National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Relief from the requirement to obtain the approval of securityholders for fund mergers and from the multi-layering prohibition in paragraph 2.5(2)(b) of NI 81-102 and approval of fund mergers under paragraph 5.5(1)(b) of NI 81-102 -- mergers were undertaken in connection with changes to the Income Tax Act (Canada) which eliminated certain tax benefits associated with character conversion transactions -- required to send written notice at least 60 days before the effective date of the mergers describing the mergers and including a statement that the fund will no longer distribute gains under forward contracts that are treated as capital gains for tax purposes -- tax impact to securityholders expected to be insignificant.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.5(2)(b), 5.1(1)(f), 5.5(1)(b), 19.1.
September 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 FIDELITY INVESTMENTS CANADA ULC (the Filer) AND IN THE MATTER OF FIDELITY AMERICAN HIGH YIELD CAPITAL YIELD FUND, FIDELITY CANADIAN BOND CAPITAL YIELD FUND, FIDELITY TACTICAL FIXED INCOME CAPITAL YIELD FUND and FIDELITY U.S. MONTHLY INCOME CAPITAL YIELD FUND (collectively, the Terminating Funds) AND IN THE MATTER OF FIDELITY AMERICAN HIGH YIELD FUND, FIDELITY CANADIAN BOND FUND, FIDELITY TACTICAL FIXED INCOME FUND and FIDELITY U.S. MONTHLY INCOME FUND (collectively, the Continuing Funds and, together with the Terminating Funds, the Funds)
The principal regulator in the Jurisdiction has received applications from the Filer for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for:
(a) exemptive relief from the requirement to obtain prior securityholder approval of the Reorganization Transactions (defined below) under paragraph 5.1(1)(f) of National Instrument 81-102 Investment Funds (NI 81-102) (the Securityholder Approval Application);
(b) approval pursuant to paragraph 5.5(1)(b) and section 5.7 of NI 81-102 in connection with the Reorganization Transactions (the Regulatory Approval Application); and
(c) exemptive relief from paragraph 2.5(2)(b) of NI 81-102 to permit:
i. Fidelity U.S. Monthly Income Capital Yield Fund to purchase units of Fidelity U.S. Monthly Income Fund; and
ii. Fidelity Tactical Fixed Income Capital Yield Fund to purchase units of Fidelity Tactical Fixed Income Fund (the Investment Application).
The Securityholder Approval Application and the Investment Application shall be collectively referred to as the Exemption Applications.
The Exemption Applications and the Regulatory Approval Application shall be collectively referred to as the "Applications".
Under the Process for Exemptive Relief applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission is the principal regulator for the Applications; 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 each of the other provinces and territories of Canada (collectively, the Jurisdictions).
Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined. The following additional term shall have the following meaning:
"Reorganization Transactions" means, collectively, the merger of (i) Fidelity American High Yield Capital Yield Fund into Fidelity American High Yield Fund, (ii) Fidelity Canadian Bond Capital Yield Fund into Fidelity Canadian Bond Fund, (iii) Fidelity Tactical Fixed Income Capital Yield Fund into Fidelity Tactical Fixed Income Fund, and (iv) Fidelity U.S. Monthly Income Capital Yield Fund into Fidelity U.S. Monthly Income Fund.
This decision is based on the following facts represented by the Filer:
1. The Filer is a corporation duly amalgamated and validly existing under the laws of the Province of Alberta and its head office is located in Toronto, Ontario.
2. The Filer is registered in Ontario, Québec and Newfoundland and Labrador in the category of investment fund manager. The Filer is also registered as a portfolio manager and mutual fund dealer in each of the Jurisdictions.
3. The Filer is the investment fund manager of the Funds.
4. None of the Filer or the Funds is in default of its obligations under the securities legislation of the Jurisdictions.
5. Each Fund is subject to the requirements of NI 81-102 and National Instrument 81-107 Independent Review Committee for Investment Funds, subject to any exemptions therefrom that may be available under applicable securities legislation or granted by the securities regulatory authorities.
6. Each Fund is a trust established under the laws of Ontario. The Filer is the trustee of each Fund.
7. Each Fund has a current prospectus in the Jurisdictions.
The Reorganization Transactions
8. The Filer is of the view that a reasonable person would consider that the:
(a) fundamental investment objectives of each Terminating Fund are "substantially similar" to the fundamental investment objective of the relevant Continuing Fund;
(b) valuation procedures of each Terminating Fund are "substantially similar" to the valuation procedures of the relevant Continuing Fund; and
(c) fee structure of each Terminating Fund is "substantially similar" to the fee structure of the relevant Continuing Fund. The Filer further confirms that the sales charge and administration fee structures are applied consistently across the Funds.
9. The Terminating Funds were launched to provide tax-efficient fixed income offerings by investing in different types of securities and entering into forward contracts (the Forwards) to provide investment returns similar to those generated by the relevant Continuing Funds.
