Next Edge Capital Corp. et al.
Headnote
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief granted from the investment fund self-dealing restrictions in the Securities Act (Ontario) to allow a pooled fund to invest in securities of an underlying fund under common management -- relief subject to certain conditions.
Applicable Legislative Provisions
Securities Act (Ontario), R.S.O. 1990, c. S.5, as am., ss. 111(2)(b), 111(3) and (4), 113, 117(1)(a), 117(2).
November 7, 2014
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 NEXT EDGE CAPITAL CORP. (the "Filer") AND IN THE MATTER OF NEXT EDGE PRIVATE DEBT FUND, NEXT EDGE COMMERCIAL TRUST and NEXT EDGE PRIVATE DEBT LP
DECISION
Background
The principal regulator in the Jurisdiction has received an application from Next Edge Capital Corp. (the Manager), on behalf of each of Next Edge Private Debt Fund (the Fund) and Next Edge Commercial Trust (the Sub Trust) (together, the Top Funds) and the Next Edge Private Debt Fund LP (the Partnership), for a decision under the securities legislation of Ontario (the Legislation) pursuant to:
a) section 113 of the Securities Act (Ontario) (Act) for relief from the following provisions:
i. paragraph 111(2)(b) of the Act, which prohibits an investment fund from knowingly making an investment in any person or company in which the investment fund, alone or together with one or more related investment funds, is a substantial security holder;
ii. subsection 111(3) of the Act, which prohibits a mutual fund in Ontario or its management company or its distribution company against knowingly holding an investment described in (i) above;
iii. subsection 111(4) of the Act, which prohibits an investment fund from knowingly holding an investment described in (i) above made on or after July 24, 2014; and
b) subsection 117(2) of the Act for relief from the requirement under paragraph 117(1)1 of the Act to file a report of every transaction of purchase or sale of securities between a mutual fund and any related person or company (collectively, the Requested Relief).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission is the principal regulator for this application; and
(b) the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, Quebec, Nova Scotia, New Brunswick, Newfoundland and Labrador, Prince Edward Island, Yukon, Northwest Territories and Nunavut.
Interpretation
Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.
Representations
This decision is based on the following facts represented by the Filer:
The Filer
1. The Filer is a corporation formed under the laws of Ontario. The principal place of business of the Manager is 1 Toronto Street, Suite 200, Toronto, Ontario M5C 2V6.
2. The Filer is registered as an Investment Fund Manager in Ontario, Québec and Newfoundland and Labrador, as an adviser in the category of Portfolio Manager in Ontario and Alberta and as a dealer in the category of Exempt Market Dealer in Ontario, British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick and Nova Scotia.
3. The Filer is not a reporting issuer in any jurisdiction of Canada and is not in default of securities legislation of any jurisdiction of Canada.
The Fund
4. Next Edge Private Debt Fund is to be established as an open ended investment fund which will be formed and organized under the laws of the Province of Ontario pursuant to a trust agreement (the Trust Agreement). The Fund's head office is located in Toronto, Ontario.
5. The Filer will be the trustee of the Fund and will continue in that capacity until it resigns or is replaced by the Fund in accordance with the Trust Agreement.
6. The investment objective of the Fund is to achieve consistent risk-adjusted returns with minimal volatility and low correlation to most traditional asset classes.
7. The Fund intends to achieve its investment objective by investing substantially all of its net assets in the Sub Trust, which will invest substantially all of its assets in the Partnership.
8. Pursuant to a management agreement to be entered into between the Fund and the Filer, the Filer will be the manager and investment adviser of the Fund.
9. An investment in the Fund is to be represented by an unlimited number of authorized trust units (the Units). Units of the Fund are to be offered in each of the provinces and territories in Canada by prospectus exemption in accordance with National Instrument 45-106 Prospectus and Registration Exemptions (NI 45-106).
10. The Fund will not be a reporting issuer under the Act and is not in default of securities legislation of any jurisdiction of Canada.
The Sub Trust
11. The Sub Trust is an unincorporated open-ended limited purpose trust to be established under the laws of the Province of Ontario pursuant to a trust indenture (the Sub Trust Indenture).
12. The Filer will be the trustee of the Sub Trust and will continue in that capacity until it resigns or is replaced by the Sub Trust in accordance with the Sub Trust Indenture.
13. The Sub Trust's sole function will be to own units of the Partnership following the closing of the offering of units of the Fund.
14. Pursuant to a management agreement to be entered into between the Sub Trust and the Filer, the Filer will be the manager and investment adviser of the Sub Trust.
15. The Fund will be the sole securityholder of the Sub Trust.
16. The Sub Trust will not be a reporting issuer under the Act and is not in default of securities legislation of any jurisdiction of Canada.
