National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief granted from short selling restrictions in NI 81-102 to permit a alternative mutual funds to short sell "government securities", as defined in NI 81-102, up to 300% of NAV -- relief also granted from the requirement in section 6.1 of NI 81-102 in order to deposit with the Prime Broker, excluding the value of the proceeds from collateral, additional collateral subject to limits of, in the case of an Alternative Fund, 25% of the net asset value.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds -- ss. 2.6.1(1)(c)(v), 2.6.2, 6.1, 6.8.1, and 19.1.
September 18, 2019
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 NINEPOINT PARTNERS LP (the Filer)
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of Ninepoint Alternative Credit Opportunities Fund (the Existing Fund), and any alternative mutual fund established in the future and managed by the Filer or an affiliate of the Filer (each, a Future Fund and, together with the Existing Fund, the Funds), for a decision under the securities legislation of the principal regulator (the Legislation) exempting the Funds from:
i. the following provisions of National Instrument 81-102 Investment Funds (NI 81-102) in order to permit each Fund to short sell "government securities" (as defined in NI 81-102) up to a maximum of 300% of a Fund's net asset value (NAV):
a) subparagraph 2.6.1(1)(c)(v), which restricts a Fund from selling a security short if, at the time, the aggregate market value of the securities sold short by the Fund exceeds 50% of the Fund's NAV; and
b) section 2.6.2, which states that a Fund may not borrow cash or sell securities short if, immediately after entering into a cash borrowing or short selling transaction, the aggregate value of cash borrowed combined with the aggregate market value of the securities sold short by the Fund would exceed 50% of the Fund's NAV.
(together, the Short Selling Limits)
ii. the requirement set out in section 6.1(1) of 81-102 that provides that, except as provided in section 6.8, 6.8.1 and 6.9, all portfolio assets of an investment fund must be held under the custodianship of one custodian that satisfies the requirements of section 6.2 in order to permit the following:
a) unless the borrowing agent is the Fund's custodian or sub-custodian, if a Fund deposits portfolio assets with a borrowing agent as security in connection with a short sale of securities, the aggregate market value of portfolio assets held by the borrowing agent after such deposit, excluding the aggregate market value of the proceeds from outstanding short sales of securities held by the borrowing agent, must not in the case of an alternative mutual fund, exceed 25% of the net asset value of the alternative mutual fund at the time of deposit.
(the Short Selling Collateral Limit)
(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 the 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 all of the provinces and territories of Canada other than the Jurisdiction (together with the Jurisdiction, the Jurisdictions).
Terms defined in National Instrument 14-101 Definitions, MI 11-102 and NI 81-102 have the same meaning if used in this decision, unless otherwise defined.
Prime Broker means any entity that acts as, among other things, a borrowing agent to one or more investments funds.
This decision is based on the following facts represented by the Filer:
The Filer and the Funds
1. The Filer is a limited partnership formed and organized under the laws of the Province of Ontario. The general partner of the Filer is Ninepoint Partners GP Inc., a corporation incorporated under the laws of the Province of Ontario. The head office of the Filer is located in Ontario.
2. The Filer is registered as (i) an investment fund manager in Ontario, Quebec and Newfoundland and Labrador, (ii) a portfolio manager in Ontario, British Columbia, Alberta, Saskatchewan, Manitoba, New Brunswick, Nova Scotia and Newfoundland and Labrador, and (iii) an exempt market dealer in Ontario, British Columbia, Alberta, Saskatchewan, Manitoba, New Brunswick, Nova Scotia, Newfoundland and Labrador and Quebec.
3. The Filer is, or will be, the investment fund manager of each of the Funds.
4. The Filer will be appointed as the manager of each Fund pursuant to a management agreement.
5. The Existing Fund is an alternative mutual fund established under the laws of Ontario that operates under the provisions of NI 81-102 applicable to alternative mutual funds. Each Future Fund will be an alternative mutual fund under NI 81-102.
6. Each Fund is, or will be, a reporting issuer in one or more Jurisdictions.
7. The securities of each Fund will be qualified for distribution to the public in some or all of the Jurisdictions pursuant to a simplified prospectus, annual information form and fund facts prepared and filed in accordance with National Instrument 81-101 -- Mutual Fund Prospectus Disclosure. Each Fund will be, governed by NI 81-102, subject to any relief therefrom granted by the securities regulatory authorities.
8. Neither the Filer nor the Existing Fund is in default of securities legislation in any Jurisdiction.
9. The investment objective of Ninepoint Alternative Credit Opportunities Fund is to provide investors with income and capital appreciation. The Fund will seek to achieve its investment objectives by primarily investing in a diversity of Canadian, U.S. and international fixed income securities for short-term and long-term gain.
Short Selling Limits
10. An important investment strategy expected to be used by the Funds will be to enter into long positions in corporate bonds while hedging the interest rate risk of those bonds by taking short positions in government bonds. The short positions in the government bonds can be achieved either through short selling government bonds or by entering into short positions in government bond futures.
11. The Short Selling Limits would restrict the Funds to short selling government securities to no more than 50% of the Fund's NAV.
12. NI 81-102 otherwise permits the Funds to obtain the additional leveraged short exposure through the use of specified derivatives, up to an aggregate exposure of 300% of the Fund's NAV.
13. The Filer is of the view, that it would be in the Funds' best interest to permit the Funds to physically short sell government securities up to 300% of the Fund's NAV, instead of being limited to achieve the same degree of leverage through either specified derivatives alone, or a combination of physical short selling and specified derivatives, for the following reasons:
(a) While derivatives can be used to create similar investment exposure as short selling up to 300% of each Fund's NAV, the use of derivatives is more complex, more expensive and riskier than short selling. Implementing derivatives necessitates incremental transactional steps and expense to each of the Funds.
