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Hamilton Capital Partners Inc. et al.
Headnote
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- An ETF that invests in a portfolio consisting of the six largest Canadian banks in its investment objectives granted relief from the concentration restriction in NI 81-102, subject to conditions -- An alternative mutual fund that uses leverage to invest in a portfolio consisting of the six largest Canadian banks based on a factor index following a transparent methodology granted relief from the concentration restriction in NI 81-102, subject to conditions.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.1(1), 2.1(1.1) and 19.1.
October 8, 2021
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO AND IN THE MATTER OF THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS AND IN THE MATTER OF HAMILTON CAPITAL PARTNERS INC. (the Filer) AND HAMILTON CANADIAN BANK MEAN REVERSION INDEX ETF (HCA) AND HAMILTON ENHANCED CANADIAN BANK ETF (HCAL AND TOGETHER WITH HCA, THE ETFS AND EACH AN ETF).
DECISION
Background
The principal regulator in Ontario has received an application from the Filer on behalf of the ETFs for a decision under the securities legislation of Ontario (the Legislation) for exemptive relief (the Exemption Sought):
(a) relieving the ETFs from subsection 2.1(1) (in the case of HCA) and subsection 2.1(1.1) (in the case of HCAL) of National Instrument 81-102 -- Investment Funds (NI 81-102), which prohibits a mutual fund from purchasing a security of an issuer, entering into a specified derivatives transaction or purchasing an index participation unit if, immediately after the transaction, more than 10% (in the case of HCA) or 20% (in the case of HCAL) of the net asset value (NAV) of the mutual fund, taken at market value at the time of the transaction, would be invested in securities of any issuer (the Concentration Restriction) to permit: (i) HCA to replicate the performance of a rules-based, variable-weight Canadian bank index, currently, the Solactive Canadian Bank Mean Reversion Index (the Index); and (ii) HCAL to replicate a multiple of the Index (together, the Concentration Relief); and
(b) to revoke and replace the Original Decisions (as such term is defined below), as such Original Decisions pertain to the ETFs (the Revocation Relief).
Under National Policy 11-203 -- Process for Exemptive Relief Applications in Multiple Jurisdictions (NP 11-203):
(a) the Ontario Securities Commission is the principal regulator for this 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 British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Newfoundland and Labrador, Nova Scotia, Prince Edward Island, Northwest Territories, Nunavut and Yukon (together with Ontario , the Jurisdictions).
Interpretation
Terms defined in National Instrument 14-101 -- Definitions, NI 81-102 or in MI 11-102 have the same meaning if used in this decision, unless otherwise defined herein.
Representations
The decision is based on the following facts represented by the Filer:
General
1. The Filer is a corporation organized under the laws of Ontario with a head office in Toronto.
2. The Filer is the trustee, portfolio manager and investment fund manager of each ETF.
3. The Filer is not in default of securities legislation in any of the Jurisdictions.
4. The Filer is registered as: (i) an investment fund manager in Ontario, Quebec and Newfoundland & Labrador; (ii) an exempt market dealer in Ontario; and (iii) a portfolio manager in Ontario.
5. Each ETF is an exchange traded mutual fund trust governed by the laws of Ontario and a reporting issuer under the laws of the Jurisdictions.
6. The securities of HCA are offered pursuant to a long form prospectus dated May 10, 2021.
7. The securities of HCAL are offered pursuant to a long form prospectus dated July 8, 2021.
8. Each ETF is subject to NI 81-102, subject to any exemptions therefrom that may be granted by the securities regulatory authorities.
9. The ETFs are not in default of securities legislation in any of the Jurisdictions.
10. HCAL is an "alternative mutual fund", as such term is defined in NI 81-102.
11. Each ETF is subject to National Instrument 81-107 Independent Review Committee for Investment Funds.
12. Units of each ETF are listed on the Toronto Stock Exchange (TSX).
The Solactive Canadian Bank Mean Reversion Index and its Constituent Securities
13. The constituent securities of the Index are the top six Canadian banks listed on the Toronto Stock Exchange or other recognized exchange in Canada by market capitalization (the Banks and each a Bank). Currently, the constituents of the Index are Bank of Montreal, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada and The Toronto-Dominion Bank.
14. The Index uses a rules-based mean reversion strategy. Currently, the Index rebalances the portfolio once a month (an Existing Index Rebalance Date) based on the percent difference between each Bank's stock price and its 50-day average price. On an Existing Index Rebalance Date: (i) the three Banks with the lowest percentage difference between their current trading price and their 50-day average price are "over-weighted" at approximately 26.5% each of the Index (each an Over-Weight Position); and (ii) the three Banks with the highest percentage difference between their current trading price and their 50-day average price are "under-weighted" at approximately 6.5% each of the Index (each an Under-Weight Position). Such portfolio weightings are maintained until the next Existing Index Rebalance Date, at which point the rebalancing process is repeated.
