Notice and Request for Comment: NI - 81-104 - Commodity Pools

 

NOTICE OF PROPOSED NATIONAL INSTRUMENT 81-104
AND COMPANION POLICY 81-104CP - COMMODITYPOOLS

 

Substance and Purpose of Proposed National Instrument and Companion Policy

 

Introduction

 

The proposed National Instrument and Companion Policy are a reformulation, on a national basis, of Ontario Securities Commission Policy 11.4 - "CommodityPool Programs" ("Policy 11.4"), which they will replace. Through these proposed instruments, the Canadian Securities Administrators (the "CSA") seek toregulate publicly offered commodity pools structured as mutual funds.

The proposed National Instrument and Companion Policy are initiatives of the CSA, and the proposed National Instrument is expected to be adopted as a rule ineach of British Columbia, Alberta, Ontario and Nova Scotia, as a Commission regulation in Saskatchewan, and as a policy in all the other jurisdictionsrepresented by the CSA. The proposed Companion Policy is expected to be implemented as a policy in all of the jurisdictions represented by the CSA.

Background

Policy 11.4 was first implemented by the Ontario Securities Commission (the "OSC") in 1978 and substantially revised in 1985.1 The OSC modelled the 1985version of Policy 11.4 (which remains the current version) after the North American Securities Administrators Association, Inc. guidelines for commodity poolprograms established in the United States (the "NASAA Guidelines"), which became effective January 1, 1984. The OSC indicated in its release of the draftPolicy 11.4 that it decided to model Policy 11.4 after the NASAA Guidelines pending more experience with publicly offered commodity pool programs.

At various times since the adoption by the OSC of Policy 11.4, the CSA have discussed implementing a national policy statement to regulate commodity pools.No national policy statement was developed. The proposed National Instrument represents agreement by the CSA to promulgate commodity pool regulation ona national basis. Accordingly, the proposed National Instrument implements, in part, the recommendation of the CSA Task Force on Operational Efficienciesthat the CSA increase the coordination of regulation, including standardization of requirements.

Since 1985, the publicly offered commodity pool industry has not developed to any great extent in Canada and certainly not to the same extent as in the UnitedStates. All publicly offered commodity pools established in Canada have been structured as continuously distributed mutual funds, using the legal forms oflimited partnerships, corporations or trusts. At present, four commodity pools are continuously offered to the public via prospectuses filed on a national basis.

The CSA have decided to depart from the 1985 OSC approach of modelling regulation of Canadian commodity pools after the NASAA Guidelines, in light ofexperience in working with Policy 11.4 and Canadian commodity pools over the past 12 years.2 Staff have experienced difficulties in administering Policy 11.4and applying its provisions to the commodity pools offered in Canada. As a result, staff have not applied certain provisions of Policy 11.4 and have modifiedothers as necessary to integrate Policy 11.4 with the mutual fund policies, regulations and rules.

In developing the proposed National Instrument and the Companion Policy, the CSA started from the proposition that commodity pools are specialized mutualfunds and, accordingly, the rules, regulations and policies of the CSA applicable to mutual funds should apply to commodity pools, except where the commoditypool structure necessitates some deviation. Additional regulation of commodity pools is also necessary having regard to their specialized nature. In particular,differing regulation is necessitated by the investment objectives and strategies commodity pools are permitted to adopt.

The proposed National Instrument reflects the CSA's rethinking of each provision of Policy 11.4. The CSA has deleted or modified provisions of Policy 11.4 asappropriate in order to ensure that the proposed National Instrument integrates properly with the Canadian regulatory structure applicable to mutual funds andreflects Canadian commercial and regulatory objectives.

Substance and Purpose of Proposed Instruments

The substance and purpose of the proposed National Instrument is to establish an appropriate regulatory regime for commodity pools, which are a type of mutualfund that invest in, or use, derivatives beyond the scope permitted by proposed National Instrument 81-102 ("NI81-102") Mutual Funds.3 The proposedNational Instrument deals with matters in which the regulatory treatment of commodity pools differs from that applicable to conventional mutual funds.Commodity pools are subject to the ordinary mutual fund rules unless those rules are specifically excluded in the proposed National Instrument. The proposedNational Instrument contains only those provisions that are specific to commodity pools, and provisions contained in Policy 11.4 have not been carried forwardinto the proposed National Instrument if they are substantially similar to provisions now covered in NI81-102.

