Fidelity Investments Canada ULC
Headnote
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief granted from short selling restrictions in NI 81-102 to permit alternative mutual funds to physically short sell securities, other than "government securities", as defined in NI 81-102, up to 100% of NAV -- relief subject to conditions.
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief granted from short selling restrictions in NI 81-102 to permit alternative mutual funds to short sell "government securities", as defined in NI 81-102, up to 300% of NAV -- relief subject to conditions.
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief granted from issuer concentration restrictions in subsection 2.1(1.1) of NI 81-102 to permit an alternative mutual fund to invest up to 35% of its NAV in securities issued or guaranteed by a foreign government or supranational agency -- relief subject to conditions.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.6.1(1)(c)(v), 2.6.2, 2.1(1.1), 19.1.
October 2, 2020
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 FIDELITY INVESTMENTS CANADA ULC (the Fidelity)
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Fidelity, or an affiliate of Fidelity (collectively, the Filer), on behalf of the alternative mutual funds it manages, or will in the future manage (Alternative Funds), for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation), for an exemption pursuant to section 19.1 of National Instrument 81-102 Investment Funds (NI 81-102), exempting the Alternative Funds from the provisions of:
(i) subparagraph 2.6.1(1)(c)(v) of NI 81-102, which restricts an alternative mutual fund from selling a security short if, at the time, the aggregate market value of all securities sold short by the fund exceeds 50% of the fund's NAV; and
(ii) section 2.6.2 of NI 81-102, which prohibits 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 all securities sold short by the fund would exceed 50% of the fund's NAV
(collectively, the Short Selling Restrictions)
in order to permit each Alternative Fund to short sell (I) securities having an aggregate market value (together with the aggregate value of any cash borrowed by the Alternative Fund) of up to 100% of the Alternative Fund's NAV (the Short Selling Relief) and (II) "government securities" (as defined in NI 81-102) up to a maximum of 300% of an Alternative Fund's NAV (the Government Securities Short Selling Relief);
(iii) subsection 2.1(1.1) of NI 81-102 which prohibits an alternative mutual fund from purchasing a security of an issuer or entering into a specified derivatives transaction, if, immediately after the transaction, more than 20% of the alternative mutual fund's NAV would be invested in securities of any one issuer, other than a "government security" (as defined in NI 81-102) (the Concentration Restriction) in order to permit each Alternative Fund to invest up to 35% of its net assets in Foreign Government Securities (as defined below) (the Concentration Restriction Relief)
(collectively, the Requested Relief).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(i) the Ontario Securities Commission is the principal regulator for this application; and
(ii) the Filer has provided notice that sub-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 and territories of Canada.
Interpretation
Unless expressly defined herein, terms used in this Application have the respective meanings given to them in MI 11-102, National Instrument 14-101 Definitions, National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81-101) and NI 81-102. In addition to the defined terms used in this Application, capitalized terms used in this Application have the following meanings:
Derivatives Strategy means a strategy that synthetically creates a strategy similar to a short hedging strategy through the use of derivative instruments.
Foreign Government Securities means evidences of indebtedness of any one issuer if those evidences of indebtedness are issued, or guaranteed fully as to principal and interest, by supranational agencies or governments other than the government of Canada or the government of a jurisdiction in Canada, or the government of the United States of America and are rated "AAA" by Standard & Poor's ("S&P") or its DRO affiliate, or have an equivalent rating by one or more other designated rating organizations or their DRO affiliates.
NAV means net asset value.
Short Hedging Strategy means a strategy aimed at reducing interest rate risk by simultaneously buying a corporate bond long and selling a closely matched, highly liquid government bond short.
Representations
This decision is based on the following facts represented by the Filer:
The Filer
1. Fidelity is a corporation continued under the laws of the Province of Alberta with its head office located in Toronto, Ontario.
2. Fidelity is registered as an investment fund manager in Ontario, Québec and Newfoundland and Labrador, as a portfolio manager in each of the Jurisdictions, as a commodity trading manager in Ontario and as a mutual fund dealer in each of the Jurisdictions.
3. The Filer is, or will be, the investment fund manager of certain alternative mutual funds (the Alternative Funds) and the Filer or a third party portfolio manager retained by the Filer is, or will be, the portfolio manager of the Alternative Funds.
