Franklin Templeton Investments Corp. et al

Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Exemption granted from the derivative cover requirements of sections 2.8(1)(d), 2.8(1)(e) and 2.8(1)(f) of NI 81-102 to allow mutual funds that are not alternative mutual funds to open, enter into or maintain standardized futures, forward contracts or swaps to permit the funds to substitute the risk to one currency, interest rate or duration for the risk of another currency, interest rate or duration -- the currency risk, interest rate risk or duration risk to which the fund is exposed is not increased by the substitution, nor is additional leverage created -- relief granted to permit the funds to create synthetic short positions subject to an aggregate limit of 20% of the net asset value of the fund for aggregate direct and synthetic short positions -- relief to alter the currency exposure of a fund subject to the condition that the aggregate currency exposure does not exceed the net asset value of the fund.

Applicable Legislative Provisions

National Instrument 81-102 Investment Funds, ss. 2.8(1)(d), 2.8(1)(e), 2.8(1)(f) and 19.1.

August 25, 2021

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 FRANKLIN TEMPLETON INVESTMENTS CORP. (Franklin) IN THE MATTER OF TEMPLETON GLOBAL BOND FUND (Franklin Existing Fund) AND IN THE MATTER OF VANGUARD INVESTMENTS CANADA INC. (Vanguard) AND IN THE MATTER OF VANGUARD GLOBAL BALANCED FUND (Vanguard Existing Fund)

DECISION

Background

The principal regulator in the Jurisdiction has received an application from Franklin and Vanguard (together, the Filers) for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for an exemption pursuant to section 19.1 of National Instrument 81-102 Investment Funds (NI 81-102) exempting each Fund (as defined below) from the cover requirements in:

(i) sections 2.8(1)(e) and 2.8(1)(f)(ii) of NI 81-102 (the Short Cover Requirements) when a Fund opens, enters into or maintains a Short Derivative (as defined below) provided that the Fund meets certain cash cover requirements and does not exceed the limits for short positions set out in NI 81-102 (the Short Derivatives Relief);

(ii) sections 2.8(1)(d) and 2.8(1)(f) of NI 81-102 (the FX Cover Requirements) when a Fund opens, enters into or maintains a long position in a FX Derivative (as defined below) in order to substitute the risk to the Base Currency for the risk of another currency without increasing the aggregate amount of currency risk to which the Fund is exposed by the substitution (the FX Derivatives Relief); and

(iii) sections 2.8(1)(d) and 2.8(1)(f) of NI 81-102 (the IR Cover Requirements) when a Fund opens, enters into or maintains a Long IR Derivative (as defined below) and a corresponding Short IR Derivative (as defined below) in order to substitute the risk to one interest rate or duration for the risk of another interest rate or duration without increasing the aggregate amount of interest rate or duration risk to which the Fund is exposed by the substitution (the IR Derivatives Relief)

(collectively, 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 the 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 Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, Northwest Territories, Nova Scotia, Nunavut, Prince Edward Island, Québec, Saskatchewan and Yukon (together with Ontario, 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 terms defined above, the following terms shall have the following meanings:

Aggregate Short Exposure means that a Fund's aggregate short exposure, both through the short sales of securities and synthetically through positions in Short Derivatives that are entered into for non-hedging purposes, cannot exceed 20% of the net asset value of the Fund;

Base Currency means the currency in which a Fund determines its net asset value;

Cover Requirements means the cover requirements set out section 2.8 of NI 81-102;

Franklin Funds means the Franklin Existing Fund and each current and future mutual fund, including each exchange-traded fund, managed or sub-advised from time to time by Franklin or one of the Franklin Templeton Companies;

Franklin Templeton Companies means, collectively, the global Franklin Templeton group of companies;

Funds means the Franklin Funds and the Vanguard Funds;

FX Derivative means a long position in a currency standardized future or currency forward contract or position in a currency swap, in each case where a Fund delivers its Base Currency and receives another currency;

Long IR Derivative means a long position in an interest rate standardized future or interest rate forward contract or the long position in an interest rate swap;

Short Derivative means a short position in a standardized future or forward contract or a position in a swap where a Fund is required to make payments under the swap, in each case that a Fund opens, enters into or maintains not for hedging purposes and in reliance on the Short Derivatives Relief;

Short IR Derivative means a short position corresponding to a Long IR Derivative;

Vanguard Companies means, collectively, the global Vanguard group of companies;

Vanguard Funds means the Vanguard Existing Fund and each current and future mutual fund, including each exchange-traded fund, managed or sub-advised from time to time by Vanguard or one of the Vanguard Companies.

