FT Portfolios Canada Co.
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Relief granted to permit mutual fund to invest in related underlying US ETF whose securities do not meet the definition of index participation unit in NI 81-102 -- mutual fund is the Canadian version of the underlying US ETF -- relief is subject to certain conditions including that both funds have the same portfolio manager who is registered both under the OSA as well as with the SEC.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 2.1(1), 2.5(2)(a), 2.5(2)(c), 19.1.
November 6, 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 FT PORTFOLIOS CANADA CO. (the Filer)
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of the First Trust Senior Loan ETF (CAD Hedged) (the Fund), an exchange-traded mutual fund subject to National Instrument 81-102 Investment Funds (NI 81-102) for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for an exemption from:
(a) subsection 2.1(1) of NI 81-102 to permit the Fund to purchase securities of the U.S. Underlying ETF (as defined below) even though, immediately after the transaction, more than 10% of the Fund's net asset value (NAV) would be invested in it;
(b) paragraph 2.5(2)(a) of NI 81-102 to permit the Fund to purchase securities of the U.S. Underlying ETF (as defined below) even though it is not subject to NI 81-102; and
(c) paragraph 2.5(2)(c) of NI 81-102 to permit the Fund to purchase securities of the U.S. Underlying ETF (as defined below) even though it is not a reporting issuer in a Jurisdiction,
(collectively, the Exemption Sought).
Under the 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 all of the provinces and territories of Canada other than the Jurisdiction (together with the Jurisdiction, the Jurisdictions).
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.
FT Funds means the Fund and the U.S. Underlying ETF.
U.S. means the United States of America.
U.S. Underlying ETF means the First Trust Senior Loan Fund, an exchange traded mutual fund whose securities are listed on The Nasdaq Stock Market LLC (the Nasdaq).
This decision is based on the following facts represented by the Filer:
1. The Filer is a corporation formed by amalgamation pursuant to a certificate of amalgamation dated November 29, 2001 under the laws of the province of Nova Scotia.
2. The Filer is the investment fund manager of the Fund and is registered as an investment fund manager under the securities legislation in Ontario, Québec and Newfoundland and Labrador and is also registered in Ontario as a mutual fund dealer. The head office of the Filer is in Toronto, Ontario.
3. The Filer is not in default of the securities legislation in any of the Jurisdictions.
The FT Funds
4. The Fund is an actively managed exchange-traded open-ended mutual fund governed by the laws of the province of Ontario.
5. The U.S. Underlying ETF is an actively managed exchange-traded fund subject to the U.S. Investment Company Act of 1940 (the Investment Company Act) and is an "investment fund" within the meaning of applicable Canadian securities legislation.
6. First Trust Advisors L.P. (FTA), an affiliate of the Filer, acts as the portfolio advisor for each FT Fund. FTA is registered under the Securities Act (Ontario) as a portfolio manager and is also registered with the U.S. Securities and Exchange Commission (the SEC) under the U.S. Investment Advisers Act of 1940.
7. The investment objective of the Fund is to provide its unitholders with a high level of current income by investing primarily in a diversified portfolio of Senior Loans (as defined below) and debt securities with capital appreciation as a secondary objective.
8. The primary investment objective of the U.S. Underlying ETF is to provide high current income and its secondary investment objective is preservation of capital.
9. Each FT Fund seeks to achieve its investment objectives by investing in a diversified portfolio of Senior Loans which are generally rated at or below BB+ by Standard & Poor's, or Bal or less by Moody's Investor Services, Inc. or a similar rating by a designated credit rating organization (as defined in NI 81-102) and debt securities.
10. Under normal market conditions, each FT Fund will invest at least 80% of its net asset value (NAV) in Senior Loans.
11. Each FT Fund seeks to achieve its investment objectives by investing at least 80% of its NAV in Senior Loans (as described below under the subheading "Senior Loans") which meet the liquidity thresholds of the Primary Index (as defined below) and/or Secondary Index (as defined below) at the time of investment.
12. Each FT Fund may also invest up to 20% of its NAV in (a) non-Senior Loan debt securities, which may be fixed-rate or floating-rate income-producing securities, (b) warrants, U.S. and non-U.S. equity and equity-like positions and interests and/or (c) securities of other investment funds or investment companies. In addition, the U.S. Underlying ETF may invest up to 15% of its net assets in Senior Loans and/or other floating rate loans that are distressed or in default.
13. The Fund generally seeks to hedge substantially all of its U.S. dollar currency exposure back to the Canadian dollar.
14. Each FT Fund may depart from its principal investment strategies and invest part or all of its assets in cash or cash equivalents for defensive purposes and during periods of high cash inflows or outflows.