10. The Terminating Funds have been closed to new purchases of units since April 2013.
11. The favorable tax treatment of these arrangements will be eliminated by new rules in the Income Tax Act (Canada) (the Tax Act), enacted on December 12, 2013, that affect the tax treatment of returns earned under "derivative forward agreements". Under the transitional provisions of these new rules, the favourable tax treatment for forward contracts similar to those used by the Terminating Funds will expire on December 31, 2014. In response to the change in tax treatment, the Filer has decided to implement the Reorganization Transactions.
12. Up to 30 days prior to the execution of the Reorganization Transactions, the Forwards held by the Terminating Funds will be closed out and the securities owned by the Terminating Funds will be sold to the Forward counterparty in exchange for cash. The Terminating Funds will then concurrently subscribe for units of the relevant Continuing Funds. The Terminating Funds will thereafter hold only units of the relevant Continuing Funds and some cash reserves for liquidity purposes until the Reorganization Transactions occur on or around January 16, 2015 (the Transaction Date).
13. The Reorganization Transactions will be structured so that immediately after the close of business on the Transaction Date, the securityholders of the Terminating Funds will have their units in the Terminating Fund redeemed at the applicable net asset value per unit in exchange for units in the relevant Continuing Fund. The value of those Continuing Fund units will be equal to the value of the Terminating Fund units held by a securityholder as at the close of business on the Transaction Date. The majority of securityholders will receive units of the same series as part of the Reorganization Transactions. Due to the fact that it would not be tax efficient to offer series T5, S5 and F5 in the Fidelity American High Yield Fund or Fidelity Canadian Bond Fund, securityholders holding those series in the Fidelity American High Yield Capital Yield Fund and Fidelity Canadian Bond Capital Yield Fund will receive the corresponding series A, B or F units (as applicable).
14. The Terminating Funds will be using only cash to invest in the Continuing Funds as part of the Reorganization Transactions. No other assets will be transferred from the Terminating Funds to the Continuing Funds.
15. The Filer intends to wind up the Terminating Funds as soon as reasonably possible following the Reorganization Transactions.
16. With respect to the Terminating Funds, the Filer will comply with the "material change report" requirements set out in Part 11 of National Instrument 81-106 Investment Fund Continuous Disclosure in connection with the Reorganization Transactions.
17. The Reorganization Transactions will not constitute material changes for the Continuing Funds.
18. The Filer will pay for the costs and expenses associated with the Reorganization Transactions and the Funds will bear none of these costs and expenses.
19. The Reorganization Transactions will be approved by the independent review committee (the IRC) of the Funds.
20. The prospectus of the Terminating Funds provides for at least 60 days' notice to be given to securityholders where transactions such as the Reorganization Transactions are to occur.
21. Securityholders may redeem their securities in advance of the Reorganization Transactions should they wish to do so.
22. The management and advisory fees and trailing commissions of the Continuing Funds are the same as those of the corresponding Terminating Funds. Accordingly, the Reorganization Transactions will have no impact upon the Terminating Fund securityholders from this perspective. Further, these securityholders can reasonably expect to bear lower administration fees over time given the: (i) tiered nature of the administration fees; (ii) relative asset sizes of the Funds; and (iii) expected future asset flows.
23. Following the Reorganization Transactions, all optional services (pre-authorized chequing plans, systematic exchange plans and systematic withdrawal plans) will continue to be available to securityholders, who will be automatically enrolled in comparable plans with respect to units of the applicable Continuing Fund unless they advise otherwise.
24. The Filer considers that the Reorganization Transactions will benefit securityholders of the Terminating Funds over time from an investment and fee perspective.
25. Securityholder approval of the Reorganization Transactions is required under paragraph 5.1(1)(f) of NI 81-102 because the Reorganization Transactions do not satisfy one of the conditions referenced in subsection 5.3(2) of NI 81-102; namely, the Reorganization Transactions will not be "qualifying exchanges" within the meaning of section 132.2 of the Tax Act or tax-deferred transactions under subsection 85(1), 85.1(1), 86(1) or 87(1) of the Tax Act.
26. Due to the fact that:
(a) each Terminating Fund holds Forwards with maturity periods of 31-35 days and the capital gains from those Forwards are realized on a regular basis;
(b) each Terminating Fund is required to distribute its net realized capital gains to securityholders in each tax year (the Distributions);
(c) the next Distributions will occur on or around each Terminating Fund's taxation year end, being December 15, 2014; and
(d) the Transaction Date will be on or around January 16, 2015,
the level of unrealized capital gains and also the impact of the Reorganization Transactions on securityholders from a capital gains tax perspective are not expected to be significant.
27. The principal regulator's approval of the Reorganization Transactions is required under paragraph 5.5.(1)(b) and section 5.7 of NI 81-102 because the Reorganization Transactions do not satisfy one of the conditions for pre-approved reorganizations under section 5.6 of NI 81-102; namely, the Reorganization Transactions will not be "qualifying exchanges" within the meaning of section 132.2 of the Tax Act or tax-deferred transactions under subsection 85(1), 85.1(1), 86(1) or 87(1) of the Tax Act.
