MD Financial Management Inc.
Multilateral Instrument 11-102 Passport System and National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions. Temporary relief from the requirement in paragraph 14.5.3(a) of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (the Custodial Records Requirement) for registered firms to take reasonable steps to ensure that cash and securities of each client or investment fund are held by a qualified custodian using an account number or other designation in the records of the qualified custodian sufficient to show that the beneficial ownership of the cash or securities of the client or investment fund is vested in that client or investment fund -- The registered firm will continue its historical relationship with a Canadian custodian who will hold client assets on an omnibus basis in accordance to facilitate transitioning its client assets to its new Canadian custodian -- The relief expires when the registered firm complies with the Custodial Records Requirement or on March 31, 2021.
Applicable Legislative Provisions
Multilateral Instrument 11-102 Passport System, s. 4.7.
National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, ss. 1.1, 14.2(2)(a.1), 14.2(2)(a.2), 14.5.2(5), 14.5.3(a), 14.6 and 15.1.
March 9, 2020
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 MD FINANCIAL MANAGEMENT INC. (the Filer)
The principal regulator in the Jurisdiction has received an application from the Filer under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) pursuant to section 15.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) for relief from the requirement in paragraph 14.5.3(a) of NI 31-103 (the Custodial Records Requirement) to permit the Filer's client accounts held in custody with State Street Trust Company of Canada (State Street) to continue to be held as part of an omnibus custody arrangement between the Filer and State Street (the Omnibus Custody Arrangement) for a limited period of time until the Filer can comply with the Custodial Records Requirement (the Exemption Sought).
Under National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(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 each of British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Nova Scotia, Prince Edward Island, Newfoundland and Labrador, Northwest Territories, Yukon and Nunavut (together with Ontario, the Jurisdictions)
Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meanings in this decision, unless otherwise defined.
The decision is based on the following facts represented by the Filer:
1. The Filer is a corporation incorporated under the laws of Canada with its head office located in Ottawa, Ontario. The Filer is registered as an adviser (portfolio manager) in each of the provinces and territories of Canada and is registered in Ontario in the category of commodity trading manager and investment fund manager. The Filer is also registered as an investment fund manager in the provinces of Québec and Newfoundland and Labrador.
2. Other than in respect of the matters outlined in this decision, the Filer is in compliance with all applicable laws.
3. As a registered adviser (portfolio manager), the Filer operates a service known as MD Private Investment Counsel (MDPIC), which allows clients to establish a discretionary managed account managed by registered advising representatives of the Filer.
4. Generally, the Filer invests the assets of its MDPIC clients primarily in mutual funds managed by the Filer. Pursuant to paragraph 14.5.2(7)(c) of NI 31-103, section 14.5.2 of NI 31-103 does not apply as the mutual fund securities held by the MDPIC clients are recorded on the books of the mutual funds managed by the Filer only in the name of the MDPIC client.
5. Some MDPIC clients wish to invest in equity securities directly, either in accordance with the Filer's equity separately managed account strategy, or because they have equity securities that they acquired through another registrant and have transferred to the Filer in moving their assets to the Filer for investment management. As prescribed by subsection 14.5.2(2) of NI 31-103, the equity securities of the MDPIC clients are held in custody with State Street. State Street is a Canadian custodian as defined in section 1.1. of NI 31-103.
6. The equity securities of the MDPIC clients are held in custody with State Street as part of the Omnibus Custody Arrangement between the Filer and State Street. The records of State Street reflect that the securities held by State Street are held in trust for the MDPIC clients of the Filer. However, individual client accounts and holdings are not reflected in the custodial accounts maintained by State Street for the Filer. The holdings of individual MDPIC client accounts are reflected in the Filer's MDPIC client account records. The Exemption Sought is in respect of assets held in the custody of State Street that are part of the Omnibus Custody Arrangement.
7. As of November 30, 2019, the Filer had approximately 60,000 MDPIC accounts representing approximately $28 billion in assets under management (AUM). Approximately 730 of these MDPIC accounts representing approximately $360 million are invested in equity securities that are held in custody with State Street as part of the Omnibus Custody Arrangement. This represents approximately 1.4% of the total MDPIC AUM.
