NP 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- exemption from National Instrument 81-106 Investment Fund Continuous Disclosure to permit an investment fund that uses specified derivatives to calculate its NAV twice a month subject to certain conditions.
Applicable Legislative Provisions
National Instrument 81-106 Investment Fund Continuous Disclosure, s. 14.2(3)(b).
June 3, 2010
IN THE MATTER OF
THE SECURITIES LEGISLATION OF
QUÉBEC AND ONTARIO
IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF
APPLICATIONS IN MULTIPLE JURISDICTIONS
IN THE MATTER OF
GLOBAL DIVERSIFIED INVESTMENT GRADE
The securities regulatory authority or regulator in each of the Jurisdictions ("Decision Maker") has received an application from the Trust for a decision under the securities legislation of the Jurisdictions (the "Legislation") for an exemption from section 14.2(3)(b) of Regulation 81-106 respecting Investment Fund Continuous Disclosure ("Regulation 81-106"), which requires the net asset value ("NAV") of an investment fund that uses specified derivatives to be calculated at least once every business day (the "Requested Relief").
Under the process for exemptive relief applications in multiple jurisdictions (for a dual application):
(a) the Autorité des marchés financiers is the principal regulator for this application;
(b) the Trust has provided notice that section 4.7(1) of Regulation 11102 respecting Passport System ("Regulation 11-102") is intended to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, New Brunswick, Nova Scotia, Prince Edward Island and Newfoundland and Labrador; and
(c) the decision is the decision of the principal regulator and evidences the decision of the securities regulatory authority or regulator in Ontario.
Terms defined in Regulation 14-101 respecting Definitions and Regulation 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 Trust:
1. The Trust is a non-redeemable investment fund established under the laws of Ontario pursuant to a master declaration of trust dated as of August 30, 2004, as amended, and a regulation made thereunder dated as of August 30, 2004, as amended.
2. The purpose of the Trust is: (i) to provide its unitholders with a fixed rate stream of monthly distributions equal to $0.0495 per unit ($0.594 per annum) up to on or about September 7, 2009 and, thereafter, a floating distribution rate equal to one-month bankers' acceptance plus 2%; (ii) to repay to its unitholders on or about September 7, 2014 (the "Expected Maturity Date"), but no later than or about September 7, 2016 (the "Legal Maturity Date"), an amount equal the residual value of the Trust. The residual value of the Trust will be equal to the lesser of: (i) the NAV per unit determined on the Expected Maturity Date or Legal Maturity Date, as applicable, and (ii) an amount of $9.35 per unit.
3. To achieve its objectives, the Trust holds positions in three credit default swap agreements dated September 9, 2004 (collectively, the "CDS") for which the counterparty is Deutsche Bank AG ("Deutsche Bank"). Under the CDS, Deutsche Bank is the protection buyer and the Trust is the protection seller. The CDS provide the Trust with an economic interest in respect of three global diversified portfolios composed of collateralized debt obligations (CDO), residential mortgage-backed securities and consumer asset-backed securities (collectively, the "Underlying Securities"). The only specified derivatives that the Trust holds are the CDS and the Trust does not intend to enter into any other specified derivative.
4. The Trust's obligations under the CDS are collateralized by a term deposit issued by National Bank of Canada ("NBC") with a maturity date of September 9, 2014.
5. The co-trustees of the Trust are GD-I Management Inc. and Global Digit Management Inc. (collectively, the "Trustees"). The Trustees also act as managers of the Trust in accordance with the definition of "investment fund manager" in the Legislation.
6. The head office of GD-I Management Inc. is located in the Province of Ontario and the head office of Global Digit Management Inc. is located in the Province of Québec. The Autorité des marchés financiers is the principal regulator for this application because the head office of one of the Trust's managers is located in the Province of Québec and the Autorité des marchés financiers is the securities regulatory authority in Canada with the most significant connection with the Trust.
7. NBC acts as administrative agent of the Trust.
8. The Trust became a reporting issuer under the Legislation on August 31, 2004.
9. Pursuant to its prospectus dated August 30, 2004, the Trust issued 10,712,500 units. 6,189,750 units were issued and outstanding as at December 31st, 2009. The units of the Trust are listed on the Toronto Stock Exchange ("TSX") under the symbol DG.UN.
10. The units of the Trust may be redeemed on a quarterly basis, on the last business day of February, May, August and November of each year, at the redemption price per unit. The redemption price is equal to the lesser of: (i) 95% of the daily weighted average trading price of the units on the TSX for the five trading days following the redemption date and (ii) an amount equal to (a) the closing price of the units on the TSX on such redemption date, or (b) the average of the highest and lowest prices of the units on the TSX, or (c) the average of the last bid and ask prices on the TSX and, in each case, less an amount payable as a result of the quarterly distributions. The Trust's annual information form dated March 31st, 2010 and the master declaration of trust provide the rules applicable to determine the redemption price.
11. The units may also be redeemed annually, on the last business day of August, at the unwind price per unit. The unwind price is equal to the sum of (i) the bid price received by the Trust from Deutsche Bank to terminate the applicable portion of the CDS and (ii) the market value of such portion of the term deposit, less the unwind costs. The Trust's annual information form dated March 31st, 2010 and master declaration of trust provide the rules applicable to determine the unwind price.
12. The redemption price and the unwind price are not computed by reference to the Trust's NAV.
13. The Trust's units cannot be redeemed at a price computed by reference to its NAV per unit before the Expected Maturity Date or the Legal Maturity Date, as applicable.
