Picton Mahoney Asset Management et al.

Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Relief granted from short selling and cash borrowing restrictions in NI 81-102 to permit alternative mutual funds to conduct physical short sales and cash borrowing up to a combined aggregate limit of 100% of the fund's net asset value, subject to conditions.

Relief also granted from custody and collateral restrictions in NI 81-102 to permit excluding, from the 25% of an alternative mutual fund's net asset value that may be deposited with a borrowing agent that is not the fund's custodian or sub-custodian as security in connection with a short sale, the aggregate market value of proceeds from outstanding short sales of portfolio securities held by the borrowing agent, subject to conditions.

Applicable Legislative Provisions

National Instrument 81-102 Investment Funds, ss. 2.6, 2.6.1, 2.6.2, 6.1 and 19.1.

July 7, 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 PICTON MAHONEY ASSET MANAGEMENT (the Filer)

AND

IN THE MATTER OF PICTON MAHONEY FORTIFIED ACTIVE EXTENSION ALTERNATIVE FUND PICTON MAHONEY FORTIFIED MARKET NEUTRAL ALTERNATIVE FUND PICTON MAHONEY FORTIFIED MULTI STRATEGY ALTERNATIVE FUND PICTON MAHONEY FORTIFIED INCOME ALTERNATIVE FUND PICTON MAHONEY FORTIFIED ARBITRAGE ALTERNATIVE FUND PICTON MAHONEY FORTIFIED ARBITRAGE PLUS ALTERNATIVE FUND (the Existing Funds) and the investment funds, including exchange traded funds, structured as "alternative mutual funds" as defined in National Instrument 81-102 Investment Funds (NI 81-102) managed and advised by the Filer in the future (the Future Funds and, collectively with the Existing Funds, the Funds)

DECISION

Background

The principal regulator in the Jurisdiction has received an application (the Application) from the Filer on behalf of the Funds for a decision under the securities legislation of the Jurisdiction (the Legislation) exempting each Fund from:

(i) the following restrictions of NI 81-102 to permit each Fund to sell securities short and/or borrow cash up to a combined aggregate total of 100% of the net asset value (NAV) of the Fund:

(a) Subparagraph 2.6.1(1)(c)(v), which restricts a 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 (together with ((i)(c) below, the Short Selling Limit);

(b) Subparagraph 2.6(2)(c), which restricts a Fund from borrowing cash if the value of cash borrowed, when aggregated with the value of all outstanding borrowing by the Fund, exceeds 50% of the Fund's NAV (together with (i)(c) below, the Cash Borrowing Limit);

(c) Section 2.6.2, which restricts a 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 (the Combined Aggregate Value) would exceed 50% of the Fund's NAV and which requires a Fund, if the Combined Aggregate Value exceeds 50% of the 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 Fund's NAV; and

(ii) the requirement in subsection 6.1(1) of NI 81-102 that, except as provided, all portfolio assets of a Fund be held under the custodianship of one qualified custodian, to permit a Fund to deposit portfolio assets with a borrowing agent that is not the Fund's custodian or sub-custodian in connection with a short sale of securities, if the aggregate market value of the portfolio assets held by the borrowing agent after such deposit, excluding the aggregate market value of the proceeds from outstanding short sales of securities held by the borrowing agent, does not exceed 25% of the NAV of the Fund at the time of deposit (the Short Sale Collateral Relief);

((i) (a) and (c) together, the Short Selling Relief, (i) (b) and (c) together, the Cash Borrowing Relief, and collectively with the Short Sale Collateral Relief, 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 the Application;

(ii) the Filer has provided notice that subsection 4.7(1) of Multilateral Instrument 11-202 Passport System (MI 11-102) is intended to be relied upon in each of British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Yukon, Northwest Territories and Nunavut (the Other Jurisdictions and, together with the Jurisdiction, the Jurisdictions).