4. The Filer is not in default of securities legislation in any of the Jurisdictions.
The Alternative Funds
5. The Alternative Funds will be alternative mutual funds governed by the laws of a Jurisdiction or the laws of Canada.
6. The Alternative Funds are, or will be, governed by the provisions of NI 81-102, subject to any exemption therefrom that has been, or may be, granted by the securities regulatory authorities.
7. As part of their investment strategies, the Alternative Funds may enter into specified derivatives transactions, borrow cash and/or sell short securities, provided that, in accordance with section 2.9.1 of NI 81-102, the Alternative Fund's aggregate exposure to such cash borrowing, short selling and specified derivatives transactions will not exceed 300% of its NAV.
Short Selling Relief
8. The investment strategies of each Alternative Fund will clearly disclose the short selling strategies of each Alternative Fund that are outside the scope of NI 81-102, including that the aggregate market value of all securities sold short by each Alternative Fund may exceed 50% of the net asset value of each Alternative Fund. The prospectus will also contain appropriate risk disclosure, alerting investors of any material risks associated with such investment strategies.
9. The investment strategies of each Alternative Fund will permit it to sell securities short, provided that at the time each Alternative Fund sells a security short (a) the aggregate market value of securities of any one issuer (other than "government securities" as defined in NI 81-102) sold short by each Alternative Fund does not exceed 10% of the net asset value of each Alternative Fund, and (b) the aggregate market value of all securities (other than "government securities" as defined in NI 81-102) sold short by each Alternative Fund does not exceed 100% of its net asset value.
10. The investment strategies of each Alternative Fund will permit each Alternative Fund to enter into a cash borrowing or short selling transaction, provided that the aggregate value of cash borrowed combined with the aggregate market value of the securities (other than "government securities" as defined in NI 81-102) sold short by each Alternative Fund does not exceed 100% of each Alternative Fund's net asset value (the Total Borrowing and Short Sales Limit). If Total Borrowing and Short Sales Limit is exceeded, each Alternative Fund shall, as quickly as commercially reasonable, take all necessary steps to reduce the aggregate value of cash borrowed combined with the aggregate value of market value of securities sold short to be within the Total Borrowing and Short Sales Limit.
11. The investment strategies of each Alternative Fund will permit each Alternative Fund to borrow cash, enter into specified derivative transactions or sell securities short, provided that immediately after entering into a cash borrowing, specified derivative or short selling transaction, the aggregate value of cash borrowed combined with the aggregate market value of all securities sold short by each Alternative Fund and the aggregate notional amount of each Alternative Fund's specified derivatives positions (other than positions held for hedging purposes, as defined in NI 81-102) would not exceed three times each Alternative Fund's net asset value (the Leverage Limit). If the Leverage Limit is exceeded, each Alternative Fund shall, as quickly as commercially reasonable, take all necessary steps to reduce the aggregate value of cash borrowed combined with the aggregate market value of securities sold short and aggregate notional amount of each Fund's specified derivatives position to be within the Leverage Limit.
12. Any short position entered into by each Alternative Fund will be consistent with the investment objective and strategies of each Alternative Fund.
13. The Filer maintains internal controls regarding physical short sales including written policies and procedures, risk management controls and proper books and records
14. Each Alternative Fund will implement the following controls when conducting a short sale:
(a) Each Alternative Fund will assume the obligation to return to the borrowing agent the securities borrowed to effect the short sale;
(b) each 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 each Alternative Fund at least as frequently as daily;
(d) the security interest provided by each Alternative Fund over any of its assets that is required to enable each Alternative Fund to effect a short sale transaction is made in accordance with section 6.8.1 of NI 81-102 and will otherwise be made in accordance with industry practice for that type of transaction and relates only to obligations arising under such short sale transaction;
(e) each 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 each Alternative Fund will keep proper books and records of short sales and all of its assets deposited with borrowing agents as security.
15. Where deemed appropriate and in the best interest of each Alternative Fund, the Filer is seeking latitude to enter into physical short positions rather than the use of synthetic short positions in order to achieve the investment objective and strategies of each Alternative Fund.
16. The Filer believes that since the underlying investment exposure between a physical short position and a synthetic short position is the same, each Alternative Fund will not be subject to any additional risks by entering into a physical short position versus a synthetic short position.
17. The Filer believes there is a greater number of options to borrow securities to short compared to a single counterparty for synthetic shorts resulting in lower borrowing costs to each Alternative Fund. As well, with a greater number of options to borrow securities to short, each Alternative Fund will be exposed to less counterparty risk than with a synthetic short position (e.g. counterparty default, counterparty insolvency, and premature termination of derivatives).
