Picton Mahoney Asset Management and The Funds
Headnote
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief from short selling issuer concentration limit in subparagraph 2.6.1(1)(c)(iv) of NI 81-102 with respect to short sales of "index participation units" -- subject to the usual conditions.
Applicable Legislative Provisions
National Instrument 81-102 -- Investment Funds, ss. 2.6.1(1)(c)(iv) and 19.1.
October 12, 2023
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 PICTON MAHONEY ASSET MANAGEMENT (the Filer) IN THE MATTER OF THE FUNDS (as defined below)
DECISION
BACKGROUND
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of the funds listed in Schedule "A" hereto (the Existing Funds) and any additional alternative mutual funds (the Future Funds and together with the Existing Funds, the Funds) of which the Filer, or an affiliate of the Filer, may be the manager, portfolio advisor and/or trustee in the future, for exemptive relief from subparagraph 2.6.1(1)(c)(iv) of NI 81-102, which restricts an alternative mutual fund from selling a security of an issuer, other than a "government security" (as defined in NI 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, in order to permit each Fund to exceed such restriction to short sell index participation units (IPUs) of one or more investment funds (each, an IPU Issuer) up to a maximum of 100% of a Fund's net asset value (NAV) at the time of the sale (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 all of the other provinces and territories of Canada (together with the Jurisdiction, the Jurisdictions).
INTERPRETATION
Terms defined in National Instrument 14-101 -- Definitions, MI 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 subsection 2.9.1 of NI 81-102, which places an overall limit on an alternative mutual fund's exposure to cash borrowing, short selling and specified derivatives equal to 300% of such fund's NAV.
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 general partnership established under the laws of the Province of Ontario, with its head office located at 33 Yonge Street, Suite 830, Toronto, Ontario M5E 1G4.
2. The Filer is registered in the categories of (a) portfolio manager and exempt market dealer in the Provinces of Alberta, British Columbia, Manitoba, Ontario, Prince Edward Island, Quebec and Saskatchewan, (b) exempt market dealer in Newfoundland and Labrador, (c) investment fund manager in the Provinces of Ontario, Newfoundland and Labrador and Quebec and (d) commodity trading manager in the Province of Ontario.
3. The Filer, or an affiliate of the Filer, is, or will be, the manager, portfolio advisor and/or trustee of the Funds.
4. The Filer is not in default of securities legislation in any of the Jurisdictions.
The Funds
5. Each of the Funds is or will be a trust, corporation or separate class of shares of a mutual fund corporation governed by the laws of a Jurisdiction.
6. Each of the Existing Funds has filed and been receipted for a simplified prospectus qualifying the units of the Existing Fund for distribution to the public in each of the Jurisdictions.
7. Each of the Future Funds will file and be receipted for a simplified prospectus or long-form prospectus, as the case may be, qualifying the units of the Future Fund for distribution to the public in one or more of the Jurisdictions.
8. Each of the Funds is or will be a reporting issuer in each of the Jurisdictions.
9. Each of the Funds is, or will be, as the case may be, an alternative mutual fund (as defined in NI 81-102) governed by the provisions of NI 81-102, subject to any relief therefrom granted by the securities regulatory authorities.
10. Each of the Funds offers, or will offer, as the case may be, one or more classes of mutual fund units and, if applicable, one or more classes of exchange-traded units.
11. The exchange traded units of the Funds are, or will be, as the case may be, listed for trading on a stock exchange in Canada (including the Toronto Stock Exchange and Neo Exchange Inc.).
12. The investment objective(s) of each of the Funds is, or will be, as the case may be, set out in the Fund's prospectus.
13. The current risk rating assigned by the Filer to each of the Existing Funds is set out in Schedule A and the Filer believes that there will be no change to the risk rating of any Existing Funds by virtue of relying on the Requested Relief.
14. None of the Existing Funds are in default of any of the requirements of securities legislation in any of the Jurisdictions.
IPU Issuers
15. The portfolio holdings of IPU Issuers are generally diversified.
16. IPU Issuers seek to provide investment results that correspond generally to the performance of a specified widely quoted 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.
17. The portfolio holdings of IPU Issuers are generally liquid.
18. 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.
19. The weight of each underlying security held in the portfolio of an IPU Issuer substantially corresponds to the weight of such security in the underlying index.
