Desjardins Global Asset Management Inc. and the Alternative Funds
Headnote
Policy Statement 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief granted from alternative mutual fund short selling restrictions in Regulation 81-102 to permit each fund to short sell index participation units of one or more IPU issuers up to a maximum of 100% of the fund's NAV at the time of sale such that, immediately after entering into a transaction to short sell index participation units or borrow cash, the aggregate market value of all securities sold short by the fund does not exceed 100% of the fund's net asset value and the aggregate market value of securities sold short by the fund combined with the aggregate value of cash borrowing by the fund does not exceed 100% of the fund's NAV -- relief from single issuer short selling restriction applies only to short sales of index participation units of the investment fund issuer, not to the underlying portfolio holdings of the investment fund issuer of the index participation units.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.6.1(1)(c)(iv) and (v), and 2.6.2.
September 23, 2022
IN THE MATTER OF THE SECURITIES LEGISLATION OF QUÉBEC AND ONTARIO (the Principal Jurisdictions) AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF DESJARDINS GLOBAL ASSET MANAGEMENT INC. (the Filer) AND IN THE MATTER OF THE ALTERNATIVE FUNDS (AS DEFINED BELOW)
DECISION
Background
The securities regulatory authority or regulator in each ofthe Principal Jurisdictions (the Decision Maker) has received an application (the Application) from the Filer, on behalf of the Alternative Funds (as defined below), for a decision under the securities legislation of the principal Jurisdiction (the Legislation) for an exemption, pursuant to section 19.1 of Regulation 81-102 respecting Investment Funds, CQLR, c. V-1.1, r. 39 (Regulation 81-102), exempting Desjardins Alt Long/Short Global Equity Markets ETF (the Proposed Fund) and all other existing and future exchange traded alternative mutual funds managed by the Filer or an affiliate or successor of the Filer (collectively with the Proposed Fund, the Alternative Funds) from the following short selling restrictions of Regulation 81-102 to permit each Alternative Fund to exceed these restrictions to short sell IPUs (as defined below) of one or more IPU Issuers (as defined below) up to a maximum of 100% of the Alternative Fund's net asset value (NAV) at the time of the sale (collectively, the Requested Relief):
(a) section 2.6.1(1)(c)(iv) of Regulation 81-102, which restricts an alternative mutual fund from selling a security of an issuer, other than a "government security", as defined in Regulation 81-102, short if, at the time, the aggregate market value of the securities of that issuer sold short by the fund exceeds 10% of the alternative mutual fund's net asset value (the Single Issuer Short Restriction);
(b) section 2.6.1(1)(c)(v) of Regulation 81-102, which restricts an alternative mutual fund from selling a security short if, at the time, the aggregate market value of the securities sold short by the alternative mutual fund exceeds 50% of the alternative mutual fund's NAV; and
(c) section 2.6.2 of Regulation 81-102, which restricts an alternative mutual fund from borrowing cash or selling securities short if, immediately after entering into a cash borrowing or short selling transaction, the aggregate value of cash borrowed combined with the aggregate market value of the securities sold short by the alternative mutual fund (the Combined Aggregate Value) would exceed 50% of the alternative mutual fund's NAV and which requires an alternative mutual fund, if the Combined Aggregate Value exceeds 50% of the alternative mutual fund's NAV, as quickly as commercially reasonable, to take all necessary steps to reduce the Combined Aggregate Value to 50% or less of the alternative mutual fund's NAV (together with the restriction described in (b) above, the Aggregate Short Restrictions).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a dual application):
(i) the Autorité des marchés financiers (the AMF) is the principal regulator (the Principal Regulator) for this Application.
(ii) the Filer has provided notice that section 4.7(1) of Regulation 11-102 respecting Passport System, CQLR, c. V-1.1, r. 1 (Regulation 11-102) is intended to be relied upon in Alberta, British Columbia, Saskatchewan, Manitoba, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Yukon, Northwest Territories and Nunavut (together with the Principal Jurisdictions, the Jurisdictions).
(iii) the decision is the decision of the Principal Regulator and evidences the decision of the regulator in Ontario.