The Partnership and General Partner
17. The Partnership was established under the laws of Ontario pursuant to a Declaration of Limited Partnership dated September 16, 2014 under the Limited Partnerships Act (Ontario). Next Edge General Partner (Ontario) Inc. (the General Partner) was incorporated under the Business Corporations Act (Ontario) on September 15, 2014.
18. The Partnership will be governed by a limited partnership agreement (the Limited Partnership Agreement) made between the General Partner and the Sub Trust. The principal place of business of the Partnership and the General Partner is 1 Toronto Street, Suite 200, Toronto, Ontario, Canada M5C 2V6.
19. The investment objective of the Partnership is to achieve consistent risk-adjusted returns with minimal volatility and low correlation to most traditional asset classes by investing primarily in a portfolio of private debt securities.
20. The Partnership intends to achieve its investment objective by allocating capital to a number of specialist loan originators and managers of credit pools (Credit Managers) to take advantage of opportunities in the private debt markets.
21. The Partnership will invest in both senior and subordinated debt, subject to the advice and recommendations of seasoned Credit Managers, with the intent of building a portfolio (the Portfolio), either directly or indirectly, of private income generating securities.
22. Initially, the Portfolio is expected to consist primarily of short term receivables. It will also be investing in, but will not be limited to, first and second lien senior loans and term mezzanine debt and bridge loans. The securities initially comprising the Portfolio will be over-collateralized and have an average term to maturity of 50-60 days. The investment strategies of the Partnership, however, provide the Partnership with the flexibility to invest other investment funds, exchange-traded funds and mutual funds and, to a lesser extent, derivatives such as forward currency agreement and options, may also be used on an opportunistic basis in order to meet the Partnership's investment objectives. The General Partner may, on 30 days' prior written notice, change the investment strategies of the Partnership to adapt to changing circumstances.
23. The General Partner is generally responsible for management and control of the business and affairs of the Partnership in accordance with the terms of the Limited Partnership Agreement. Pursuant to a management agreement, the General Partner has engaged the Filer to carry out its duties, including management of the Partnership on a day-to-day basis, management of the Portfolio and distribution of the units of the Partnership, but remains responsible for supervising the Filer's activities on behalf of the Partnership.
24. The General Partner's investment in the Partnership will be nominal.
25. The Sub Trust will be the sole Limited Partner of the Partnership.
26. The Partnership is not a reporting issuer under the Act and is not in default of securities legislation of any jurisdiction of Canada.
Fund-on-Fund Structure
27. The Fund allows investors to obtain exposure to the investment portfolio of the Partnership and its investment strategies through direct investment by the Fund in securities of the Sub Trust and direct investment by the Sub Trust in the securities of the Partnership (the Fund-on-Fund Structure).
28. For the units of the Fund to be offered to deferred income plans, it is necessary that the Fund qualify as a "mutual fund trust" under the Income Tax Act (Canada). In order to qualify as a "mutual fund trust", amongst other conditions, the sole undertaking of the Fund must be investing of its funds in property. The Partnership, amongst its activities, intends to acquire interests in factoring participation agreements. While those investments will be passive, the nature of the participation is such that it may be argued from a tax perspective to constitute an undertaking by the Fund (assuming it participated directly) other than merely investing its funds in property which may be viewed as putting the Fund offside the definition of "mutual fund trust" for the purposes of the Income Tax Act (Canada).
29. The interposition of the Sub Trust between the Fund and the Partnership further strengthens this position, since in some cases a partner of a limited partnership may be considered to itself be carrying on the activities of the Partnership.
30. An investment in the Sub Trust by the Fund will be compatible with the investment objectives of the Fund, and an investment in the Partnership by the Sub Trust will be compatible with the investment objectives of the Sub Trust.
31. The amount invested in the Partnership by the Sub-Trust, both managed by the Filer, will exceed 20% of the outstanding voting securities of the Partnership. Accordingly, the Sub-Trust will be a substantial securityholder of the Partnership.
32. The amount invested in the Sub-Trust by the Fund, both managed by the Filer, will exceed 20% of the outstanding voting securities of the Sub-Trust. Accordingly, the Fund will be a substantial securityholder of the Sub-Trust.
33. The Top Funds and the Partnership are related funds by virtue of the common management of these funds by the Filer.
34. The Filer is entitled to receive a management fee, payable in consideration of the services provided to the Fund and the Partnership. The Filer will ensure that the arrangements between the Fund, the Sub Trust and the Partnership in respect of an investment in the Fund-on-Fund Structure will avoid the duplication of management fees and incentive fees. Other than the management fee payable by the Fund to the Filer, which will be utilized to pay the servicing commissions, the Filer and its affiliates do not charge, and will not charge, any management fee or incentive fee to the Fund or the Sub Trust.
35. There will be no sales fees or redemption fees payable by the Top Funds in respect of an acquisition, disposition or redemption of securities of the Partnership.
36. Prior to the time of purchase of Units of the Fund, an investor will be provided with an offering memorandum of the Fund which contains disclosure about the relationships, aggregate fee disclosure and potential conflicts of interest between the Top Funds and the Partnership.