The proposed Companion Policy clarifies how the proposed National Instrument integrates with NI81-102, and brings certain matters relating to the proposedNational Instrument to the attention of persons or companies involved with the establishment or administration of commodity pools.

This Notice summarizes the proposed National Instrument and Companion Policy and highlights the more significant changes made to Policy 11.4 by theproposed National Instrument. The concordance that is being published with this Notice and the proposed National Instrument and Companion Policy outlinesthe treatment of each provision of Policy 11.4 in the proposed instruments. Further background and explanation of changes are contained in the footnotescontained in the proposed National Instrument and Companion Policy. In addition, reference should be made to the Notice of, and footnotes to, NI81-102 andits Companion Policy for background and explanation of provisions of those instruments that are proposed to be applicable to commodity pools.

Summary of Proposed National Instrument

Part 1. Section 1.1 contains definitions of terms and phrases used in the proposed National Instrument that are not defined in NI81- 102 or in NationalInstrument 14-101 Definitions.4 The National Definitions Instrument sets out definitions for commonly used terms and definitions of terms used in more thanone national instrument and should be read together with the proposed National Instrument. Subsection 1.1(2) of the proposed National Instrument confirmsthat terms defined in NI81-102 and used in the proposed National Instrument have the respective meanings ascribed to them in NI81-102.

The proposed National Instrument defines a "commodity pool" as a mutual fund that is permitted to use or invest in specified derivatives and physicalcommodities beyond what is permitted by NI81-102. Because commodity pools are mutual funds, they must comply with all applicable rules, regulations andpolicies of the CSA applicable to mutual funds, unless the proposed National Instrument provides otherwise.

Section 1.2 sets out the application of the proposed National Instrument. It applies to all commodity pools and also regulates certain activities of industryparticipants that pertain to commodity pools. The application to commodity pools is limited to those that are reporting issuers and have issued securities under aprospectus at some time in their history. Through this section, the CSA intends to clarify that publicly offered commodity pools must continue to comply withthe applicable sections of the proposed National Instrument even if their securities are no longer being offered for sale in a jurisdiction.

The definition of "commodity pool" includes, generally, mutual funds that invest in physical commodities other than as permitted by National Instrument 81-102.However, a mutual fund that is established as a "precious metals fund" is not a commodity pool. A precious metals fund is currently required to obtain a waiveror exemption from the provisions of National Policy Statement No. 39 ("NP39") and, when it comes into force, from the provisions of NI81-102 that restrict theability of mutual funds to invest in commodities. However, those funds do not have the risk characteristics of commodity pools, and will remain subject to NP39or NI81-102.

Part 2. Section 2.1 exempts commodity pools from the operation of certain of the investment restriction and practice requirements of NI81-102. These are theprovisions that pertain to investment in physical commodities and specified derivatives; these provisions, if applicable to commodity pools, would prohibit acommodity pool from carrying out its investment objectives. Section 2.1 is consistent with the general approach of the CSA in the preparation of the proposedNational Instrument and is consistent with Policy 11.4. The proposed National Instrument attempts to provide commodity pools with adequate freedom toundertake potentially risky investment objectives, so long as adequate disclosure of the risks associated with its objectives is made to the investor.

Except for the specific investment restrictions and practices listed in section 2.1, commodity pools must comply with all other investment restrictions andpractices set out in Part 2 of NI81-102.

The CSA note that the proposed National Instrument does not exempt commodity pools from having to comply with paragraphs 2.1(1)(f) and(g) of NI81-102,being the "illiquid asset" restrictions. Accordingly, commodity pools must manage their portfolios to ensure that not more than 10 percent of their net assets areinvested in "illiquid assets" (as defined in NI81-102), on both an ongoing and a "time of investment" basis. The CSA are not aware that the existing commoditypools need relief from the comparable investment restriction presently contained in subsection 2.05(2) of National Policy Statement No. 39 in order to achievetheir investment objectives and strategies, but request specific comment on whether some leeway from the "illiquid asset" restrictions should be introduced intothe proposed National Instrument. If commodity pools require some change to these restrictions, comment should be made on what alternative restriction shouldbe included in the proposed National Instrument, having regard to the fact that commodity pools are redeemable investment vehicles and like all such vehicles,must be able to honour redemption requests on demand.