Representations

This decision is based on the following facts represented by the Filers (unless otherwise indicated below):

Franklin, Vanguard and the Funds

1. Franklin represents that it is the investment fund manager of the Franklin Existing Fund. Franklin is registered as an investment fund manager, portfolio manager, mutual fund dealer and exempt market dealer in the Province of Ontario. Franklin is also registered as a portfolio manager, mutual fund dealer and exempt market dealer in all other Canadian provinces and the Yukon Territory and as an investment fund manager in the Provinces of Alberta, British Columbia, Manitoba, Newfoundland and Labrador, Nova Scotia and Québec. The head office of Franklin is in Toronto, Ontario.

2. Franklin represents that either Franklin or one of the Franklin Templeton Companies, each of which is an affiliate of Franklin, is, or will be, the investment advisor or the sub-advisor to the Franklin Funds.

3. Vanguard represents that it is the investment fund manager of the Vanguard Existing Fund. Vanguard is registered as an investment fund manager in each of the Provinces of Ontario, Québec and Newfoundland and Labrador, as an exempt market dealer in each the Provinces of Canada, and as a portfolio manager and a commodity trading manager in the Province of Ontario. The head office of Vanguard is in Toronto, Ontario.

4. Vanguard represents that either Vanguard or one of the Vanguard Companies, each of which is an affiliate of Vanguard, is, or will be, the investment advisor or the sub-advisor to the Vanguard Funds.

5. Each Fund is, or will be, a mutual fund created either under the laws of the Province of Ontario or Alberta or under the laws of Canada and is, or will be, subject to the provisions of NI 81-102, subject to any relief therefrom granted by the securities regulatory authorities.

6. Franklin represents that neither Franklin nor the Franklin Existing Fund is in default of securities legislation in any Jurisdiction and Vanguard represents that neither Vanguard nor the Vanguard Existing Fund is in default of securities legislation in any Jurisdiction.

7. The securities of each Fund are, or will be, qualified for distribution pursuant to a prospectus that was, or will be, prepared and filed in accordance with the securities legislation of the Jurisdictions. Accordingly, each Fund is, or will be, a reporting issuer or the equivalent in each Jurisdiction.

8. The investment strategies of each Fund permit, or will permit, the Fund to enter into specified derivative transactions, including long and short positions in specified derivatives. These specified derivatives may be used for purposes of hedging, efficient portfolio management and/or investment purposes.

9. Each Filer has developed a number of policies and mechanisms to monitor the use of derivatives by the Funds in order to comply with the requirements in NI 81-102. In addition, each Filer has written control policies and procedures that set out the risk management procedures applicable to derivative transactions in respect of the Funds, including Short Derivatives, FX Derivatives and Long IR Derivatives (and the corresponding Short IR Derivative). These policies and procedures set out specific procedures for authorization, documentation, reporting, monitoring (including monitoring the level of a Fund's applicable exposures daily) to ensure that (a) the Aggregate Short Exposure does not exceed 20% of the Fund's net asset value and (b) neither the currency exposure nor the interest rate exposure exceeds the Fund's net asset value. These policies and procedures also require each Filer to monitor the Fund's FX Derivatives daily to ensure that the amount of Base Currency to be delivered under the FX Derivatives does not exceed the value of the assets held by the Fund that are denominated in its Base Currency and to review the derivative strategies of the Funds to ensure that these functions are performed by individuals independent of those who trade. Independent personnel employed by a Filer (and any sub-advisor appointed by a Filer, if applicable) review the use of derivatives as part of their ongoing supervision of a Fund's investment practices, including exposure thereunder.

The Short Derivatives Relief

10. Section 4.3 of the Companion Policy 81-102CP states that NI 81-102 is designed to prevent the use of specified derivatives for the purpose of leveraging the assets of the mutual fund. According to this section, the provisions of subsection 2.8(1) of NI 81-102 restrict leveraging with specified derivatives used for non-hedging purposes.

11. The purpose of the Short Cover Requirements is to prohibit a mutual fund from obtaining leveraged exposure to portfolio assets when using certain specified derivatives other than for hedging purposes.

12. The short sale provisions set out in section 2.6.1 of NI 81-102 permit an investment fund to achieve a limited amount of leverage, as an investment fund that complies with the conditions set out in that section is permitted to sell short securities that have an aggregate market value of up to 20% of the net asset value of the investment fund, provided that, among other things, the investment fund holds cash cover in an amount that, together with portfolio assets deposited with borrowing agents as security in connection with short sales by the investment fund, is at least equal to 150% of the aggregate market value of the securities sold short by the investment fund on a daily mark-to-market basis.