15. The portfolio managers at FTA responsible for overseeing each FT Fund's portfolio and investments are the same.
16. FTA seeks to invest in Senior Loans for the Fund in the same manner as the U.S. Underlying ETF.
17. The Fund distributes its securities pursuant to a long form prospectus prepared pursuant to National Instrument 41-101 General Prospectus Requirements (NI 41-101) and Form 41-101F2 Information Required in an Investment Fund Prospectus (Form 41-101F2) and is governed by the applicable provisions of NI 81-102, subject to any exemptions therefrom that have been, or may in the future be, granted by the Canadian securities regulatory authorities.
18. Units of the Fund are listed and traded on the Toronto Stock Exchange (the TSX).
19. The Fund is a reporting issuer in each of the Jurisdictions.
20. The Fund is not in default of the securities legislation in any of the Jurisdictions.
21. Each of FTA and the U.S. Underlying ETF is regulated by the SEC. The regulatory oversight of FTA and the U.S. Underlying ETF by the SEC is functionally equivalent to that of the Filer and the Fund which are both primarily regulated by the OSC
22. The Bank of New York Mellon, a sister company of CIBC Mellon Trust Company, the Fund's custodian, fund accountant and valuation agent, acts as the administrator, custodian and fund accountant and transfer agent for the U.S. Underlying ETF. The Bank of New York Mellon is also the securities lending agent for both the Fund and the U.S. Underlying ETF.
23. The U.S. Underlying ETF's primary performance benchmark is the S&P/LSTA U.S. Leveraged Loan 100 Index (the Primary Index). The Fund's performance benchmark, is the Canadian dollar hedged version of the Primary Index (S&P/LSTA Leveraged Loan 100 Index (CAD-Hedged)).
24. As at April 30, 2020, the total value of the U.S. Underlying ETF was $1.37 billion and the U.S. Underlying ETF held 161 individual positions across 30 industries; the average size of transaction undertaken by the Fund being approximately $7.7 million. As at April 30, 2020, the total value of the Fund was $49 million and the Fund held 114 individual positions across 26 industries; the average size of transaction undertaken by the Fund being approximately $376,000.
25. FTA seeks to invest on behalf of each FT Fund in Senior Loans or other debt of companies possessing some or all of the attributes below which it believes helps generate higher risk-adjusted total returns:
(a) Senior Loans or other debt of companies that have developed strong positions within their respective markets and exhibit the potential to maintain sufficient cash flows and profitability to service their obligations in a range of economic environments;
(b) Senior Loans or other debt of companies that possess advantages in scale, scope, customer loyalty, product pricing or product quality versus their competitors, thereby minimizing business risk and protecting profitability;
(c) Senior Loans or other debt of established companies that have demonstrated a record of profitability and cash flows over several economic cycles; and
(d) Senior Loans or other debt of a target company that has an experienced management team with an established track record of success.
26. FTA seeks to invest on behalf of each FT Fund in a portfolio of Senior Loans or other debt among various borrowers and industries, thereby potentially reducing the risk of a downturn in any one company or industry having a disproportionate impact on the value of the fund.
27. The U.S. Underlying ETF may invest up to 15% of its NAV in securities and other instruments that are, at the time of investment, illiquid (as determined using the SEC's standard applicable to investment companies). The Fund is subject to NI 81-102 which limits the extent to which the Fund may invest in illiquid assets to a similar degree.
28. Each FT Fund has, since its inception, invested sparingly in illiquid assets and FTA makes efforts to avoid the Fund from investing in illiquid assets to the extent possible.
29. Neither FT Fund employs leverage for the purposes of obtaining additional exposure to Senior Loans.
30. The portfolio holdings of the U.S. Underlying ETF are available on the U.S. Underlying ETF's website and are updated on a daily basis.
31. Securities of the U.S. Underlying ETF are offered in their primary market in a manner similar to the Fund pursuant to a prospectus filed with the SEC which discloses material facts, similar to the disclosure requirements under Form 41-101F2.
32. The U.S. Underlying ETF is required to prepare key investor information documents which provide disclosure that is substantially similar to the disclosure required to be included in the ETF facts document required by Form 41-101F4 Information Required in an ETF Facts Document.
33. The U.S. Underlying ETF is subject to continuous disclosure obligations which are substantially similar to the disclosure obligations under National Instrument 81-106 Investment Fund Continuous Disclosure.
34. The U.S. Underlying ETF is required to update information of material significance in its prospectus, to prepare management reports and an unaudited set of financial statements at least semi-annually, and to prepare management reports and an audited set of financial statements annually.
