Vanguard Investments Canada Inc. et al.

Decision

Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Relief granted from section 2.8(1)(d) of National Instrument 81-102 Investment Funds permitting each Fund to hold as cover, in respect of the requirement under section 2.8(1)(d) of NI 81-102 receivable arising from declared divides to facilitate "equitization" of those payments once declared, thereby permitting the Fund to seek to track its applicable index in respect of the Receivable or to otherwise invest the amount of the Receivable, as applicable.

Applicable Legislative Provisions

National Instrument 81-102 -- Investment Funds, ss. 2.8(1)(d) and 19.1.

October 31, 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 VANGUARD INVESTMENTS CANADA INC. (the Filer) AND THE EXCHANGE-TRADED FUNDS AND MUTUAL FUNDS MANAGED BY THE FILER (the Existing Funds)

DECISION

Background

The principal regulator in the Jurisdiction has received an application from the Filer, which is the trustee and the investment fund manager of the Existing Funds, for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for an exemption, pursuant to section 19.1 of National Instrument 81-102 Investment Funds (NI 81-102) permitting each Existing Fund and each future exchange-traded fund and mutual fund managed by the Filer (collectively, the Future Funds and, together with the Existing Funds, the Funds) to hold as cover, in respect of the requirement under section 2.8(1)(d) of NI 81-102 that a mutual fund must not open or maintain a long position in a standardized future, unless the mutual fund holds cash cover in an amount that, together with margin on account for the specified derivative and the market value of the specified derivative, is not less than, on a daily mark-to-market basis, the underlying market exposure of the specified derivative (the Cover Requirement), one or more receivables (each, a Receivable) of the Fund arising as a result of a declaration or payment of a distribution, dividend or other payment on one or more Securities (as defined below) held by the Fund in order to equitize the Receivable during the period from the date that the Fund becomes entitled to receive the Receivable until the date that the Receivable is actually received by the Fund, thereby permitting the Fund to seek to track its applicable index in respect of the Receivable or to otherwise invest the amount of the Receivable, as applicable (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 Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, Northwest Territories, Nova Scotia, Nunavut, Prince Edward Island, Québec, Saskatchewan and Yukon (together with Ontario, the Jurisdictions).

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:

1. The Filer is the trustee, the investment fund manager and the portfolio manager of the Existing Funds and will be the trustee and the investment fund manager of the Future Funds.

2. The Filer is registered as an investment fund manager in each of the Provinces of Ontario, Québec and Newfoundland and Labrador, as an exempt market dealer in each the Provinces, and as a portfolio manager and a commodity trading manager in the Province of Ontario. The head office of the Filer is in Toronto, Ontario.

3. Each Fund is, or will be, a mutual fund created under the laws of the Province of Ontario and is, or will be, governed by the provisions of NI 81-102, subject to any relief therefrom granted by the securities regulatory authorities.

4. The Filer is not in default of securities legislation in any Jurisdiction.

5. The securities of the Funds are, or will be, qualified for distribution pursuant to a prospectus that is, or will be, prepared and filed in accordance with the securities legislation of the Jurisdictions. Accordingly, the Funds are, or will be, reporting issuers or the equivalent in each Jurisdiction.

6. Each Fund either seeks to track, or will seek to track, to the extent reasonably possible and before fees and expenses, the performance of a market index (an Index) (each, an Index Fund) or seeks to invest, or will seek to invest, its portfolio assets in accordance with its investment objective and investment strategies (each, a non-Index Fund).

7. In pursuing its investment objective, each Index Fund may invest in the constituent securities of the applicable Index or in a broadly diversified subset of constituent securities and/or other securities that, in the aggregate, approximates the applicable Index. In the case of each non-Index Fund, such non-Index Fund may invest in equity and fixed income securities and other financial instruments in accordance with that non-Index Fund's investment objective and investment strategies. Each equity security or financial instrument, such as a specified derivative, where the underlying interest is an equity security held by a Fund from time to time is referred to herein as a Security.

