On September 14, staff of the Compliance and Registrant Regulation (CRR) Branch at the Ontario Securities Commission (OSC) published their Annual Summary Report for Dealers, Advisers and Investment Fund Managers (Report). The OSC encourages registrants to use the Report to learn more about recent and proposed regulatory initiatives, the OSC’s expectations for registrants, and how staff interpret initial and ongoing requirements for registration and compliance. Although we hope you find our takeaways from the Report useful, the discussion below doesn’t replace the Report or consultation with your counsel about the Report’s implications for your business.
A. Focus Areas for 2020-21 Compliance Reviews
Staff expect their upcoming compliance reviews to prioritize the following areas:
COVID-19 impact on registrants;
Suitability assessments, including concentration;
Review of some firms to confirm their level of operational activities; and
Marketing practices, including environmental, social and governance (ESG) offerings.
During the Portfolio Management Association of Canada’s Fall Regulatory and Compliance Webcast on September 24, a CRR staff member indicated that they expect the marketing practices sweep to begin shortly, either in late October or in November.
AUM Law’s focused and general compliance risk assessments can save you time and money by enabling you to pro-actively identify and address issues before they flare up into problems or you are audited by the OSC. But if the OSC calls you for an audit before you call us, we can conduct a strategic and expedited “911” review, so that you can begin identifying and addressing any material issues and are better-positioned to make a good first impression with OSC staff in the initial meeting. Contact us to learn more about these services.
B. Spotlight on Compliance Deficiencies
In 2019-20, CRR staff conducted compliance reviews in the following areas, among others:
A suitability sweep of exempt market dealers (EMDs) and portfolio managers (PMs);
High-risk firms identified through the 2018 Risk Assessment Questionnaire (RAQ) or the “Registration as a First Compliance Review Program”;
Desk reviews of firms reporting financial statement losses in their 2017 and 2018 audited annual financial statements;
Desk reviews of U.S.-based firms relying on the international dealer, international adviser, and/or non-resident investment fund manager registration exemptions (International Exemptions Review);
Investment fund managers (IFMs) that had recently acquired or purchased assets of another IFM; and
IFMs that are members of a self-regulatory organization (SRO).
As usual, the Report includes aggregate data on the type and severity of compliance deficiencies identified during last year’s reviews. The largest number of deficiencies related to compliance systems (40%, up 2% from 2018-19), and there was a tie for second place. Know-your-client (KYC), know-your-product (KYP) and suitability matters tied with client reporting matters, with each category representing 13% of deficiencies identified during the past year’s reviews. The largest number of significant deficiencies in 2019-20 concerned compliance systems (9%), KYC/KYP/suitability (8%), and conflicts of interest/referral arrangements (7%).
As they have in the past few years, staff organized their discussion of compliance deficiencies by theme. Below, we have highlighted topics that we think will be of particular interest to our readers.
1) Compliance Function
Some Annual Compliance Reports Got “Needs Improvement” Grades: Staff noted that chief compliance officers (CCOs) at some firms failed to prepare annual compliance reports, as required by section 5.2 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) or prepared cursory reports that didn’t contain enough detail to support the CCO’s assessment of the firm’s compliance function and/or the firm’s and employees’ compliance with securities legislation.
Service Provider Oversight: CRR staff are continuing to see situations where IFMs are performing little to no oversight of their outsourced fund administration and portfolio functions, or of their custodian. Common deficiencies included failures to:
Obtain and evaluate a Service Organization Controls (SOC) report, when one was available from the service provider;
Document and maintain evidence of the specific monitoring activities performed;
Periodically validate the accuracy of prices used by the service provider in portfolio valuation; and
Review material and complex corporate actions to confirm they were accurately processed and recorded by the service provider.
The good news is that, in this year’s suitability sweep, CRR staff generally saw improvements in firms’ KYC and suitability processes, compared with prior years’ reviews. However, they are continuing to see deficiencies in some areas, including:
Inadequate collection and documentation of up-to-date KYC information;
Inadequate documentation of suitability assessments (e.g. failure to document how a product that did not align with the client’s investment objectives nevertheless was suitable when other components of a client’s profile were considered);
Managed accounts with portfolios that didn’t align with the client’s target asset mix reflected in their KYC documentation;
Clients over-concentrated in a single issuer/issuer group or industry/asset class;
Advisers and dealers not considering a clients’ total holdings of illiquid securities when assessing concentration risk;
Inappropriate use of client-directed trade instructions (e.g. firms requesting such an instruction instead of conducting a suitability assessment first);
Non-compliance with investment limits under the offering memorandum (OM) prospectus exemption;
Inadequate documentation to support the determination that investors qualified as “accredited investors”; and/or
Relying on third parties to collect KYC information for some clients without an advising representative (AR) or dealing representative (DR) of the firm meeting or speaking with such clients directly.
KYC and suitability obligations remain an area of ongoing concern for securities regulators. AUM Law can conduct a focused review of your client-facing documentation, policies and procedures and then help your firm can make any changes needed to comply with existing laws and implement the changes required by the client-focused reforms (CFRs) by the December 31, 2021 deadline. Please contact us to discuss how we can help.
