The Ontario Securities Commission (OSC) recently released its annual Summary Report for Investment Fund and Structured Product Issuers (Report), prepared by the Investment Funds and Structured Products Branch (IFSP Branch) for the fiscal year ended March 31, 2023.
The Report provides an overview of the key operational and policy initiatives of the IFSP Branch over the past year and is organized into four areas: (i) operational highlights, (ii) regulatory policy initiatives, (iii) emerging issues and initiatives impacting investment funds, and (iv) stakeholder outreach.
The Report notes that the trend of steadily increasing investment fund reporting issuers in Ontario slowed in 2023, with an increase of approximately 59 funds in 2023 compared to an increase of 144 funds in 2022. Total investment fund assets under management (AUM) fell slightly year-over-year, from C$2.36-trillion at the end of fiscal year 2022 to C$2.3-trillion at the end of fiscal year 2023, with conventional mutual funds accounting for C$1.9-trillion of total AUM. As of December 31, 2022, there were 126 investment fund managers (IFMs) offering over 4,500 publicly offered investment funds as compared to 128 IFMs in the prior year.
Exchange traded funds (ETFs), a subset of mutual funds, saw a slight increase in AUM of 4% from the previous fiscal year. ETF net sales were concentrated in the equity asset category. Money market ETFs (primarily high interest savings funds) saw strong inflows as investors sought safety and capital preservation given market uncertainty.
Confidential Pre-File Process
The Report recommends that for unique or novel products, IFMs use the confidential pre-file process for prospectus and exemptive relief applications to maintain the proposed product offering’s confidentiality and maintain any competitive or market advantage until regulatory concerns are resolved.
ESG-Related Fund Filings
IFSP Branch staff undertook a review of prospectuses and related documents, including sales communications, of funds whose investment objectives reference environmental, social and governance (ESG) factors and other funds that use ESG strategies (ESG-Related Funds), in accordance with the guidance provided in Canadian Securities Administrators (CSA) Staff Notice 81-334 ESG-Related Investment Fund Disclosure (ESG Staff Notice). To date, prospectus reviews of ESG-Related Funds have been primarily focused on investment strategy disclosure. These reviews have resulted in IFSP Branch staff requesting that issuers improve their disclosure by clarifying the types of strategies and ESG factors relevant to the issuer, which IFSP Branch staff believe will provide investors with a better sense of the significance of ESG factors to a fund’s investment process and ultimately enable investors to make more informed investment decisions.
Novel Prospectus Filings
The Report highlights two novel prospectus filings that were receipted in fiscal year 2023.
Single Stock ETFs
The IFSP Branch issued final prospectus receipts for single stock ETFs. These are ETFs that invest in a single specified United States public issuer. The fundamental investment objective of each ETF is to seek to provide long-term capital appreciation through purchasing and holding securities of a single specified U.S. issuer. Some of these ETFs are alternative mutual funds that use leverage through cash borrowing to purchase additional securities of the U.S. issuer. The single-stock ETFs also seek to provide distributions by writing covered call and/or cash covered put options on a portion of their respective portfolios. These ETFs received exemptive relief from the concentration restrictions applicable to investment funds under National Instrument 81-102 Investment Funds (NI 81-102) to permit each ETF to invest in a single issuer in excess of the investment restrictions contained in NI 81-102.
Decumulation and Tontine Funds
After being subject to a relatively extensive confidential pre-file process, the second novel prospectus filing receipted was for two related funds: a “decumulation” fund and a “tontine” trust. The decumulation fund intends to pay set distributions for the life of the fund and the tontine trust intends to provide payouts to surviving unitholders over the course of the last year of its operation. Investors are able to invest in either fund on a standalone basis or in a hybrid series of the decumulation fund which automatically switches an amount per year from the decumulation fund to the tontine trust, providing the investor with a stream of monthly distributions from the decumulation fund and a “longevity hedge” from the tontine trust. Both funds have a fixed termination date of December 31, 2042. The tontine trust is redeemable on demand or death. The tontine trust obtained relief to enable it to pay a redemption price at less than net asset value (NAV) per unit, so that the difference can be retained within the fund for the benefit of surviving unitholders and be paid out when the trust terminates.
Exemptive Relief Applications
The Report notes a decline in relief applications received and completed in fiscal year 2023 as compared to 2022 of 20% and 25%, respectively. The decline is attributed to the amendments that included codifying certain frequently granted exemptive relief to IFMs. Novel relief applications comprised 4% of applications completed in 2023 as compared to 6% in 2022.
