1832 Asset Management L.P. and Dynamic Premium Yield Plus Fund
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- alternative mutual funds granted relief from paragraph 2.6(2)(c) and section 2.6.2 of NI 81-102 to borrow cash up to 100% of NAV -- relief subject to conditions.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.6(2)(c), 2.6.2 and 19.1.
July 6, 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 1832 ASSET MANAGEMENT L.P. (the Filer) AND DYNAMIC PREMIUM YIELD PLUS FUND (the Alternative Fund)
The principal regulator in the Jurisdiction has received an application (the Application) from the Filer on behalf of the Alternative Fund for a decision under the securities legislation of the Jurisdiction exempting the Alternative Fund from:
(a) subparagraph 2.6(2)(c) of National Instrument 81-102 Investment Funds (NI 81-102), which restricts the Alternative Fund from borrowing cash if the value of cash borrowed, when aggregated with the value of all outstanding borrowing by the Alternative Fund, exceeds 50% of the Alternative Fund's NAV (together with (b) below, the Cash Borrowing Limit); and
(b) section 2.6.2 of NI 81-102, which restricts the Alternative 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 Alternative Fund (the Combined Aggregate Value) would exceed 50% of the Alternative Fund's NAV and which requires the Alternative Fund, if the Combined Aggregate Value exceeds 50% of the Alternative 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 Alternative Fund's NAV (together, the Exemption Sought).
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 (collectively, together with the Jurisdiction, the Canadian Jurisdictions).
Unless expressly defined herein, terms in this Application have the respective meanings given to them in National Instrument 81-101 Mutual Fund Prospectus Disclosure, NI 81-102, National Instrument 14-101 Definitions or MI 11-102.
NAV means net asset value;
Prime Broker means any entity that acts as a lender or borrowing agent to investment funds; and
Prospectus means the simplified prospectus of the Alternative Fund prepared in accordance with Form 81-101F1 -- Contents of Simplified Prospectus, as the same may be amended from time to time.
This decision is based on the following facts represented by the Filer:
1. The Filer is a limited partnership formed and organized under the laws of the province of Ontario. The general partner of the Filer is 1832 Asset Management G.P. Inc., an Ontario corporation wholly-owned directly by the Bank of Nova Scotia, with its head office in Toronto, Ontario.
2. The Filer is registered as: (i) a portfolio manager in all the provinces of Canada and in the Northwest Territories and the Yukon; (ii) an exempt market dealer in all of the provinces in Canada (except Prince Edward Island and Saskatchewan); (iii) an investment fund manager in Ontario, Quebec, Newfoundland and Labrador and the Northwest Territories; (iv) a commodity trading manager in Ontario; (v) an adviser in Manitoba; and (vi) a derivatives portfolio manager in Quebec.
3. The Filer is the manager of the Alternative Fund.
4. The Filer is not in default of applicable securities legislation in any of the Canadian Jurisdictions.
The Alternative Fund
5. The Alternative Fund is established under the laws of Ontario or Canada as an investment fund that is a trust and is a reporting issuer in the Canadian Jurisdictions.
6. The Alternative Fund is an alternative mutual fund governed by NI 81-102, subject to any exemptions therefrom that have been, or may be, granted by the applicable securities regulatory authorities.
7. The securities of the Alternative Fund are qualified for distribution in the Canadian Jurisdictions under a Prospectus prepared and filed in accordance with the securities legislation of such Canadian Jurisdictions.
8. The Alternative Fund is not in default of securities legislation of any Canadian Jurisdiction except possibly in relation to the subject matter of the application filed by the Filer along with other investment fund managers on December 21, 2022 seeking an exemption from subsection 4.1(1) of NI 81-102.
Reasons for the Exemption Sought
9. Key investment strategies which may be utilized by the Alternative Fund may include the use of cash borrowing to provide additional investment exposure in connection with the investment strategies of the Alternative Fund in excess of the Cash Borrowing Limit.
10. The ability to engage in additional cash borrowing in connection with the investment strategies of the Alternative Fund may provide material cost savings to the Alternative 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 Alternative Fund.
11. The costs to the Alternative Fund of engaging in 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 the Alternative Fund in relation to the aggregate amount of the Alternative Fund's assets held in the prime brokerage margin account in relation to cash borrowing;
(b) Margin requirements for derivative instruments are primarily based on the underlying investment exposure and, as a result, can be high; and
(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 the Alternative Fund to use these portfolio assets to satisfy collateral requirements rather than utilizing them in connection with the Alternative Fund's investment strategy.