3) NOT Now – Internal Firm Suspensions Require a Notice of Termination (All)
A firm that internally suspends a registered or permitted individual must file a Notice of Termination (NOT), so that the regulators and the public (through the NRD database). Firms that do not file a NOT, as required, run the risk of being held responsible for any registerable activity the individual conducts, even while under a firm-imposed suspension.
Staff indicated in the Report that some firms have been reluctant to file a NOT due to concerns that having the individual reinstated will be time-consuming. To address that concern and encourage firms to file NOTs as required, CRR staff have committed to a streamlined review process for assessing an individual’s suitability for registration after a firm-imposed suspension. In particular, CRR staff will permit firms to file Form 33-109F7 Reinstatement of Registered Individuals and Permitted Individuals (instead of Form 33-109F4) and will not require a new application fee, if certain criteria are met, including the following:
The firm notifies staff in advance of the issue that led to the suspension;
Staff is satisfied with the remedial actions that the firm has indicated it will take;
The firm files a timely NOT;
The firm notifies staff at least five business days in advance of its intention to reinstate the individual;
There is no new detrimental information from the time the NOT was submitted; and
There are no changes to information previously submitted in items 13 through 16 of Form 33-109F4.
AUM Law can advise you on, prepare and complete registration-related filings such as NOTs, as required. Please contact us if you have questions about or need assistance with matters like these.
4) Cross-Jurisdictional Registration Issues
Servicing Non-Ontario Clients without Required Registration (PMs / EMDs): According to the Report, Staff continue to see firms and representatives who do not have the required registrations in the relevant jurisdictions to trade in, or advise on, securities for clients outside Ontario. For example, some firms and/or their representatives are purporting to rely on the client mobility exemptions for Canadian clients without satisfying the criteria for those exemptions. Staff encourage firms to, among other things:
Take an inventory of the residency of the firm’s existing clients;
If the firm determines that any of its clients are located in jurisdictions where the firm and/or its registered individuals are not registered and do not have a valid exemption to rely upon, take immediate steps to come into compliance or discontinue the offering of any advisory or dealing services to the relevant clients;
Train employees on the limitations of conducting dealing or advising activities in other jurisdictions;
If applicable, take adequate steps to confirm that all requirements to rely upon the client mobility exemption are met (including verifying that the individual and firm do not exceed the allowable number of eligible clients in each jurisdiction and submitting Form 31-103F3 Use of Mobility Exemption to the regulator in the relevant jurisdiction); and
Maintain adequate records for all of the above.
International Firms with Canadian Clients (EMDs / IFMs / PMs): During its International Exemptions Review, staff found that some firms had not filed up-to-date forms with the OSC to properly rely on the exemption and/or did not always provide clients with the required disclosure (or maintain evidence that the disclosure was provided). In addition, some international advisers had not maintained sufficient evidence to demonstrate that the advice being provided to Canadian clients with respect to Canadian securities was incidental to the advice being provided on foreign securities. Also, CRR staff noted that some firms, who were providing advisory services to permitted clients registered as advisers in Canada, were improperly purporting to rely on the international adviser exemption in section 8.26 of NI 31-103, instead of complying with the exemption criteria for international sub-advisers in section 8.26.1.
Please do not hesitate to contact us if you need advice or assistance regarding the application of Canadian registrant regulation requirements to your cross-border activities.
5) Distribution of a Registered Firm’s Own Shares (EMDs / PMs)
The Report discusses two compliance issues arising from situations where registered firms distribute their own shares to investors. First, staff reiterated that, even where the firm is relying upon a prospectus exemption to effect the distribution, the firm still must comply with its registrant obligations (e.g. relating to KYC and suitability) in connection with the distribution.
Second, staff emphasized that when firms distribute their own shares to existing and prospective clients, the resulting relationship is one that presents the highest degree of conflict of interest recognized by National Instrument 33-105CP Underwriting Conflicts (NI 33-105). In such situations, it is unclear if the firm is acting in the capacity of an issuer or, as a registered firm, by advising or recommending an investment in the firm’s shares to its existing clients (either as a PM through a managed account or as an EMD). In addition, this business model could create the perception that investors who are clients might be favoured over non-investor clients (e.g. with respect to access to proprietary information or the allocation of investment opportunities). The Report outlines steps that firms can take to respond to this conflict. Among other things, staff recommend that firms:
Disclose and explain the conflict to potential investors and obtain an appropriate acknowledgement from them;
Disclose all risk factors relating to the investment in the firm;
Advise potential investors to seek independent advice regarding the investment and provide all information needed for such advice; and
Develop and implement appropriate policies and procedures to, among other things:
Identify and address all related conflicts of interest;
Address the fair allocation of investment opportunities among clients; and
Prohibit sharing of the registered firm’s business information with shareholders of the firm that are also clients, in a manner that might prejudice other clients.
