Securities Law & Instruments

Headnote

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), 2.5(2)(e) and 2.5(2)(f) of NI 81-102 to allow certain conventional open-end mutual funds and ETFs 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 the underlying ETFs -- Relief needed because underlying ETFs are mutual funds that do not file a simplified prospectus under NI 81-101 and are not index participation units eligible for exemptions under the rule -- Underlying ETFs are subject to NI 81-102, are not commodity pools under NI 81-104, and do not rely on any exemptive relief from the restrictions regarding the purchase of physical commodities, the use of derivatives and the use of leverage -- Top funds to apply "look-through" requirement in subsections 2.1(3) and (4) of NI 81-102 to each investment in securities of an Underlying ETF.

Applicable Legislative Provisions

National Instrument 81-102 Mutual Funds, ss. 2.1(1), 2.2(1)(a), 2.5(2)(a), 2.5(2)(e), 2.5(2)(f).

April 30, 2014

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 FT PORTFOLIO CANADA CO. (the Filer) AND IN THE MATTER OF THE TOP FUNDS (defined below)

DECISION

Background

The principal regulator in the Jurisdiction has received an application from the Filer for a decision under the securities legislation of the Jurisdiction (the Legislation) granting an exemption to the existing mutual funds (the Existing Top Funds) and the future mutual funds (the Future Top Funds, and collectively with the Existing Top Funds, the Top Funds), which are subject to National Instrument 81-102 -- Mutual Funds (NI 81-102) and are managed by the Filer or an affiliate of the Filer, from the following prohibitions in NI 81-102:

(a) subsection 2.1(1) (the Concentration Restriction), to permit each Top Fund to purchase a security of an Underlying ETF (as defined below) or enter into a specified derivatives transaction with respect to an Underlying ETF even though, immediately after the transaction, more than 10 percent of the net asset value (NAV) of the Top Fund would be invested, directly or indirectly, in the securities of the Underlying ETF;

(b) paragraph 2.2(1)(a), to permit each Top Fund to purchase securities of an Underlying ETF such that, after the purchase, the Top Fund would hold securities representing more than 10 percent of

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

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

(c) paragraph 2.5(2)(a), to permit each Top Fund to invest in securities of an Underlying ETF (as defined below, and which are exchange traded mutual funds that are not subject to National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81-101)); and

(d) paragraphs 2.5(2)(e) and 2.5(2)(f) of NI 81-102, to permit 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 an Underlying ETF

(collectively, 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 British Columbia, Alberta, Saskatchewan, Manitoba, Quebec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Yukon, Northwest Territories and Nunavut.

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.

Representations

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

The Filer

1. The Filer is a corporation formed by amalgamation pursuant to a certificate of amalgamation dated November 29, 2001 under the federal laws of Nova Scotia. The head office of the Filer is located in Toronto, Ontario.

2. The Filer or an affiliate of the Filer acts, or will act, as the investment fund manager of the Top Funds.

3. None of the Filer, the Existing Top Funds or the Existing Underlying ETFs (as defined below), is in default of the securities legislation of any of the provinces and territories of Canada.

The Top Funds

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

5. The Top Funds are, or will be, governed by the 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 Top Fund distributes, or will distribute, its securities pursuant to a prospectus prepared pursuant to NI 81-101 or a prospectus prepared pursuant to National Instrument 41-101 General Prospectus Requirements (NI 41-101).

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 NAV in the exchange traded mutual funds listed in Schedule "A" (the Existing Underlying ETFs) and such other similar exchange traded mutual funds that may be established and managed by the Filer or an affiliate of the Filer in the future (the Future Underlying ETFs, and together with the Existing Underlying ETFs, the 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 judgment of responsible persons uninfluenced by considerations other than the best interests of the Top Fund.

10. Each Top Fund is not, and will not be, a commodity pool governed by National Instrument 81-104 Commodity Pools (NI 81-104).

11. No Top Fund has, or will have, a net market exposure greater than 100% of its NAV.

The Underlying ETFs

12. The Filer, or an affiliate of the Filer acts, or will act, as the investment fund manager of each Underlying ETF.

13. Each Underlying ETF is, or will be:

(a) an open-ended mutual fund, subject to NI 81-102 and NI 41-101, subject to any exemptions therefrom that have been, or may in the future be, granted by the securities regulatory authorities;

(b) a reporting issuer in the provinces and territories of Canada in which its securities are distributed; and

(c) listed on the Toronto Stock Exchange (the TSX) or another recognized exchange in Canada.

14. Each Underlying ETF distributes, or will distribute, its securities pursuant to a prospectus prepared pursuant to NI 41-101.

15. No Underlying ETF holds, or will hold more than 10% of its NAV in securities of other mutual funds unless the securities of the other mutual fund are securities of a money market fund, as defined in NI 81-102, or index participation units (IPUs), as defined in NI 81-102, issued by a mutual fund.

16. The securities of the Underlying ETFs do not, or will not constitute IPUs.

17. Each Underlying ETF does not, or will not, pay management or incentive fees which to a reasonable person would duplicate a fee payable by the Top Fund for the same service.

18. If the investment fund manager of a Top Fund (the "Top Fund Manager") determines that the management fees and incentive fees payable by an Underlying ETF to its investment fund manager (the "Underlying ETF Manager") would duplicate a fee payable by the Top Fund for the same service, the Underlying ETF Manager will pay a management fee rebate to the Top Fund that will not exceed the management fee payable by the Top Fund to the Top Fund Manager in respect of the Top Fund's investment in the Underlying ETF.

19. Holders of securities of an Underlying ETF may:

(a) sell such securities on the TSX or other recognized exchange in Canada on which the securities are listed for trading;

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

(c) exchange a prescribed number of securities (a PNU) (or an integral multiple thereof) of the Underlying ETF for cash and securities, the exchange price being equal to the NAV of the securities of the Underlying ETF tendered for exchange on the effective day of the exchange request.

