HSBC Investment Funds and HSBC Mortgage Fund - MRRS Decision

Headnote

Mutual Reliance Review System for Exemptive Relief Applications -- National Instrument 81-102 Mutual Funds Section 19.1 -- Relief from certain self-dealing restrictions in Section 4.2 of NI 81-102 - A mutual fund seeks relief from Section 4.2 of NI 81-102 to enable it to purchase mortgages from parties related to the fund manager -- The purchase or sale is consistent with, or is necessary to meet, the investment objectives of the mutual fund and is in the best interests of the fund's investors; the IRC of the mutual fund has approved the transaction, or the fund manager follows any standing instructions that the IRC provides in connection with the transaction.

Applicable Legislative Provisions

National Instrument 81-102 Mutual Funds, ss. 4.2 19.1.

IN THE MATTER OF

THE SECURITIES LEGISLATION OF

BRITISH COLUMBIA, ALBERTA, SASKATCHEWAN,

MANITOBA, ONTARIO, QUEBEC, NEW BRUNSWICK,

NOVA SCOTIA, AND NEWFOUNDLAND

AND LABRADOR

(the Jurisdictions)

AND

IN THE MATTER OF

THE MUTUAL RELIANCE REVIEW SYSTEM

FOR EXEMPTIVE RELIEF APPLICATIONS

AND

IN THE MATTER OF

HSBC INVESTMENT FUNDS (CANADA) INC. (the Filer)

AND

IN THE MATTER OF

HSBC MORTGAGE FUND (the Fund)

MRRS DECISION DOCUMENT

Background

The local securities regulatory authority or regulator (the Decision Maker) in each of the Jurisdictions has received an application from the Filer on behalf of the Fund for a decision under section 19.1 of National Instrument 81-102 Mutual Funds (NI 81-102) for relief from section 4.2 of NI 81-102 to permit the Fund to purchase mortgages from and sell mortgages to HSBC Bank Canada, HSBC Mortgage Corporation (Canada) and other affiliates of the Filer (the "HSBC Affiliates") (the Requested Relief);

Under the Mutual Reliance Review System for Exemptive Relief Applications:

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

(b) this MRRS decision document evidences the decision of each Decision Maker.

Interpretation

Defined terms contained in National Instrument 14-101 Definitions have the same meaning in this decision unless they are defined in this decision.

Representations

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

1. The Filer is a corporation organized under the laws of Canada, with a head office located in British Columbia.

2. The Filer is a wholly-owned subsidiary of HSBC Investments (Canada) Limited (the Portfolio Manager). The Portfolio Manager is a wholly-owned subsidiary of HSBC Bank Canada.

3. The Filer is registered under applicable securities legislation in each province of Canada, other than Prince Edward Island, as a dealer in the category of mutual fund dealer (or equivalent) and is a member of the Mutual Fund Dealers Association of Canada.

4. The Filer is the manager, trustee and promoter of the Fund.

5. The Fund is an open-ended mutual fund established under a declaration of trust governed by the laws of British Columbia. Units of the Fund are qualified for sale in each of the Jurisdictions under a simplified prospectus and annual information form filed in and accepted by each of the Jurisdictions.

6. The Filer has appointed an independent review committee (IRC) in accordance with the requirements under National Instrument 81-107 Independent Review Committee for Investment Funds (NI 81-107) for the Fund.

7. The Portfolio Manager is registered under applicable securities legislation in each province of Canada, other than Prince Edward Island, as an adviser in the category of portfolio manager and investment counsel (or equivalent).

8. The Portfolio Manager is the principal investment advisor of the Fund.

9. The Fund's investment objective is to earn as high a level of income as possible while protecting invested capital by investing primarily in Canadian dollar denominated residential first mortgages on property in Canada and other debt obligations.

10. The Fund purchases mortgages from the HSBC Affiliates.

11. HSBC Bank Canada has agreed to repurchase any mortgage purchased by the Fund from it or HSBC Mortgage Corporation (Canada) if the mortgage is in default in respect of the payment of principal and interest beyond 90 days of the due date, or if the mortgage fails to meet the criteria for a mortgage in which the Fund may invest established by National Policy Statement No. 29 or by the Fund's internal statement of policies.

12. In addition, the Fund has agreed not to sell any mortgage purchased from HSBC Bank Canada or HSBC Mortgage Corporation (Canada) to any other person without giving HSBC Bank Canada the first right to purchase the mortgage within 30 days of receipt of written notice from the Fund of its intention to sell.

13. HSBC Bank Canada has agreed to administer the mortgages which are acquired by the Fund from it or HSBC Mortgage Corporation (Canada).

14. The Fund will purchase a mortgage from or sell a mortgage to an HSBC Affiliate only if:

(a) the transaction is made in accordance with clause 2.4(c) of Section III of National Policy Statement No. 29 such that

(i) the purchase or sale is made at the principal amount which will produce a yield to the Fund of not more than a quarter of one percent less than the interest rate at which the HSBC Affiliate is making commitments, at the time of purchase, to loan on the security of comparable mortgages, and

(ii) in the case of a purchase of a mortgage,

A. the HSBC Affiliate that sells it to the Fund enters into an agreement (the Repurchase Agreement) with the Fund whereby the HSBC Affiliate that sells the mortgage is obligated to repurchase it if the mortgage goes into default for more than 90 days and in circumstances benefiting the Fund, and

B. the Filer considers that the Repurchase Agreement is sufficient to justify the difference in yield referred to in subparagraph (ii) above;

(b) HSBC Bank Canada guarantees the performance of the other HSBC Affiliate under the Repurchase Agreement referred to in paragraph (a)(ii)A. above;

(c) the Filer causes the Fund to comply with the disclosure provisions of Section IV of National Policy Statement No. 29; and

(d) the Filer causes the Fund to include disclosure in its prospectus that the Fund will engage in principal transactions in mortgages with the HSBC Affiliates.