6) Captive Dealers (EMDs)
Staff reminded EMD-only firms that distribute securities of a related or connected issuer with common mind and management (Captive Dealers) that they must adequately respond to the material conflicts that arise in this business model. The EMD’s financial incentives to sell its related or connected issuer’s securities may come into conflict with its regulatory obligations, such as those concerning suitability and fair dealing. Staff recommend that Captive Dealers, among other things, to assign a responsible individual, such as the CCO or ultimate designated person (UDP), who has not been directly involved with the trade in question, to confirm that investors understand:
The relationship between the Captive Dealer and the related or connected issuer;
The investment’s key features; and
The concentration risks associated with investing in a limited number of related or connected issuers.
Staff also encourage Captive Dealers to ensure that the relevant employees have been trained to explain the nature of the material conflicts of interest inherent in the business model and the importance of avoiding, managing and/or disclosing them and understand their KYC, KYP and suitability obligations.
7) Financial Conflicts of Interest (All)
Staff identified certain financial conflict of interest situations such as the payment of consulting fees or placement fees to registered firms by companies that the firms’ funds or managed accounts invested in and where the conflict of disclosure to clients was non-existent or inadequate. According to staff, if a registered firm is paid by issuers of securities that it recommends to its clients, it should:
Structurally segregate its corporate finance business from its advisory business and implement internal information barriers;
Enhance its monitoring controls over clients’ suitability assessments;
Fully disclose the issuer relationships and compensation arrangements in offering documents and account opening documents;
Disclose all conflicts of interest in the relationship disclosure information (RDI) required by section 14.2 of NI 31-103;
Provide clear and meaningful disclosure in plain language about the nature and impact of each conflict; and
Obtain the client’s written acknowledgment that they understand the nature and impact of each disclosed financial conflict of interest before selling the product or service to them.
8) Inappropriate Reliance on Custodian to Satisfy Account Statement Delivery Obligations (PMs)
Staff reminded PMs that they cannot meet their statement delivery obligations by relying solely upon their custodian to deliver position and transactional information to clients. If a PM has entered into a service arrangement with a dealer member (DM) of the Investment Industry Regulatory Organization of Canada (IIROC), the PM can satisfy its obligation to deliver statements to a client if that client’s DM, acting as custodian, sends a DM statement to the client, provided that the PM:
Does not hold any of the investments it manages for the client;
Verifies that the investments it manages for the client are held in a separate account for the client where the DM knows the client’s name and address;
Discloses the service arrangement to the client in accordance as called for by Section 3 of CSA Staff Notice 31-347 Guidance for Portfolio Managers for Service Arrangements with IIROC Dealer Members;
Confirms that for each of the client’s accounts at the DM, a DM statement is delivered to client at the required frequency with the required content;
Takes reasonable steps to verify that the DM statements are complete and accurate;
Complies with client requests or agreements to receive PM statements from the PM, supplemental to the DM statement; and
Verifies that the market value data it uses to prepare the client’s annual investment performance report is consistent with the data in the relevant DM statement delivered to the client.
Staff also note that PMs should maintain their own records of clients’ investment positions and trades, including evidence to support reconciliations between their records and the DM’s statements and establish policies and procedures to verify that DM statements are complete, accurate and delivered on a timely basis.
9) Trade Confirmations for Managed Accounts (PM / EMD)
The Report addresses a frequently asked question about whether a firm registered as an EMD, IFM and PM must send trade confirmations to its managed account clients for each purchase or sale of a security of a proprietary fund where the firm also acted as the registered dealer for the trade. According to staff, since the firm is already subject to obligations as a PM when it purchases the security on behalf of the managed account, there are no additional obligations that apply if it conducts the trades through its dealer registration. Provided that the managed account client consented not to receive trade confirmations for each transaction in the account, staff would not expect the firm to provide real time trade confirmations.
10) Other Deficiencies
We’ve briefly summarized below some additional staff recommendations and commentary that we think our readers may find relevant.
Custodial and Prime Brokerage Agreements (IFMs): CRR staff reminded IFMs that they need to have written agreements in place between the prospectus-exempt funds managed by them and the funds’ custodian and/or prime broker.
Funds Purchasing Securities from “Responsible Persons” (IFMs / PMs): According to staff, some registered advisers have been selling securities owned by the adviser’s firm to an investment fund managed by the adviser, contrary to the prohibition in paragraph 13.5(2)(b) of NI 31-103 on advisers knowingly causing investment funds they manage to purchase securities from a “responsible person”. Staff emphasized that firms should have policies, procedures and pre-trade controls to identify prohibited transactions like these and prevent them from occurring.
Impact of IFRS 16 on Working Capital (All): Some firms are not applying IFRS 16 Leases correctly, or at all, which has resulted in some firms incorrectly calculating their excess working capital balances. In some cases, this resulted in the firm being capital-deficient.
Insurance Coverage (All): Firms should check that their coverage is adequate, that bonding policies provide for a double aggregate limit or full reinstatement of coverage, that claims of other entities covered under a global policy do not reduce limits or coverage available to the registered firm, and that the registered firm should have the right to claim directly against the insurer for losses under a global policy.
Personal Trading (All): CRR staff are continuing to see deficiencies in firms’ personal trading policies and procedures. Identified deficiencies included inadequate policies and procedures, failures to enforce the firm’s policy, failing to maintain complete information on the person trading accounts of all “Access Persons”, and failing to require written pre-approval of Access Persons’ trades.