Part 3. Part 3 provides specific requirements concerning the initial capitalization of commodity pools that are more onerous than those applicable to mutual fundsin NI81-102 and that differ somewhat from the requirements of Policy 11.4. Under the proposed National Instrument, a commodity pool will not be permitted toissue securities to the public, in effect, unless an initial investment of $50,000 is made in the commodity pool by a person or company, or group of persons orcompanies, related to it, and subscriptions aggregating $500,000 have been received from other persons or companies. The $50,000 investment will be requiredto remain in the commodity pool until its dissolution or termination. The $500,000 requirement is consistent with Policy 11.4 (although Policy 11.4 permittedany amounts invested by the promoters to be included in the requisite $500,000), but the $50,000 requirement represents a change. Policy 11.4 requires nominimum investment by promoters, although it does require that any such investment made at the inception of the pool must remain in the pool for the life of thepool (section C.III).

The $50,000 requirement is designed to encourage promoters to ensure that the commodity pool is being properly run for the benefit of the investors, byrequiring that the promoter of a pool, or a related party, will itself be an investor in the pool at all times. The $500,000 requirement is intended to ensure that thecommodity pool has sufficient investment capital to become operational and achieve its investment objectives.

Part 4. Part 4 carries forward from Policy 11.4 two conflict of interest provisions that prohibit commodity pool advisers and managers from being paid fees fromthe commodity pool if they also receive brokerage commissions from trading conducted by the pool. The CSA considers the provisions in this Part to benecessary in order to moderate "churning" and unnecessary portfolio turnover of assets held in the portfolios of commodity pools. Having regard to the natureof the investment objectives and strategies of commodity pools, commodity pools may be more susceptible to churning and unnecessary turnover of assets thanconventional mutual funds.

Part 5. Section 5.1 prescribes the proficiency requirements applicable to participating dealers and their sales representatives wishing to sell securities ofcommodity pools.

Since commodity pools are mutual funds any dealer or broker and their representatives registered to sell mutual funds in a province are permitted to sellsecurities of commodity pools in that province, under applicable securities legislation. However, the CSA considers commodity pools to be sufficiently morespecialized and complex than conventional mutual funds having regard to their investment objectives and strategies that additional proficiency requirements forsalespersons and their supervisors are warranted. The CSA wish to ensure that salespersons of participating dealers distributing securities of commodity poolsunderstand the nature of the portfolios and the investment strategies followed by commodity pools in order that they may properly advise their clients.

Accordingly, section 5.1 provides that no registered salesperson, partner, director or officer of a principal distributor or participating dealer of a commodity poolmay sell securities of commodity pools unless they have successfully completed the Canadian Futures Examination offered by the Canadian Securities Institute,or its predecessor. In addition, all principal distributors and participating dealers must have at least one supervisory personnel located in the applicable provincewho has successfully completed the above- noted courses and the Canadian Commodity Supervisors Examination. This supervisory personnel must beresponsible for reviewing all trades in securities of commodity pools placed through the principal distributor or participating dealer in the province. Section 5.1permits principal distributors to sell through participating dealers that satisfy the requirements, subject to compliance with other applicable securities legislationeven if the principal distributor is not permitted by the Instrument to sell securities of commodity pools directly.

Section 5.1 represents a departure from the provisions of Policy 11.4 and the administrative practice followed by staff of the OSC. Policy 11.4 requiresparticipating dealers to be registered as dealers (without limiting the category of registration) under the Securities Act (Ontario) (the "Ontario Act") and also asfutures commission merchants under the Commodity Futures Act (Ontario). Policy 11.4 also requires that salespersons of participating dealers be duallyregistered. Staff of the OSC administer Policy 11.4 to require only that the participating dealer be dually registered; salespersons are not required to beregistered also under the Commodity Futures Act (Ontario). The effect of the dual registration requirement is that any dealer wishing to sell securities ofcommodity pools must be a member of a self-regulatory organization - that is, a member of the Investment Dealers Association of Canada or one of the stockexchanges.