13. The Short Cover Requirements predate section 2.6.1 of NI 81-102. From a risk management perspective, the ability of an investment fund to be able to enter into short positions should not differentiate between a physical short position under section 2.6.1 of NI 81-102 and a position in a Short Derivative that is entered into for non-hedging purposes. Whether a Fund enters in a physical short position or achieves that short position through a Short Derivative, the exposure of the Fund is essentially identical. Each Filer believes that a Fund's incremental risk exposure in opening or entering into a Short Derivative compared to the short position risk inherent in a physical short position is negligible. Any such difference (operation or counterparty risks, etc.) will be adequately monitored and managed.

14. Each Filer has in place, or will implement, a policy that provides that each Fund must comply with the Aggregate Short Exposure requirement.

15. This policy also provides, or will provide, that in connection with each Short Derivative opened, entered into or maintained by a Fund, the Fund must hold cash cover in an amount that, together with portfolio assets deposited with counterparties, dealers or futures exchanges as collateral or margin in connection with the Short Derivative by the investment fund, is at least 150% of the daily mark-to-market value of the Short Derivative, being the aggregate of the notional amount of the Short Derivative plus/minus the daily increase/decrease in the value of the Short Derivative.

FX Derivatives Relief

16. A Fund that opens, enters into or maintains a FX Derivative is required to hold cover in accordance with the FX Cover Requirements.

17. Pursuant to NI 81-102, a Fund is permitted to open and maintain a currency standardized futures or forward contract and enter into and maintain a currency swap pursuant to which a Fund delivers: (a) a non-Base Currency and receives another non-Base Currency without being subject to the FX Cover Requirements because (i) the transaction would be a "currency cross hedge" (as defined in NI 81-102), and (ii) the definition of "hedging" under NI 81-102 includes a transaction that is a currency cross hedge transaction; (b) a non-Base Currency and receives the Base Currency without being subject to the FX Cover Requirements because the definition of "hedging" under NI 81-102 includes such a transaction.

18. The ability of a Fund to open or enter into a FX Derivative without being subject to the FX Cover Requirements will enable the Fund to substitute its risk to its Base Currency for a risk to another currency, without increasing the aggregate amount of currency risk to which the Fund is exposed by the substitution. Subject to the Cover Requirements, a Fund's currency exposure (calculated in the Fund's Base Currency) will not, at any time, exceed the net asset value of the Fund.

19. The sub-adviser of each Fund takes a deliberate approach towards monitoring and managing the currency exposure and risk in the Fund's portfolio. Moreover, the sub-adviser does not passively accept currency exposure of the securities a Fund holds and seeks to manage foreign currency exposure separately from cash assets.

20. In addition, the FX Derivatives Relief will permit the sub-advisor to adjust a Fund's currency exposure to align with the currency exposures of the Fund's benchmark. In addition, if the sub-advisor has the mandate to deviate from the Fund's benchmark exposure, the FX Derivatives Relief will permit the sub-advisor to overlay its active currency views on top of the neutral currency positioning to obtain greater or lower exposure to foreign currencies relative to the Fund's benchmark.

21. Whether a Fund directly holds a foreign security or opens or enters into a FX Derivative to obtain foreign currency exposure, the currency exposure is essentially identical. Each Filer believes that a Fund's potential incremental risk exposure in opening or entering into a FX Derivative compared to the currency exposure embedded within a foreign-currency denominated asset is negligible. Any such difference (operational, counterparty or cash flow risks, etc.) will be adequately monitored and managed.

22. The purpose of the FX Cover Requirements is to prohibit a mutual fund from obtaining leveraged exposure to portfolio assets when using certain specified derivatives other than for hedging purposes.

IR Derivatives Relief

23. A Fund that opens, enters into or maintains a Long IR Derivative and a corresponding Short IR Derivative is required to hold cover in accordance with the IR Cover Requirements.

24. The ability of a Fund to open or enter into a Long IR Derivative and a corresponding Short IR Derivative without being subject to the IR Cover Requirements will enable the Fund to substitute its risk to one interest rate, portfolio duration or yield curve for a risk to another interest rate, portfolio duration or yield curve. Subject to the Cover Requirements, the aggregate notional amount of interest rate, duration or yield curve risk to which a Fund is exposed by this substitution will not, at any time, exceed the market value of the long portfolio assets held by the Fund that are exposed to interest rate, duration or yield curve risk.

25. The sub-adviser of each Fund takes a deliberate approach towards monitoring and managing the interest rate, duration exposure and yield curve risk in the Fund's portfolio.

