NexGen Financial Limited Partnership et al. - MRRS Decision
Headnote
Mutual Reliance Review System for Exemptive Relief Applications -- Relief granted from multi-layering prohibition to permit mutual funds to invest in securities of a multi-tiered fund that invests more than 10% of the market value of its net assets in another underlying fund -- underlying fund used for tax efficient cash management purposes -- underlying fund has identical investment objective as a related money market fund and uses derivatives to obtain the returns of the related money market fund -- National Instrument 81-102 Mutual Funds, s.2.5(2)(b).
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, ss. 2.5, 2.5(2)(b), 19.1.
March 6, 2008
IN THE MATTER OF
THE SECURITIES LEGISLATION OF
BRITISH COLUMBIA, ALBERTA, ONTARIO
AND QUEBEC
(the Jurisdictions)
AND
IN THE MATTER OF
THE MUTUAL RELIANCE REVIEW SYSTEM
FOR EXEMPTIVE RELIEF APPLICATIONS
AND
IN THE MATTER OF
NEXGEN FINANCIAL LIMITED PARTNERSHIP
(NexGen)
AND
IN THE MATTER OF
NEXGEN CANADIAN GROWTH AND
INCOME REGISTERED FUND
NEXGEN CANADIAN BALANCED
GROWTH REGISTERED FUND
NEXGEN CANADIAN DIVIDEND AND
INCOME REGISTERED FUND
NEXGEN CANADIAN LARGE CAP
REGISTERED FUND
NEXGEN CANADIAN GROWTH
REGISTERED FUND
NEXGEN GLOBAL VALUE
REGISTERED FUND
NEXGEN NORTH AMERICAN DIVIDEND AND
INCOME REGISTERED FUND
NEXGEN NORTH AMERICAN LARGE CAP
REGISTERED FUND
NEXGEN NORTH AMERICAN VALUE
REGISTERED FUND
NEXGEN NORTH AMERICAN GROWTH
REGISTERED FUND
NEXGEN NORTH AMERICAN SMALL / MID CAP
REGISTERED FUND
NEXGEN AMERICAN GROWTH REGISTERED FUND
(collectively, the Existing Registered Funds)
MRRS DECISION DOCUMENT
Background
The local securities regulatory authority or regulator (the Decision Maker) in each of the Jurisdictions has received an application from NexGen for a decision under the securities legislation of the Jurisdictions (the Legislation) that exempts the Existing Registered Funds and any other future fund established by NexGen that has the same investment structure as an Existing Registered Fund and is a party to a Fund on Fund Arrangement (as defined below) (Future Registered Funds, and together with the Existing Registered Funds, the Registered Funds) from the requirements of paragraph 2.5(2)(b) of National Instrument 81-102 -- Mutual Funds (NI 81-102) that prohibits a mutual fund from investing in another mutual fund if the other mutual fund holds more than 10% of the market value of its net assets in securities of other mutual funds (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 or in Quebec Commission Notice 14-101 have the same meaning in this decision unless they are defined in this decision.
"Tax Managed Funds" means all existing and future funds with a multiple tax class structure within NexGen Investment Corporation that have issued, or will issue, shares of its Inter-Fund Class to a corresponding Registered Fund pursuant to the Fund on Fund Arrangement described in paragraph 4 of this decision.
Representations
This decision is based on the following facts represented by NexGen:
1. NexGen is a limited partnership formed under the laws of the Province of Ontario having its head office in Toronto, Ontario. NexGen is registered as an adviser in the categories of investment counsel and portfolio manager and as a dealer in the categories of mutual fund dealer and limited market dealer.
2. NexGen is or will be the manager of the Registered Funds, the Tax Managed Funds, the NexGen Canadian Cash Tax Managed Fund (the Cash Tax Managed Fund) and the NexGen Canadian Cash Registered Fund (the Cash Registered Fund) (collectively, the Funds). Securities of the existing Funds are qualified for sale in the Jurisdictions pursuant to two separate simplified prospectuses and annual information forms dated May 9, 2007 and March 6, 2007. None of the existing Funds is in default of any requirements of the Legislation.
3. Each of the Registered Funds offers, or will offer, units of various separate series (each, a Series). The Tax Managed Funds offer, or will offer, four publicly offered tax classes, being the: (i) Capital Gains Class; (ii) Return of Capital Class; (iii) Dividend Tax Credit Class; and (iv) Compound Growth Class (collectively, the Public Classes) and a single non-publicly offered class, being the Inter-Fund Class. Each of the Tax Managed Funds offers, or will offer, shares of each Series of each of the Public Classes.
The Fund on Fund Relief
4. Each of the Registered Funds invests substantially all of its portfolio assets in a combination of non-publicly offered limited recourse debt and securities of the Inter-Fund Class of the corresponding Tax Managed Fund which has a similar investment objective as that of the applicable Registered Fund (the Fund on Fund Arrangement).
