National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Relief granted from subsection 6.1(1) of NI 81-102 to permit alternative mutual funds and other mutual funds to exclude the aggregate market value of proceeds from outstanding short sales of portfolio securities held by the borrowing agent, from the limits of 25% of an alternative mutual fund's net asset value and 10% of a mutual fund's that is not an alternative mutual fund's net asset value that may be deposited with a borrowing agent that is not the fund's custodian or sub-custodian as security in connection with a short sale -- subject to routine conditions.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 6.1(1) and 19.1.
September 15, 2020
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 EVOLVE FUNDS GROUP INC. (the Filer)
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of Evolve Gold Miners Fund (GLC), any alternative mutual fund established in the future and managed by the Filer or an affiliate of the Filer (collectively with GLC, the Alternative Mutual Funds) and any current or future mutual fund, other than an Alternative Mutual Fund, managed by the Filer or an affiliate of the Filer (each, a Mutual Fund and, together with the Alternative Mutual Funds, the Funds) for a decision under the securities legislation of the principal regulator (the Legislation) exempting the Funds from the requirement set out in subsection 6.1(1) of National Instrument 81-102 Investment Funds (NI 81-102) that provides that, except as provided in section 6.8, 6.8.1 and 6.9 of NI 81-102, 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 a Fund to deposit portfolio assets with a borrowing agent that is not the Fund's custodian or sub-custodian in connection with a short sale of securities, if the aggregate market value of the 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, does not:
(a) in the case of each Mutual Fund, exceed 10% of the net asset value (NAV) of the Mutual Fund at the time of deposit; and
(b) in the case of each Alternative Mutual Fund, exceed 25% of the NAV of the Alternative Mutual Fund at the time of deposit,
(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 subsection 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 (collectively 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:
1. The Filer is registered as (a) an investment fund manager in Newfoundland and Labrador, Ontario and Québec; (b) a commodity trading manager in Ontario; and (c) a portfolio manager in Ontario.
2. The Filer or an affiliate of the Filer is, or will be, the investment fund manager of each of the Funds.
3. GLC (currently called "Gold Miners Split Corp.") is currently structured as a split share corporation, and is authorized to issue an unlimited number of preferred shares, Class A shares and common shares. The preferred shares and Class A shares of GLC were distributed pursuant to an initial offering under a long form prospectus prepared in accordance with the requirements of National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81-101) and National Instrument 41-101 General Prospectus Requirements (NI 41-101) dated April 26, 2019 in all of the Jurisdictions.
4. GLC is currently undergoing a restructuring, pursuant to which, among other things, the preferred shares of GLC will be redeemed and cancelled, and the Class A shares of GLC will be re-designated as exchange traded fund shares (the ETF Shares) of a new non-cumulative, redeemable, non-voting class of shares to be called "Evolve Gold Miners Fund" (collectively, the Restructuring).
5. The Filer has filed a preliminary prospectus and preliminary ETF Facts document dated August 17, 2020 in all of the Jurisdictions with respect to the ETF Shares. Following the completion of the Restructuring, GLC will become subject to the requirements of NI 81-102 that relate to alternative mutual funds.
6. Each Fund is, or will be, a reporting issuer in one or more Jurisdictions and distributes its units or shares, as applicable, to the public pursuant to disclosure documents prepared and filed in accordance with NI 81-101 or NI 41-101.
7. None of the Filer, GLC, or an existing Fund is in default of securities legislation in any Jurisdiction.
8. 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, the entity that acts as, among other things, a Prime Broker to it, whether the Fund is an Alternative Mutual Fund or a Mutual Fund.
9. Effective as of January 3, 2019, NI 81-102 was amended to include alternative mutual funds. The ability of alternative mutual funds to participate in leverage transactions, such as 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.
10. Under section 6.8.1 of NI 81-102, if a Mutual Fund engages as its Prime Broker an entity that is not its custodian or sub-custodian, then it may only deliver to its Prime Broker portfolio assets having a market value, in the aggregate, of not more than 10% of the NAV of the Mutual Fund at the time of deposit. If an Alternative Mutual Fund engages as its Prime Broker an entity that is not its custodian or sub-custodian, then it may only deliver to its Prime Broker portfolio assets having a market value, in the aggregate, of not more than 25% of the NAV of the Alternative Mutual Fund at the time of deposit.
11. A Prime Broker may not wish to act as borrowing agent for a Mutual Fund that wants to sell short securities having an aggregate market value of up to 20% of the Mutual Fund's NAV if the Prime Broker is only permitted to hold as security for such transactions portfolio assets, including the proceeds from the short sale, having an aggregate market value that is not in excess of 10% of the NAV of the Mutual Fund.
12. The issue is even greater in the context of an Alternative Mutual Fund, as a Prime Broker will not want to 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 the Alternative Mutual Fund's NAV if the Prime Broker is only permitted to hold as security for such transactions 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 Alternative Mutual Fund.
13. 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 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.
14. Many Prime Brokers that are qualified to act as a custodian or sub-custodian under NI 81-102 are not widely appointed as custodians or sub-custodians under NI 81-102 as it can be both operationally challenging and costly to appoint them to act in such capacity.
15. Given the typical collateral requirements that Prime Brokers impose on their customers that engage in the short sale of securities, if the 10% and 25% of NAV limitations set out in section 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 will result in inefficiencies for the Funds, increase their costs of operations, reduce returns and negatively impact investors.
16. While the collateral limits for the short sale of securities is currently topical in the context of alternative mutual funds, the Filer submits that there is no policy reason to differentiate between Alternative Mutual Funds and Mutual Funds to the extent that Mutual Funds also engage in the short selling of securities.
17. The Filer submits that it is not prejudicial to the public interest to grant the Exemption Sought.
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 the Funds otherwise comply with subsections 6.8.1(2) and (3) of NI 81-102.