction.

 

Decision

 

The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.

 

Borrowing Requirement

 

1.             The decision of the principal regulator is that the Exemption Sought in respect of the Borrowing Requirement is granted, provided that the Filer will be in compliance with the following conditions:

 

(a)           the borrowing by the ETF in respect of a distribution does not exceed the portion of the distribution that represents, in the aggregate, amounts that are payable to the ETF but have not been received by the ETF from the Issuers and, in any event, does not exceed five percent of the net assets of the ETF;

 

(b)           the borrowing is not for a period longer than 45 days;

 

(c)           any security interest in respect of the borrowing is consistent with industry practice for the type of borrowing and is only in respect of amounts owing as a result of the borrowing;

 

(d)           the ETF does not make any distribution to Securityholders where the distribution would impair the ETF’s ability to repay any borrowing to fund distributions; and

 

(e)           the final prospectus of the ETF discloses the potential borrowing, the purpose of the borrowing and the risks associated with the borrowing.

 

Top Fund Exemptions

 

2.             The decision of the principal regulator under the Legislation is that the Exemption Sought in respect of the Top Fund Exemptions is granted, provided that:

 

(a)           the investment by a Top Fund in securities of an Underlying ETF is in accordance with the investment objectives of the Top Fund;

 

(b)           a Top Fund does not short sell securities of an Underlying ETF;

 

(c)           the Underlying ETF is not a commodity pool governed by NI 81-104;

 

(d)           other than any exemptive relief granted in favour of an Underlying ETF, the Underlying ETF complies with the requirements of:

 

(i)            section 2.3 of NI 81-102 regarding the purchase of physical commodities;

 

(ii)           sections 2.7 and 2.8 of NI 81-102 regarding the purchase, sale or use of specified derivatives; or

 

(iii)          subsections 2.6(a) and 2.6(b) of NI 81-102 with respect to the use of leverage;

 

(e)           in connection with the Exemption Sought from the Concentration Restriction, the Top Fund shall, for each investment it makes in the securities of an Underlying ETF, apply, to the extent applicable, subsections 2.1(3), 2.1(4) and 2.1(5) of NI 81-102 as if those provisions applied to a Top Fund's investments in securities of the Underlying ETF, and, accordingly, limit a Top Fund's indirect holdings in securities of an issuer held by one or more Underlying ETFs as required by, and in accordance with, subsections 2.1(3), 2.1(4) and 2.1(5) of NI 81-102;

 

(f)            the investment by a Top Fund in securities of an Underlying ETF is made in compliance with section 2.5 of NI 81-102, with the exception of paragraph 2.5(2)(a) and, in respect only of brokerage fees incurred for the purchase and sale of Underlying ETFs by a Top Fund, paragraph 2.5(2)(e) of NI 81-102; and

 

(g)           the prospectus of each Top Fund discloses, or will disclose in the next renewal of its prospectus after the date of this decision, in the investment strategy section, the fact that the Top Fund has obtained the Exemption Sought to permit the relevant transactions on the terms described in this decision.

 

“Darren McKall”

Manager, Investment Funds and Structured Products Branch

Ontario Securities Commission