15. In the event that the total amount required to effect redemptions of units of the Fund as at the close of business on any valuation day exceeds the liquid assets then held by the Fund, HSBC Bank Canada has agreed that, upon receipt of written notice from the Fund, it will

(a) purchase or find a purchaser for such value of mortgages held by the Fund as may be necessary to provide the Fund with the amount required. The sale of mortgages in such circumstances will be carried out in accordance with the representations provided in paragraph 14 above; or

(b) in lieu of purchasing or finding a purchaser for mortgages, lend, on a temporary basis only, such sums to the Fund as may be necessary to effect such redemptions but not exceeding in the aggregate 5% of the net asset value of the Fund. HSBC Bank Canada is entitled to receive from the Fund, in respect of such loans, interest at a rate at least as favourable to the Fund as the rates then generally charged by HSBC Bank Canada on comparable loans to other persons who are not affiliated with HSBC Bank Canada.

16. The provisions of National Policy Statement No. 29 set out guidelines relating to the acquisition of mortgages by a mutual fund from lending institutions with whom such fund does not deal at arm's length and provide certain protections to the investing public.

17. The Filer will only cause the Fund to purchase a mortgage from or sell a mortgage to an HSBC Affiliate if the transaction is made in accordance with section 2.4(c) of Section III of National Policy Statement No. 29.

18. None of the HSBC Affiliates from which mortgages are purchased or to which mortgages are sold for the Fund, or any of their directors, officers or employees, participate in the formulation of investment decisions made on behalf of, or advice given to, the Fund by the Portfolio Manager. All decisions to purchase mortgages for the Fund's portfolio from the HSBC Affiliates are made based on the judgement of responsible persons uninfluenced by considerations other than the best interests of the Fund.

19. The Filer is of the view that the purchase and sale of mortgages between the Fund and the HSBC Affiliates is in the best interests of the Fund.

20. To the extent that a Fund purchases mortgages from, or sells mortgages to the HSBC Affiliates this fact is set out, and will continue to be set out, in the simplified prospectus and annual information form of the Fund.

21. National Instrument 81-106 Investment Fund Continuous Disclosure requires the Fund to include the dollar amount of commission, spread, or any other fee paid to a related party in connection with a portfolio transaction. To the extent that the Fund is purchasing mortgages from, or selling mortgages to the HSBC Affiliates these facts will be set out in the management report of fund performance of the Fund filed with the securities regulatory authorities in the applicable Jurisdictions and delivered to unitholders (if requested) on a semi-annual basis, so that the information will be provided the securities regulatory authorities in the applicable Jurisdictions and to unitholders the Fund in fulfillment of its continuous disclosure obligations.

22. Section 4.2 of NI 81-102 prohibits a mutual fund from purchasing a security from or selling a security to an associate or affiliate of the manager, portfolio adviser or trustee of the mutual fund.

23. As HSBC Bank Canada and HSBC Mortgage Corporation (Canada) are "affiliates" of the Filer, the Fund is prohibited by section 4.2 of NI 81-102 from purchasing mortgages from or selling mortgages to HSBC Bank Canada, HSBC Mortgage Corporation (Canada) or other affiliates of the Filer.

24. Section 4.3(1) of NI 81-102 provides an exemption from the prohibition in section 4.2 of NI 81-102 if, among other conditions, the price payable for the mortgages is not more than the ask price of the security as reported by any available public quotation in common use (in the case of a purchase by the Fund) or not less than the bid price of the security as reported by any available public quotation in common use (in the case of a sale by the Fund).

25. The Fund is not able to rely on section 4.3(1) of NI 81-102 because purchases of mortgages will not be made on an exchange as required by section 4.3(1) of NI 81-102.

26. NI 81-107 does not provide an exemption for principal trading of the type contemplated by the Requested Relief.

27. The IRC will consider the policies and procedures of the Filer and will provide its approval on whether the proposed transactions in mortgages achieve a fair and reasonable result for the Fund in accordance with section 5.2(2) of NI-81-107.

28. The Filers are not in default of requirements under the Legislation except for their inadvertent failure to obtain the Requested Relief for transactions prior to the date of this decision document. Despite this inadvertence, the Filers have complied with all terms and conditions, including the requirements under National Policy Statement No. 29, of prior MRRS decisions granting relief similar to the Requested Relief based on similar facts now presented in the Filers' application.

Decision

Each of the Decision Makers is satisfied that the test contained in applicable securities legislation in each Jurisdiction that provides the Decision Maker with the jurisdiction to make the decision has been met.

The decision of the Decision Makers is that the Requested Relief is granted provided that:

(a) the purchase or sale is consistent with, or is necessary to meet, the investment objective of the Fund;

(b) the IRC of the Fund has approved the transaction in accordance with section 5.2(2) of NI 81-107;

(c) the Filer, as manager of the Fund, complies with section 5.1 of NI 81-107;

(d) the Filer, as manager of the Fund, and the IRC of the Fund comply with section 5.4 of NI 81-107 for any standing instructions the IRC provides in connection with the transactions; and

(e) the Fund keeps the written records required by section 6.1(2)(g) of NI 81-107.