12. The Alternative Fund 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 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.
13. 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 Exemption Sought would provide the Filer with access to a more functional source of additional leverage to utilize on behalf of the Alternative Fund at a lower cost which, in turn, would benefit investors.
14. The investment strategies of the Alternative Fund permit, or will permit, it to:
(a) borrow cash, provided that, at the time, the value of cash borrowed when aggregated with the value of all outstanding borrowing by the Alternative Fund does not exceed 100% of the Alternative Fund's NAV;
(b) 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 Alternative Fund does not exceed 100% of the Alternative Fund's NAV (the Total Borrowing and Short Selling Limit). If the Total Borrowing and Short Selling Limit is exceeded, the Alternative 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
(c) 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 Alternative Fund's specified derivatives positions (other than positions held for hedging purposes, as defined in NI 81-102) would not exceed 300% of the Alternative Fund's NAV as set out in section 2.9.1 of NI 81-102 (the Leverage Limit). If the Leverage Limit is exceeded, the Alternative 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 Alternative Fund's specified derivatives positions (other than positions held for hedging purposes) to be within the Leverage Limit.
15. NI 81-102 contemplates that alternative mutual funds may 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. Accordingly, the Exemption Sought would simply allow the Alternative Fund to do directly what it could otherwise do indirectly through the use of specified derivatives.
16. The Alternative Fund requires the flexibility to borrow cash when doing so is, in the opinion of the Filer, in the best interests of the Alternative Fund and to not be obligated to utilize an equivalent 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.
17. The Filer believes that the Exemption Sought would allow the Filer to manage the Alternative Fund's investment exposure more effectively 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 Alternative Fund. 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 Alternative Fund.
18. The Filer, as a registrant and a fiduciary, is in the best position to determine, depending on the surrounding circumstances, whether the Alternative Fund should obtain additional investment exposure via cash borrowing versus achieving the same result through the use of specified derivatives. The Exemption Sought would provide the Filer with the required flexibility to obtain additional investment exposure through cash borrowing or synthetic transactions. Accordingly, the Exemption Sought would permit the Filer to implement more effective portfolio management activities on behalf of the Alternative 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.
19. Any cash borrowing transaction entered into by the Alternative Fund will be consistent with the investment objectives and strategies of the Alternative Fund.
20. The investment strategies of the Alternative Fund will clearly disclose that the cash borrowing strategies and abilities of the Alternative Fund are outside the scope of NI 81-102, including that the aggregate amount of cash borrowed may exceed 50% of the Alternative Fund's NAV. The Prospectus will also contain appropriate risk disclosure, alerting investors of any material risks associated with such investment strategies.
21. The Filer does not consider that granting the Exemption Sought would constitute either a fundamental or material change for the Alternative Fund under NI 81-102 or National Instrument 81-106 Investment Fund Continuous Disclosure.
22. The Filer will determine the risk rating for the Alternative 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 Alternative Fund would change if the Exemption Sought were granted.
23. The Filer has comprehensive risk management policies and/or procedures that address the risks associated with cash borrowing in connection with the implementation of the investment strategy of the Alternative Fund.
24. The Filer believes that it is in the best interests of the Alternative Fund to be permitted to obtain additional investment exposure through the use of cash borrowing in excess of the current limits set out in NI 81-102.
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 Exemption Sought is granted provided that:
1. The Alternative Fund may borrow cash only if, immediately after the cash borrowing transaction:
(a) the aggregate value of all cash borrowing by the Alternative Fund does not exceed 100% of the Alternative Fund's NAV;
(b) the aggregate market value of securities sold short by the Alternative Fund combined with the aggregate value of cash borrowing by the Alternative Fund does not exceed 100% of the Alternative Fund's NAV; and
(c) the Alternative Fund's aggregate exposure to short selling, cash borrowing and specified derivatives does not exceed the Leverage Limit.
2. The cash borrowing transaction:
(a) otherwise complies with all of the cash borrowing requirements applicable to alternative mutual funds under sections 2.6 and 2.6.2 of NI 81-102; and
(b) is consistent with the Alternative Fund's investment objectives and strategies.
3. The Prospectus discloses in the investment strategies that the Alternative Fund can sell securities short or borrow cash up to, and subject to, the limits described in condition 1 above.
Investment Funds and Structured Products Branch
Ontario Securities Commission
Application File #: 2023/0280
SEDAR File #: 3552392