Commerce Split Corp. et al.
Headnote
NP 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Exemptive relief granted to exchange traded funds from certain investment restrictions on National Instrument 81-102 Mutual Funds -- Filers enter into Forward Agreements when the net asset value declines below a specified level -- Forward Agreements are an integral feature of the public offering.
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds , ss. 2.6(a)(ii), 2.7(1)(a)(ii), 2.7(4).
October 3, 2008
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
COMMERCE SPLIT CORP., M SPLIT CORP.,
AND TDB SPLIT CORP.
(the Filers)
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Filers for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) exempting the Filers from:
(a) the prohibition contained in section 2.6(a)(ii) of National Instrument 81-102 -- Mutual Funds (NI 81-102) to permit the Filers to borrow cash or provide a security interest over its portfolio assets in accordance with industry practice with respect to this type of transaction;
(b) the prohibition contained in section 2.7(1)(a)(ii) of NI 81-102 to permit the Filers to enter into the forward contracts that have a remaining term to maturity of greater than five years; and
(c) the prohibition contained in section 2.7(4) of NI 81-102 to permit the Filers to each have the mark-to-market value of its exposure to any one counterparty in respect of its specified derivative positions in excess of 10% of the net assets of the mutual fund for a period of 30 days or more.
(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 this application, and
(b) the Filers have provided notice that Section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in each of the other provinces of Canada.
Interpretation
Terms defined in National Instrument 14-101Definitions 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 Filers:
The Filers
1. Each Filer is a mutual fund corporation incorporated under the laws of the Province of Ontario, and was created to provide exposure to common shares of a Canadian financial institution (Canadian Imperial Bank of Commerce in the case of Commerce Split Corp., Manulife Financial Corporation in the case of M Split Corp. and the Toronto-Dominion Bank in the case of TDb Split Corp.) through its two classes of securities: Priority Equity Shares and Class A Shares.
2. Holders of the Priority Equity Shares are provided with a stable yield and downside protection on the return of their initial investment. Holders of Class A Shares are provided with leveraged exposure to shares of the applicable financial institution (the Portfolio Shares) including exposure to increases or decreases in the value of the Portfolio Shares and the benefit of increases in the dividends paid on those shares.
3. Quadravest Inc. (the Manager) is the manager of the Filers within the meaning of that term in NI 81-102. Quadravest Capital Management Inc. (Quadravest), an affiliate of the Manager, is the portfolio adviser of the Filers within the meaning of that term in NI 81-102. RBC Dexia Investor Services Trust, a trust company meeting the requirements of section 6.2 of NI 81-102, acts as the custodian of the assets of the Filers.
4. The Priority Equity Shares and Class A Shares of each Filer are listed on the Toronto Stock Exchange.
Priority Equity Portfolio Protection Plan
5. Each Filer has adopted a strategy (the Priority Equity Portfolio Protection Plan) intended to provide that the amount owing to the holders of the Priority Equity Shares (the Priority Equity Share Repayment Amount) will be paid in full to holders of the Priority Equity Shares on the date on which the Filers are scheduled to terminate, being December 1, 2014 (the Termination Date).
6. The Priority Equity Portfolio Protection Plan provides that if the net asset value of a Filer declines below a specified level, Quadravest must liquidate a portion of the Portfolio Shares held by the Filer and use the net proceeds to implement the Priority Equity Share Portfolio Protection Plan. Each prospectus filed by the Filers contemplated that the principal way in which the Priority Equity Share Portfolio Protection Plan would be implemented would be through a forward agreement (a Forward Agreement).
7. The counterparty to the Forward Agreements (the Counterparty) will agree to pay to the applicable Filer on the Termination Date an amount (the Forward Amount) in exchange for the Filer agreeing to deliver to the Counterparty on the Termination Date certain equity securities (the Capital Repayment Portfolio) agreed upon by the Filer and the Counterparty (all of which constitute "Canadian securities" as defined in subsection 39(6) of the Income Tax Act (Canada)) and purchased by the Filer with the net proceeds of the sale of Portfolio Shares held by the Filer. The long term debt of the Counterparty, or of a guarantor of its obligations to such Filer, will have an approved credit rating from an approved credit rating organization, within the meaning of those terms in NI 81-102.
8. The Filers will either pledge to the Counterparty the securities sold to the Counterparty under the Forward Agreements or deposit other acceptable securities with the Counterparty as security for the obligations of the Filers under the Forward Agreements in accordance with industry practice for this type of transaction.
9. A Forward Agreement will provide for partial dispositions of the securities subject to the Forward Agreement so as to permit the Filers to unwind the Priority Equity Portfolio Protection Plan when permitted to do so by its terms, or in the case of retractions of Priority Equity Shares and Class A Shares occurring prior to the Termination Date.
10. As a result of declines in the values of banks and other companies operating in the Canadian financial services sector, Quadravest must now enter into a Forward Agreement with respect to Commerce Split Corp., and may in the future need to enter into similar agreements with respect to the other two Filers.
11. The Filers will pledge the Capital Repayment Portfolio securities, or deposit other acceptable collateral (the Pledged Securities) in support of their obligations under the Forward Agreements. The pledge or deposit will be in accordance with the industry practice for this type of transaction.
12. Each Forward Agreement will be entered into for hedging purposes as defined in NI 81-102, since its purpose is to protect holders of the Priority Equity Shares from the risk of loss of their original investment as a result of diminution in value of the Filers' assets over its life. The terms of the Forward Agreements will be specifically negotiated to support this purpose.
13. Although they will not have this exposure at the date a Forward Agreement is entered into, it is possible that, as a result of fluctuations in the value of the Filers' assets, (including the Forward Agreement), the Forward Agreement could at a future date represent more than 10% of a Filer's net assets. Accordingly, it is possible that the Filers could at a future date have exposure to a single counterparty in excess of 10% of the Filers' net assets.
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 the mark-to-market value of a Filer's exposure to any single Counterparty under a Forward Agreement does not exceed 30% of a Filer's net assets for a period of 60 days.