National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Relief granted from subsection 2.1(1) and paragraphs 2.2(1)(a), 2.5(2)(a), (c) and (e) of National Instrument 81-102 Investment Funds to allow mutual funds to invest in ETFs listed on a Canadian exchange, and to allow the top funds to pay brokerage commissions for the purchase and sale of the securities of related underlying ETFs – Underlying ETFs are subject to NI 81-102 – Relief subject to terms and conditions based on investment restrictions of NI 81-102 such that top funds cannot do indirectly via investment in underlying ETFs what they cannot do directly under NI 81-102.
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), 19.1.
October 9, 2018
IN THE MATTER OF
THE SECURITIES LEGISLATION OF
ONTARIO (the Jurisdiction)
IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS
IN MULTIPLE JURISDICTIONS
IN THE MATTER OF
BROMPTON FUNDS LIMITED
The principal regulator in the Jurisdiction has received an application from Brompton, on behalf of the existing and future mutual funds, that are, or will be managed by the Filer (as defined below) (the Funds), for a decision (the Exemption Sought) under the securities legislation of the principal regulator (the Legislation) exempting each Fund from the following provisions of National Instrument 81-102 – Investment Funds (NI 81-102) in order to permit the Funds to invest in securities of exchange-traded funds that are not index participation units (the Underlying ETFs):
(a) subsection 2.1(1) (the Concentration Restriction) to permit each Fund to purchase securities of an Underlying ETF or enter into a specified derivatives transaction with respect to an Underlying ETF even though, immediately after the transaction, more than 10% of the net asset value (NAV) of the Fund would be invested, directly or indirectly, in securities of the Underlying ETF (the Concentration Relief);
(b) paragraph 2.2(1)(a) (the Control Restriction) to permit each Fund to purchase securities of an Underlying ETF even though, immediately after the purchase, the 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 Relief);
(c) paragraph 2.5(2)(a) to permit each Fund to invest in securities of Underlying ETFs that do not offer securities under a simplified prospectus in accordance with National Instrument 81-101 – Mutual Fund Prospectus Disclosure (NI 81-101); and
(d) paragraph 2.5(2)(e) of NI 81-102 to permit each Fund to pay brokerage fees in relation to its purchase and sale of securities of Related Underlying ETFs (as defined below) (the Brokerage Fee Relief).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission is the principal regulator for the application; and
(b) Brompton has provided notice that subsection 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).
Terms defined in National Instrument 14-101 – Definitions, MI 11-102 and NI 81-102 have the same meaning if used in this decision, unless otherwise defined. In addition, the following terms as used in this decision have the following meanings:
Filer means Brompton or an affiliate or associate of Brompton
Related Underlying ETF means an Underlying ETF that is managed by the Filer.
This decision is based on the following facts represented by Brompton:
1. Brompton is a corporation incorporated under the laws of the Province of Ontario, with its head office located at Suite 2930, Bay Wellington Tower, Brookfield Place, 181 Bay Street, Toronto, Ontario, M5J 2T3.
2. Brompton is, or will be, the promoter and manager of the Funds and is registered in the categories of: (a) investment fund manager in the Provinces of Newfoundland and Labrador, Ontario and Quebec and (b) commodity trading manager, exempt market dealer and portfolio manager in the Province of Ontario.
3. Brompton and the existing Funds are not in default of securities legislation in any of the Jurisdictions.
4. Each Fund is, or will be, a mutual fund organized and governed by the laws of a Jurisdiction of Canada.
5. Each Fund distributes, or will distribute, some or all of its securities pursuant to a long form prospectus prepared pursuant to National Instrument 41-101 – General Prospectus Requirements (NI 41-101) and Form 41-101F2 – Information Required in an Investment Fund Prospectus (Form 41-101F2) and is or will be governed by the applicable provisions of NI 81-102, subject to any exemptions therefrom that have been, or may in the future be, granted by the securities regulatory authorities.
6. Each Fund is, or will be, a reporting issuer in one or more Jurisdictions.
7. Each Fund is, or will be, subject to National Instrument 81-107 – Independent Review Committee for Investment Funds (NI 81-107).
8. A Fund may, from time to time, wish to invest up to 100% of its net asset value in any one or more Underlying ETFs in accordance with its investment objectives.
The Underlying ETFs
9. Each Underlying ETF is, or will be, an open-ended mutual fund subject to NI 81-102, subject to any exemption therefrom that may be granted by the securities regulatory authorities.
10. Securities of each Underlying ETF are, or will be:
(a) distributed pursuant to a long form prospectus prepared pursuant to NI 41-101 and Form 41-101F2; and
(b) listed on the Toronto Stock Exchange or another “recognized exchange” in Canada, as that term is defined in the Legislation.