18. The Short Selling Relief will provide the Filer with the necessary flexibility to make timely trading decisions between physical short and synthetic short positions based on what is in the best interest of each Alternative Fund. The Filer, as a registrant and a fiduciary, is in the best position to determine whether each Fund should enter into a physical short position or a synthetic short position, depending on the surrounding circumstances. Accordingly, the Short Selling Relief will permit the Filer to engage in the most effective portfolio management available for the benefit of each Alternative Fund and its unitholders.
Government Securities Short Selling Relief
19. Certain of the Alternative Funds, as part of their investment strategy, will employ a Short Hedging Strategy, whereby the Alternative Funds will enter into long positions in corporate bonds while hedging the interest rate risk of those bonds by taking short positions in government bonds. The short positions in the government bonds can be achieved either through short selling government bonds or by entering into short positions in government bond futures.
20. The Short Selling Restrictions would restrict an Alternative Fund to short selling government securities to no more than 50% of the Alternative Fund's NAV.
21. The only securities proposed to be sold short by an Alternative Fund in excess of 100% of an Alternative Fund's NAV will be "government securities" (as defined in NI 81-102). Subject to the Short Selling Relief and the Government Securities Short Selling Relief, the Alternative Funds will otherwise comply with the provisions governing short selling by an alternative mutual fund under sections 2.6.1 and 2.6.2 of NI 81-102.
22. NI 81-102 otherwise permits the Alternative Funds to obtain the additional leveraged short exposure through the use of specified derivatives, up to an aggregate exposure of 300% of the Alternative Fund's NAV.
23. The Filer is of the view that it would be in each Alternative Fund's best interest to permit the Alternative Funds to physically short sell government securities up to 300% of the Alternative Fund's NAV, instead of being limited to achieving the same degree of leverage through either specified derivatives alone, or a combination of physical short selling and specified derivatives, for the following reasons:
(a) While derivatives can be used to create similar investment exposure as the Short Hedging Strategy up to 300% of an Alternative Fund's NAV, the use of derivatives is less effective, is more complex, and is riskier than the Short Hedging Strategy. Derivatives typically provide credit exposure that is less targeted than the Short Hedging Strategy with a longer duration that increases risk, often without commensurately higher returns. In addition, implementing derivatives strategies necessitates incremental transactional steps. These steps increase both operational risk and counterparty risk, as well as cost.
(b) The risk of covering short government securities positions in a rising market is largely mitigated by several factors: (i) the strong correlation between the government security sold short and the corporate fixed income security held long by an Alternative Fund which provides a hedge against short cover risk; (ii) government securities are highly liquid and more than one issuance of government securities can be used to hedge interest rate risk; (iii) government securities have markedly lower price volatility than equity securities; (iv) unlike equity securities, government securities have an effective upper value limit; and (v) financial institutions that facilitate short selling are regulated and implement effective risk controls on short sellers.
24. Each Alternative Fund's aggregate exposure to short selling, cash borrowing and specified derivatives transactions will not exceed the Leverage Limit.
25. 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 NI 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 cause the portfolio manager of the Alternative Fund to monitor the short positions of the Alternative Fund at least as frequently as daily and the Filer, as investment fund manager, will monitor the short positions of the Alternative Fund at least as frequently as monthly;
(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 NI 81-102 and will otherwise be made in accordance with industry practice for that type of transaction and relates only to obligations arising under such short sale transaction;
(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 will cause the portfolio manager of the Alternative Fund, on behalf of the Alternative Fund, to keep proper books and records of short sales and all of the Alternative Fund's assets deposited with borrowing agents (as defined in NI 81-102) as security and the Filer, on behalf of the Alternative Fund, will have access to such books and records.
26. Each Alternative Fund's prospectus will contain adequate disclosure of the Alternative Fund's short selling activities, including material terms of the Short Selling Relief.
Concentration Restriction Relief
27. To achieve the investment objective of certain of the Alterative Funds, it is expected that the portfolio manager will employ a variety of fundamentally-driven and systematically-driven investment strategies. These Alternative Funds may invest in long and short positions in corporate and government fixed-income securities and instruments of issuers anywhere in the world.