The CSA decided not to carry forward the dual registration requirement into the proposed National Instrument, having regard to, in part, the fact that only theWestern provinces and Ontario have separate categories of registration for dealers involved in commodity futures trading (exchange contract trading in theWestern provinces). The CSA is primarily concerned with the understanding and knowledge of sales representatives of participating dealers and theirsupervisors concerning commodities markets and derivative strategies. The imposition of specific proficiency requirements on sales representatives ofparticipating dealers and their supervisors should deal adequately with the primary regulatory concern. The proposed National Instrument does not impose thehigher standards required of dealers by membership in a self-regulatory organization on participating dealers that would not otherwise have to comply with thosehigher standards.

Section 5.2 of the proposed National Instrument has been carried forward from Policy 11.4. This section is designed to ensure that a commodity pool has nolong term liabilities in light of the potential volatility of commodity pools and their, generally, more limited life span, by requiring all agreements between a pooland a service provider have a 60-day notice period for termination without penalty.

The CSA did not carry forward into the proposed National Instrument the related requirement in Policy 11.4 that management and investment managementagreements and any other agreement between a manager, an investment adviser or a promoter and a commodity pool be limited to one year terms. OSC staff didnot impose this requirement on the existing commodity pools and the CSA believe such a provision is not justified.

Part 6. Part 6 deals with the special considerations applicable to commodity pools structured as limited partnerships and is consistent with Policy 11.4. It seeksto ensure that the rights provided to investors by section 5.1 of NI81-102 (the section that provides securityholders the right to approve certain changesproposed to be made to a mutual fund) do not expose limited partners of a commodity pool to greater liability than their investment in the commodity pool byreason of causing the limited partners to lose their limited partnership status. The statute and case law as to when limited partners can lose their limited partnerstatus varies from jurisdiction to jurisdiction. Therefore, Part 6 requires each commodity pool to obtain a legal opinion concerning these matters at appropriatetimes.

Part 7. Part 7 modifies the redemption requirements of NI81-102 as they apply to commodity pools in three respects.

Section 7.1 allows commodity pools to establish and implement a policy that allows the pool to suspend the right of securityholders to request the redemption oftheir securities for a period of up to six months after the date on which the receipt for the initial prospectus of the commodity pool is issued. This allows thecommodity pool to have a reasonable period of time to establish itself and make its initial investments without having to manage its portfolio so as toaccommodate redemption requests. Policy 11.4 provided for this right to suspend redemptions.

Section 7.2 allows a commodity pool to establish and implement a policy requiring that redemption requests be received up to two business days before the dateon which the net asset value used in establishing the redemption price will be calculated. This provision recognizes that the investment portfolio of a commoditypool may be more difficult to manage to accommodate redemption requests than that of a mutual fund, and so some additional time is provided. However, thetwo business day period is a shorter period than the 10 day period permitted by Policy 11.4. The CSA believe the commodities markets and the derivativesmarkets have developed since 1985 and a longer notice period is no longer necessary for commodity pools.

Section 7.3 allows a commodity pool to take up to 15 days to pay redemption proceeds, rather than the three business days allowed in NI81-102. Thisrecognizes that the portfolio of a commodity pool may be more difficult to liquidate than that of a conventional mutual fund. However, the 15-day period isshorter than the 30-day period permitted by Policy 11.4, reflecting the fact that the derivatives markets are more liquid than they once were.

Part 8. Part 8 requires that a commodity pool calculate its net asset value at least once each business day, which is consistent with Policy 11.4 and NI81-102 (formutual funds that use permitted derivatives).

Part 9. Part 9 varies the provisions of securities legislation applicable to the filing, content and sending to securityholders of financial statements of mutual fundsas that legislation applies to commodity pools. Because commodity pools are mutual funds, they are subject to the financial reporting obligations generally ofmutual funds, except as provided for in Part 9. The main difference between the financial disclosure obligations of commodity pools and those conventionalmutual funds is that commodity pools are required to prepare the relevant financial statements on a quarterly basis, rather than semiannually as for mutual funds.The quarterly requirements contained in Part 9 represent a relaxation of the monthly requirement imposed by Policy 11.4.

All financial statements required to be prepared under securities legislation by conventional mutual funds must be prepared by commodity pools; Part 9 imposesadditional disclosure requirements for the financial statements of commodity pools. The additional disclosure requirements are designed to provide relevant andmeaningful information about the portfolio of a commodity pool.