5. Each Tax Managed Fund is, or will be, party to a Fund on Fund Arrangement. Currently, each Tax Managed Fund may invest its cash from time to time in securities of the Cash Tax Managed Fund up to a limit of 10% of the market value of the net assets of such Fund at the time of purchase. The Cash Tax Managed Fund is not classified as a money market fund under NI 81-102.
6. The Cash Tax Managed Fund has recently entered into a derivative transaction (as described in paragraph 7 below) in accordance with NI 81-102 to provide it with an investment return similar to that of the Cash Registered Fund. The investment returns of the Cash Tax Managed Fund and the Cash Registered Fund differ primarily due to the cost of the derivative. The Cash Registered Fund is classified as a money market fund under NI 81-102.
7. Recently, approximately 80% of the net assets of the Cash Tax Managed Fund assets were converted into equity securities pursuant to a derivative contract used to provide the Cash Tax Managed Fund with the returns of the Cash Registered Fund in exchange for the returns on the equity securities. The remaining approximately 20% of the net assets of the Cash Tax Managed Fund are invested in a combination of the short term money market instruments set out in section (a) of the definition of "money market fund" in NI 81-102 (Eligible Money Market Investments). The portion of the portfolio of the Cash Tax Managed Fund that is invested in Eligible Money Market Investments has a dollar-weighted average term to maturity not exceeding 90 days (calculated on the basis that the term of a floating rate obligation is the period remaining to the date of the next rate setting).
8. The Cash Tax Managed Fund has a similar investment objective as the Cash Registered Fund, namely, the pursuit of income while preserving capital primarily through investment in short term Canadian fixed income securities (with maturity dates of less than one year). In addition, the Cash Tax Managed Fund and the Cash Registered Fund have the same portfolio manager and sub-advisor.
9. The only difference between the investment objectives of the Cash Managed Fund and the Cash Registered Fund is that the Cash Tax Managed Fund is permitted to pursue its investment objective indirectly through the use of derivatives. Such derivative use was desired to optimize the tax efficiency of the Cash Tax Managed Fund, by ensuring capital gains treatment (rather than income treatment) in respect of earnings from the derivative contract.
10. At all times, the net assets of the Cash Tax Managed Fund will be invested in a combination of Eligible Money Market Investments and equity securities which are the subject of a derivative used to provide the Cash Tax Managed Fund with the investment returns of the Cash Registered Fund. At all times, the portion of the portfolio of the Cash Tax Managed Fund that is invested in Eligible Money Market Investments will have a dollar-weighted average term to maturity not exceeding 90 days (calculated on the basis that the term of a floating rate obligation is the period remaining to the date of the next rate setting). The Cash Registered Fund and Cash Tax Managed Fund represent "mirror funds" because of their similarities in investment objectives, strategy, portfolio manager and fee structure.
11. Through its derivative, the Cash Tax Managed Fund has converted otherwise non-eligible investments consisting of short term securities into an eligible investment for capital tax purposes and thus has reduced the capital tax otherwise payable, which is of benefit to its shareholders.
12. Several of the Tax Managed Funds have significant short term securities (including short term treasury bills) within their portfolios because the portfolio managers of such Funds have adopted defensive investment measures due to prevailing market conditions. Instead of holding such short term securities in their portfolios, the Tax Managed Funds wish to invest more than 10% of their net assets in the Cash Tax Managed Fund from time to time.
13. If the Tax Managed Funds were able to invest their surplus cash in shares of the Cash Tax Managed Fund without restriction, it would allow NexGen to reduce highly taxed interest income and increase the amount of capital gains available to each Tax Managed Fund in periods when the fund expenses in each Tax Managed Fund are not sufficient to offset highly taxed investment income. All investors in the Tax Managed Funds are taxable and benefit from a substitution of capital gains for interest income on an after tax basis, subject to the cost of such transactions relative to the computed tax benefit. In addition, NexGen would also be able to totally eliminate the capital tax payable by these Funds. The capital tax will be eliminated as the Cash Tax Managed Fund and the derivatives it utilizes are eligible investments for purposes of reducing capital tax payable. These tax savings and investment flexibility are of benefit to the securityholders of each of the Tax Managed Funds that invests its cash in the Cash Tax Managed Fund.
14. The simplified prospectus of the Tax Managed Funds will disclose that the Tax Managed Funds have the ability to invest their cash in the Cash Tax Managed Fund.
15. A Tax Managed Fund's investment in shares of the Cash Tax Managed Fund will represent the business judgment of responsible persons uninfluenced by considerations other than the best interests of the applicable Tax Managed Fund.
16. The Funds' Independent Review Committee has provided a recommendation that the proposed investments by the Tax Managed Funds in the Cash Tax Managed Fund achieve a fair and reasonable result for the applicable 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 the Registered Funds, in connection with their proposed investments in securities of the Tax Managed Funds, make such investments in compliance with each provision of section 2.5 of NI 81-102, except for paragraph 2.5(2)(b).