11. Each Underlying ETF is, or will be, a reporting issuer in one or more of the Jurisdictions.
12. Each Underlying ETF is, or will be, subject to NI 81-107 in respect of conflict of interest matters to which NI 81-107 applies.
13. The securities of an Underlying ETF will not meet the definition of index participation unit (IPU) in NI 81-102 because the purpose of the Underlying ETF will not be to:
(a) hold the securities that are included in a specified widely quoted market index in substantially the same proportion as those securities are reflected in that index; or
(b) invest in a manner that causes the Underlying ETF to replicate the performance of that index.
14. The securities of an Underlying ETF are, or will be, listed on a recognized exchange in Canada and the market for them is, or will be, liquid because it is, or will be, supported by a designated broker and dealers. As a result, the Filer expects a Fund to be able to dispose of such securities through market facilities in order to raise cash, including to fund the redemption requests of its securityholders.
15. No Underlying ETF will hold more than 10% of its NAV in securities of another investment fund unless: (a) the Underlying ETF is a clone fund, as defined in NI 81-102, (b) the other investment fund is a money market fund, as defined in NI 81-102; or (c) securities of the other investment fund are IPUs.
16. No Fund will pay management or incentive fees which, to a reasonable person, would duplicate a fee payable by an Underlying ETF for the same service.
17. Absent the Exemption Sought, an investment by a Fund in an Underlying ETF would be prohibited by paragraph 2.5(2)(a) of NI 81-102 because the Underlying ETFs do not offer securities under a simplified prospectus in accordance with NI 81-101. An investment by a Fund in an Underlying ETF would not qualify for the exception in paragraph 2.5(3)(a) of NI 81-102 because the securities of the Underlying ETF are not IPUs.
The Concentration Relief and Control Relief
18. An investment in an Underlying ETF by a Fund is an efficient and cost effective alternative to administering one or more investment strategies similar to that of the Underlying ETF and will represent the business judgement of responsible persons uninfluenced by considerations other than the best interests of the Fund.
19. An investment in an Underlying ETF by a Fund should pose limited investment risk to the Fund because each Underlying ETF will be subject to NI 81-102, subject to any exemption therefrom that may in the future be granted by the securities regulatory authorities.
20. Due to the potential size disparity between the Funds and the Underlying ETFs, it is possible that a relatively small investment, on a percentage of NAV basis, by a relatively larger Fund in securities of an Underlying ETF could result in such Fund holding 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 that Underlying ETF, contrary to the Control Restriction.
21. An investment by a Fund in securities of an Underlying ETF will not qualify for the exemptions set out in:
(a) paragraph 2.1(2)(d) of NI 81-102 from the Concentration Restriction; and
(b) paragraph 2.2(1.1)(b) of NI 81-102 from the Control Restriction, because securities of the Underlying ETFs are not IPUs.
22. The material difference between the securities of an Underlying ETF and the securities of a conventional mutual fund is the method of distribution and disposition.
The Brokerage Fee Relief
23. The trades conducted by a Fund may not be of the size necessary for the Fund to be eligible to purchase or exchange securities of a Related Underlying ETF directly from the Related Underlying ETF at its NAV per security. Trades in securities of a Related Underlying ETF are therefore likely to be conducted by a Fund in the secondary market through the facilities of a recognized exchange. Absent the Brokerage Fee Relief, paragraph 2.5(2)(e) of NI 81-102 would not permit a Fund to pay brokerage fees incurred in connection with a Related Underlying ETF.
24. All brokerage fees related to trades in securities of Related Underlying ETFs will be borne by the Funds in the same manner as any other portfolio transactions made on an exchange.
25. If a Fund trades in securities of a Related Underlying ETF with or through the Filer acting as dealer, the Filer will comply with its obligations under NI 81-107 in respect of any proposed related party transactions. These related party transactions will be disclosed to securityholders of the applicable Fund in its management report of fund performance.
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted, provided that:
(a) the investment by a Fund in securities of an Underlying ETF is in accordance with the investment objectives of the Fund;
(b) a Fund does not short sell securities of an Underlying ETF;
(c) an Underlying ETF is not a commodity pool as defined in National Instrument 81104 – Commodity Pools;
(d) the Underlying ETF does not rely on exemptive relief from 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) paragraphs 2.6(a) and 2.6(b) of NI 81-102 with respect to the use of leverage;
(e) securities of each Underlying ETF are listed on a recognized exchange in Canada; and
(f) the prospectus of each Fund discloses, or will disclose in the next renewal of its prospectus following the date of this decision, in the investment strategy section, the fact that the Fund has obtained the Exemption Sought to permit investments in Underlying ETFs on the terms described in this decision.
Manager – Investment Funds & Structured Products
Ontario Securities Commission