Interpretation

Terms defined in National Instrument 14-101 Definitions have the same meaning if used in this decision, unless otherwise defined;

AIF means an annual information from of a Fund prepared in accordance with Form 81-102F2 Contents of Annual Information Form, as amended from time to time;

Prime Broker means any entity that acts as a lender or borrowing agent, as the case may be, to one or more investment funds;

Prospectus means a prospectus of a Fund prepared in accordance with Form 81-101F1 Contents of Simplified Prospectus or Form 41-101F2 Information Required in an Investment Fund Prospectus, as each may be amended from time to time;

Securities Lending Agreements means agreements which effect securities lending, repurchase or reverse repurchase transactions between a Fund, as lender of the securities, third party borrowers and the Fund's securities lending agent;

Representations

This decision is based on the following facts represented by the Filer:

The Filer

1. The Filer is a general partnership formed under the laws of the Province of Ontario. The head office of the Filer is in Toronto, Ontario.

2. The Filer is the investment fund manager and portfolio manager of each Existing Fund and will be the investment fund manager and portfolio manager of each of the Future Funds. As such, the Filer is, or will be, responsible for managing the assets of the Funds and has, or will have, complete discretion to invest and reinvest the Funds' assets and is, or will be, responsible for executing all portfolio transactions.

3. The Filer is registered as an investment fund manager, portfolio manager and exempt market dealer in the Province of Ontario and is registered as an adviser in the category of commodity trading manager under the Commodity Futures Act (Ontario).

4. The Filer is also registered as an investment fund manager, portfolio manager and exempt market dealer in the Province of Québec; an investment fund manager and exempt market dealer in the Province of Newfoundland and Labrador; an exempt market dealer in the Province of Alberta; and as a portfolio manager and exempt market dealer in the provinces of British Columbia, Saskatchewan, Manitoba and Prince Edward Island.

5. The Filer is not in default of applicable securities legislation in any of the Jurisdictions.

The Funds

6. Each of the Funds is, or will be, organized as a trust established under the laws of the Province of Ontario or another Jurisdiction.

7. Each of the Existing Funds is, and each of the Future Funds will be, an open-ended public "alternative mutual fund" as defined in and governed by NI 81-102.

8. Units of the Funds are, or will be, offered by Prospectus, AIF, fund facts and, in certain instances, ETF facts, filed in one or more of the Jurisdictions and, accordingly, each Fund is, or will be, a reporting issuer in the Jurisdictions where the Requested Relief is relied upon.

9. Each of the Existing Funds is not in default of applicable securities legislation in any of the Jurisdictions.

Reasons for the Requested Relief

Short Selling Relief and Cash Borrowing Relief

10. The investment objective of each Fund will differ but, in each case, key investment strategies which may be utilized by a Fund will include (a) the use of market-neutral, offsetting, inverse or shorting strategies requiring the use of short selling in excess of the Short Selling Limit and/or (b) the use of cash borrowing to provide additional investment exposure in connection with the investment strategies of the Fund in excess of the Cash Borrowing Limit.

11. Market-neutral strategies are well-recognized for limiting market risk, balancing long and short positions within an investment portfolio with the objective of providing positive returns regardless of whether the broader market rises, falls or is flat. Market-neutral strategies are designed to have less volatility than the broader market when measured over medium to long-term periods. Market-neutral strategies also provide diversification to investors as returns are intended to be uncorrelated to the performance of the broader market -- such strategies are designed to effectively remove any "beta" component from their returns and investment exposures.

12. As part of an investment strategy, short positions can serve as both a hedge against exposure to a long position or a group of long positions and also as a source of returns with an offsetting long position or positions. The Funds will generally seek to generate an attractive risk/return profile independent of the direction of the broad equity markets. As such, at the portfolio level, these strategies will seek to hedge out a Fund's exposure to the direction of broad equity markets, and to generate positive performance from the difference, specifically, the spread between the performance of the portfolio's long and short positions.