15. The common shares of the Banks are listed on the TSX.
16. The Banks are among the largest public issuers in Canada.
17. Solactive AG (the Index Provider) is the third party provider of the Index. Based on a market consultation report released by the Index Provider on September 16, 2021, the Filer understands that the Index Provider intends to make the following changes to the Index (the Index Changes):
(a) the Index will be rebalanced quarterly (rather than monthly) or such other frequency as may be determined by the Index Provider to the new applicable Over-Weight Positions and Under-Weight Positions (a New Index Rebalance Date and together with the Existing Index Rebalance Date, an Index Rebalance Date); and
(b) each Over-Weight Position and each Under-Weight Position will be determined based on a 200-day average price (rather than a 50-day average price) or such other measure as may be determined by the Index Provider.
Original Decisions
18. HCA obtained relief from the Concentration Restriction pursuant to a decision dated April 29, 2020 (the Original HCA Decision).
19. HCAL obtained relief from the Concentration Restriction pursuant to a decision October 5, 2020 (the Original HCAL Decision and together with the Original HCA Decision, the Original Decisions and each an Original Decision).
20. If the Index Changes are made, the ETFs will no longer be able to rely on the Original Decisions.
Hamilton Canadian Bank Mean Reversion Index ETF
21. The investment objective of HCA is to replicate, to the extent reasonably possible and before the deduction of fees and expenses, the performance of the Index.
22. The investment strategy of HCA is to invest in and hold the constituent securities (common shares of the Banks) of the Index in substantially the same proportion as they are reflected in the Index or securities intended to replicate the performance of the Index. As an alternative to, or in conjunction with investing in and holding common shares of the Banks, HCA may therefore invest in other securities to obtain exposure to the Banks in a manner that is consistent with HCA's investment objective. HCA may also hold cash and cash equivalents or other money market instruments in order to meet its obligations.
23. Following an Index Rebalance Date, the investment portfolio of HCA will have been rebalanced and HCA will have acquired and/or disposed of the appropriate number of securities in order to track the portfolio weighting of the Index.
24. Outside of an Index Rebalance Date, any investments by HCA (owing, for example, to subscriptions received in respect of units of HCA), if any, will be such that securities are acquired up to the same weights as such securities exist in HCA's portfolio, based on their relative market values, at the time of such investment.
25. HCA therefore invests up to approximately: (i) 26.5% of its NAV in a Bank security that represents an Over-Weight Position in the Index; and (ii) 6.5% of its NAV in a Bank security that represents an Under-Weight Position in the Index.
26. In order to achieve its investment objective, and based on its investment strategy and the Original HCA Decision, HCA therefore invests in a portfolio of Banks, such that immediately after a purchase, more than 10% of HCA's NAV may be invested in any one Bank security for the purposes of determining compliance with the Concentration Restriction.
27. The investment objective and investment strategy of HCA, as well as the risk factors associated therewith, including concentration risk, are disclosed in the prospectus of HCA, as may be renewed or amended from time to time. The names of the Banks are also disclosed in the prospectus of HCA, as may be renewed or amended from time to time.
Hamilton Enhanced Canadian Bank ETF
28. The investment objective of HCAL is to replicate, to the extent reasonably possible and before the deduction of fees and expenses, a multiple of the performance of the Index. Specifically, HCAL seeks to replicate approximately 1.25 times the Index.
29. HCAL uses leverage. The leverage may be created through the use of cash borrowings and shall not exceed the limits on the use of leverage permitted under applicable securities legislation for alternative mutual funds.
30. HCAL seeks to achieve its investment objective by borrowing cash to invest in and hold a proportionate share of, or a sampling of the constituent securities of, the Index in order to track approximately 1.25x the performance of the Index. As an alternative to, or in conjunction with investing in and holding the constituent securities, HCAL may also invest in other securities, including other mutual funds or exchange traded funds to obtain exposure to the constituent securities of the Index in a manner that is consistent with HCAL's investment objective. HCAL may also hold cash and cash equivalents or other money market instruments in order to meet its obligations.
31. The maximum aggregate exposure of the Fund to cash borrowing, short selling and specified derivatives will not exceed approximately 125% of its NAV.
32. In order to ensure that a unitholder's risk is limited to the capital invested, HCAL's leverage ratio will be rebalanced in certain circumstances and when the leverage ratio breaches certain bands. Specifically, HCAL's leverage ratio will be rebalanced back to 125% of HCAL's NAV within two business days (a Leverage Rebalance Date and together with an Index Rebalance Date, a Rebalance Date) of the ETF's leverage ratio moving 2% away from its target leverage ratio of 125% (i.e., if the leverage ratio is less than 123% or if the leverage ratio is greater than 127%).
33. Following a Rebalance Date, the investment portfolio of HCAL will have been rebalanced and HCAL will have acquired and/or disposed of the appropriate number of securities in order to track the multiple of the portfolio weighting of the Index.
