The Ontario Securities Commission (OSC) recently released a new edition of the Investment Funds Practitioner, providing an overview of recent issues arising from applications for exemptive relief, prospectuses and continuous disclosure documents filed by investment funds. This legal update summarizes key issues and provides tips for investment fund issuers.
Dual class flow-through LPs
Issue: The OSC has observed that some flow-through limited partnerships are attempting to issue two classes of units under the same prospectus where each class has its own distinct portfolio of assets and is a separate non-redeemable investment fund (Dual Class LPs).
Tip: If one prospectus is used to qualify a Dual Class LP, the prospectus must provide disclosure on a per class (i.e., per fund) basis, rather than on an aggregate basis (i.e., for the partnership as a whole) with respect to certain categories, including: (i) the minimum offering amount; (ii) the maximum leverage ratio; and (iii) the estimated offering expenses. Furthermore, in the annual information form separate responses are required on a per class basis for each item under Form 41-101F2 unless the responses are identical for both classes.
Market-priced redemptions of ETFs to be capped at NAV
Issue: In staff's view, section 10.3(3) of National Instrument 81-102 – Investment Funds (NI 81-102) prohibits redemptions of securities of ETFs at a price higher than the NAV per security.
Tip: If an ETF offers redemptions of its securities at a price determined with reference to the closing market price of those securities, the ETF cannot redeem the securities at the market price if the market price is greater than the NAV per security. Instead, the OSC expects the redemption price per security in such instances to be capped at the NAV per security of the ETF. The ETF's prospectus should include a statement disclosing such cap.
Default automatic reinvestment of distributions
Issue: Staff re-stated its view that, due to conflict of interest concerns, an investment fund should not make automatic reinvestment of distributions in additional securities of the fund the default option, rather than cash payout, for investors that have not otherwise specifically requested cash payouts.
Tip: The OSC is more focused on investment funds that pay distributions on a regular basis, although all funds should take note (especially where investors may be subject to additional fees, such as deferred sales charges on securities received as distributions).
Fund Facts – past performance for funds with performance gaps
Issue: The "How has this fund performed?" section of the Fund Facts of a mutual fund requires disclosure for the past performance of a fund, but there are certain instances in which a class or series of a fund may have had a gap during which it had no securities outstanding and as a result it is not possible to calculate returns or show performance for the applicable period.
Tip: Where a class or series of a fund has a gap, the OSC has asked managers to use the performance data of another series of the fund that does not have a gap as a "proxy" (the Proxy Series) for the performance of the first series that has a gap (the Gap Series). Where the performance data for the Proxy Series is being used as an alternative to the Gap Series, the OSC asks that managers ensure the fees for the Proxy Series are not lower than those of the Gap Series and that the Proxy Series does not have any special features that would cause a material difference in performance (e.g., currency hedging). In addition, where the performance data of a Proxy Series is included in the Fund Facts, the OSC expects the Fund Facts to include a notation indicating as much.
Rehypothecation of collateral for OTC derivatives
Issue: The OSC received an inquiry as to whether portfolio assets deposited by a prospectus qualified investment fund with a counterparty as collateral in connection with a specified derivatives transaction pursuant to section 6.8(3) of NI 81-102 may be rehypothecated (i.e., pledged, sold or otherwise encumbered) by the counterparty.
Tip: The OSC concluded that rehypothecation by a counterparty of pledged assets of a prospectus qualified investment fund in connection with a specified derivatives transaction is not permitted for such a fund, and thus fund managers must ensure that any agreement documenting OTC derivatives transactions (such as the ISDA) prohibits the counterparty from using the collateral for any purpose other than the original purpose of the pledge, i.e., the completion of the "particular specified derivatives transaction."Accordingly, the OSC advises managers to ensure the documentation (i) adequately protects the fund's portfolio assets from counterparty credit risk; (ii) limits the purpose of the deposited collateral to that of the completion of the derivatives transaction in a manner consistent with NI 81-102; and (iii) limits the ability of the counterparty to deal with the deposited assets in a manner that is consistent with the ability of the fund's custodian to deal with the fund's assets under custody.
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