National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief from certain specified derivatives and custodial requirements to permit mutual funds to enter into swap transactions that are cleared through a clearing corporation -- relief required because of new U.S. requirements to clear over-the-counter derivatives including swaps -- decision treats cleared swaps similar to other cleared derivatives -- National Instrument 81-102 Investment Funds.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.7(1) and (4), 6.1(1), 19.1.
December 3, 2014
IN THE MATTER OF THE SECURITIES LEGISLATION OF QUÉBEC AND ONTARIO (the Jurisdictions) AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF NATIONAL BANK INVESTMENTS INC. (the Filer)
The securities regulatory authority or regulator in each of the Jurisdictions (the Decision Maker) has received an application from the Filer for a decision under the securities legislation of the Jurisdictions (the Legislation), pursuant to section 19.1 of Regulation 81-102 respecting Investment Funds (c. V-1.1, r. 39) (Regulation 81-102), exempting the NB Funds (as defined below):
(i) from the requirement in subsection 2.7(1) of Regulation 81-102 that a mutual fund must not purchase an option or a debt-like security or enter into a swap or a forward contract unless, at the time of the transaction, the option, debt-like security, swap or contract has a designated rating or the equivalent debt of the counterparty, or of a person or company that has fully and unconditionally guaranteed the obligations of the counterparty in respect of the option, debt-like security, swap or contract, has a designated rating;
(ii) from the limitation in subsection 2.7(4) of Regulation 81-102 that the mark-to-market value of the exposure of a mutual fund under its specified derivatives positions with any one counterparty other than an acceptable clearing corporation or a clearing corporation that clears and settles transactions made on a futures exchange listed in Appendix A to Regulation 81-102 shall not exceed, for a period of 30 days or more, 10 percent of the net asset value of the mutual fund; and
(iii) from the requirement in subsection 6.1(1) of Regulation 81-102 to hold all portfolio assets of a mutual fund under the custodianship of one custodian in order to permit each NB Fund to deposit cash and other portfolio assets directly with a Futures Commission Merchant (as defined below) and indirectly with a Clearing Corporation (as defined below) as margin,
in each case, with respect to cleared Swaps (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 Filer has provided notice that subsection 4.7(1) of Regulation 11-102 respecting Passport System (c. V-1.1, r. 1) (Regulation 11-102) is intended to be relied upon in each jurisdiction of Canada other than the Jurisdictions (the Other Jurisdictions); 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 81-102, Regulation 14-101 respecting Definitions (c. V-1.1, r. 3), and Regulation 11-102 have the same meaning if used in this decision, unless otherwise defined. Capitalized terms used in this decision have the following meanings:
"Applicable NB Funds" means each of National Bank Global Tactical Bond Fund, National Bank High Yield Bond Fund, National Bank Corporate Bond Fund, National Bank Bond Fund, National Bank Global Bond Fund, National Bank Long Term Bond Fund, National Bank Floating Rate Income Fund, National Bank Income Fund and National Bank Preferred Equity Fund;
"CFTC" means the U.S. Commodity Futures Trading Commission;
"Clearing Corporation" means any of the Chicago Mercantile Exchange Inc., ICE Clear Credit LLC and LCH.Clearnet Limited and any other clearing organization that is permitted to operate in the Jurisdictions or the Other Jurisdictions, as the case may be, where the NB Fund is located;
"Dodd-Frank" means the Dodd-Frank Wall Street Reform and Consumer Protection Act;
"Futures Commission Merchant" means any futures commission merchant that is registered with the CFTC and is a member of a Clearing Corporation;
"NB Funds or individually, an NB Fund" means (i) the Applicable NB Funds and (ii) all existing mutual funds and any mutual funds subsequently established in the future that may enter into cleared Swaps (as defined below) and for which the Filer acts, or will act, as investment fund manager;
"OTC" means over-the-counter;
"Portfolio Manager" means each portfolio manager retained from time to time by the Filer to manage all or a portion of the investment portfolio of one or more NB Funds;
"Swaps" means the swaps that are, or will become, subject to a clearing determination issued by the CFTC, including fixed-to-floating interest rate swaps, basis swaps, forward rate agreements in U.S. dollars, the Euro, Pounds Sterling or the Japanese Yen, overnight index swaps in U.S. dollars, the Euro and Pounds Sterling and untranched credit default swaps on certain North American indices (CDX.NA.IG and CDX.NA.HY) and European indices (iTraxx Europe, iTraxx Europe Crossover and iTraxx Europe HiVol) at various tenors;
"U.S. Person" has the meaning attributed thereto by the CFTC.
This decision is based on the following facts represented by the Filer:
1. The Filer is, or will be, the investment fund manager of each NB Fund. The Filer is registered as an investment fund manager in each of the Provinces of Québec, Ontario and Newfoundland and Labrador and as a mutual fund dealer in the Jurisdictions and in the Other Jurisdictions. The head office of the Filer is located at 1100 University Street, Montreal, Québec, H3B 2G7.
2. Fiera Capital Corporation is the portfolio manager for all of the Applicable NB Funds other than National Bank Global Tactical Bond Fund. BNY Mellon Asset Management Canada Ltd. is the portfolio manager of National Bank Global Tactical Bond Fund. The Filer will retain duly registered portfolio manager for the investment portfolio of each future NB Fund.
3. Fiera Capital Corporation and BNY Mellon Asset Management Canada Ltd. are duly registered as portfolio manager in the Jurisdictions and in the Other Jurisdictions.
