AIM Funds Management Inc. - MRRS Decision
Headnote
Mutual Reliance Review System for Exemptive Relief Applications -- s. 19.1 of National Instrument 81-102 Mutual Funds -- exemption from section 1(1) to permit money market funds to invest in two specified money market funds and exemption from section 2.8(1) to permit mutual funds to cover specified derivative positions with: (i) money market funds and (ii) any bonds, debentures, notes or other evidences of indebtedness and floating rate notes subject to conditions.
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, ss. 1(1), 2.8(1), 19.1.
June 6, 2006
IN THE MATTER OF
THE SECURITIES LEGISLATION OF
BRITISH COLUMBIA, ALBERTA, SASKATCHEWAN,
MANITOBA, ONTARIO, QUÉBEC,NEW BRUNSWICK,
NOVA SCOTIA, PRINCE EDWARD ISLAND,
NEWFOUNDLAND AND LABRADOR, NORTHWEST
TERRITORIES, NUNAVUT TERRITORY AND
YUKON TERRITORY (the "Jurisdictions")
AND
IN THE MATTER OF
THE MUTUAL RELIANCE REVIEW SYSTEM
FOR EXEMPTIVE RELIEF APPLICATIONS
AND
IN THE MATTER OF
AIM FUNDS MANAGEMENT INC.
("AIM Trimark") (the "Filer")
MRRS DECISION DOCUMENT
Background
The local securities regulatory authority or regulator (the "Decision Maker") in each of the Jurisdictions has received an application from the Filer for a decision under the securities legislation of the Jurisdictions (the "Legislation") for approval:
• to the extent that cash cover is required in respect of specified derivatives, to permit each of the mutual funds managed by AIM Trimark, together with all future mutual funds managed by AIM Trimark (collectively, the "Funds"), to cover specified derivative positions with:
• any bonds, debentures, notes or other evidences of indebtedness that are liquid (collectively, "Fixed Income Securities");
• floating rate evidences of indebtedness; or
• units of a Canadian and/or a U.S. money market fund managed by AIM Trimark (collectively, the "Cash Management Funds"); and
• to permit each of the Funds that are money market funds, as defined under National Instrument 81-102 -- Mutual Funds ("NI 81-102"), to invest in units of the Cash Management Funds,
(collectively, the "Requested Relief").
Under the Mutual Reliance Review System for Exemptive Relief Applications:
(a) the Ontario Securities Commission is the principal regulator for this application; and
(b) this MRRS decision document evidences the decision of each Decision Maker.
Interpretation
Defined terms contained in National Instrument 14-101 - Definitions have the same meaning in this decision unless they are defined in this decision. Terms defined in NI 81-102 have the same meaning in this decision as in NI 81-102.
Representations
This decision is based on the following facts represented by the Filer:
The Funds
1. The Funds are or will be mutual funds established under the laws of the Province of Ontario. AIM Trimark is a corporation amalgamated under the laws of the Province of Ontario. AIM Trimark is or will be the manager and promoter of each of the Funds.
2. The Funds are or will be reporting issuers under the securities laws of some or all of the provinces and territories of Canada.
3. Many of the Funds may use specified derivatives under their investment strategies to gain exposure to securities and financial markets instead of investing in the securities directly. The Funds may also use derivative instruments to:
(a) reduce risk by protecting the Funds against potential losses from changes in interest rates;
(b) reduce the impact of currency fluctuations on the Funds' portfolio holdings; and
(c) provide protection for the Funds' portfolios.
When specified derivatives are used for non-hedging purposes, the Funds are subject to the cash cover requirements of NI 81-102.
4. AIM Trimark intends to establish the Cash Management Funds, units of which may be held by the Funds for cash management purposes. The Cash Management Funds will restrict their investments to those permitted for money market funds under NI 81-102. AIM Trimark will ensure that there will be no duplication of fees in respect of a Fund's investment in the Cash Management Funds.
Cash Cover
5. The purpose of the cash cover requirement in NI 81-102 is to prohibit a mutual fund from leveraging its assets when using certain specified derivatives and to ensure that the mutual 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 mutual 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 mutual fund. Currently, the definition of "cash cover" includes six different categories of securities, including certain evidences of indebtedness (cash equivalents and commercial paper) that generally have a remaining term to maturity of 365 days or less and that have an approved credit rating or are issued or guaranteed by an entity with an approved credit rating (collectively, "short-term debt").
6. In addition to the securities currently included in the definition of cash cover, the Funds propose to invest in Fixed Income Securities, floating rate evidences of indebtedness and/or units of the Cash Management Funds for purposes of satisfying their cash cover requirements.
Fixed Income Securities
7. While the money market instruments that are currently permitted as cash cover are highly liquid, these instruments typically generate very low yields relative to longer dated instruments and similar risk alternatives.
8. The definition of cash cover addresses regulatory concerns of interest rate risk and credit risk by limiting the terms of the instruments and requiring the instruments to have an approved credit rating. By permitting the Funds to use for cash cover purposes Fixed Income Securities with a remaining term to maturity of 365 days or less and an approved credit rating, the regulatory concerns are met, since the term and credit rating will be the same as other instruments currently permitted to be used as cash cover.
