National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Relief from the requirement to obtain the approval of securityholders before changing the fundamental investment objectives of an exchange traded mutual fund -- Relief required as a result of changes to federal budget eliminating certain tax benefits associated with character conversion transactions -- Required to send written notice at least 60 days before the effective date of the change to the investment objectives of the fund setting out the change, the reasons for such change, a statement that the fund will no longer distribute gains under forward contracts that are treated as capital gains for tax purposes.
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, ss. 5.1(c) and 19.1.
August 26, 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 iSHARES ADVANTAGED SHORT DURATION HIGH INCOME ETF (the Fund) AND IN THE MATTER OF BLACKROCK ASSET MANAGEMENT CANADA LIMITED (the Filer)
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of the Fund for a decision under the securities legislation of the Jurisdiction (the Legislation) for an exemption under section 19.1 of National Instrument 81-102 -- Mutual Funds (NI 81-102) from the requirements of subsection 5.1(c) of NI 81-102 in order to permit the Fund to change its fundamental investment objective without obtaining the prior approval of the unitholders of the Fund (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 paragraph 4.7(1)(c) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Northwest Territories, Nunavut and Yukon.
Terms defined in NI 81-102 have the same meaning in this decision as in NI 81-102. Certain other defined terms have the meanings given to them below under "Representations".
This decision is based on the following facts represented by the Filer:
1. The Filer is the trustee and manager of the Fund and is a registered portfolio manager, exempt market dealer and investment fund manager in the Province of Ontario. The Filer is also registered as a commodity trading manager in the Province of Ontario.
2. The principal offices of the Filer and the Fund are located at 161 Bay Street, Suite 2500, Toronto, Ontario, M5J 2S1.
3. Neither the Filer nor the Fund is in default of the securities legislation of any province or territory of Canada.
4. The Fund is an exchange-traded fund established under the laws of the Province of Ontario and is a reporting issuer in all provinces and territories of Canada (the Offering Jurisdictions).
5. The Fund is a mutual fund subject to NI 81-102, subject to any exemptions therefrom that have been granted by securities regulatory authorities.
6. The common units and advisor class units of the Fund are listed on the Toronto Stock Exchange (the TSX) and are qualified for distribution in all Offering Jurisdictions pursuant to a (final) prospectus dated October 16, 2013 (the Prospectus).
7. The common units and advisor class units of the Fund currently trade on the TSX under the ticker symbols CSD and CSD.A, respectively.
8. The Fund's fundamental investment objective, as disclosed in the Prospectus, is as follows:
"[The Fund] has been created to maximize total returns for unitholders consisting of both tax-efficient monthly distributions and capital appreciation, and to preserve capital. Distributions are intended to be tax efficient when compared to units of a trust that depends solely on interest, dividend and/or other investment income to pay distributions."
9. The Fund's investment strategy, as disclosed in the Prospectus, is to obtain exposure to the performance of an actively managed diversified high-yield debt portfolio (the High Income Portfolio) consisting primarily of below investment grade debt securities as rated by Moody's Investor's Services, Inc., Standard & Poor's Financial Services LLC and Fitch Rating Service Inc. (Ba1/BB+/BB+ or below) or which are unrated but judged by the Filer, its affiliates or a sub-advisor to be of comparable quality, with an opportunistic allocation to investment grade debt securities and other select fixed income debt obligations with a near term maturity of five years or less and/or an effective duration of less than one year as determined by the Filer, its affiliates or a sub-advisor.
10. Historically, the Fund has obtained exposure to the High Income Portfolio indirectly by entering into one or more forward purchase and sale agreements with a Canadian chartered bank or an affiliate thereof and does not own and has no right to acquire the High Income Portfolio.
Amendments to the Income Tax Act (Canada)
11. On March 21, 2013 (the Budget Date), the federal Minister of Finance proposed new federal taxation rules in connection with the 2013 Federal Budget (the Tax Amendments).
12. The Tax Amendments, which were subsequently enacted on December 13, 2013, deem gains on the settlement of certain forward agreements (character conversion transactions) to be included in ordinary income rather than treated as capital gains. In certain circumstances that include compliance with certain growth limits in the notional size of a forward agreement set out in the Tax Amendments (the Growth Limits), forward agreements that existed prior to the Budget Date will be "grandfathered", meaning that the Tax Amendments will not apply to them. The two forward agreements of the Fund that were in effect as of the Budget Date, one forward agreement (the CAD Legacy Forward) relating to the Canadian dollar-denominated common units and Canadian dollar-denominated advisor class of units of the Fund and one forward agreement (the USD Legacy Forward) relating to the U.S. dollar-denominated common units and U.S. dollar-denominated advisor class of units of the Fund (collectively, the USD Units), were grandfathered.
13. In the fourth quarter of 2013, the Filer disclosed and implemented certain changes to the Fund in response to the Tax Amendments in order to enable the Fund to resume operating as an open-ended exchange-traded fund by accepting new subscriptions (which, generally, were suspended on an interim basis following the release of the Tax Amendments). In particular: (i) the Fund implemented a new interim investment strategy as described below; and (ii) the USD Units were terminated and de-listed from the TSX and are no longer offered and sold by the Fund. In addition, the USD Legacy Forward was terminated.
14. To preserve the grandfathered status of the CAD Legacy Forward until its final settlement, the Filer has not permitted, and plans not to allow, the Fund to enter into transactions that would result in the CAD Legacy Forward exceeding the Growth Limits.