C. Regulatory Actions – Conduct Concerns During the Registration Process
The Report also includes data on CRR regulatory actions, including data comparing the different kinds of regulatory actions taken in the past five fiscal years. In addition to providing an overview of all regulatory actions concerning registrants, this year the Report highlights CRR staff’s approach to handling conduct concerns that arise during the registration process.
CSA Guidance Has Helped: Staff discussed the decrease since fiscal 2018 in the number of regulatory actions involving denial of registration. They believe that the 2017 publication by the Canadian Securities Administrators (CSA) of Staff Notice 33-320 The Requirement for True and Complete Applications for Registration (SN 33-320) has provided helpful guidance to firms conducting due diligence on the individuals they’re sponsoring and deterred some non-disclosure by registrants. Staff have also been conducting early-stage conference calls with firms where concerns have been identified, which has led to firms reviewing and, in seventeen cases in fiscal 2020, withdrawing applications that otherwise might have resulted in denial of registration.
Non-Disclosure in Registration Applications Is Still a Problem. Nevertheless, CRR staff are continuing to identify material non-disclosure of regulatory, criminal and/or financial information in registration applications, and this concern still constitutes a substantial number of the cases reviewed by CRR where registration is ultimately denied.
How Staff Handle Conduct Concerns in Registration Process: The Report includes a flow chart outlining the typical process CRR staff follow if a Registration Team refers a matter to the Registrant Conduct Team for investigation. According to the flow chart:
CRR management will share their initial regulatory concerns with the firm.
The Registrant Conduct Team will take steps that may include interviewing third parties who may have relevant information, as well as the individual applicant.
If the Registrant Conduct Team recommends that an application be granted subject to terms and conditions or that the application be refused, the applicant will be given an opportunity to be heard (OTBH), except in the rare situation where the matter is referred to the OSC’s Enforcement Branch.
Before an OTBH commences, the applicant can accept the proposed terms and conditions if the sponsoring firm agrees. If the OTBH goes forward, the Director of CRR will make a decision and give written reasons. If the Director refuses the application or grants it subject to terms and conditions, the applicant can ask an OSC panel to review the Director’s decision.
AUM Law has extensive experience helping firms get their employees prepare a strong application package and engage with regulators should any challenging situations arise. Please contact us to discuss how we can help.
D. Policy Initiatives
As usual, the Report summarizes certain policy initiatives affecting registrants and provides links to the relevant publications. This year, the Report covers:
Burden reduction initiatives (see our bulletin article here);
A status update on the client-focused reforms (see our bulletin article here and our recently updated publication In a Nutshell: Implementing the Client-Focused Reforms);
On September 17, the Canadian Securities Administrators (CSA) published for comment proposed changes to the offering memorandum (OM) prospectus exemption (OM Exemption) in National Instrument 45-106 Prospectus Exemptions (NI 45-106) and related guidance in Companion Policy 45-106CP (Proposed Amendments). The principal changes introduce new disclosure requirements for issuers engaged in real estate activities and issuers that are collective investment vehicles.
A. New Requirements for Issuers with Real Estate Activities
“Real estate activities” are defined, subject to certain exceptions, as “an undertaking, the purpose of which is primarily to generate for security holders income or gain from the lease, sale or other disposition of real property.” Activities relating to mineral, oil and gas projects are excluded from the definition, as are distributions in Québec of certain products that provide a real right of ownership in an immovable or give the holder of a security a right of exclusive use of a residential unit and space in an immovable owned by the security’s issuer.
Independent Appraisal: Issuers that engage in real estate activities and wish to rely on the OM Exemption will have to provide to the purchaser and file with the relevant securities regulatory authorities an independent appraisal of any interest in real property if:
The issuer has acquired or proposes to acquire an interest in real property from a related party (as that term is defined in NI 45-106);
A value for an interest in real property is disclosed in the offering memorandum (OM); and/or
The issuer intends to spend a material amount of the proceeds from the offering on an interest in real property.
New Disclosure Schedule: Subject to the de minimis exemption noted below, issuers engaging in real estate activities also will have to complete new Schedule 1 Additional Disclosure Requirements for an Issuer Engaged in Real Estate Activities to Form 45-106F2:
Issuers that develop real property will have to provide detailed disclosure about the project, such as descriptions of milestones and required permissions/approvals.
Issuers that own and operate real property will have to provide detailed disclosure about matters such as the property’s age, condition and occupancy level.
All issuers engaged in real estate activities will have to disclose the purchase and sale history of any of the issuer’s real property involving a related party.
All issuers engaged in real estate activities will have to disclose penalties, sanctions, criminal or quasi-criminal proceedings, and/or bankruptcy or insolvency proceedings for parties such as the developer.
De Minimis Exemption: The disclosure requirements in Schedule 1 will not apply to an interest in real property, or more than one interest in real property taken together, that when considered in relation to all interests in real property held by the issuer, is not significant enough to influence a decision by a reasonable investor to buy, hold or sell a security of the issuer.