13. The ability to engage in additional short selling and cash borrowing in connection with the investment strategies of a Fund may provide material cost savings to the Fund compared to obtaining the same level of investment exposure through the use of specified derivatives while, at the same time, not increasing the overall level of risk to the Fund.

14. The costs to the Funds of engaging in physical short sales and cash borrowing are typically less when compared to the equivalent derivative transactions due to a number of factors which may include:

(a) Prime Brokers typically have greater flexibility to offer more favourable financing terms to a Fund in relation to the aggregate amount of the Fund's assets held in the prime brokerage margin account. Derivative instruments, such as futures contracts and over the counter (OTC) derivatives, are not held in a prime brokerage account and therefore reduce the ability of a Fund to obtain the most beneficial pricing terms available.

(b) Margin requirements for derivative instruments are primarily based on the underlying investment exposure and, as a result, can be high.

(c) Certain derivative instruments (such as futures contracts) require cash or near cash securities (such as government treasuries) to be deposited with the counterparty as collateral. This would require a Fund to use these portfolio assets to satisfy collateral requirements rather than utilizing them in connection with the Fund's investment strategy.

15. The Funds may use cash borrowing as a more flexible and cost-efficient means of providing additional leverage for investment strategies such as merger arbitrage strategies where the use of derivative instruments to provide the same level of exposure may not be not practical. In connection with such strategies, the Filer is typically required to respond in a timely manner to public disclosure relating to a transaction and market movements in the share price of the target and/or acquiror company. The use of cash borrowing in such circumstances provides an easily accessible tool which enables the Filer to implement the investment decision more quickly compared to the use of derivative instruments which provide the same level of exposure on a synthetic basis.

16. Cash borrowing is more efficient to utilize on a day to day basis compared to derivative instruments which generally require a higher degree of negotiation and ongoing administration on the part of the Filer. The Cash Borrowing Relief would provide the Filer with access to a more functional source of additional leverage to utilize on behalf of the Funds at a lower cost which, in turn, would benefit investors.

17. The investment strategies of each Fund permit, or will permit, it to:

(a) sell securities short provided that, at the time the Fund sells a security short (i) the aggregate market value of securities of any one issuer (other than "government securities" as defined in NI 81-102) sold short by the Fund does not exceed 10% of the NAV of the Fund and (ii) the aggregate market value of all securities sold short by the Fund does not exceed 100% of its NAV;

(b) borrow cash provided that, at the time, the value of cash borrowed when aggregated with the value of all outstanding borrowing by the Fund does not exceed 100% of the Fund's NAV;

(c) borrow cash or sell securities short, provided that the aggregate value of cash borrowed combined with the aggregate market value of the securities sold short by the Fund does not exceed 100% of the Fund's NAV (the Total Borrowing and Short Selling Limit). If the Total Borrowing and Short Selling Limit is exceeded, the Fund shall, as quickly as is commercially reasonable, take all necessary steps to reduce the aggregate value of cash borrowed combined with the aggregate market value of securities sold short to be within the Total Borrowing and Short Selling Limit; and

(d) borrow cash, sell securities short or enter into specified derivatives transactions, provided that immediately after entering into a cash borrowing, short selling or specified derivative transaction, the aggregate value of cash borrowed combined with the aggregate market value of securities sold short and aggregate notional amount of the Fund's specified derivatives positions (other than positions held for hedging purposes, as defined in NI 81-102) would not exceed 300% of the NAV of the Fund as set out in section 2.9.1 of NI 81-102 (the Leverage Limit). If the Leverage Limit is exceeded, the Fund shall, as quickly as is 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 the aggregate notional amount of the Fund's specified derivatives positions (other than positions held for hedging purposes) to be within the Leverage Limit.