37. The offering memorandum will describe the Fund's intent, or ability, to invest in securities of the Sub Trust and the Sub Trust's intent, or ability, to invest in securities of the Partnership. The offering memorandum will also disclose that the Sub Trust and the Partnership are managed by the Filer.
38. Each of the Top Funds and the Partnership will prepare annual audited financial statements and interim financial reports in accordance with National Instrument 81-106 Investment Funds Continuous Disclosure (NI 81-106) and will otherwise comply with the applicable requirements of NI 81-106.
39. Unitholders of the Fund will receive, on request, a copy of the Fund's audited annual financial statements and interim financial reports. The financial statements of the Fund will disclose its holdings of units in the Sub Trust.
40. Unitholders of the Fund will receive, on request, a copy of the audited annual financial statements and interim financial reports of the Sub Trust and the Partnership. The financial statements of the Sub Trust will disclose its holdings of securities of the Partnership.
41. Each of the Fund, the Sub Trust and the Partnership has matching valuation dates and are valued on a monthly basis.
42. Units of the Fund can be redeemed on any valuation date.
43. The Filer manages or will manage the portfolio of the Partnership to ensure there is sufficient liquidity to provide for redemptions of units by unitholders of the Fund.
44. Each of the Fund and the Sub trust is a "clone fund" as defined in National Instrument 81-102 Investment Funds (NI 81-102).
Generally
45. Since neither the Fund nor the Sub Trust is a reporting issuer, they are not subject to NI 81-102 and, therefore, the Top Funds are unable to rely upon the exemption codified in subsection 2.5(7) of NI 81-102.
46. In the absence of the Requested Relief, the Fund would be precluded from investing in the Sub Trust, and the Sub Trust would be precluded from investing in the Partnership, due to the investment prohibitions in paragraph 111(2)(b) and subsections 111(3) and 111(4) of the Act.
47. In the absence of the Requested Relief, the Filer would be required to file a report for every transaction between the Top Fund and the Partnership under paragraph 117(1)(a) of the Act.
48. The Fund's investments in the Partnership through the Sub Trust represent the business judgment of responsible persons uninfluenced by considerations other than the best interests of the investment funds concerned.
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 Requested Relief is granted, provided that the Filer ensures that:
(a) securities of the Fund are distributed in Canada solely pursuant to exemptions from the prospectus requirements in NI 45-106;
(b) the investment by the Fund in the Sub Trust and the investment by the Sub Trust in the Partnership is compatible with the fundamental objectives of the Fund and the Sub Trust, respectively;
(c) the Sub Trust will not purchase or hold securities of the Partnership unless, at the time of the purchase of securities of the Partnership, the Partnership holds no more than 10% of its net assets in securities of other investment funds other than securities
(i) of a "money market fund" (as defined in NI 81-102), or
(ii) that are "index participation units" (as defined in NI 81-102) issued by an investment fund;
(d) no management fees or incentive fees are payable by the Fund that, to a reasonable person, would duplicate a fee payable by the Sub Trust or the Partnership for the same service;
(e) no management fees or incentive fees are payable by the Sub Trust that, to a reasonable person, would duplicate a fee payable by the Partnership for the same service;
(f) no sales fees or redemption fees are payable by (i) the Fund in relation to its purchases or redemptions of securities of the Sub Trust, or (ii) the Sub Trust in relation to its purchases or redemptions of securities of the Partnership;
(g) the Filer will provide to investors in the Fund an offering memorandum (or other similar document), which discloses:
(i) that the Fund will purchase units of the Sub Trust and the Sub Trust will purchase units of the Partnership;
(ii) the fact that the Sub Trust and the Partnership are also managed and advised by the Filer;
(iii) the fact that substantially all of the assets of the Fund are invested in securities of the Sub Trust and that substantially all of the assets of the Sub Trust are invested in securities of the Partnership; and
(iv) the process or criteria used to select the Partnership's investments;
(h) investors in the Fund will be informed that they are entitled to receive from the Filer, on request and free of charge, the annual financial statements and interim financial reports of the Fund, the Sub Trust and the Partnership;
(i) the Filer does not cause the units of the Sub Trust held by the Fund to be voted at any meeting of holders of such units, except that the Filer may arrange for the units the Fund holds of the Sub Trust to be voted by the beneficial holders of units of the Fund;
(j) the Filer does not cause the units of the Partnership held by the Sub Trust to be voted at any meeting of holders of such units, except that the Filer may arrange for the units the Sub Trust holds of the Partnership to be voted by the beneficial holders of units of the Fund;
(k) the Fund is the only securityholder of the Sub Trust and the Sub Trust is the only limited partner of the Partnership;
(l) the General Partner's investment in the Partnership is nominal; and
(m) each of the Fund and the Sub Trust is a "clone fund" as defined in NI 81-102.