The Investment Application
28. As set out in paragraph 12 above, after the final Forwards have matured, the Terminating Funds will hold only units of the relevant Continuing Funds and some cash reserves for liquidity purposes until the Transaction Date (the Interim Period).
29. For the purposes of section 2.5 of NI 81-102, the purchase of units of Fidelity U.S. Monthly Income Fund and Fidelity Tactical Fixed Income Fund (each a Reference Fund) by Fidelity U.S. Monthly Income Capital Yield Fund and Fidelity Tactical Fixed Income Capital Yield Fund (each a Top Fund), respectively, during the Interim Period will result in three-tier fund of fund structures. These multi-tiered fund structures are contrary to the multi-layering prohibition in clause 2.5(2)(b) of NI 81-102 as the Reference Funds hold securities of other mutual funds managed by the Filer (the Third Tier Funds) which represent more than 10% of each Reference Fund's net asset value. These structures do not fit within the exceptions to clause 2.5(2)(b) found in subsection 2.5(4) of NI 81-102.
30. On August 24, 2012, the Filer obtained exemptive relief from clause 2.5(2)(b) of NI 81-102 on behalf of certain mutual funds managed by the Filer to permit such funds to obtain exposure to other mutual funds, which invest in Third Tier Funds (the Prior Three-Tier Relief). However, as the Prior Three-Tier Relief contemplated that the exposure to those other mutual funds would be obtained through one or more specified derivatives, the Prior Three-Tier Relief would not exempt the Top Funds from clause 2.5(2)(b) of NI 81-102 in respect of direct purchases of units of the Reference Funds.
31. The current investment objectives of each Top Fund disclose that each Top Fund will provide a return based on the performance of its corresponding Reference Fund and that the Reference Funds may, in turn, invest in Third Tier Funds. Additionally, the investment strategies of the Top Funds disclose the investment strategies of the Reference Funds.
32. The investment by the Top Funds in securities of the Reference Funds will be made in accordance with the provisions of section 2.5 of NI 81-102, except for the requirements of clause 2.5(2)(b). The investment by the Reference Funds in securities of Third Tier Funds is, and will be, made in accordance with the provisions of section 2.5 of NI 81-102.
33. There will be no duplication of fees between each tier of these multi-tier structures. The simplified prospectus for the Top Funds and Reference Funds discloses that fees and expenses will not be duplicated as a result of investments in underlying funds.
34. The Interim Period arrangements under which the Top Funds will invest directly in the Reference Funds, which in turn invest in Third Tier Funds, is akin to, and no more complex than, the three-tier structure currently permitted under clause 2.5(4)(a) of NI 81-102.
35. The Filer has determined that it is more efficient and less costly for the Top Funds if they achieve their investment objectives by investing all, or substantially all, of their assets in securities of the Reference Funds during the Interim Period, instead of investing directly in the same securities and in the same proportions in which the Reference Funds invest.
36. An investment by the Top Funds in the Reference Funds and by the Reference Funds in the Third Tier Funds represents the business judgment of responsible persons uninfluenced by considerations other than the best interests of the Top Funds and Reference Funds, as the case may be.
37. The Filer has determined that it would be in the best interests of the Top Funds and not prejudicial to the public interest to receive the exemption sought under the Investment Application.
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 is that the relief sought under the Exemption Applications and the approval sought under the Regulatory Approval Application are granted provided that:
(1) the Reorganization Transactions are approved by the IRC of the Funds;
(2) the Filer sends the following to each Terminating Fund securityholder at least 60 days before the Transaction Date:
(a) a detailed notice that sets out the information necessary for the securityholder to understand the applicable Reorganization Transaction, including:
(i) a brief description of that Reorganization Transaction and the Transaction Date;
(ii) a description of the applicable Continuing Fund;
(iii) the IRC's determination with respect to that Reorganization Transaction;
(iv) the tax consequence of that Reorganization Transaction;
(v) where applicable, highlighted disclosure for holders of the series T5, S5 and F5 units of Fidelity American High Yield Capital Yield Fund and Fidelity Canadian Bond Capital Yield Fund stating that such securityholders will receive corresponding series A, B or F units of the applicable Continuing Fund, and the differences between the different series;
(vi) a statement that securityholders may obtain, free of charge, the most recent annual and interim financial statements, the current simplified prospectus, annual information form and fund facts and the most recent management report on fund performance that have been made public by contacting the Filer or by accessing the website of the Filer or SEDAR; and
(vii) in relation to the Top Funds, a description of the three-tier structure that will be implemented during the Interim Period; and
(b) the fund facts document of the series of the Continuing Fund that the securityholder will hold after the completion of the applicable Reorganization Transaction.