26. In addition, the IR Derivatives Relief will permit the sub-advisor to adjust a Fund's interest rate, duration or yield curve exposure to align with those exposures in the Fund's benchmark. In addition, if the sub-advisor has the mandate to deviate from the Fund's benchmark exposure, the IR Derivatives Relief will permit the sub-advisor to obtain greater or lower exposure to interest rate, duration or yield curve relative to the Fund's benchmark.

27. Whether a Fund directly holds an interest-bearing asset or opens or enters into a Long IR Derivative to obtain an interest rate, duration or yield curve exposure, the exposure is very similar. Each Filer believes that a Fund's potential incremental risk exposure in opening or entering into a Long IR Derivative compared to the exposure embedded within an interest-bearing asset is negligible. Any such difference (operational, counterparty or cash flow risks, etc.) will be adequately monitored and managed.

28. The purpose of the IR Cover Requirements is to prohibit a mutual fund from obtaining leveraged exposure to portfolio assets when using certain specified derivatives other than for hedging purposes.

29. Given a Fund's holding of interest-bearing assets (Interest-Bearing Holdings), by entering into and maintaining a Long IR Derivative and its corresponding Short IR Derivative, the Fund will deliver a return based on one interest rate and receive a return based on another interest rate

General

30. Permitting the Funds to open, enter into and maintain Short Derivatives, FX Derivatives and/or Long IR Derivatives (and the corresponding Short IR Derivative) without the requirement to comply with the Short Cover Requirements, the FX Cover Requirements or the IR Cover Requirements, as the case may be, will provide the Funds with a better opportunity to pursue and achieve their investment objectives.

31. Each Filer believes that the Requested Relief is in the best interests of the Funds as it allows active management of portfolio assets in a way that does not create a by-product of unmanaged short position, currency or interest rate risk, as applicable.

32. Each Filer is seeking the Requested Relief to permit the Funds to engage in strategies in a manner that is not otherwise permitted under NI 81-102.

33. It would not be prejudicial to the public interest to grant the Requested Relief to the Filers and 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 is that the Requested Relief is granted, provided that:

(a) the use of Short Derivatives, FX Derivatives and/or Long IR Derivatives (and the corresponding Short IR Derivative) contemplated by this decision is consistent with the fundamental investment objectives and investment strategies of the applicable Fund;

(b) a Fund must not open or enter into a Short Derivative if, immediately after opening or entering into a Short Derivative, the Fund does not comply with the Aggregate Short Exposure limit;

(c) a Fund must not open, enter into or maintain a Short Derivative unless the Fund holds cash cover in an amount that, together with portfolio assets deposited with counterparties, dealers or futures exchanges as collateral or margin in connection with the Short Derivative by the Fund, is at least equal to 150% of the daily mark-to-market value of the Short Derivative, being the aggregate of the notional amount of the Short Derivative plus/minus the daily increase/decrease in the value of the Short Derivative;

(d) a Fund must not open or enter into a FX Derivative if, immediately after opening or entering into the FX Derivative, the aggregate amount of the Fund's Base Currency to be delivered under all FX Derivatives Contracts (the Aggregate FX Amount) would exceed the value of the assets held by the Fund that are denominated in its Base Currency (the Base Currency Holdings);

(e) if a Fund's Aggregate FX Amount exceeds at any time the value of its Base Currency Holdings, the Fund must, as quickly as is commercially reasonable, take all necessary steps to reduce the Aggregate FX Amount to an amount that does not exceed the value of its Base Currency Holdings;

(f) the opening and maintenance by a Fund of each Short IR Derivative meets the definition of "hedging" in NI 81-102 in respect of corresponding long Interest-Bearing Holdings held directly or indirectly by the Fund;

(g) if all or a portion of a Short IR Derivative terminates or is closed out, then a Fund must terminate or close out an equivalent portion of its corresponding Long IR Derivative;

(h) a Fund will not open or maintain a Long IR Derivative unless the underlying market exposure to the Fund of the Long IR Derivative would not exceed, on a daily mark-to-market basis, the aggregate of: (i) the market value of its corresponding Short IR Derivative and Interest-Bearing Holdings; and (ii) the market value of the Long IR Derivative (the Aggregate Amount); and

(i) if the underlying market exposure to a Fund of a Long IR Derivative exceeds the Aggregate Amount referenced in condition (h) above, then the Fund must, as quickly as is commercially reasonable, take all necessary steps to reduce the underlying market exposure of its Long IR Derivative so that the underlying market exposure of its Long IR Derivative no longer exceeds the Aggregate Amount.