8. The Custodial Records Requirement came into force on June 4, 2018 as part of a package of amendments to NI 31-103, which were designed to enhance the custody requirements applicable to accounts managed by registered advisers, as well as other registrants (the Custody Amendments).
9. The Filer complies with the balance of the Custody Amendments but has not been able to comply with the Custodial Records Requirement as it relates to the equity securities held by State Street on behalf of the MDPIC Clients as part of the Omnibus Custody Arrangements. Since the publication of the Custody Amendments in final form, the Filer considered various options to determine how best it could transition the Omnibus Custody Arrangements to become compliant with the Custodial Records Requirement. After some discussion, it was determined that the existing technological system and relationship of the Filer with State Street does not allow for the Omnibus Custodial Arrangement to be converted to a custody relationship that is in compliance with the Custodial Records Requirement without significant changes to the systems used by State Street. Following its acquisition by The Bank of Nova Scotia effective October 3, 2018, the Filer explored the option of transitioning the custody of the MDPIC client equity securities to The Bank of Nova Scotia Trust Company (Scotiatrust), an affiliate of the Filer that meets the definition of "Canadian custodian" in section 1.1 of NI 31-103.
10. The Filer has now determined that the best option is to move the custody of the MDPIC client equity securities to Scotiatrust, given that Scotiatrust has in place technology systems and tools relating to compliance with the Custodial Records Requirement and, among other things, client statements and other reporting that the Filer can leverage, without duplication of efforts, if the Filer's applicable MDPIC clients also become clients of Scotiatrust, acting as custodian.
11. Although Scotiatrust and the Filer are affiliates by virtue of being subsidiaries of The Bank of Nova Scotia, Scotiatrust is functionally independent of the Filer for the purposes of NI 31-103 because:
(a) Scotiatrust is a Canadian custodian under paragraph (b) of the definition of "Canadian custodian" in NI 31-103 and
(b) The Filer has determined that Scotiatrust has established and maintains a system of controls and supervision that a reasonable person would conclude is sufficient to manage the risks to the MDPIC clients associated with the custody of the MDPIC clients' securities held with Scotiatrust.
12. Notwithstanding that the Filer and Scotiatrust have agreed to establish a custodial relationship for MDPIC clients holding equity securities, the transition of the applicable MDPIC clients and the applicable equity securities to the custodial relationship with Scotiatrust is expected to take several months to complete, given the systems and procedural changes that must be put in place. The Filer considers that the earliest date that the transition will be complete will be in the fall 2020. Given that transition projects of this nature may be delayed for reasons beyond the control of the parties, the Filer considers it is reasonable for the transition to be concluded by March 31, 2021, such that full compliance with the Custody Amendments will be in place by that date.
13. During the interim period where the Omnibus Custodial Arrangement is utilized, State Street will continue as the custodian for the MDPIC accounts holding equity securities and State Street is a Canadian custodian as defined in section 1.1 of NI 31-103.
14. Except as described in this decision, the Filer complies with the Custody Amendments which includes delivering relationship disclosure information to the Filer's clients that describes the risks and benefits to the applicable clients arising from their assets being held under the Omnibus Custodial Arrangement.
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:
(i) any securities of a client that are held in an account in the name of the Filer are held separate and apart from the Filer's own property and held by State Street (a "Canadian custodian" as defined in section 1.1 of NI 31-103) in a custodial account in trust for clients of the Filer;
(ii) the Filer conducts monthly reconciliations between its separate fully-disclosed client account records and the omnibus records of State Street, and retains records of the results of these reconciliations;
(iii) the Filer completes a monthly review of its reconciliation process which includes an internal certification of account reconciliations, and retains records of the results of these reconciliations;
(iv) the Filer ensures that State Street completes an annual internal control report in accordance with International Standards on Assurance Engagements (ISAE 3402) or similar standards, providing evidence of independent oversight and reassurance on the quality and controls of the Omnibus Custodial Arrangement;
(v) the Filer's clients continue to receive account statements from the Filer detailing their individual holdings as required by law; and
(vi) the Exemption Sought will no longer be available in any jurisdiction of Canada after the date that is the earlier of:
A. the date on which the Filer implements the custody arrangement with Scotiatrust that complies with the Custodial Record Requirement and
B. March 31, 2021.