14. The NAV per unit of the Trust is currently calculated by NBC twice a month, (i) on the 15th day of each month, or if the 15th is not a business day, on the preceding business day, and (ii) on the last business day of each month. The NAV is calculated in accordance with Canadian Generally Accepted Accounting Principles (GAAP) and the policies described in the Trust's Annual Information Form dated March 31, 2010.
15. The CDS are specified derivatives and will terminate on the Expected Maturity Date or the Legal Maturity Date, as applicable. Therefore, the Trust is required to calculate its NAV at least once every business day pursuant to section 14.2(3)(b) of Regulation 81-106.
16. The NAV on a particular date is calculated using the fair value or the Trust's assets and liabilities. Substantially all of the assets of the Trust consist of (i) cash or cash equivalent, (ii) the CDS and (ii) the term deposit.
17. In order to calculate the NAV of the Trust, NBC must establish the fair value of the Trust's positions in the CDS. Determining the fair value of the CDS requires considerable effort since they are complex derivatives that are not traded on an active market. The fair value of the CDS is established by using a valuation technique that uses bid and offer prices provided by Deutsche Bank (the "Bid and Offer Prices"). The Bid and Offer Prices represent an indication of the prices that Deutsche Bank may pay or charge to purchase or sell a tranche of the CDS. These prices may reflect factors such as the market's assessment of the overall credit quality of the Underlying Securities, as measured by the quoted price of the Underlying Securities (and derivatives thereof), interest rates as well as factors that are proprietary to Deutsche Bank.
18. The Bid and Offer Prices are established upon Deutsche Bank's internally developed manual process, which requires proprietary valuation procedures and consultation with Deutsche Bank's trading desk to assess the results. This process consumes several hours to be completed. The initial 2004 agreement between the Trust and Deutsche Bank states that the Bid and Offer Prices would be provided on a monthly basis. Deutsche Bank accepted in September 2009 to amend the agreement to provide the Bid and Offer Prices on a twice a month basis without any additional compensation.
19. In accordance with the Trust's valuation policies and procedures, NBC verifies the reasonableness of the Bid and Offer Prices. The methodology used by NBC is base correlation and Gaussian Copula One factor. This process involves a lot of assumptions and market variables about the Underlying Securities. All significant discrepancies between the pricing obtained by NBC and those provided by Deutsche Bank are analysed and settled.
20. The Trust has established that it would be impractical and unduly burdensome to calculate and disclose a reliable and accurate NAV on a timely basis without the Bid and Offer Prices.
21. Subject to its approval by the Trustees, the NAV per unit is disclosed within approximately one week from (i) the 15th day of each month, or if the 15th is not a business day, the preceding business day, and (ii) the last business day of each month. The NAV per unit is available at no cost on SEDAR and on a special section of National Bank Financial's Website established for the Trust.
22. The Trust's management reports of fund performance disclose that the NAV per unit is available on SEDAR and on National Bank Financial's Website, and the frequency at which the NAV per unit is calculated and disclosed.
23. Although the NAV per unit is mainly used as a direct reference for the calculation of the Trust's residual value on maturity, which is not expected to occur before the Expected Maturity Date or the Legal Maturity Date, as applicable, its disclosure, combined with other factors, facilitates market price discovery to foster fair and efficient capital markets. The NAV per unit is important information for investors in order to determine whether to purchase, hold or sell units of the Trust.
24. The Trust currently expects that its units will remain listed on the TSX until the Expected Maturity Date or the Legal Maturity Date, as applicable. Therefore, unitholders have the option of liquidating their units on the TSX, which serves as the primary source of liquidity for the Trust's units.
25. In accordance with section 11.2 of Regulation 81-106, the Trust is required to promptly disclose any material change.
26. The Trust used specified derivatives and calculated its NAV once a month between September 9, 2004, the date of the closing of its initial public offering, and September 7, 2008, in accordance with the provisions of the Legislation that were in effect during this period.
27. The provisions of subsection 14.2(5) of NI 81-106 were amended on September 8, 2008 when Regulation to amend Regulation 81-106 respecting Investment Fund Continuous Disclosure came into force. Since this amendment, the Trust has had the obligation to calculate its NAV at least once every business day in accordance with the requirement of paragraph 14.2(3)(b) of NI 81-106.
28. Since September 8, 2008, the Trust has not been in compliance with the requirement of subsection 14.2(3) of Regulation 81-106. The Trust did not seek an exemptive relief for the frequency of the calculation of its NAV before August 31, 2009 because of its oversight of the coming into force of the amendment to subsection 14.2(5) of Regulation 81-106.
29. The Trust filed the Requested Relief after it received a Continuous Disclosure Review comment letter dated August 11, 2009 from the Autorité des marchés financiers, wherein the Autorité des marchés financiers requested that the Trust explain why it was not calculating its NAV at least once every business day in accordance with Regulation 81-106.
30. Except as disclosed above, the Trust is not in default of the Legislation.
Each of the Decision Makers is satisfied that the decision meets the test set out in the Legislation for the Decision Maker to make the decision.
The decision of the Decision Makers under the Legislation is that the Requested Relief is granted provided that:
(a) the units of the Trust remain listed on the TSX;
(b) the Trust calculates its NAV per unit at least twice a month, (i) on the 15th day of each month, or if the 15th is not a business day, on the preceding business day, and (ii) on the last business day of each month; and
(c) the Trust's NAV per unit is available at no cost and on a timely basis on SEDAR and on National Bank Financial's Website.