Noteworthy Exemptive Relief Applications
The Report notes that in addition to the exemptive relief granted in relation to the novel prospectus filings described above, relief was granted from the custodian requirements in part 6 of NI 81-102 to permit a fund to use specified warehouse providers to custody the fund’s physical battery metals. IFSP Branch staff was also engaged on relief granted by the Alberta Securities Commission, as principal regulator, to an alternative mutual fund from the total leverage exposure limits under NI 81-102. The relief permits the fund to exceed the limit of 300% of the fund’s NAV on combined exposure to derivatives, cash borrowing and short selling (calculated on a “net notional” basis), provided that the fund’s value-at-risk (VaR) exposure does not exceed 20% of the fund’s NAV as measured on an ”absolute VaR” basis. The terms of the relief effectively follow the framework and requirements in other jurisdictions, in particular the European Union and the U.S., that permit funds to use VaR as a leverage risk management tool.
Continuous Disclosure Reviews
Crypto Asset Funds
IFSP Branch staff conducted a major issue-oriented continuous disclosure review of crypto asset funds and issued comment letters on areas such as valuation, liquidity risk management, custody, crypto trading platforms, as well as other continuous disclosure obligations. CSA staff published CSA Staff Notice 81-336 Guidance on Crypto Asset Investment Funds that are Reporting Issuers to help IFMs understand and comply with securities law requirements for public investment funds holding crypto assets. During this period, the OSC has also taken enforcement actions against a number of non-compliant global crypto asset trading platforms.
Following publication of the ESG Staff Notice, IFSP Branch staff also began conducting reviews of continuous disclosure, sales communications and portfolio holdings of ESG-Related Funds based on staff’s interpretation of the guidance in the ESG Staff Notice. These reviews included a review of disclosure in management reports of fund performance and on fund websites. Where issues have been identified in relation to website disclosure or other sales communications that staff considered misleading or in conflict with the fund’s regulatory offering documents, the sales communication was removed or revised and/or the prospectus disclosure was updated to resolve the conflicting information. Where a correction was required to be made to an IFM’s website, staff have requested the IFM to issue a news release in relation to such corrections in accordance with the process set out in OSC Staff Notice (Revised) 51-711 Refilings and Corrections of Errors (SN 51-711). In accordance with SN 51-711, staff notes that any deficiency for an issuer identified during a staff review, and leads to corrective disclosure and continuous disclosure filings, the issuer’s website or its social media may result in staff putting the issuer on the Refilings and Errors List. The Report notes that IFSP Branch staff are continuing to review ESG-Related Funds.
Independent Review Committee (IRC)
IFSP Branch staff are working with another CSA jurisdiction and considering a potential publication of staff guidance and observations based on a targeted continuous disclosure review focused on National Instrument 81-107 Independent Review Committee for Investment Funds. The disclosure review was comprised of both a desk review of fund prospectuses, IRC Reports to securityholders and IFM websites, and letters sent to IRC Chairs and IFMs.
Reports of Exempt Distribution
IFSP Branch staff review Form 45-106F1 Report of Exempt Distribution (45-106F1) submissions for investment fund issuers and have summarized the top six “flags” (i.e., issues) noted in the submissions reviewed for January to March 2023, as follows: activity fee owing, number of Ontario purchasers differing between 45-106F1 and Schedule 1, incorrect issuer information, late fee owing, distribution amounts differing between 45-106F1 and Schedule 1, and distribution dates differing between 45-106F1 and Schedule 1. Staff notes that issuers have an obligation to meet their reporting obligations and IFMs must comply with these requirements on behalf of their funds.
Regulatory Policy Initiatives, Emerging Issues and Initiatives Impacting Investment Funds
The Report notes certain major policy initiatives that are ongoing, including: proposed amendments to implement an access-based model for investment fund reporting issuers, the investment fund settlement cycle, modernization of the prospectus filing model and continuous disclosure documents, and a review of principal distributor practices.
The Report also highlights certain emerging issues and initiatives impacting investment funds over the next year, including: changes to the OSC fees rule, the transition to SEDAR+, the upcoming cessation of the Canadian Dollar Offered Rate, the annual Investment Fund Survey and cybersecurity breaches.
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