Floating Rate Evidences of Indebtedness
9. Floating rate evidences of indebtedness, also known as floating rate notes ("FRNs"), are debt securities issued by the federal or provincial governments, the Crown or other corporations and other entities with floating interest rates that reset periodically, usually every 30 to 90 days.
10. Although the term to maturity of FRNs can be more than 365 days, the Funds propose to limit their investment in FRNs used for cash cover purposes to those that have interest rates that reset at least every 185 days.
11. Allowing the Funds to use FRNs for cash cover purposes could increase the rate of return earned by each of the Fund's investors without reducing the credit quality of the instruments held as cash cover. The frequent interest rate resets mitigate the risk of investing in FRNs as cash cover. For the purposes of money market funds under NI 81-102 meeting the 90 days dollar-weighted average term to maturity, the term of a floating rate evidence of indebtedness is the period remaining to the date of the next rate setting. If a FRN resets every 365 days, then the interest rate risk of the FRN is about the same as a fixed rate instrument with a term to maturity of 365 days.
12. Financial instruments that meet the current cash cover requirements have low credit risk. The current cash cover requirements provide that evidences of indebtedness of issuers, other than government agencies, must have approved credit ratings. As a result, if the issuer of FRNs is an entity other than a government agency, the FRNs used by the Funds for cash cover purposes will have an approved credit rating as required by NI 81-102.
13. Given the frequent interest rate resets, the nature of the issuer and the adequate liquidity of FRNs, the risk profile and the other characteristics of FRNs are similar to those of short-term debt, which constitute cash cover under NI 81-102.
Cash Management Funds
14. Under NI 81-102, in order to qualify as money market funds, the Cash Management Funds are restricted to investments that are, essentially, considered to be cash cover. These investments include floating rate evidences of indebtedness if their principal amounts continue to have a market value of approximately par at the time of each change in the rate to be paid to their holders.
15. If the direct investments of the Cash Management Funds would constitute cash cover under NI 81-102 (assuming that the relief allowing FRNs as cash cover is granted), then indirectly holding these investments through an investment in the units of one or both of the Cash Management Funds should also satisfy the cash cover requirements of NI 81-102.
AIM Trimark's Derivative Policies and Risk Management
16. AIM Trimark and each of its affiliated sub-advisors have their own written policies and procedures relating to the use of derivatives for the Funds. These policies and procedures are reviewed at least annually by senior management of AIM Trimark or the sub-advisor, as applicable. The Chief Investment Officer of AIM Trimark is responsible for oversight of all derivative strategies used by the Funds. In addition, compliance personnel employed by AIM Trimark and the sub-advisor, as applicable, review the use of derivatives as part of their ongoing review of Fund activity. Limits and controls on the use of derivatives are part of AIM Trimark's fund compliance regime and include reviews by analysts who ensure that the derivative positions of the Funds are within applicable policies.
17. The prospectus and annual information form of the Funds discloses the internal controls and risk management processes of AIM Trimark regarding the use of derivatives and, upon renewal, will include disclosure of the nature of the exemptions granted in respect of the Funds.
18. Without these exemptions regarding the cash cover requirements of NI 81-102, the Funds will not have the flexibility to potentially enhance yield and to more effectively manage their exposure under specified derivatives.
Money Market Funds
19. The Funds that are money market funds should be permitted to invest in units of the Cash Management Funds as the Cash Management Funds will themselves be money market funds and will only invest in securities that are permitted to be held by money market funds under NI 81-102. By investing in units of the Cash Management Funds, the Funds that are money market funds would be doing indirectly what they are able to do directly.
20. AIM Trimark believes that having the opporunity to pool the money market instruments of the Funds, including the Funds that are money market funds, in the Cash Management Funds will increase the size of the Cash Management Funds and may lead to better yields for all of the Funds, including the money market funds.
General
21. AIM Trimark is of the view that the requested approval is not against the public interest, is in the best interests of the Funds and represents the business judgment of responsible persons uninfluenced by considerations other than the best interest of the Funds.
Decision
Each of the Decision Makers is satisfied that the test contained in the Legislation that provides the Decision Maker with the jurisdiction to make the decision has been met.
The decision of the Decision Makers under the Legislation is that the Requested Relief is granted provided that:
(a) the Fixed Income Securities have a remaining term to maturity of 365 days or less and have an approved credit rating;
(b) the FRNs meet the following requirements:
(i) the floating interest rates of the FRNs reset no later than every 185 days;
(ii) the FRNs are floating rate evidences of indebtedness with the principal amounts of the obligations that will continue to have a market value of approximately par at the time of each change in the rate to be paid to the holders of the evidences of indebtedness;
(iii) if the FRNs are issued by a person or company other than a government or permitted supernational agency, the FRNs must have an approved credit rating;
(iv) if the FRNs are issued by a government or permitted supranational agency, the FRNs have their principal and interest fully and unconditionally guaranteed by
(A) the government of Canada or the government of a jurisdiction in Canada; or
(B) the government of the United States of America, the government of one of the states of the United States of America, the government of another sovereign state or a permitted supernational agency if, in each case, the FRN has an approved credit rating; and
(v) the FRNs meet the definition of conventional floating rate debt instrument in section 1.1 of NI 81-102.