Interpretation
Terms defined in Regulation 14-101 respecting Definitions, CQLR c.V-1. 1, r. 3, Regulation 11-102 and NI 81-102 have the same meaning if used in this decision, unless otherwise defined. In addition to the defined terms used in this decision, capitalized terms used in this decision have the following meanings:
Aggregate Limit means the aggregate gross exposure restriction in section 2.9.1 of Regulation 81-102, which places an overall limit on an alternative mutual fund or non-redeemable investment fund's exposure to cash borrowing, short selling and specified derivatives equal to 300% of such fund's NAV.
IPU means "index participation unit", as defined in Regulation 81-102.
IPU Issuer means an investment fund the securities of which are IPUs.
Representations
This decision is based on the following facts represented by the Filer:
The Filer
1. The Filer is a corporation established under the laws of the Province of Québec, with its head office located in Montréal, Québec.
2. The Filer is currently an affiliate of Desjardins Securities Inc. as they are both directly or indirectly held by Fédération des Caisses Desjardins du Québec.
3. The Filer is registered as a portfolio manager in each of the Jurisdictions, as a commodity trading manager in Ontario, derivatives portfolio manager in Québec, exempt-market dealer in each of the Jurisdictions, as an investment fund manager in Ontario, Alberta, Manitoba, Nova Scotia, Newfoundland and Labrador and Québec and as an advisor in Manitoba.
4. The Filer, or an affiliate or successor of the Filer, is, or will be, the investment fund manager of the Alternative Funds. The Filer has filed a preliminary prospectus for the Proposed Fund concurrent with the filing of this Application and accordingly, will be a reporting issuer in each of the Jurisdictions.
5. Neither the Filer nor the Proposed Fund are in default of any of the requirements of securities legislation in any of the Jurisdictions.
The Proposed Fund
6. The Proposed Fund will be an exchange traded alternative mutual fund established under the laws of the Province of Québec and will be governed by the provisions of Regulation 81-102, subject to any relief therefrom granted by the securities regulatory authorities.
7. Concurrent with the filing of this Application, the Proposed Fund has filed a preliminary prospectus in each of the Jurisdictions qualifying the distribution of a class of Canadian dollar denominated hedged units (the "CDN Hedged Units") and a separate class of U.S. dollar denominated hedged units (the "USD Hedged Units", and together with the CDN Hedged Units, the "Units").
8. The Filer, on behalf of the Proposed Fund, has applied to list the Units on the Toronto Stock Exchange (the "TSX"). Subject to receiving conditional approval and satisfying the TSX's original listing requirements, the Units will be listed for trading on the TSX.
9. The Proposed Fund's investment objective, as set out in its preliminary prospectus, is to seek to achieve positive returns in both positive or negative equity market conditions. In order to achieve its investment objectives, the Proposed Fund primarily invests in long and/or short positions on equity index futures throughout the world and/or equity index ETFs listed in Canada or in the United States, treasury bills, money market instruments or other equivalent short term debt securities, with the objective of maximizing returns with controlled volatility and while maintaining a low correlation to traditional asset classes. Foreign currency exposure is generally hedged back to the currency in which the Units are denominated through the use of currency forward contracts.
10. The Filer's assessed risk rating of the Proposed Fund is low to medium and the Filer believes this risk rating would not change by virtue of relying on the Requested Relief.
IPU Issuers
11. IPU Issuers are generally diversified. IPU Issuers seek to provide investment results that correspond generally to the performance of a specified market index comprised of multiple issuers by holding a portfolio of securities that are included in the index or otherwise investing in a manner that causes the IPU Issuer to replicate the performance of that index.
12. IPU Issuers are generally liquid. The creation process for IPUs of IPU Issuers can quickly increase the available supply of IPUs of IPU Issuers in the marketplace, making the potential for a liquidity issue inherently lower.
13. The weight of each underlying security held in an IPU Issuer substantially corresponds to the weight of such security in the underlying index.
The Requested Relief
14. Sections 2.1(1) and 2.1(1.1) of Regulation 81-102 restrict an investment fund from purchasing a security of an issuer, entering into a specified derivatives transaction or purchasing an IPU if, immediately after the transaction, more than 10% of its NAV, in the case of a mutual fund other than an alternative mutual fund, or more than 20% of its NAV, in the case of an alternative mutual fund or non-redeemable investment fund, would be invested in securities of any one issuer (the Concentration Restriction).