35. FTA is subject to a governance framework which sets out the duty of care and standard of care, which require FTA to act in the best interest of unitholders of the U.S. Underlying ETF.
36. The securities of the U.S. Underlying ETF are listed and traded on the Nasdaq (a recognized exchange in the United States). The listing requirements of the Nasdaq are consistent with the listing requirements of the TSX and NEO Exchange Inc. in Canada.
37. The market for securities of the U.S. Underlying ETF is liquid because it is a large fund with US$1.37 billion in assets (as at April 30, 2020) and is traded on the Nasdaq (i.e. it is more liquid because of its size and its trading volume). In addition, it is supported by authorized participants (who are U.S. broker-dealers) which make the market for the securities of the U.S. Underlying ETF and are incentivized to do so because of the arbitrage opportunities inherent in making such market. Accordingly, the Filer expects the Fund to be able to dispose of its securities of the U.S. Underlying ETF through market facilities in order to raise cash, including to fund the redemption requests of its unitholders from time to time.
38. A first lien senior floating rate loan (a Senior Loan) is an advance or commitment of funds made by one or more banks or similar financial institutions to one or more corporations, partnerships or other business entities and typically pays interest at a floating or adjusting rate that is determined periodically at a designated premium above a base lending rate, most commonly, LIBOR, plus a premium. A Senior Loan is considered senior to all other unsecured claims against the borrower, senior to or equal with all other secured claims, meaning that in the event of a bankruptcy of the borrower the Senior Loan, together with other first lien claims, it is entitled to be the first to be repaid out of proceeds of the assets securing the loans, before other existing unsecured claims or interests receive repayment. However, in bankruptcy proceedings, there may be other claims, such as taxes or additional advances that take precedence.
39. Each FT Fund invests in Senior Loans made predominately to businesses operating in North America but may also invest in Senior Loans made to businesses operating outside of North America.
40. Each FT Fund may invest in Senior Loans directly, either from the borrower as part of a primary issuance or in the secondary market through assignments of portions of Senior Loans from third parties, or participations in Senior Loans, which are contractual relationships with an existing lender in a loan facility whereby the U.S. Underlying ETF purchases the right to receive principal and interest payments on a loan but the existing lender remains the recordholder of the loan.
41. When identifying prospective investment opportunities in Senior Loans for the FT Funds, FTA invests primarily in Senior Loans that are below investment grade quality at the time of investment, and relies on fundamental credit analysis in an effort to attempt to minimize the loss of each FT Fund's capital and to select assets that provide attractive relative value. Each FT Fund may also invest in unrated securities deemed by the investment advisor to be of comparable quality to those securities rated below investment grade. Each FT Fund may invest in securities of any rating. Securities rated below investment grade, commonly referred to as "junk" or "high yield" securities, include securities that are rated Ba1/BB+/BB+ or below by Moody's Investors Service, Inc., Fitch Inc., or Standard & Poor's, Inc., respectively.
42. The size of the leveraged loan market in the U.S. is currently around US$1.2 trillion. FTA believes that Senior Loans are an important and desirable asset class for investors given the asset's unique combination of relatively high yield potential and low duration and given that historically, Senior Loans have resulted in higher recovery rates than high yield bonds and higher long-term risk-adjusted returns than other major fixed income asset classes.
43. The Filer submits that Senior Loans typically have low historical correlation to other asset classes and accordingly, they provide investors with the opportunity to diversify their investment portfolio.
44. In order to get exposure to a Senior Loan, each FT Fund invests in "tranches". A "tranche" is a tradeable portion of debt within a Syndicated Loan. A "Syndicated Loan" is a commercial loan provided by a group of lenders which is structured, arranged and administered by one or more commercial or investment banks known as "arrangers". Tranches within a Syndicated Loan may have different risk and reward profiles (i.e. maturity, level of risk and yields or interest rates).
45. Given the size of the U.S. Underlying ETF, it is able to invest in a greater number of tranches of different Syndicated Loans whereas the Fund, given that it has significantly less assets than the U.S. Underlying ETF, invests in fewer tranches resulting in less diversification within its portfolio. In addition, because of its size, the U.S. Underlying ETF can purchase, hold and sell round lots of Syndicated Loans (i.e. loan participations of US$1 million or more) ("Round Lots") which are typically more liquid and more easily valued than odd lots of Syndicated Loans (i.e. loan participations of less than US$1 million) ("Odd Lots"). Generally, smaller Odd Lot positions are harder and more expensive to trade than Round Lots.
46. Given the benefits that the Fund can achieve by obtaining exposure to Senior Loans through direct investment in the U.S. Underlying ETF (being diversification, liquidity, access to greater tranche Senior Loan exposure and the ability to buy Round Lots), the Fund would like to invest up to 100% of its net assets in the U.S. Underlying ETF.