18. An alternative mutual fund that is subject to NI 81-102 is permitted to take leveraged long and short positions using specified derivatives up to the Leverage Limit. As such, the Short Selling Relief and Cash Borrowing Relief would not be required if the Funds utilized solely specified derivatives (such as over-the-counter total return swaps) to obtain short exposure to the underlying securities or to provide additional investment exposure in connection with the Fund's investment strategies. NI 81-102 contemplates that alternative mutual funds may utilize shorting strategies using a combination of short sale transactions (subject to the Short Selling Limit) and specified derivative positions and obtain additional investment exposure using a combination of cash borrowing (subject to the Cash Borrowing Limit) and specified derivative positions subject, in all cases, to the Leverage Limit. Alternative mutual funds that were previously known as commodity pools provide 100% or 200% inverse exposure through the use of specified derivatives, which is consistent with the Leverage Limit and does not trigger the application of the Short Selling Limit or Cash Borrowing Limit for which the Filer is requesting exemptive relief. Accordingly, the Short Selling Relief and Cash Borrowing Relief would simply allow the Funds to do directly what they could otherwise do indirectly through the use of specified derivatives.

19. The Funds require the flexibility to enter into physical short positions and borrow cash when doing so is, in the opinion of the Filer, in the best interests of the applicable Fund and to not be obligated to utilize an equivalent short position or amount of leverage synthetically through the use of specified derivatives as a result of regulatory restrictions in NI 81-102 that the Filer believes do not provide any material additional benefit or protection to investors.

20. Certain Existing Funds have used derivative instruments to synthetically achieve the exposure for which the Short Selling Relief and the Cash Borrowing Relief is requested. The Filer believes that the Short Selling Relief and the Cash Borrowing Relief would allow the Filer to more effectively manage each Fund's investment exposure by providing it with the ability to respond to market developments in a timely manner and enabling the Filer to reduce the related expenses incurred by the Funds. In addition, specified derivative options may not be readily available for certain securities, may be relatively illiquid or may require large capital commitments on the part of the Fund.

21. While there may be certain situations where using a synthetic short position may be preferable, physical short positions are typically less costly, because of the ability to execute trades with a larger number of counterparties, compared to a single counterparty for synthetic shorts. This can result in lower borrowing costs for the Fund and reduce its exposure to counterparty risk (e.g. counterparty default, counterparty insolvency and premature termination of derivatives) compared to a synthetic short position.

22. The Filer, as a registrant and a fiduciary, is in the best position to determine, depending on the surrounding circumstances, whether the Funds should enter into a physical short position and/or obtain additional investment exposure via cash borrowing versus achieving the same result through the use of specified derivatives. The Short Selling Relief and Cash Borrowing Relief would provide the Filer with the required flexibility to make timely trading decisions between physical and synthetic short sale positions and/or achieving additional investment exposure through cash borrowing or synthetic transactions. Accordingly, the Short Selling Relief and the Cash Borrowing Relief would permit the Filer to implement more effective portfolio management activities on behalf of a Fund and its investors. Investors would benefit by obtaining access to a more diversified set of investment opportunities than are currently available, while remaining within the overall investment limits set out in NI 81-102.

23. Any physical short position or cash borrowing transaction entered into by a Fund will be consistent with the investment objectives and strategies of the applicable Fund.

24. The Prospectus, AIF, fund facts and ETF facts, as applicable, will comply with the applicable requirements of National Instrument 81-101 Mutual Fund Prospectus Disclosure and Form 41-101F4 Information Required in an ETF Facts Document for alternative mutual funds, including cover page text box disclosure in the fund facts and ETF facts to highlight how the Fund differs from other mutual funds and alternative mutual funds and emphasize that the short selling and cash borrowing strategies and increased ability to engage in short selling and cash borrowing permitted for the Fund are outside the scope of the restrictions in NI 81-102 applicable to both mutual funds and alternative mutual funds.

25. The investment strategies of each Fund will clearly disclose that the short selling and cash borrowing strategies and abilities of the Fund are outside the scope of NI 81-102, including that the aggregate market value of all securities sold short by the Fund and/or the aggregate amount of cash borrowed may exceed 50% of the NAV of the Fund. The Prospectus will also contain appropriate risk disclosure, alerting investors of any material risks associated with such investment strategies.