B. New Requirements for Collective Investment Vehicles
“Collective Investment Vehicle” is defined very broadly in the Proposed Amendments to mean an issuer whose primary purpose is to invest money provided by its security holders in a portfolio of securities. This definition will include issuers that hold portfolios of mortgages, other loans, or receivables. Also, the definition will include investment funds, to the extent they are permitted to use the OM Exemption.
New Disclosure Schedule: New Schedule 2 Additional Disclosure Requirements for an Issuer That is a Collective Investment Vehicle to Form 45-106F2 will require such issuers to disclose, among other things:
The issuer’s investment objectives;
Detailed information about the portfolio;
Information about the portfolio’s performance; and
Penalties, sanctions, criminal or quasi-criminal proceedings, and/or bankruptcy or insolvency proceedings for persons involved in the selection and management of the investments.
C. Other Amendments
The Proposed Amendments also include some general amendments, which are meant to clarify or streamline parts of NI 45-106 or improve disclosure for investors. For example, to make reading and reviewing OMs more efficient, the filed copy will have to be formatted so that words can be search electronically.
Form 45-106F2 Offering Memorandum for Non-Qualifying Issuers (Form 45-106F2) will be revised to include new cover page disclosure items, such as working capital deficiencies, payments to related parties, payments to finders and sellers, restrictions on redemption and retraction rights, and insufficiency of funds to accomplish the proposed objectives. Other changes to Form 45-106F2 include:
Enhanced disclosure if a material amount of the offering proceeds will be transferred to another issuer that is not one of the issuer’s subsidiaries;
Disclosure of purchase and/or sale histories of the issuer’s business or assets (other than real estate) involving a related party;
The addition of related parties that receive compensation to the compensation disclosure and securities ownership table;
Requirements to disclose criminal and quasi-criminal convictions;
Additional disclosure regarding fees or limitations on redemption or retraction rights;
More disclosure regarding redemption and retraction activities, including requests made to or fulfilled by the issuer, including the price paid, source of funds, and outstanding requests;
Disclosure of the source of funds for dividends or distributions paid that exceed cash flow from operations; and
Cautionary disclosure where expert reports, statements or opinions are included in an OM and the expert is not subject to statutory liability.
Interim Financial Reports for Ongoing Distributions: OMs will have to be amended to include an interim financial report for the most recently completed 6-month interim period when a distribution of securities under an OM is ongoing.
Form 45-106F4 Risk Acknowledgement (Form 45-106F4) will be amended, with the intention of making the form more understandable and useful to investors and to align the form with risk acknowledgment forms required with other prospectus exemptions.
Related Local Amendments Are Contemplated in Certain Jurisdictions. For example, the Alberta and British Columbia Securities Commissions expect to repeal local rules that require additional disclosure in OMs that relate to real estate projects. These local matters are disclosed, jurisdiction by jurisdiction, in Annex E of the version of the Notice of Proposed Amendments published in that jurisdiction. In Ontario, no local amendments are contemplated but the Ontario Securities Commission has included an Ontario-specific regulatory impact analysis in Annex E of the Notice published in Ontario.
D. Our Takeaways
The Proposed Amendments will make it more cumbersome for issuers with real estate activities or that are collective investment vehicles (including mortgage investment entities) to use the OM Exemption. The deadline for comments is December 16, 2020. If you have questions or would like to discuss how the Proposed Amendments might affect your business, please contact us.
On September 17, the Canadian Securities Administrators (CSA) published final rule amendments (Amendments) to National Instrument 81-105 Mutual Fund Sales Practices (NI 81-105) and certain other instruments to prohibit:
The payment of trailing commissions by members of the organization of any publicly offered mutual fund (Fund Organizations) to participating dealers who do not make a suitability determination in connection with the client’s purchase and ownership of prospectus-qualified mutual fund securities (Payment Ban); and
The solicitation or acceptance of trailing commissions by participating dealers from Fund Organizations in connection with the securities of a mutual fund held in the account of a client of a participating dealer if that dealer wasn’t required to make a suitability determination in respect of that client for those securities (Dealer Ban and, collectively with the Payment Ban, the Trailing Commission Bans).
The Trailing Commission Bans are expected to take effect on June 1, 2022 (Effective Date), which is also when the ban on deferred sales charges (DSCs) for investment funds (DSC Ban) is expected to take effect in all Canadian jurisdictions except Ontario (Participating Jurisdictions). Unlike the DSC Ban, which will apply only in the Participating Jurisdictions, the Trailing Commission Ban will take effect across Canada.
Changes to the Final Rules: In response to comments received on its September 2018 proposals (2018 Proposals), the CSA made a number of changes that it considers “non-material” to the final rule amendments, including the following:
What’s a Suitability Determination? A definition of “suitability determination” has been added to NI 81-105 to specify where a suitability determination is required under securities legislation and/or the rules and policies of self-regulatory organizations (SROs).
Ban on Dealers Clarified: In the 2018 Proposals, the prohibition on participating dealers accepting or soliciting certain types of trailing commissions came about indirectly through existing subsection 2.2(2) of NI 81-105, which permits a participating dealer to solicit and accept certain payments, benefits and reimbursements from a mutual fund organization if that organization is permitted to provide the payments or benefits. The Amendments make this prohibition explicit in new subsection 2.2(3).