The CSA note that some jurisdictions have granted orders that have exempted existing commodity pools from preparing and filing Statements of PortfolioTransactions and Statements of Investment Portfolio, which are statements required to be prepared by conventional mutual funds. Those orders remain in forceafter the proposed National Instrument comes into force, although the proposed National Instrument does not exempt commodity pools that do not have suchorders from having to prepare these statements. The CSA request specific comment on the utility of commodity pools preparing these financial statements. Therelevant CSA jurisdictions have granted past relief on the basis that those statements do not provide investors with meaningful information. Given the significantvolume of trading generally conducted by commodity pools, the complexity of the instruments that are traded and the number of positions that are taken toreflect the various investment strategies that might be adopted by a commodity pool, the existing commodity pools submitted as part of their application forregulatory relief, that the information contained in these statements would be frequently out of date and quite lengthy. The CSA consider that these statementsare significant information sources for mutual fund investors and are reluctant to exempt new commodity pools from the requirement to prepare these statementswithout further consideration of comments on the practicalities and the usefulness of these statements.

Part 10. Part 10 imposes specific prospectus disclosure requirements on commodity pools. Section 10.2 requires bold face front page disclosure of the risksassociated with investing in commodity pools. Warnings, if appropriate, about trades occurring outside Canada and the lack of experience of any or all of thepromoter, manager and portfolio manager of the commodity pools are also mandated. Section 10.3 imposes specific prospectus disclosure requirements.Section 10.4 provides that a commodity pool prospectus is subject to the ordinary long form prospectus rules applicable to non-mutual fund issuers in respect offinancial statement disclosure. That is, five years of historical financial statements must be provided in the prospectus, with interim statements made up within 90days of the date of the prospectus. The CSA are considering changing this to three years.5

The requirements of Part 10 are generally consistent with the requirements of CSA staff imposed on existing commodity pools in the review of theirprospectuses.

Part 11. Section 11.1 permits the regulator or, except in the case of Ontario, the securities regulatory authority to provide exemptions from the proposedNational Instrument. Section 11.2 provides that, in certain circumstances, the granting of such an exemption is evidenced by the issuance of a receipt for theprospectus of a commodity pool.

Part 12. Section 12.1 provides for the inclusion of an effective date of the proposed National Instrument. No effective date is included in the proposed NationalInstrument at this time; the CSA anticipate that the proposed National Instrument will come into force on a date that is approximately six months after it hasbeen adopted by the CSA jurisdictions, in order to provide a transitional period for market participants.

Section 12.2 provides that the prospectus of a commodity pool for which a receipt has been obtained before the proposed National Instrument has come intoforce is not required to comply with the specific disclosure requirements of the proposed National Instrument, primarily contained in Part 10. This provisionpermits a commodity pool to continue to use a prospectus that is receipted before the proposed National Instrument comes into force, and is designed to ease thetransition required to be made by commodity pools in complying with the proposed National Instrument. The provision does not require an amendment of aprospectus of a commodity pool to be prepared and filed after the proposed National Instrument comes into force; however commodity pools may amend theirprospectus to ensure that the prospectus continues to contain full, true and plain disclosure.

Major Matters Not Carried Forward from Policy 11.4 to the Proposed National Instrument

General. The CSA have concluded that many of the provisions of Policy 11.4 should not be carried forward into the proposed National Instrument. Generally,this conclusion was reached because the provision in question was inconsistent with the Canadian regulatory approach to mutual fund regulation, because theprovision was considered to impose ineffective regulation or in some cases, was already dealt with in NI81-102 and was applicable more generally to mutualfunds. The following is a summary of the major provisions of Policy 11.4 that have not been carried forward into the proposed National Instrument. Referenceshould also be made to the concordance published with this Notice for a detailed list of the provisions of Policy 11.4 not carried forward into the proposedNational Instrument.

Requirements of the Promoter, Manager and Adviser. Part C of Policy 11.4 imposes a number of specific requirements on a promoter, manager and adviser of acommodity pool. Specifically, those persons are required to have a minimum of three years experience with commodity pools, and have a financial condition thatis "commensurate" with financial obligations assumed in connection with a commodity pool. These requirements are considered too vague to be carried forwardinto the proposed National Instrument. CSA staff generally consider these issues in the course of a review of a commodity pool prospectus.

