OSC releases proposals regarding retail alternative funds

On September 22, 2016, the Canadian Securities Administrators (CSA) issued a request for comment with respect to the final stage of Phase 2 of their Modernization of Investment Fund Product Regulation Project. This stage focuses on proposed amendments to National Instrument 81-102 Mutual Funds (NI 81-102) to create a regulatory framework pursuant to which “alternative funds” (i.e., mutual funds that adopt fundamental investment objectives that permit them to invest in asset classes or adopt investment strategies that are otherwise prohibited in NI 81-102) (Alternative Funds) can be offered to retail investors. The CSA has also proposed changes to NI 81-102 that will affect conventional mutual funds and non-redeemable investment funds.
 

The CSA has proposed that Alternative Funds:

• be subject to a concentration restriction equal to 20% of net asset value (NAV);
• have no limits on investments in physical commodities;
• be subject to a restriction on investing in illiquid assets if, after the purchase, more than 10% of the Alternative Fund’s NAV would be invested in illiquid assets, with a hard cap of 15% of NAV;
• be subject to current fund-of-fund investment restrictions applicable to conventional mutual funds. However, unlike conventional mutual funds, underlying funds would only have to be subject to NI 81-102 or comply with the provisions of NI-81-102 applicable to Alternative Funds or non-redeemable investment funds;
• be permitted to borrow up to 50% of NAV, subject to certain requirements;
• be permitted to short sell securities subject to an overall limit of 50% of NAV and a limit of 10% of NAV with respect to the securities of any one issuer;
• be subject to a combined overall limit of 50% of NAV with respect to short-selling and cash borrowing;
• be permitted to enter into specified derivatives transactions where neither the derivative nor the counterparty has a “designated rating”; and
• not be permitted to have aggregate gross exposure through borrowing, short-selling or using specified derivatives in excess of three times NAV (which restriction would need to be met on an ongoing daily basis).

The CSA has also proposed that Alternative Funds be subject to a seed capital requirement of $150,000 (i.e., the manager of an Alternative Fund would need to invest $150,000 on launch and maintain that investment until the Alternative Fund has raised at least $500,000 from outside investors). The CSA is consulting with the Mutual Fund Dealers Association of Canada to determine the appropriate proficiency requirements for dealing representatives of mutual fund dealers that will trade in securities of Alternative Funds.

As noted above, the CSA is also proposing that certain amendments be made to NI 81-102 that will affect conventional mutual funds and non-redeemable investment funds. More specifically, it has been proposed that:

• non-redeemable investment funds be subject to a concentration restriction equal to 20% of NAV;
• conventional mutual funds be permitted to invest up to an aggregate of 10% of their NAV in gold, silver, palladium and platinum;
• conventional mutual funds be subject to a “look through” test pursuant to which investments in underlying funds would be considered when calculating the 10% precious metals restriction outlined in the previous bullet;
• non-redeemable investment funds be subject to a restriction on investing in illiquid assets if, after the purchase, more than 20% of the non-redeemable investment fund’s NAV would be invested in illiquid assets, with a hard cap of 25% of NAV;
• conventional mutual funds be permitted to invest up to 10% of their NAV in Alternative Funds and non-redeemable investment funds that are subject to NI 81-102;
• non-redeemable investment funds only be permitted to borrow up to 50% of NAV, subject to certain requirements;
• non-redeemable investment funds, when short selling, be subject to an overall limit of 50% of NAV and a limit of 10% of NAV with respect to the securities of any one issuer;
• non-redeemable investment funds be subject to a combined overall limit of 50% of NAV with respect to short-selling and cash borrowing; and
• non-redeemable investment funds not be permitted to have aggregate gross exposure through borrowing, short-selling or using specified derivatives in excess of three times NAV (which restriction would need to be met on an ongoing daily basis).

The CSA invites all interested parties to provide written feedback on the proposals by December 22, 2016.