8. While a Security is held in the portfolio of a Fund, the issuer of that Security may declare payable, and make or pay, a distribution, a dividend, or another payment, such as in connection with a corporate action, on the Security. Once declared payable, that distribution, dividend or other payment becomes a Receivable of the applicable Fund effective as of the date of entitlement.

9. Under the rules and methodology that govern each Index, an Index treats each Receivable as an investable asset of the applicable Index and deems the amount of the Receivable to be invested in one or more of the constituent securities of the Index effective as of the date that securityholders of the applicable Security would first become entitled to receive the Receivable.

10. In order to meet its investment objective and to reduce any tracking error in respect of the applicable Index, each Index Fund opens and maintains a long position in one or more standardized futures during the period from the date that the Index Fund becomes entitled to receive the applicable Receivable until the date that the Receivable is actually received by the Index Fund.

11. Similarly, in order to meet its investment objective and to be as fully invested as possible, each non-Index Fund also opens and maintains a long position in one or more standardized futures during the period from the date that the non-Index Fund becomes entitled to receive the applicable Receivable until the date that the Receivable is actually received by the non-Index Fund.

12. In connection with each futures position held by a Fund, the Fund will hold and segregate, on a daily mark-to-market basis, the amount of cash actually required to be paid by it on settlement of that futures position.

13. The Cover Requirement is based on the assumption that on termination or settlement of each futures position, the mutual fund is required to pay a gross amount equal to the mark-to-market value of the entire underlying market exposure of the standardized future. Accordingly, the Cover Requirement requires a mutual fund to hold a combination of cash cover, margin on account for the futures position and the market value of the futures position that has a value that is not less than, on a daily mark-to-market basis, the underlying market exposure of the futures position.

14. The purpose of the cash cover requirements in NI 81-102 is to prohibit an investment fund from leveraging its assets when using certain specified derivatives and to ensure that the investment fund is in a position to meet its obligations on the settlement date. This is evident from the definition of "cash cover", which is defined as certain specific portfolio assets of the investment fund that have not been allocated for specific purposes and that are available to satisfy all or part of the obligations arising from a position in specified derivatives held by the investment fund. Currently, the definition of "cash cover" includes eight different categories of portfolio assets, including receivables of the investment fund arising from the disposition of portfolio assets, net of payables arising from the acquisition of portfolio assets.

15. In addition to the portfolio assets included in the definition of cash cover, each Fund would also like to include any Receivable of the Fund arising as a result of a declaration or a payment of a distribution, dividend or other payment on a Security for purposes of satisfying the Cover Requirement.

16. The inclusion of Receivables as an acceptable form of cover for purposes of the Cover Requirement will allow the Index Funds to track the applicable Index without creating unnecessary tracking error and will allow the non-Index Funds to be fully invested in accordance with their investment objectives. In each case, this may positively impact the performance of all of the Funds and the economic returns to investors.

17. Treating Receivables as cover for purposes of the Cover Requirements is consistent with the global market treatment of Receivables. Given the historically low risk of non-payment associated with Receivables and the need for the industry to have a consistent approach to the different market practices regarding the length of the period between entitlement to a Receivable and receipt of that Receivable, Receivables are treated generally as part of the applicable index by relevant index providers and as an asset of the applicable investment fund by industry participants in most developed markets.

18. As each Fund enters into one or more of the relevant standardized futures in order to equitize each Receivable, the notional amount of the standardized futures position or positions will equal the dollar value of the applicable Receivable. As an asset of the Fund, each Receivable is available to serve as, and should be able to be used for, cash cover for the related standardized futures position or positions.

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 for each long position in a standardized future that a Fund opens or maintains in order to equitize a Receivable, the Fund holds, on each trading day, a combination of the amount of the Receivable, cash cover and margin or collateral posted by the Fund in connection with its obligation under that futures position that, in the aggregate, has a value that is not less than, on a daily mark-to-market basis, the underling market exposure of the standardized future.

"Darren McKall"
Manager
Investment Funds and Structured Products Branch
Ontario Securities Commission