National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- filer seeking relief from NI 81-102 to permit alternative mutual funds to short sell up to 100% of net assets in connection with "market neutral" or other short selling strategies -- NI 81-102 would allow funds to achieve similar short exposure through derivatives -- physical short selling is cheaper and more efficient and will not increase risk to the funds compared to short exposure through derivatives.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds -- ss. 2.6.1(1)(c)(v), 2.6.2(1) and 19.1(2).
September 17, 2019
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO (the Jurisdiction) AND IN THE MATTER OF THE PROCESS FOR RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF RBC GLOBAL ASSET MANAGEMENT INC. (the Filer)
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of RBC QUBE Market Neutral World Equity Fund (the Proposed Fund), a mutual fund that is currently offered for sale in Canada pursuant to an exemption from the prospectus requirements, but will be structured as an "alternative mutual fund" within the meaning of National Instrument 81-102 Investment Funds (NI 81-102), and such alternative mutual funds as may be established in the future and for which the Filer or an affiliate of the Filer acts as investment fund manager (the Future Funds and together with the Proposed Fund, the Funds, and each a Fund), for a decision under the securities legislation of the Jurisdiction (the Legislation) that exempts the Funds from the following provisions of NI 81-102 (the Short Selling Restrictions), in order to permit the Funds to short sell securities up to 100% of a Fund's net asset value (NAV):
(i) Subparagraph 2.6.1(1)(c)(v) which restricts an alternative mutual fund from selling a security short if, at the time, the aggregate market value of all securities sold short by the fund exceeds 50% of the fund's net asset value (NAV); and
(ii) Section 2.6.2, which prohibits an alternative mutual fund from borrowing cash or selling securities short if, immediately after entering into a cash borrowing or short selling transaction, the aggregate value of cash borrowed combined with the aggregate market value of all securities sold short by the investment fund would exceed 50% of the fund's NAV
(the Requested Relief).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(i) the Ontario Securities Commission is the principal regulator for this application; and
(ii) the Filer 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 each of the other provinces and territories of Canada (the Other Jurisdictions and together with the Jurisdiction, the Jurisdictions).
Terms defined in NI 81-102, National Instrument 14-101 Definitions, and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.
This decision is based on the following facts represented by the Filer:
1. The Filer is registered as an adviser in the category of portfolio manager and as a dealer in the category of exempt market dealer under the securities legislation of each of the Jurisdictions, is registered as an investment fund manager in each of British Columbia, Ontario, Québec and Newfoundland and Labrador and is also registered in Ontario as a commodity trading manager. The Filer's head office is in Toronto, Ontario.
2. The Filer is the investment fund manager and portfolio manager, and an affiliate is the trustee of the Proposed Fund, and the Filer or an affiliate of the Filer, will be the trustee, investment fund manager and portfolio manager of the Future Funds. The Filer is not in default of applicable securities legislation in any of the Jurisdictions.
3. Units of the Proposed Fund are currently offered pursuant to certain exemptions from the prospectus requirements of the securities legislation of the provinces and territories of Canada. The Proposed Fund is not in default of any of its obligations under the securities legislation of the Jurisdictions. The Filer intends to convert and structure the Proposed Fund as a public alternative mutual fund and units of the Proposed Fund will be offered pursuant to a simplified prospectus, annual information form and fund facts prepared in accordance with National Instrument 81-101 -- Mutual Fund Prospectus Disclosure (NI 81-101).
4. The Future Funds will be mutual funds created under the laws of the Province of Ontario or British Columbia and will be governed by the provisions of NI 81-102, subject to any relief therefrom granted by the securities regulatory authorities. Each Fund will be an alternative mutual fund for purposes of NI 81-102.
5. Units of the Funds will be offered by simplified prospectus, annual information form and fund facts prepared in accordance with NI 81-101, or by a long form prospectus and ETF Facts prepared in accordance with National Instrument 41-101 -- General Prospectus Requirements (NI 41-101) as applicable, (a Prospectus) filed in all of the Jurisdictions and each Fund will be a reporting issuer in each of the Jurisdictions.
6. The investment objectives of the Proposed Fund are to provide consistent absolute returns that are substantially independent of the performance of the global equity market. The Proposed Fund intends to achieve its investment objective by investing primarily in securities of issuers listed on global equity markets which are expected to outperform comparable securities, while selling short an equivalent dollar amount of global equity securities which are expected to underperform (the Market-Neutral Strategy).
7. The proposed investment objective for each Future Fund will differ, but in each case, a core investment strategy as stated in the simplified prospectus or long form prospectus, as applicable, will make the extensive use of short selling an investment strategy that is available to the portfolio manager in order to achieve the investment objectives of the applicable Fund and the portfolio manager's desired combination of long and short positions.
Reasons for the Requested Relief
8. Because the Proposed Fund employs the Market-Neutral Strategy that requires a constant level of 100% shorts, the Short-Selling Restrictions would prevent the Proposed Fund from achieving its investment objectives through physical short selling alone. The Proposed Fund would instead have to use some combination of physical and synthetic short selling through derivatives in order to achieve the desired short exposure. The Future Funds that have investment strategies that contemplate short selling in excess of 50% of their NAV will be similarly restricted by the Short-Selling Restrictions.
9. The Filer would like the flexibility to enter into physical short positions when doing so is in the best interests of the Funds and not be obliged to enter into short positions synthetically through the use of derivatives in order to achieve a Fund's investment objectives or strategies.