34. Outside of a Rebalance Date, any investments by HCAL (owing, for example, to subscriptions received in respect of Units of HCAL), if any, will be such that securities are acquired up to the same weights as such securities exist in HCAL's portfolio, based on their relative market values, at the time of such investment.
35. On a leveraged basis, HCAL therefore invests up to approximately: (i) 33.3% of its NAV in a Bank security that represents an Over-Weight Position in the Index; and (ii) 8.3% of its NAV in a Bank security that that represents an Under-Weight Position in the Index.
36. In order to achieve its investment objective, and based on its investment strategy and the Original HCAL Decision, HCAL therefore invests in a portfolio of Banks, such that immediately after a purchase, more than 20% of HCAL's NAV may be invested in any one Bank security for the purposes of determining compliance with the Concentration Restriction.
37. The investment objective and investment strategy of HCAL, as well as the risk factors associated therewith, including concentration risk, are disclosed in the prospectus of HCAL, as may be renewed or amended from time to time. The names of the Banks are also disclosed in the prospectus of HCAL, as may be renewed or amended from time to time.
Rationale for Investment
38. The Filer notes that, in respect of each ETF, its strategy to acquire securities of an applicable Bank is transparent, passive and fully disclosed to investors. An ETF will not invest in securities other than applicable Bank securities (or securities designed to gain exposure to the Bank securities as described herein). In addition, in respect of an ETF, the names of the applicable Banks invested are listed in the ETF's prospectus. Consequently, unitholders of an ETF are already fully aware of the risks involved with an investment in the securities of the ETF.
39. Given the composition of each ETF's portfolio, if the Index Changes are made, it will be impossible for an ETF to achieve its investment objective and pursue its investment strategy without obtaining further relief from the Concentration Restriction.
40. The units of an ETF are highly liquid securities, as designated brokers act as intermediaries between investors and the ETF, standing in the market with bid and ask prices for the units of the ETF to maintain a liquid market for the units of the ETF. The majority of trading in units of an ETF occurs in the secondary market.
41. If required to facilitate distributions or pay expenses of an ETF, securities of the applicable Bank securities will be sold pro-rata across the ETF's portfolio according to their relative market values at the time of such sale.
42. As noted, future subscriptions for ETF securities, if any, will be used to acquire securities of each applicable Bank up to the same weights as the Bank securities exist in the ETF's portfolio, based on their relative market values at the time of such subscription.
43. In view of the Filer, each ETF is also akin to a "fixed portfolio investment fund" , as such term is defined in NI 81-102, in that each will: (a) have fundamental investment objectives that include holding and maintaining a fixed portfolio of publicly traded equity securities of one or more issuers, the names of which are disclosed in its prospectus; and (b) trade the securities referred to in paragraph (a) only in the circumstances disclosed in its prospectus.
44. The Filer further notes that a "fixed portfolio investment fund" is exempt from the Concentration Restriction, provided purchases of securities are made in accordance with its investment objectives. Given the similarities between the ETFs and "fixed portfolio investment funds", the Filer submits it would not be unreasonable to grant the Exemption Sought.
45. The Banks are among the largest public issuers in Canada. The common shares of the Banks are some of the most liquid equity securities listed on the TSX and are less likely to be subject to liquidity concerns than the securities of other issuers.
46. The liquidity of the common shares of the Banks is evidenced by the markets for options in connection therewith. A liquid market for options on the common shares of the Banks is provided by the Montreal Exchange.
47. The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
Decision
The decision of the principal regulator is that the Revocation Relief is granted and the Concentration Relief is granted in respect of an ETF for so long as:
(a) the investment in a Bank is made in accordance with the ETF's investment objectives and investment strategies to replicate, to the extent reasonably possible and before the deduction of fees and expenses, the performance of the Index (in the case of HCA) and 1.25 times the performance of the Index (in the case of HCAL);
(b) the ETF's investment strategies disclose that, following an applicable Rebalance Date, the ETF will invest in the Banks up to the stated maximum percentages described at paragraph 25 or 35, above, as applicable. Outside of a Rebalance Date, any investments by an ETF, if any, will be such that securities of each applicable Bank are acquired up to the same weights as the Bank securities exist in the ETF's portfolio, based on their relative market values at the time of such investment;
(c) the ETF's investment strategies disclose the rebalance frequency of the ETF's portfolio; and
(d) the ETF includes at the time its prospectus is next renewed: (i) disclosure regarding the Exemption Sought under the heading "Exemptions and Approvals"; and (ii) a risk factor regarding the concentration of the ETF's investments in the Banks and the risks associated therewith.
"Darren McKall"
Darren McKall, Manager\
Investment Funds & Structured Products Branch
Ontario Securities Commission
Application File #: 2021/0519
SEDAR File #: 3279875