15. Section 2.1(2) of Regulation 81-102 provides an exception to the Concentration Restriction for an IPU that is a security of an investment fund. The Filer has submitted that the rationale for this exception is in part that an IPU Issuer should be considered a look-through vehicle in that it is comprised of and represents a diversified group of issuers whose securities it holds in proportion to the underlying index, thereby mitigating the concentration risk otherwise associated with a fund holding the securities of a single issuer. The Filer believes a similar rationale applies to shorting IPU Issuers.
16. A significant risk associated with short positions generally is the potential to be unable to obtain the securities required to cover the short position, or to be unable to obtain them without additional costs, at the required time due to a lack of liquidity in the market. The Filer has submitted that the liquidity of the IPU Issuers as described above significantly reduces the risk that an Alternative Fund may not be able to cover or exit a short position in an IPU Issuer. On this basis, short sales of IPU Issuers will not have the same risk profile as a short sale of a single issuer or of a security that lacks liquidity of this magnitude.
17. The Funds are permitted to short sell IPUs of multiple IPU Issuers up to the limits of the Aggregate Short Restrictions. However, the Filer has submitted that shorting a single IPU Issuer is preferable in certain cases to shorting multiple IPU Issuers where the liquidity of the single IPU Issuer being sold short is higher than other IPU Issuers tracking the same index, or where the underlying index tracked by a particular IPU Issuer otherwise presents more favourable investment characteristics than other IPU Issuers.
18. The Filer is of the view that, in the case of IPU Issuers, given their high diversity and liquidity, the concentration risk otherwise associated with shorting securities of a single issuer is mitigated and, as a result, the Requested Relief would permit the Alternative Funds to benefit from efficiencies without prejudicing investors.
19. The Requested Relief is requested to permit each Alternative Fund to short sell IPUs of IPU Issuers without otherwise impacting such Alternative Fund's ability to borrow cash or engage in short sales under Regulation 81-102, in circumstances where the Filer believes that it is more beneficial to gain the desired short exposure to IPU Issuers: (a) through shorting fewer IPU Issuers than would otherwise be necessary under the Single Issuer Short Restriction; and (b) by way of short sales potentially in excess of the Aggregate Short Restrictions rather than by way of specified derivative transactions.
20. While an Alternative Fund could acquire exposure, including short exposure, to IPU Issuers in pursuit of its respective investment strategy through derivative transactions, the Filer believes that short sales of IPU Issuers may provide a faster, more efficient and flexible means of achieving diversification and hedging against market risk.
21. As such, the Filer is of the view that it would be in the Alternative Funds' best interest to permit each Alternative Fund to physically short sell IPUs of IPU Issuers, up to 100% of the Alternative Fund's NAV at the time of sale, instead of being limited to achieving that degree of leverage through either specified derivatives alone, or a combination of physical short selling and specified derivatives, including for the following reasons. In some circumstances, the availability of derivatives with similar risk characteristics to corresponding indices may be limited. Alternatively, pricing of a short position at a particular point in time may be preferable to the pricing of a corresponding derivatives contract. Granting the Requested Relief would expand the scope of available tools at the disposal of the Filer, as portfolio manager, to achieve market hedging, and thereby provide the Filer, as portfolio manager, with the best execution and best liquidity. In addition, the Requested Relief may also be less risky than certain derivatives transactions by allowing the Alternative Fund to, in part, mitigate against settlement risk (which is the risk that one of the parties to the derivatives contract defaults under the derivatives contract). Use of derivatives may also be incrementally riskier by exposing the Alternative Fund to operational risk (such as the case of a party to a derivatives contract failing to maintain adequate internal procedures or controls including intra-day settlements or managing closing-out the transaction) and liquidity risk.
22. The Requested Relief would allow the Filer, as portfolio manager of the Alternative Fund, greater flexibility and liquidity in pursuing a hedging strategy that reduces potential market volatility by expanding options for hedging to include selling highly liquid IPU Issuers short.
23. Notwithstanding the Requested Relief, the Alternative Funds would otherwise still be required to comply with all of the requirements applicable to alternative mutual funds in sections 2.6.1 and 2.6.2 of Regulation 81-102, including with the 50% of NAV restriction on cash borrowing and the 50% of NAV restriction on short selling securities (in respect of securities that are not IPUs of IPU Issuers) in paragraphs 2.6(2)(c) and 2.6.1(1)(c)(v) of Regulation 81-102 respectively and with the total borrowing and short sale limits in section 2.6.2 of Regulation 81-102.