15. The Fund has implemented a new interim investment strategy (the Hybrid Strategy), in accordance with its current investment objective, through which the Fund: (i) continues to maintain exposure to the High Income Portfolio indirectly through the use of the CAD Legacy Forward; and (ii) invests the proceeds from the sale of new units of the Fund in a portfolio of directly-held securities selected from the eligible universe of securities in which the High Income Portfolio is permitted to invest. As of June 20, 2014, approximately $350 million (approximately 87%) of the Fund's assets are invested in the High Income Portfolio indirectly through the use of the CAD Legacy Forward, while approximately $52 million (approximately 13%) of the Fund's assets are invested in a portfolio of directly-held securities.
16. With the implementation of the Hybrid Strategy, unitholders of the Fund will continue to benefit from the tax-advantaged (i.e., capital gain) character of that portion of the Fund's distributions that are funded through the partial settlement of the CAD Legacy Forward until its scheduled expiry on February 24, 2016 or earlier termination. Upon investing the proceeds from new subscriptions directly through the Hybrid Strategy, the Filer expects that these tax benefits will diminish over time as the Fund accepts new subscriptions and the tax benefit is spread over the Fund's larger asset base. The portion of future distributions derived from the Fund's direct investments is expected to be fully taxable as ordinary income (net of allowable expenses).
17. Following the expiry or earlier termination of the CAD Legacy Forward, the Filer expects that the Fund will invest primarily in a portfolio of directly-held securities and does not intend to enter into any character conversion transactions.
18. The temporary suspension of subscriptions in response to the Tax Amendments was disclosed to unitholders of the Fund in a press release dated April 3, 2013 and subsequently included in a prospectus amendment and material change report, each dated April 15, 2013. The Hybrid Strategy was initially announced to unitholders by way of a press release dated September 17, 2013 and was subsequently described in a prospectus amendment, material change report and amended and restated summary documents, each dated September 27, 2013 and in the Prospectus and final summary documents, each dated October 16, 2013. A description of the Hybrid Strategy was also included in the notice dated October 1, 2013 that was mailed to unitholders of the Fund in connection with the termination of the USD Units. On December 9, 2013, the Filer issued a press release notifying unitholders of the Fund of the implementation of the previously-disclosed Hybrid Strategy and the re-opening of the Fund and subsequently filed amended and restated summary documents on December 20, 2013.
19. The implementation of the Hybrid Strategy has been effected in accordance with the Fund's current investment objective that is described above.
20. The Filer expects that the Fund's distributions will remain tax-advantaged for the time being, with the tax-advantaged component of the Fund's distributions diminishing over time as the Fund accepts new subscriptions and the tax benefit is spread over the Fund's larger asset base. In planning for the expected change to the tax-advantaged nature of the Fund's distributions, it is necessary to change the investment objective of the Fund (the Change of Investment Objective) to remove the references to tax-efficiency such that the Fund's investment objective will read as follows:
"[The Fund] has been created to maximize total returns for unitholders consisting of both monthly distributions and capital appreciation, and to preserve capital, by investing in or obtaining economic exposure to a diversified high-yield debt portfolio consisting primarily of below investment grade debt securities."
Reasons for the Exemption Sought
21. Following a careful review of the impact of the Tax Amendments on the Fund, the Filer implemented the changes described above, including the Hybrid Strategy, in the fourth quarter of 2013 in order to enable the Fund to resume operating as an open-ended exchange-traded fund.
22. Given the expected change to the tax-advantaged nature of the Fund's distributions over time as a result of the implementation of the Hybrid Strategy, the Filer has determined that it is necessary to implement the Change of Investment Objective (through the amendment of the declaration of trust governing the Fund) as it will no longer be possible for the Fund to pursue the tax-advantaged elements of its current investment objective.
23. The Change of Investment Objective will become necessary as a consequence of the Tax Amendments and the implementation of the Hybrid Strategy in response thereto.
24. The Filer believes that the Change of Investment Objective will not affect the risk profile of the Fund or the suitability of the Fund for existing unitholders.
25. To effectively communicate the Change of Investment Objective to unitholders of the Fund, the Filer proposes to provide not less than 60 days' written notice to Fund unitholders of the Change of Investment Objective. In addition, the Filer will treat the Change of Investment Objective as a "material change" and, thereby, the Fund will issue a press release and file a material change report, prospectus amendment and amended and restated summary documents.
26. The unitholder notice and material change disclosure will provide sufficient notice and information to Fund unitholders of the Change of Investment Objective, particularly since the impact of the Tax Amendments and the corresponding implementation of the Hybrid Strategy by the Fund were previously fully disclosed to unitholders of the Fund as described above.
27. With such notice and material change disclosure relating to the Change of Investment Objective, the prior disclosure of the changes to the Fund, including the implementation of the Hybrid Strategy, and the general media coverage of the Tax Amendments, unitholders of the Fund will be in a fully informed position to make an investment decision relating to their continuing participation in the Fund following the implementation of the Change of Investment Objective and will have adequate notice in order to sell their units through the facilities of the TSX if they are not in favour of the change.
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, at least 60 days before the effective date of the Change of Investment Objective, the Filer sends to each unitholder of the Fund a written notice that sets out the change of investment objective, the reasons for such change and a statement that the Fund will no longer be able to provide tax-advantaged returns after the expiration or earlier termination of the CAD Legacy Forward.