Knowledge Qualifier Added to Payment Ban: In response to the 2018 Proposals, some Fund Organizations stated that they sometimes do not know whether a suitability determination is required to be made in connection with a mutual fund purchase, for example because they use the same dealer code for multiple affiliated dealers, including full-service and order execution only (OEO) dealers. To address this situation, the Payment Ban in subsection 3.2(4) of NI 81-105 has been amended to clarify that it applies only if the Fund Organization knows or ought reasonably to know that the participating dealer is not required to make a suitability determination.
Exemptions from Fund Facts and ETF Facts Delivery Requirements Added: National Instrument 41-101 Prospectus Requirements has been amended to exempt switches from a trailing commission-paying series or class of a mutual fund to a no-trailing commission series or class of the same fund in client accounts administered by dealers who are not required to make a suitability determination (Switch Exemptions).
Transitional Impacts: The notice accompanying the Amendments summarizes the potential impacts of the Trailing Commission Bans and outlines options for Fund Organizations and affected dealers to consider.
DSC Holdings: As of the Effective Date, dealers who are not required to make a suitability determination may not accept trailing commissions for mutual fund securities purchased under the DSC option (DSC Holdings).
As of the Effective Date, mutual fund securities subject to trailing commissions and not purchased under the DSC option must be switched to a no-trailing commission series or class of the same mutual fund, if the dealer who administers the client account was not required to make a suitability determination. If, however, the mutual fund does not have a no-trailing commission series or class, then other alternatives should be considered, such as transferring the holdings to a dealer required to make a suitability determination.
Pre-authorized purchase plans that provide for the purchase of mutual fund securities subject to trailing commissions payable to dealers not required to make a suitability determination will have to be amended to switch over to the purchase of no-trailing commission mutual funds.
Transfers from full-service to OEO accounts: The CSA expects OEO dealers to inform investors at or before the time of a proposed transfer of accounts that they cannot accept transfers of trailing commission-paying mutual fund securities, including DSC Holdings, into OEO accounts. The CSA also noted that DSC Holdings, which pay trailing fees and are subject to early redemption fees, should not be transferred to OEO dealers after the Effective Date.
Deadlines: The CSA expects the definition of “suitability determination” and the Switch Exemptions to take effect on December 31, 2020. The Trailing Commission Bans and other amendments are expected to take effect on June 1, 2022.
On September 18, the Canadian Securities Administrators (CSA) published Staff Notice 81-333 Guidance on Effective Liquidity Risk Management for Investment Funds (Guidance) to help funds develop and maintain an effective liquidity risk management (LRM) framework. The Guidance is intended primarily for investment funds subject to National Instrument 81-102 Investment Funds (NI 81-102), but the CSA believes the practices and examples discussed in the Guidance may be relevant to other funds as well.
The Guidance summarizes key international regulatory developments in this area and the applicable Canadian securities framework. Under Canadian securities legislation, IFMs must establish and maintain an effective LRM framework and exercise due care, skill and diligence in managing the liquidity of their funds.
The Guidance discusses five key elements of an effective LRM framework:
Strong and effective governance;
Creation and ongoing maintenance of effective LRM processes;
Stress testing (which is not specifically required under Canadian securities regulation but is encouraged);
Disclosure of liquidity risks; and
Use of LRM tools to manage potential and actual liquidity issues.
The Guidance also sets out six principles (LRM Principles) and related implementation strategies for investment funds to consider in connection with their creation and maintenance of effective LRM processes:
At the design stage and on an ongoing basis, align the fund’s investment objectives, strategy, and redemption policy with the liquidity profile of the fund’s underlying portfolio assets and the redemption demands of the investor base.
Create and adhere to robust policies and procedures that integrate LRM considerations.
Perform active, ongoing portfolio monitoring using qualitative and quantitative metrics to ensure adequate levels of liquidity exist to meet redemption needs and other obligations. All relevant data should be used to actively manage liquidity risks.
Set internal liquidity thresholds and targets that management of the fund can use to assess the liquidity profile of a fund and make any necessary adjustments.
Report material liquidity events in a timely manner for consideration by relevant personnel of the IFM.
Where possible, identify emerging liquidity concerns and potential liquidity shortages.
The Guidance also emphasizes that effective LRM approaches will vary, depending on the fund’s characteristics, and that the Guidance is not intended to suggest or endorse a “one size fits all” approach. If you would like to discuss the application of the Guidance to your business, please do not hesitate to contact us.
On August 6, the Canadian Securities Administrators (CSA) published final amendments to national rules affecting the prospectus and registration exemptions for distributions of securities involving syndicated mortgages (National Amendments). In addition, some provinces including Ontario have proposed additional changes to their local prospectus and registration exemptions, and the Financial Services Regulatory Authority of Ontario (FSRA) is consulting on draft guidance (FSRA Guidance) for its supervision of mortgage brokers and administrators dealing in certain syndicated mortgages. The National Amendments, proposed FSRA Guidance, and proposed Ontario-specific amendments prospectus and registration exemptions (Ontario Rules) are expected to come into effect on March 1, 2021. Below, we highlight key features of the reforms.