Suitability Criteria. Part D of Policy 11.4 imposes certain minimum suitability criteria that an investor must possess before investing in a commodity pool. Policy11.4 also requires a commodity pool to develop suitability standards for investors in its securities and disclose such requirements in the prospectus. A minimumcash subscription of $2,000 is required. These requirements have not been carried forward on the basis that a principal distributor or participating dealer of acommodity pool is required to satisfy the "know your client" and "suitability" obligations imposed by Canadian securities legislation in selling securities of acommodity pool.

Fees, Compensation and Expenses. Part E of Policy 11.4 entitles a promoter of a commodity pool to be reimbursed, from the "gross proceeds" of a commoditypool, up to 15 percent of the initial "reasonable" organizational and offering expenses of a commodity pool. This approach is inconsistent with the rule containedin Part 3 of NI81-102. The CSA consider it inappropriate that investors in a new mutual fund, including a mutual fund established as a commodity pool,compensate the persons or companies that organized the fund for their expenses in doing so.

Part E also imposes specific limits on the quantum of the management fee and the nature of any incentive fees that may be paid by a commodity pool. Theseprovisions have not been carried forward on the basis that the CSA believes that generally the appropriate regulatory approach to fees is to mandate theirdisclosure, but not regulate the quantum.

Policy 11.4 describes permissible incentive fee arrangements. The CSA consider that incentive fees payable to managers or advisers of commodity pools shouldcomply with the requirements set out in section 7.1 of NI81-102; namely they must be calculated by reference to a relevant benchmark and must take intoaccount cumulative losses. The CSA do not propose to exempt the existing commodity pools from this requirement upon the coming into force of the proposedNational Instrument; in that regard, subsection 20.3(2) of NI81-102 is inapplicable to existing commodity pools by virtue of section 2.1 of the proposed NationalInstrument.

Conflict of Interest Provisions. Various parts of Policy 11.4, including Part E, impose a number of restrictions on the persons or companies involved in theadministration or investment activity of commodity pools designed to deal with potential conflicts of interest. The CSA have reviewed these provisions with aview to determining whether those provisions should be made applicable to mutual funds generally (and therefore included in NI81-102), remain applicable tocommodity pools only (and therefore be included in the proposed National Instrument) or be deleted entirely. The CSA believe that the provisions nowcontained in Part 4 of the proposed National Instrument are the only such provisions that properly apply to commodity pools only. The CSA have proposed thatthe requirements of Policy 11.4 that limit the ability of commodity pools to exculpate or indemnify promoters, managers or portfolio adviser (contained inSection VI of Part C of Policy 11.4) should apply to all mutual funds, and accordingly have moved those provisions into section 4.3 of NI81-102. No otherconflict of interest provisions of Policy 11.4 have been carried forward, on the basis that the provisions are considered redundant in light of the general fiduciarystandards imposed on those administering mutual funds by securities legislation or by law.

Rights of Participants. Policy 11.4 requires annual meetings of securityholders of a commodity pool and provides a list of fundamental changes to a commoditypool that require the approval of securityholders. Policy 11.4 also provides that 10 percent of the securityholders of a commodity pool may requisition asecurityholder meeting. The CSA are of the view that commodity pools should be subject to the same regime in this regard as conventional mutual funds, andhave therefore not carried forward these requirements. In the view of the CSA, the essence of a mutual fund is that securityholders that are dissatisfied withoperation of, or proposed changes to, the mutual fund can "vote with their feet" and redeem their securities at net asset value, rather than take steps to changethe administration of the fund. The CSA believe that these principles are as applicable to commodity pools as they are to conventional mutual funds. Consistentwith this approach, the proposed National Instrument amends the redemption provisions contained in Policy 11.4 to make it considerably quicker (and hencemore viable) for a securityholder to have his or her securities of a commodity pool redeemed; Policy 11.4 permits commodity pools to limit redemptions to onceevery quarter.