20. No Underlying ETF will be a commodity pool governed by NI 81-104.

21. No Underlying ETF has, or will have, a net market exposure greater than 100% of its NAV.

22. The Existing Underlying ETFs primarily achieve, and any Future Underlying ETFs will primarily achieve, their investment objectives through direct holdings of securities and, in some circumstances, through investments in specified derivatives for hedging and non-hedging purposes, in accordance with their investment objectives and strategies and with NI 81-102.

23. All brokerage costs related to trades in securities of the Underlying ETFs will be borne by the Top Funds in the same manner as any other portfolio transactions made on an exchange.

24. Each Top Fund 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 in securities of an Underlying ETF. If a Top Fund makes a trade in securities of an Underlying ETF with or through an affiliate or associate 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 applicable Top Fund in its management report of fund performance.

25. The securities of each Underlying ETF are highly liquid, as designated brokers act as intermediaries between investors and each Underlying ETF, standing in the market with bid and ask prices for such securities to maintain a liquid market for them.

Reasons for the Exemption Sought

26. An investment in an Underlying ETF by a Top Fund is an efficient and cost effective alternative to administering one or more investment strategies directly.

27. Absent the Exemption Sought, a Top Fund would be prohibited by subsection 2.1(1) of NI 81-102 from investing more than 10 percent of its NAV in the securities of an Underlying ETF. The Exemption Sought would only grant each Top Fund relief from the Concentration Restriction in respect of the Top Fund's direct or indirect holdings of securities issued by an Underlying ETF. The Exemption Sought would not relieve a Top Fund from the obligation to comply with the Concentration Restriction in respect of the Top Fund's indirect holdings in securities held by an Underlying ETF and each Top Fund will comply with the Concentration Restriction in respect of the Top Fund's indirect holdings in securities held by an Underlying ETF and apply sections 2.1(3) and (4) of NI 81-102.

28. 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 NAV basis, by a relatively large Top Fund in an Underlying ETF could result in that Top Fund holding securities representing more than 10% of (i) the votes attaching to the outstanding voting security of the Underlying ETF, or (ii) the outstanding equity securities of that Underlying ETF, contrary to the control restriction in paragraph 2.2(1)(a) of NI 81-102.

29. Absent the Exemption Sought, an investment by a Top Fund in an Underlying ETF would be prohibited by paragraph 2.5(2)(a) of NI 81-102 because the Underlying ETF does not and will not have offered securities under a simplified prospectus in accordance with NI 81-101 as contemplated by section 2.5(2)(a) of NI 81-102. The only material difference between the securities of an Underlying ETF and the securities of any other mutual fund governed by NI 81-102 is the method of distribution. If the Exemption Sought is granted, the Top Funds will be permitted to purchase securities of a mutual fund that is listed on the TSX or another recognized exchange in Canada in the same manner that they are permitted to invest in securities of a mutual fund that is not listed on such an exchange.

30. An investment by a Top Fund in an Underlying ETF would not qualify for the exemption in paragraph 2.5(3)(a) of NI 81-102 from paragraph 2.5(2)(a) of NI 81-102 because the Underlying ETF does not issue IPUs.

31. It is anticipated that many of the trades conducted by the Top Funds would not be of the size necessary for a Top Fund to be eligible to purchase or redeem a PNU directly from the Underlying ETF. As a result, it is anticipated that the majority of trading in respect of securities of the Underlying ETFs will be conducted in the secondary market using the facilities of the TSX or other recognized exchange in Canada.

32. Absent the Exemption Sought, when a Top Fund trades securities of an Underlying ETF on the TSX or other recognized exchange in Canada, paragraphs 2.5(2)(e) and 2.5(2)(f) would not permit the Top Fund to pay any brokerage fees incurred in connection with the trade.

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.

The decision of the principal regulator under the Legislation is that the Exemption Sought is granted, provided that:

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

(b) the Underlying ETF does not rely on exemptive relief from:

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

(ii) the requirements of 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.

(c) each Top Fund and each Underlying ETF is not a commodity pool governed by NI 81-104 and neither the Top Fund nor the Underlying ETF will use leverage;

(d) in connection with the relief from subsection 2.1(1) under this decision allowing a Top Fund to invest more than 10% of its net asset value in the securities of an Underlying ETF, the Top Fund shall, for each investment it makes in securities of an Underlying ETF, apply subsections 2.1(3) and 2.1(4) of NI 81-102 as if those provisions applied to a Top Fund's investments in securities of an Underlying ETF, and accordingly limit a Top Fund's indirect holdings in securities of an issuer held by one or more Underlying ETFs to no more than 10% of the Top Fund's net asset value;

(e) the relief from paragraphs 2.5(2)(e) and 2.5(2)(f) will only apply to the brokerage fees incurred for the purchase and sale of securities of Underlying ETFs by the Top Funds; and

(f) the prospectus of each Top Fund discloses, or will disclose the next time it is renewed after the date of this decision, the fact that the Top Funds have obtained the Exemption Sought to permit the relevant transactions on the terms described in this decision.

"Darren McKall"
Manager, Investment Funds
Ontario Securities Commission

 

SCHEDULE "A"

EXISTING UNDERLYING ETFs

First Trust AlphaDEXTM Canadian Dividend Plus ETF
First Trust AlphaDEXTM U.S. Dividend Plus ETF (CAD-Hedged)
First Trust AlphaDEXTM Emerging Market Dividend ETF (CAD-Hedged)
First Trust AlphaDEXTM Global Energy Income Plus ETF (CAD-Hedged)
First Trust Senior Loan ETF (CAD-Hedged)