The National Amendments will amend National Instrument 45-106 Prospectus Exemptions (NI 45-106), National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103), and the related companion policies. Among other things:
The existing prospectus and registration exemptions in Ontario, Newfoundland and Labrador, the Northwest Territories, Nova Scotia, Nunavut, Prince Edward Island and the Yukon for securities that are syndicated mortgages (Mortgage Exemptions) will be removed. This will align the regulatory frameworks in these jurisdictions with the rest of Canada.
The private issuer prospectus exemption (Private Issuer Exemption) will be removed for distributions of syndicated mortgages.
Because of these changes, exempt distributions of syndicated mortgages in Canada will have to be effected under another prospectus exemption, such as the accredited investor exemption (AI Exemption), offering memorandum exemption (OM Exemption), or family, friends and business associates exemption (FFBA Exemption).
Consistent with the current approach in British Columbia for syndicated mortgages distributed under the OM Exemption, the National Amendments will require supplemental disclosure tailored to syndicated mortgages.
In Ontario and other jurisdictions where the Mortgage Exemptions currently apply to syndicated mortgages, market participants that are in the business of trading syndicated mortgages will need to determine whether the registration requirement applies to them.
Changes since 2019: The National Amendments are substantially similar to the proposed amendments published by the CSA for comment in March 2019 (2019 Proposal). But there have been a few changes. For example, Form 45-106F18 Supplemental Disclosure for Syndicated Mortgages will require disclosure of the potential subordination of the syndicated mortgage, clarify the calculation of the loan-to-value ratio, and include additional examples of risk factors.
Some jurisdictions have proposed further changes to their exemptions:
Qualified syndicated mortgages: Ontario and New Brunswick have published for comment prospectus and registration exemptions for “qualified syndicated mortgages” (QSMs), and we expect Nova Scotia to introduce a similar pair of exemptions. Alberta and Québec have proposed a prospectus-only exemption for trades in QSMs.
Distributions of non-qualified syndicated mortgage investments (NQSMIs) to permitted investors: Ontario and New Brunswick also have proposed prospectus and registration exemptions for distributions of NQSMIs to permitted clients (i.e. institutional and high net worth investors). Alberta has proposed a prospectus-only exemption for trades in NQSMIs to permitted clients, while Québec is asking for feedback on whether such an exemption should be introduced.
Reports of exempt distribution: Ontario and New Brunswick will not require a Form 45-106F1 Report of Exemption Distribution to be filed for distributions of QSMs under their new prospectus exemptions or for distributions of NQSMIs sold to permitted clients.
Who will regulate what in Ontario beginning in March 2021? FSRA currently regulates all syndicated mortgage investments in Ontario. When the new regime comes into effect, FSRA will continue to supervise transactions involving qualified, syndicated mortgage investments and the mortgage brokers and administrators involved in such transactions. Oversight of NQSMIs will be split between FSRA and the OSC, depending on the status of the investor/lender and the type of transaction. In particular, FSRA will supervise:
NQSMI transactions with permitted clients;
NQSMI transactions with permitted and non-permitted clients before March 1, 2021 (Legacy NQSMIs); and
Administrators of NQSMIs.
Mortgage brokerages that deal in mortgages and syndicated mortgages only with permitted clients will not have to register with the OSC and the distributions of these products to permitted clients will be exempt from the prospectus requirement. There will be dual oversight however, in some circumstances. For example, FSRA will have oversight over mortgage brokers dealing in NQSMIs when they act on behalf of the borrower who is not a permitted client, with the OSC having oversight over the trades with respect to that investor/lender.
The proposed FSRA Guidance describes FSRA’s forward-looking, risk-based approach to supervision of the firms and transactions over which it will have authority and outlines the data it plans to collect from firms to inform its risk assessments.
Comment Deadline: Comments on the proposed Ontario Rules and FSRA’s Proposed Guidance are due on September 21, 2020. If you are interested in submitting comments or have questions about how these changes to the syndicated mortgages regime could affect your business, please contact us.
On August 27, the Canadian Securities Administrators (CSA) published a report on their four-year study of what individual investors think about fees and the performance of their investments and how they interact with their advisors (Report). The study was conducted to measure the impact of Phase 2 of the Client Relationship Model (CRM2) and the mutual fund “point of sale” (POS) rules on investor knowledge, attitudes and behaviour, although the CSA acknowledges that other developments such as news coverage and growing interest in low-cost funds may have contributed to the changes identified in the Report. Key findings include the following:
Fees: Readership of account statements hasn’t changed much since 2016, but more investors reported having a better understanding of how fees affect investment returns and considered it important to monitor the fees they were charged. However, there was no improvement between 2016 and 2019 in the number of investors indicating that their advisors discussed the impact of fees on returns with them.
Clients (Dis)Satisfaction: There was a statistically significant decline between 2016 and 2019 in how satisfied investors were with their advisors. More investors reported that they had changed, or were likely to change, their advisor in 2019 as compared with 2016.