Requested Relief
20. Subsection 2.1(1.1) of NI 81-102 restricts an alternative mutual 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 20% of its NAV would be invested in securities of any one issuer (the Concentration Restriction).
21. Subsection 2.1(2) of NI 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 can be applied in respect to shorting IPU Issuers.
22. 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 mutual 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.
23. The Funds are, or will be, as the case may be, 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.
24. 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 Funds to benefit from efficiencies without prejudicing investors.
25. The Requested Relief is requested to permit each Fund to short sell IPUs of IPU Issuers without otherwise impacting such Fund's ability to borrow cash or engage in short sales under NI 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.
26. While a 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.
27. As such, the Filer is of the view that it would be in each Fund's best interest to permit the Fund to physically short sell IPUs of IPU Issuers, up to 100% of the 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:
(a) 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.
(b) Granting the Requested Relief would expand the scope of available tools at the disposal of the Filer, as portfolio advisor, to achieve market hedging, and thereby provide the Filer, as portfolio advisor, with the best execution and best liquidity.
(c) The Requested Relief is less risky than certain derivatives transactions by allowing the 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 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.
28. The Requested Relief would allow the Filer, as portfolio advisor of the Funds, 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.
29. Notwithstanding the Requested Relief the Funds would otherwise still be required to comply with all of the requirements applicable to alternative mutual funds in subsections 2.6.1 and 2.6.2 of NI 81-102, subject to any relief granted therefrom by the securities regulatory authorities.
30. The Requested Relief would not change a Fund's obligation to comply with the Aggregate Limit. The Aggregate Limit would continue to apply to a Fund's combined exposure to borrowing, short selling and derivatives and the Requested Relief. A decision to grant the Requested Relief would not permit a Fund to exceed the Aggregate Limit through a combination of investment strategies.
31. If a Fund's aggregate gross exposure were to exceed the Aggregate Limit, subsection 2.9.1(5) of NI 81-102 would require the Fund to, as quickly as commercially reasonable, take all necessary steps to reduce the aggregate gross exposure to 300% of the Fund's NAV or less.
32. Each short sale by a Fund will be made consistent with the Fund's investment objective(s), strategies and restrictions.
33. Each Fund will implement the following controls when conducting a short sale:
(a) the 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 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 Fund at least as frequently as daily;
(d) the security interest provided by the Fund over any of its assets that is required to enable the Fund to effect a short sale transaction is made in accordance with section 6.8.1 of NI 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 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 keep proper books and records of short sales and all of the Fund's assets deposited with the Borrowing Agent(s) as security.
34. Each Fund's prospectus will contain adequate disclosure of the Fund's short selling activities, including the material terms of the Requested Relief.
35. For the reasons provided above, the Filer has submitted that it would not be prejudicial to the public interest and the protection of investors to grant the Requested Relief.
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 is that the Requested Relief is granted, provided that:
(a) the only securities that a Fund will sell short in an amount that exceeds 50% of the Fund's NAV at the time of sale will be IPUs of IPU Issuers;
(b) the only securities that a Fund will sell short (other than "government securities", as defined in NI 81-102), resulting in the aggregate market value of the securities of that issuer sold short by the Fund exceeding 10% of the Fund's NAV at the time of sale, will be IPUs of IPU Issuers;
(c) the relief granted by this decision only applies in respect of a Fund's short sales of IPUs of an IPU Issuer and each 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 Fund sells short. For each IPU of an IPU Issuer the Fund sells short, the 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;
(d) a Fund may sell an IPU of an IPU Issuer short or borrow cash only if, immediately after the transaction: (i) the aggregate market value of all securities sold short by the Fund does not exceed 100% of the Fund's NAV; and (ii) 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;
(e) each Fund will otherwise comply with all of the requirements applicable to alternative mutual funds in subsections 2.6.1 and 2.6.2 of NI 81-102, subject to any relief granted therefrom by the securities regulatory authorities;
(f) a Fund's aggregate exposure to short selling, cash borrowing and specified derivatives will not exceed the Aggregate Limit;
(g) each short sale will be made consistent with the Fund's investment objectives and investment strategies; and
(h) each Fund's prospectus discloses, or will disclose at the time of its next renewal, as applicable, that the Fund is able to sell short IPUs of one or more IPU Issuers in an amount up to 100% of the Fund's NAV at the time of sale, including the material terms of this decision.
Application File #: 2023/0445
SEDAR File #: 6028777