Reasons for Exemption Sought
47. Absent the Exemption Sought, an investment by the Fund of up to 100% of its NAV in securities of the U.S. Underlying ETF would be prohibited by:
(a) subsection 2.1(1) of NI 81-102 because more than 10% of the Fund's NAV would be invested in securities of the U.S. Underlying ETF;
(b) paragraph 2.5(2)(a) of NI 81-102 because the U.S. Underlying ETF is not subject to NI 81-102; and
(c) paragraph 2.5(2)(c) of NI 81-102 because the U.S. Underlying ETF is not a reporting issuer in a Jurisdiction.
48. An investment by the Fund in the U.S. Underlying ETF would not qualify for the exception in (a) subsection 2.1(2) or (b) paragraph 2.5(3)(a) of NI 81-102 because the securities of the U.S. Underlying ETF are not index participation units.
49. The Fund's investment objectives and investment strategies seek to provide its unitholders with exposure to a diversified portfolio of Senior Loans. The Filer submits that having the ability to invest up to 100% of the Fund's NAV in securities of the U.S. Underlying ETF will provide the Fund with access to investment opportunities that the Fund is currently unable to access due to its size, which will in turn allow the Fund to maintain a much more diversified portfolio.
50. The Filer believes that an investment in securities of the U.S. Underlying ETF by the Fund is an efficient and cost effective alternative to investing in Senior Loans directly.
51. The investment objectives, investment strategies, investment restrictions and risk factors applicable to the Fund and the U.S. Underlying ETF are substantially the same. The Fund is essentially the Canadian version of the U.S. Underlying ETF and is managed by affiliates and advised by the same portfolio advisor and portfolio management team. Accordingly, as FTA is the portfolio advisor for both funds, the Filer is in a position to ensure that the requirements of NI 81-102 are complied with.
52. The only material difference in the investment strategies utilized by the Fund and the U.S. Underlying ETF is that the Fund seeks to hedge substantially all of its U.S. dollar currency exposure back to the Canadian dollar.
53. The Fund will not pay any management or incentive fees in connection with an investment in securities of the U.S. Underlying ETF which to a reasonable person would duplicate a fee payable by the U.S. Underlying ETF for the same service.
54. Given the benefits that the Fund can achieve by obtaining exposure to Senior Loans through direct investment in the U.S. Underlying ETF (being diversification, liquidity, access to greater tranche Senior Loan exposure and the ability to buy Round Lots), the Fund would like to invest up to 100% of its net assets in the U.S. Underlying ETF.
55. Any risks associated with an investment in securities of the U.S. Underlying ETF are mitigated by the fact that:
(a) the U.S. Underlying ETF will be subject to the Investment Company Act and FTA oversight of the SEC and
(b) the U.S. Underlying ETF will comply with sections 2.1 (concentration restriction), 2.2 (control restrictions), 2.3 (restrictions concerning types of assets), 2.4 (restrictions concerning illiquid assets), 2.6 (restrictions on borrowing and other investment practices) and 2.6(1) (restrictions regarding short sales) of NI 81-102.
56. The amount of loss that could result from an investment by the Fund in securities of the U.S. Underlying ETF will be limited to the amount invested by the Fund in the U.S. Underlying ETF.
57. An investment by the Fund in securities of the U.S. Underlying ETF represents, or will represent, the business judgement of responsible persons uninfluenced by considerations other than the best interests of the Fund.
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 Exemption Sought is granted, provided that:
(a) the investment by the Fund in securities of the U.S. Underlying ETF is in accordance with the investment objectives of the Fund;
(b) the U.S. Underlying ETF is an investment company subject to the Investment Company Act in good standing with the SEC;
(c) the portfolio manager of each FT Fund is FTA, or its successor, that is: (i) registered under the Securities Act (Ontario) as a portfolio manager and (ii) registered with the SEC under the U.S. Investment Advisers Act of 1940;
(d) the U.S. Underlying ETF will not, at the time securities of the U.S. Underlying ETF are acquired by the Fund, hold more than 10% of its NAV in securities of any other mutual fund other than securities of a money market fund or a mutual fund that issues index participation units;
(e) the aggregate amount of all borrowings of the U.S. Underlying ETF does not exceed 10% of its NAV at the time of borrowing; and
(f) the prospectus of the Fund will disclose in the next renewal of its prospectus following the date of this decision, in the investment strategy section, the fact that the Fund has obtained the Exemption Sought to permit investments in the U.S. Underlying ETF on the terms described in this decision.
Manager, Investment Funds and Structured Products Branch
Ontario Securities Commission