Notice of Drop in Net Asset Value. Part H of Policy 11.4 requires a commodity pool to notify all securityholders within seven business days of a deep decline,as defined in the policy, in the net asset value of the commodity pool. This notice provision was designed to provide securityholders with information that wouldallow them to requisition a meeting to wind up the commodity pool or to take other appropriate steps. The CSA believe that this remedy, although theoreticallyproviding additional protections to securityholders of commodity pools, is highly impractical, and does not afford a securityholder any real ability to effectchanges in the administration of a commodity pool on a timely basis. Therefore, this provision has been deleted. As described in the preceding paragraph, theredemption provisions of the proposed National Instrument have been amended from those contained in Policy 11.4 to give securityholders greater freedom toredeem their securities on a timely basis than under Policy 11.4. The CSA recognize that securityholders of commodity pools can monitor the net asset value oftheir securities through reports of such net asset values in the financial press. Imposing a notice requirement on commodity pools in respect of "deep declines" innet asset value is not necessary.

Summary of Proposed Companion Policy

The proposed Companion Policy clarifies that a commodity pool is a mutual fund, and is therefore subject to all the securities legislation applicable to mutualfunds generally unless specifically excluded. The proposed Companion Policy reminds persons or companies involved with the establishment or administration ofa commodity pool to consider the application of NI81-102 and the securities legislation relating to mutual funds of the jurisdictions in which a prospectus for thecommodity pool will be filed. The proposed Companion Policy also points out that commodity pools continue to be prohibited from using the simplifiedprospectus system generally available to other mutual funds.

Part 3 of the Companion Policy describes the central regulatory concern with commodity pools, namely the concern that the liability of securityholders notexceed the amount those securityholders invest in a commodity pool. Since the use of leverage by a commodity pool is unlimited, it is very important thatsecurityholders be shielded by the legal structure of the commodity pool from any liability to make up losses of the commodity pool that exceed its assets. TheCSA will review very closely a prospectus of a commodity pool that appears to be structured in a manner that exposes an investor to liability beyond originalinvestment. Part 3 of the Companion Policy also encourages commodity pools to consider additional safeguards in entering into futures or other tradingagreements.

The proposed Companion Policy also states that the procedures for applying for an exemption from the proposed National Instrument in more than onejurisdiction that is described in the Companion Policy to NI81-102 should be followed for commodity pools that are applying for an exemption from theproposed National Instrument.

Terms used in the proposed Companion Policy that are defined or interpreted in the proposed National Instrument or a definition instrument in force in thejurisdiction should be defined or interpreted in accordance with the proposed National Instrument or definition instrument, unless the context otherwise requires.

Authority for Proposed National Instrument

In those jurisdictions in which the National Instrument is to be adopted or made as a rule or regulation, the securities legislation in each of those jurisdictionsprovides the securities regulatory authority with rule-making or regulation-making authority in respect of the subject matter of the proposed National Instrument.

In Ontario, the following sections of the Ontario Act provide the OSC with authority to make the proposed National Instrument. Paragraph 143(1)23 of theOntario Act authorizes the OSC to make rules exempting reporting issuers from any requirement of Part XVIII (Continuous Disclosure) among other things,under circumstances that the OSC considers justify the exemption. Paragraph 143(1)34 of the Ontario Act authorizes the OSC to make rules regulatingcommodity pools, including certain matters specified in the paragraph. Paragraph 143(1)35 of the Ontario Act authorizes the OSC to make rules regulating orvarying the Ontario Act in respect of derivatives, including, among other things, prescribing requirements that apply to mutual funds and commodity pools.

Alternatives Considered

The proposed National Instrument replaces Policy 11.4 in Ontario and represents a new initiative of the CSA in jurisdictions other than Ontario. The OSCbelieves that regulation of commodity pools is appropriately effected through a rule and did not consider any alternatives to making the proposed NationalInstrument a rule in Ontario.

Related Instruments

The proposed National Instrument and Companion Policy are related to each other, and to NI81-102 and the Companion Policy to NI81-102.

Unpublished Materials

In proposing the National Instrument and Companion Policy, the CSA have not relied on any significant unpublished study, report, decision or other writtenmaterials.