(b) There is a potential mismatch between the corporate bond and government security futures contract, which makes the use of derivatives less efficient than short selling government securities. The futures contract has standard terms set by the exchange on which it trades and is not directly linked to one particular government security. This makes it more difficult to determine whether the interest rate exposure of the government security futures contract is a good match for the interest rate exposure of the corporate bond it is meant to hedge. On the other hand, the short position in a government security that the market pairs with a corporate bond has been selected due to its proven effectiveness in hedging the interest rate exposure of the corresponding corporate bond.
14. The only securities sold short by the Funds in excess of 50% of a Fund's NAV will be "government securities" as such term is defined in NI 81-102. The Funds will otherwise comply with the provisions governing short selling by an alternative mutual fund under sections 2.6.1 and 2.6.2 of NI 81-102.
15. Each Fund's aggregate exposure to short selling, cash borrowing and specified derivatives transactions will not exceed 300% of the Fund's NAV, in compliance with subsection 2.9.1 of NI 81-102 (the Aggregate Exposure Limit).
16. Each Fund will implement the following controls when conducting a short sale:
(a) The Fund will assume the obligation to return to the Borrowing Agent (as defined in NI 81-102) the securities borrowed to effect the short sale;
(b) The Fund will receive cash for the securities sold short within normal trading settlement periods for the market in which the short sale is effected;
(c) The Filer will monitor the short positions of the Fund at least as frequently as daily;
(d) The security interest provided by the Fund over any of its assets that is required to enable the Fund to effect a short sale transaction is made in accordance with section 6.8.1 of NI 81-102 and will otherwise be made in accordance with industry practice for that type of transaction and relates only to obligations arising under such short sale transaction;
(e) The Fund will maintain appropriate internal controls regarding short sales, including written policies and procedures for the conduct of short sales, risk management controls and proper books and records; and
(f) The Filer and the Fund will keep proper books and records of short sales and all of its assets deposited with Borrowing Agents as security.
17. Each Fund's prospectus (the Prospectus) will contain adequate disclosure of the Fund's short selling activities, including material terms of the Short Selling Limits.
Short Selling Collateral Limit
18. In connection with, among other things, the short sale of securities that the Funds will or may engage in, each Fund is permitted to grant a security interest in favour of, and deposit pledged portfolio assets with, its Prime Broker. If a Fund engages as its Prime Broker an entity that is not its custodian or sub-- custodian, then a Fund may, as an alternative mutual fund, under section 6.8.1 of NI 81-102, only deliver to its Prime Broker portfolio assets having a market value, in the aggregate, of not more than 25% of the NAV of such Fund at the time of deposit.
19. A Prime Broker may not act as borrowing agent for an alternative mutual fund that wants to sell short securities having an aggregate market value of up to 50% of such fund's NAV if the Prime Broker is only permitted to hold, as security for such transaction, portfolio assets, including the proceeds from the short sale, having an aggregate market value that is not in excess of 25% of the NAV of the fund.
20. Effective as of January 3, 2019, NI 81-102 was amended to include alternative mutual funds. Prior to and since that date, a number of investment fund managers have either launched alternative mutual funds or are planning to do so. The ability of alternative mutual funds to borrow cash and to sell short securities more extensively than other investment funds governed by NI 81-102 has led to the increased involvement of Prime Brokers in the operations of these alternative mutual funds. While the prime brokerage model works well in the exempt investment fund space, the prime brokerage community and investment fund managers are experiencing greater difficulties in applying that model to alternative mutual funds and other investment funds under NI 81-102.
21. The prime brokerage operational and pricing models in the context of short selling are premised on the ability of the Prime Broker to retain, as collateral for the obligations of the applicable Fund, the proceeds from the sale of the short sales, whether such proceeds are cash or are used by the Fund to purchase other portfolio assets. These models are also based on the ability of the Prime Broker to hold additional assets of the Fund as collateral for those obligations.
22. Given the collateral requirements that Prime Brokers impose on their customers that engage in the short sale of securities, if the 25% of NAV limitations set out in subsection 6.8.1 of NI 81-102 apply, then the Funds will need to retain two, or more, Prime Brokers in order to sell short securities to the extent permitted under section 2.6.1 of NI 81-102. This would result in inefficiencies for the Funds and would increase their costs of operations.
23. The requirement for additional Prime Brokers increases costs for the Fund, which will reduce returns and negatively impact investors.
24. The Filer represents that it would not be prejudicial to the public interest to grant the Exemption Sought from the Short Selling Collateral Limit.
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
1. The decision of the principal regulator under the Legislation is that the Exemption Sought from the Short Selling Limits is granted provided that:
a) The only securities which a Fund will sell short in an amount that exceeds 50% of the Fund's NAV will be securities that meet the definition of "government security" as such term is defined in NI 81-- 102.
b) Each short sale by a Fund will comply with all of the short sale requirements applicable to alternative mutual funds in sections 2.6.1 and 2.6.2 of NI 81-102.
c) A Fund's aggregate exposure to short selling, cash borrowing and specified derivatives will not exceed the Aggregate Exposure Limit.
d) Each short sale will be made consistent with a Fund's investment objectives and investment strategies.
e) A Fund's Prospectus will disclose that the Fund is able to short sell "government securities" (as defined in NI 81-102) in an amount up to 300% of the Fund's NAV, including the material terms of this decision.
2. The decision of the principal regulator under the Legislation is that the Exemption Sought from the Short Selling Collateral Limit is granted provided that the Funds otherwise comply with subsections 6.8.1(2) and (3) of NI 81-102.