24. The Requested Relief would not change each Alternative Fund's obligation to comply with the Aggregate Limit. The Aggregate Limit would continue to apply to an Alternative Fund's combined exposure to borrowing, short selling and derivatives and the Requested Relief. A decision to grant the Requested Relief would not permit an Alternative Fund to exceed the Aggregate Limit through a combination of investment strategies.
25. If the aggregate gross exposure were to exceed the Aggregate Limit, section 2.9.1(5) of Regulation 81-102 would require an Alternative Fund to, as quickly as commercially reasonable, take all necessary steps to reduce the aggregate gross exposure to 300% of the Alternative Fund's NAV or less.
26. Each short sale will be made consistent with the Alternative Funds' investment objectives and strategies.
27. Each Alternative Fund will implement the following controls when conducting a short sale:
(a) The Alternative Fund will assume the obligation to return to the Borrowing Agent (as defined in Regulation 81-102) the securities borrowed to effect the short sale;
(b) The Alternative Fund will receive cash for the securities sold short within normal trading settlement periods for the market in which the short sale is effected;
(c) The Filer will monitor the short positions of the Alternative Fund at least as frequently as daily;
(d) The security interest provided by the Alternative Fund over any of its assets that is required to enable the Alternative Fund to effect a short sale transaction is made in accordance with Section 6.8.1 of Regulation 81-102 and will otherwise be in accordance with industry practice for that type of transaction and relates only to obligations arising under such short sale transactions;
(e) The Alternative Fund will maintain appropriate internal controls regarding short sales, including written policies and procedures for the conduct of short sales, risk management controls and proper books and records; and
(f) The Filer and the Alternative Funds will keep proper books and records of short sales and all of its assets deposited with the Borrowing Agents as security.
28. Each Alternative Fund's prospectus will contain adequate disclosure of the Alternative Fund's short selling activities, including material terms of the Requested Relief.
29. For the reasons provided above, the Filer submits that it would not be prejudicial to the public interest and the protection of investors to grant the Requested Relief
Decision
Each of the Decision Makers is satisfied that the decision meets the test set out in the Legislation for the Decision Maker to make the decision.
The decision of the Decision Makers under the Legislation is that the Requested Relief is granted provided that:
1. The only securities that an Alternative Fund will sell short in an amount that exceeds 50% of the Alternative Fund's NAV at the time of sale will be IPUs of IPU Issuers;
2. The only securities that an Alternative Fund will sell short (other than "government securities", as defined in Regulation 81-102), resulting in the aggregate market value of the securities of that issuer sold short by the Alternative Fund exceeding 10% of the Alternative Fund's NAV at the time of sale, will be IPUs of IPU Issuers;
3. The relief from the Single Issuer Short Restriction granted by this decision only applies in respect of an Alternative Fund's short sales of IPUs of an IPU Issuer and each Alternative Fund will comply with the Single Issuer Short Restriction in respect of its exposure to the securities held by each IPU Issuer the IPUs of which the Alternative Fund sells short. For each IPU of an IPU Issuer the Alternative Fund sells short, the Alternative Fund will be considered to be directly selling short its proportionate share of the securities held by the IPU Issuer, except that it will not be considered to be directly selling short a security or instrument that is a component of, but represents less than 10% of, the securities held by the IPU Issuer;
4. An Alternative Fund may sell an IPU of an IPU Issuer short or borrow cash only if, immediately after the transaction: (a) the aggregate market value of all securities sold short by the Alternative Fund does not exceed 100% of the Alternative Fund's NAV; and (b) the aggregate market value of securities sold short by the Alternative Fund combined with the aggregate value of cash borrowing by the Alternative Fund does not exceed 100% of the Fund's NAV;
5. Each Alternative Fund will otherwise comply with all of the requirements applicable to alternative mutual funds in sections 2.6.1 and 2.6.2 of Regulation 81-102;
6. An Alternative Fund's aggregate exposure to short selling, cash borrowing and specified derivatives will not exceed the Aggregate Limit;
7. Each short sale will be made consistent with the Alternative Fund's investment objectives and investment strategies; and
8. Each Alternative Fund's prospectus discloses that the Fund is able to sell short IPUs of one or more IPU Issuers in an amount up to 100% of the Alternative Fund's NAV at the time of sale, including the material terms of this decision.