28. While such Alternative Funds may invest in a diversified portfolio of fixed-income securities, each such Alternative Fund's portfolio manager may seek the discretion to gain exposure to any one issuer of Foreign Government Securities in excess of the Concentration Restriction.
29. Allowing the Alternative Funds to hold highly rated fixed-income securities issued by governments will enable the Alternative Funds to preserve capital in foreign markets during adverse market conditions, to have access to assets with minimal credit risk and will enable the portfolio manager to assess its views on interest rates and duration.
30. The increased flexibility to hold Foreign Government Securities may also yield higher returns than Canadian shorter-term government fixed-income alternatives.
31. Subsection 2.1(1.1) of NI 81-102 prohibits the Fund from purchasing a security of an issuer, other than a "government security" as defined in NI 81-102, if immediately after the purchase more than 20% of the net asset value of the fund, taken at market value at the time of the purchase, would be invested in securities of the issuer.
32. The Foreign Government Securities are not "government securities" as such term is defined in NI 81-102.
33. The Filer believes that the ability to purchase Foreign Government Securities more than the limit in subsection 2.1(1.1) of NI 81-102 will better enable the Alternative Funds to achieve their fundamental investment objectives, thereby benefitting the Alternative Funds' investors.
34. The Alternative Fund will only purchase Foreign Government Securities if the purchase is consistent with the Alternative Fund's fundamental investment objectives.
35. The prospectus for the Alternative Fund will disclose the risks associated with concentration of net assets of the Alternative Fund in securities of a limited number of issuers.
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:
In the case of the Short Selling Relief:
(a) each Alternative Fund may sell a security short or borrow cash only if, immediately after the transaction:
(i) the aggregate market value of all securities (other than "government securities" as defined in NI 81-102) sold short by each Alternative Fund does not exceed 100% of each Alternative Fund's net asset value;
(ii) the aggregate value of cash borrowing by each Alternative Fund does not exceed 50% of each Alternative Fund's net asset value; and
(iii) the aggregate market value of securities (other than "government securities" as defined in NI 81-102) sold short by each Alternative Fund combined with the aggregate value of cash borrowing by each Alternative Fund does not exceed 100% of each Alternative Fund's net asset value.
(b) each short sale made by each Alternative Fund will otherwise comply with all of the short sale requirements applicable to alternative mutual funds under section 2.6.1 and 2.6.2 of NI 81-102;
(c) each Alternative Fund's aggregate exposure to short selling, cash borrowing and specified derivatives will not exceed the Leverage Limit;
(d) each short sale will be made consistent with each Alternative Fund's investment objectives and strategies; and
(e) each Alternative Fund will disclose in its offering documents that each Alternative Fund can short sell securities (other than "government securities" as defined in NI 81-102) up to 100% of each Alternative Fund's NAV, including the material terms of this decision.
In the case of the Government Securities Short Selling Relief:
(a) the only securities which an Alternative Fund will sell short in an amount that exceeds 100% of the Alternative Fund's NAV will be securities that meet the definition of "government security" as such term is defined in NI 81-102;
(b) each short sale by an Alternative Fund will otherwise comply with all of the short sale requirements applicable to alternative mutual funds in sections 2.6.1 and 2.6.2 of NI 81-102;
(c) an Alternative Fund's aggregate exposure to short selling, cash borrowing and specified derivatives will not exceed the Leverage Limit;
(d) each short sale will be made consistent with an Alternative Fund's investment objectives and investment strategies; and
(e) an Alternative Fund's prospectus will disclose that the Alternative Fund is able to short sell "government securities" (as defined in NI 81-102) in an amount up to 300% of the Alternative Fund's NAV, including the material terms of this decision.
In the case of the Concentration Relief:
(a) any security that may be purchased under the Concentration Relief is traded on a mature and liquid market;
(b) the acquisition of the securities purchased pursuant to this decision is consistent with the fundamental investment objectives of the Alternative Fund;
(c) the prospectus of the Alternative Fund discloses the additional risk associated with the concentration of the net asset value of the Fund in securities of fewer issuers, such as the potential additional exposure to the risk of default of the issuer in which the Alternative Fund has so invested and the risks, including foreign exchange risks, of investing in the country in which the issuer is located; and
(d) the prospectus of the Alternative Fund discloses, in the investment strategies section, a summary of the nature and terms of the Requested Relief, along with the conditions imposed and the type of securities covered by this decision.
"Darren McKall"
Manager
Investment Funds and Structured Products Branch
Ontario Securities Commission