Anticipated Costs and Benefits

Commodity pool issuers and service providers to commodity pools should benefit, over the longer term, from the proposed National Instrument and theCompanion Policy. The intent of the CSA in preparing the proposed National Instrument is to (i) clarify the mandatory rules applicable to commodity pools andtheir related service providers and (ii) to update those requirements to reflect current administrative practice and the views of the CSA. For the most part, theproposed National Instrument does not impose rules on commodity pool issuers and their service providers that are substantially different from those rules andpolicies under which commodity pools and their service providers have historically been governed. Accordingly, the proposed National Instrument should notimpose significantly greater compliance costs than are currently borne by commodity pools and their service providers, and may result in a lessening of thosecosts, assuming the CSA have been successful in their aim to achieve legislative certainty and clarity in the rules. The CSA anticipate that commodity pools andtheir service providers may experience a transition period in which costs are incurred in reviewing and understanding the rules provided for in the proposedNational Instrument and NI81-102, but that such a transition period will not be materially different from the transition period for any rule of the CSA replacingan existing rule or policy of the CSA.

The Notice accompanying the publication of NI81-102 contains a discussion of the costs associated with the proposed rules that will be applicable to commoditypools set out in that proposed national instrument.

The proposed National Instrument may decrease certain of the costs of creating and administering a commodity pool through the deletion of several of theprovisions of Policy 11.4 that impose costs on a commodity pool, such as the requirement to hold annual meetings and the obligation to provide certain noticesto securityholders.

On the other hand, the proposed National Instrument will impose additional costs on persons or companies that organize a commodity pool by eliminating theability to recover some of the organizational and offering expenses, which is permitted under Policy 11.4. Promoters of new commodity pools will be required toinvest $50,000 in a commodity pool, which must be retained in the commodity pool for the life of the commodity pool. The proposed National Instrument willalso restrict the ability of a commodity pool, including existing commodity pools, to be charged an incentive fee by a manager or adviser. Participating dealersand their representatives wishing to sell securities of a commodity pool will be required to be properly proficient in the commodities markets through theimposition of the proficiency requirements of Part 5 of the proposed National Instrument.

Based on experience to date under Policy 11.4, the CSA believe that the benefits of the proposed National Instrument justify the costs. Industry participants andinvestors in commodity pools should benefit from the modernization of the rules applicable to public commodity pools and from any reductions in costs incurredby commodity pool issuers and their service providers in complying with these rules.

Regulations to be Revoked or Amended

In Ontario, the adoption of the proposed National Instrument does not require any regulation to be revoked or amended.

Comments

Interested parties are invited to make written submissions with respect to the proposed National Instrument. Submissions received by October 31, 1997 will beconsidered.

Submissions should be sent to all of the Canadian securities regulatory authorities listed below in care of the Ontario Commission, in duplicate, as indicatedbelow:

 

British Columbia Securities Commission
Alberta Securities Commission
Saskatchewan Securities Commission
The Manitoba Securities Commission
Ontario Securities Commission
Office of the Administrator, New Brunswick
Registrar of Securities, Prince Edward Island
Nova Scotia Securities Commission
Securities Commission of Newfoundland
Securities Registry, Government of the Northwest Territories
Registrar of Securities, Government of the Yukon Territory

c/o Daniel P. Iggers, Secretary
Ontario Securities Commission
20 Queen Street West
Suite 800, Box 55
Toronto, Ontario M5H 3S8

Submissions should also be addressed to the Commission desvaleurs mobilières du Québec as follows:

Jacques Labelle, General Secretary
Commission des valeurs mobilières du Québec
800 Victoria Square
Stock Exchange Tower
P.O. Box 246, 17th Floor
Montréal, Québec H4Z 1G3

A diskette containing the submissions (in DOS or Windows format,preferably WordPerfect) should also be submitted. As securitieslegislation in certain provinces requires that a summary of writtencomments received during the comment period be published,confidentiality of submissions cannot be maintained.

Questions may be referred to any of:

Lata Casciano
Senior Policy Advisor, Policy & Legislation
British Columbia Securities Commission
(604) 660-4785

Mavis Legg
Manager, Securities
Alberta Securities Commission
(403) 297-2663

Rebecca A. Cowdery
Special Counsel, Market Operations
Ontario Securities Commission
(416) 593-8129

Daniel Laurion
Deputy Director
Regulation and Market Development
Commission des valeurs mobilières du Québec
(514) 873-5326
 

Proposed National Instrument and Companion Policy

The text of the proposed National Instrument and Companion Policy follow, together with footnotes that are not part of the proposed National Instrument orCompanion Policy, but have been included to provide background and explanation.

DATED: June 27, 1997.