4. Each NB Fund is, or will be, a mutual fund created under the laws of the Province of Ontario and is, or will be, subject to the provisions of Regulation 81-102.
5. Neither the Filer nor the NB Funds, are or will be, in default of securities legislation in the Jurisdictions or any Other Jurisdictions.
6. The securities of each NB Fund are, or will be, qualified for distribution pursuant to a simplified prospectus that is, or will be, prepared and filed in accordance with the securities legislation of the Jurisdictions and the Other Jurisdictions. Accordingly, each NB Fund is, or will be, a reporting issuer or the equivalent in the Jurisdictions and in the Other Jurisdictions.
7. The investment objective and investment strategies of each NB Fund permits, or will permit, the NB Fund to enter into derivative transactions, including Swaps. Each of the Portfolio Managers for the Applicable NB Funds considers Swaps to be an important investment tool that is available to it to properly manage the Applicable NB Fund's portfolio. Some of the Applicable NB Funds currently use foreign exchange swaps and/or interest rate swaps to achieve their investment objectives. All of the Applicable NB Funds may use Swaps in the future.
8. Dodd-Frank requires that certain OTC derivatives be cleared through a Futures Commission Merchant at a clearing organization recognized by the CFTC. Generally, where one party to a Swap is a U.S. Person, that Swap must be cleared, absent an available exception.
9. Each Applicable NB Fund may enter into derivatives on an OTC basis with Canadian, U.S. and other international counterparties. These OTC derivatives are entered into in compliance with the derivative provisions of Regulation 81-102.
10. In order to benefit from both the pricing benefits and reduced trading costs that the Portfolio Manager may be able to achieve through its trade execution practices for its advised investment funds and other accounts and from the reduced costs associated with cleared OTC derivatives as compared to other OTC trades, the Filer wishes to have the NB Funds have the ability to enter into cleared Swaps.
11. In the absence of the Requested Relief, each Portfolio Manager will need to structure the Swaps entered into by the NB Funds so as to avoid the clearing requirements of the CFTC. The Filer respectfully submits that this would not be in the best interests of the NB Funds and their investors for a number of reasons, as set out below.
12. The Filer strongly believes that it is in the best interests of the NB Funds and their investors to be able to execute OTC derivatives with U.S. Persons, including U.S. swap dealers.
13. In its role as a manager for the NB Funds, the Filer has determined that central clearing represents a good choice for the investors in the NB Funds to mitigate the legal, operational and back office risks faced by investors in the global swap markets.
14. A Portfolio Manager may use the same trade execution practices for all of its advised investment funds and other accounts, including the NB Funds. An example of these trade execution practices is block trading, where a large number of securities are purchased or sold or large derivative trades are entered into on behalf of a number of investment funds and other accounts advised by one Portfolio Manager. These practices include the use of cleared Swaps if such trades are executed with a U.S. swap dealer. If the NB Funds are unable to employ these trade execution practices, then each affected Portfolio Manager will have to create separate trade execution practices only for the NB Funds and will have to execute trades for the NB Funds on a separate basis. This will increase the operational risk for the NB Funds, as separate execution procedures will need to be established and followed only for the NB Funds.
In addition, the NB Funds will no longer be able to enjoy the possible price benefits and reduction in trading costs that a Portfolio Manager may be able to achieve through a common practice for its advised funds and other accounts. In the Filer's opinion, best execution and maximum certainty can best be achieved through common trade execution practices, which, in the case of OTC derivatives, involve the execution of Swaps on a cleared basis.
15. As a member of the G20 and a participant in the September 2009 commitment of G20 nations to improve transparency and mitigate risk in derivatives markets, Canada has expressly recognized the systemic benefits that clearing OTC derivatives offers to market participants, such as the NB Funds. The Filer respectfully submits that the NB Funds should be encouraged to comply with the robust clearing requirements established by the CFTC by granting them the Requested Relief.
16. The Requested Relief is analogous to the treatment currently afforded under Regulation 81-102 to other types of derivatives that are cleared, such as clearing corporation options, options on futures and standardized futures. This demonstrates that, from a policy perspective, the Requested Relief is consistent with the views of the Canadian securities authorities in respect of cleared derivative trades.
17. For the reasons provided above, the Filer submits that it would not be prejudicial to the public interest to grant the Requested Relief.
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, in respect of the deposit of cash and portfolio assets as margin:
(a) in Canada,
(i) the Futures Commission Merchant is a member of a SRO that is a participating member of CIPF; and
(ii) the amount of margin deposited and maintained with the Futures Commission Merchant does not, when aggregated with the amount of margin already held by the Futures Commission Merchant on behalf of the NB Fund, exceed 10 percent of the net asset value of the NB Fund as at the time of deposit; and
(b) outside of Canada,
(i) the Futures Commission Merchant is a member of a Clearing Corporation and, as a result, is subject to a regulatory audit;
(ii) the Futures Commission Merchant has a net worth, determined from its most recent audited financial statements that have been made public or from other publicly available financial information, in excess of the equivalent of $50 million; and
(iii) the amount of margin deposited and maintained with the Futures Commission Merchant does not, when aggregated with the amount of margin already held by the Futures Commission Merchant on behalf of the NB Fund, exceed 10 percent of the net asset value of the NB Fund as at the time of deposit.
This decision will terminate on the earlier of (i) the coming into force of any revisions to the provisions of Regulation 81-102 that address the clearing of OTC derivatives, and (ii) two years from the date of this decision.