26. The Filer does not consider that granting the Short Selling and Cash Borrowing Relief would constitute either a fundamental or material change for the Existing Funds under NI 81-102 or National Instrument 81-106 Investment Fund Continuous Disclosure.

27. The Filer will determine the risk rating for each Fund using the Investment Risk Classification Methodology as set out in Appendix F of NI 81-102. The Filer does not anticipate that the current risk ratings of the Existing Funds would change if the Short Selling and Cash Borrowing Relief were granted.

28. The Filer has comprehensive risk management policies and/or procedures that address the risks associated with short selling and cash borrowing in connection with the implementation of the investment strategy of each Fund.

29. 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 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 within the constraints of the Requested Relief as 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 industry practice for that type of transaction and relates only to obligations arising under such short sale transactions;

(e) The Filer 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 assets of a Fund deposited with borrowing agents as security.

30. The Filer believes that it is in the best interests of each of the Funds to be permitted to engage in physical short selling and to obtain additional investment exposure through the use of cash borrowing in excess of the current limits set out in NI 81-102.

Short Sale Collateral Relief

31. As part of its investment strategies, each Fund that engages in short sales of securities is permitted to grant a security interest in favour of and to deposit pledged portfolio assets with its Prime Broker. If a Fund engages as its Prime Broker an entity that is not its custodian or sub-custodian, then a Fund may only deliver to its Prime Broker portfolio assets having a market value, in the aggregate, of not more than 25% of the NAV of the Fund at the time of deposit.

32. A Prime Broker may not wish to act as the borrowing agent for a Fund that has the ability to sell securities short that have an aggregate market value of up to 50% of the Fund's NAV (or more if the Short Selling Relief is granted) if the Prime Broker is only permitted to hold, as security for such transactions, portfolio assets having an aggregate market value that is not in excess of 25% of the NAV of the Fund.

33. Prime Brokers that are qualified to act as a custodian or sub-custodian under NI 81-102 are not widely appointed as custodians or sub-custodians under NI 81-102 as it can be both operationally challenging and costly to appoint them to act in such capacity.

34. Given the typical collateral requirements that Prime Brokers impose on their customers who engage in the short sale of securities, if the Short Sale Collateral Limits apply, the Funds would need to retain multiple Prime Brokers in order to sell short securities to the extent permitted under Section 2.6.1 of NI 81-102 and, if granted, the Short Selling Relief described above. Managing and overseeing relationships with multiple Prime Brokers introduces unnecessary operational and administrative complexities and additional costs of operation for the Funds.

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:

In respect of the Short Selling and Cash Borrowing Relief:

1. A Fund may sell a security short or borrow cash only if, immediately after the cash borrowing or short selling transaction:

(a) the aggregate market value of all securities sold short by the Fund does not exceed 100% of the Fund's NAV;

(b) the aggregate value of all cash borrowing by the Fund does not exceed 100% of the Fund's NAV;

(c) 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; and

(d) the Fund's aggregate exposure to short selling, cash borrowing and specified derivatives does not exceed the Leverage Limit.

2. In the case of a short sale, the short sale:

(a) otherwise complies 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; and

(b) is consistent with the Fund's investment objectives and strategies.

3. In the case of a cash borrowing transaction, the transaction:

(a) otherwise complies with all of the cash borrowing requirements applicable to alternative mutual funds under section 2.6 and 2.6.2 of NI 81-102; and

(b) is consistent with the Fund's investment objectives and strategies.

4. The Prospectus under which securities of a Fund are offered:

(a) discloses that the Fund can sell securities short or borrow cash up to, and subject to, the limits described in condition 1 above; and

(b) describes the material terms of this decision.

In respect of the Short Sale Collateral Relief:

5. Each Fund otherwise complies with subsections 6.8.1(2) and (3) of NI 81-102.

"Darren McKall"

Manager

Investment Funds and Structured Products Branch

Ontario Securities Commission