10. The underlying investment exposure between a physical short position and a synthetic short position is the same. The Funds would not be subject to any additional risks by entering a physical short position over a synthetic short position.
11. In addition, while there may be certain situations in which using a synthetic short position may preferable, physical shorts are typically less costly, because of the ability to execute trades with a larger number of counterparties, compared to a single counterparty for synthetic shorts. This can result in wider options for borrowing securities resulting in lower borrowing costs. Funds are also exposed to less counterparty risk than with a synthetic short position (e.g. counterparty default, counterparty insolvency, and premature termination of derivatives).
12. The Requested Relief would provide the Filer with the necessary flexibility to make timely trading decisions between physical short and synthetic short positions based on what is in the best interest of the Funds. The Filer, as a registrant and a fiduciary, is in the best position to determine whether the Funds should enter into a physical short position or a synthetic short position, depending on the surrounding circumstances. Accordingly, the Requested Relief would permit the Filer to engage in the most effective portfolio management available for the benefit of the Funds and their unitholders.
13. The Prospectus for each Fund will comply with the requirements of and applicable to alternative mutual funds, including cover page text box disclosure to highlight how the Funds differ from other mutual funds, and emphasize that the short selling strategies permitted by the Funds are outside the scope of NI 81-102 applicable to both alternative mutual funds and conventional mutual funds.
14. The Filer will determine each Fund's risk rating using the Investment Risk Classification Methodology as set out in Appendix F of NI 81-102.
15. The investment strategies of each Fund will clearly disclose the short selling strategies of the Funds which are outside the scope of NI 81-102, including that the aggregate market value of all securities sold short by the Fund may exceed 50% of the Fund's NAV. The Prospectus will also contain appropriate risk disclosure, alerting investors of any material risks associated with such investment strategies.
16. The investment strategies of each Fund will permit it to sell securities short, provided that at the time the Fund sells a security short (a) the aggregate market value of securities of any one issuer (other than "government securities" as defined in NI 81-102) sold short by the Fund does not exceed 10% of the Fund's NAV, and (b) the aggregate market value of all securities sold short by the Fund does not exceed 100% of its NAV.
17. The investment strategies of each Fund will permit the Fund to enter into a cash borrowing or short selling transaction, provided that at the time a Fund sells a security short, the aggregate value of cash borrowed combined with the aggregate market value of the securities sold short by the Fund does not exceed 100% of the Fund's net asset value, or such other percentage required to achieve the investment objectives of the Fund.
18. The investment strategies of each Fund will permit the Fund to borrow cash, enter into specified derivative transactions or sell securities short, provided that immediately after entering into a cash borrowing, specified derivative or short selling transaction, the aggregate value of cash borrowed combined with the aggregate market value of all securities sold short by the Fund and the aggregate notional amount of the Fund's specified derivatives positions (other than positions held for hedging purposes, as defined in NI 81-102) would not exceed 300% of the Fund's NAV (the Leverage Limit). If the Leverage Limit is exceeded, the Fund shall, as quickly as commercially reasonable, take all necessary steps to reduce the aggregate value of cash borrowed combined with the aggregate market value of securities sold short and aggregate notional amount of the Fund's specified derivatives position to be within the Leverage Limit, in compliance with section 2.9.1 of NI 81-102.
19. Any physical short position entered into by a Fund will be consistent with the investment objectives and strategies of the applicable Fund.
20. Each Fund will implement the following controls when conducting a short sale
(a) The Fund will assume the obligation to return to the borrowing agent the securities borrowed to effect the short sale;
(b) The Fund will receive cash for the securities sold short within normal trading settlement periods for the market in which the short sale is effected;
(c) The Filer will monitor the short positions of the Fund at least as frequently as daily;
(d) The security interest provided by the Fund over any of its assets that is required to enable the Fund to effect a short sale transaction is made in accordance with section 6.8.1 of NI 81-102 and will otherwise be made in accordance with industry practice for that type of transaction and relates only to obligations arising under such short sale transaction;
(e) The Fund will maintain appropriate internal controls regarding short sales, including written policies and procedures for the conduct of short sales, risk management controls and proper books and records; and
(f) The Filer and each Fund will keep proper books and records of short sales and all of its assets deposited with borrowing agents as security.
21. The Filer believes that it is in the best interests of the Funds to be permitted to engage in physical short selling in excess of the current limits set out in NI 81-102 applicable to alternative mutual funds.
22. Based on the foregoing, we respectfully submit that it would not be prejudicial to the public interest for the Commission to grant the Exemption Sought.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that:
1. A Fund may sell a security short or borrow cash only if, immediately after the transaction:
(a) the aggregate market value of all securities sold short by the Fund does not exceed 100% of the Fund's NAV;
(b) the aggregate value of cash borrowing by the Fund does not exceed 50% of the Fund's NAV; and
(c) the aggregate market value of securities sold short by the Fund combined with the aggregate value of cash borrowing by the Fund does not exceed 100% of the Fund's NAV.
2. Each short sale made by a Fund will otherwise comply with all of the short sale requirements applicable to alternative mutual funds under section 2.6.1 and 2.6.2 of NI 81-102.
3. A Fund's aggregate exposure to short selling, cash borrowing and specified derivatives will not exceed the Leverage Limit.
4. Each short sale will be made consistent with the Fund's investment objectives and strategies.
5. Each Fund's Prospectus will disclose that the Fund can short sell securities in an amount up to 100% of the Fund's NAV, including the material terms of this decision.