Fund Facts Are Just Fine: Very few investors reported that they want more information to be included in the Fund Facts document.
Let’s (Not) Talk about Investment Plans: Investors reported little change in representatives’ practices of discussing investment planning with them, comparing 2019 to 2016 levels.
Firms with a significant number of individual clients might find it worthwhile to skim the Tracking Study as well as the Report. The Tracking Study includes demographic data and more detailed breakdowns of the findings (e.g. by province and account type). For example, the Tracking Study shows that a statistically significant increase in the percentage of investors advised under the discretionary authority (PM model) recently changed, or were likely to change, their investment firm (13% in 2016, versus 24% in 2019).
The CSA said that it expects the study results to inform its policymaking, although it did not provide any specifics. If you want to discuss the Report’s relevance for your business operations, please do not hesitate to contact us.
Inventions, apologies, clean water and comedians. Canada is great at many things. Add to that list our tolerance for studies of our securities regulatory system. Here at AUM Law, we’ve been dipping into the initial consultation report (Report) of the Ontario government’s Capital Markets Modernization Task Force (Task Force). Like ice wine, the Report is better sipped than guzzled and so in this month’s bulletin we’ve highlighted a handful of proposals that we think will be of particular interest to readers of this newsletter.
Background: The Task Force began its work in February 2020 and since then has engaged with over 110 stakeholders to learn more about the challenges that businesses and investors face in Ontario’s capital markets. Now, the Task Force is seeking feedback on 47 proposals to supplement the policing function of Ontario’s capital markets regulatory framework with a public policy imperative to grow those markets.
Self-Regulatory Organizations (SROs): SRO reform is a hot topic. Adding to the proposals we discussed last month, the Task Force has its own recommendations, including those outlined below, to transform the regulatory framework for SROs and registered firms.
Create a single SRO to regulate both investment fund dealers and mutual funder dealers and conduct national market surveillance.
In the longer term, transfer all registration functions and oversight of all firms distributing products and providing advice to investors from the OSC to the SRO.
Increase the OSC’s oversight over the existing SROs and any future SRO. For example, the OSC would approve SRO annual business plans and be able to veto significant publications (including rules and guidance) and key appointments.
Link SRO executives’ compensation and incentive structures to their public interest and policy mandate, require SROs boards to include directors with investor protection experience, require a greater proportion of directors (including the chair) to be independent, and introduce cooling-off periods between working for a member firm and becoming an independent director of an SRO.
The Task Force also is considering whether to recommend an ombudsperson service to address complaints that SRO member firms have about the services received from their SRO.
Capital-Raising: Many of the Task Force’s proposals, including the recommendations set out below, focus on making Ontario capital markets more attractive to issuers and investors:
Expand the definition of accredited investor (AI) so that distributions under the AI exemption can be made to individuals who hold the CFA Charter or have completed other relevant proficiency requirements such as the Canadian Securities Course (CSC) exam, Exempt Market Products exam, or the Series 7 Exam plus the New Entrants Course Exam.
Allow exempt market dealers (EMDs) to participate as selling group members in prospectus offerings and sponsor reverse takeovers (RTOs).
Develop a regulatory framework for retail private equity investment funds, such as the “interval fund” concept in the United States. (An interval fund is a type of unlisted, closed-end fund that periodically offers to buy back a stated portion of its shares.)
In the Report, the Task Force discusses the phenomenon of angel investor groups assisting with early stage financing of start-ups. According to the Report, angel investor groups consist of AIs who professionalize and share due diligence, domain knowledge, and expertise as they consider investing in early stage issuers. Some angel investor groups seek to be structured to earn a fee from working with their members to collaboratively finance these start-ups and such arrangements could, in some circumstances, trigger registration requirements. The Task Force recommends that the registration rules be changed so that angel groups can work with their AI members.
Liberalize reporting issuers’ ability to pre-market transactions to institutional investors before filing a preliminary prospectus. This regulatory change would be combined with increased monitoring and compliance examinations by regulators of the trading of those who might have advance knowledge of an offering.
Ownership Transparency: The Task Force sets out several proposals that may be of particular relevance to institutional investors who hold securities of reporting issuers. For example:
Decrease the ownership threshold for early warning reports decrease from 10% to 5%. Feedback is requested on, among other things, whether requiring passive investors to report ownership at the 5% threshold would create undue burden relative to the disclosure benefits.
Require institutional investors whose investments exceed a certain dollar threshold to disclose on a quarterly basis their holdings in Canadian reporting issuers whose market capitalization is above a certain threshold.
A Bigger Sandbox: The Task Force recommends that the OSC Launchpad and the Financial Services Regulatory Authority (FSRA) create an Ontario Regulatory Sandbox to serve innovative start-ups operating across Ontario’s financial services sector. Ideally, the Ontario Regulatory Sandbox would expand into a Canadian Super Sandbox involving all provincial and federal financial sector regulators.
Other Recommendations: The summary above highlights only a handful of the Task Force’s recommendations. The Report also includes potentially high-impact proposals such as:
Separating the OSC’s regulatory and adjudicative functions;
Expanding the OSC’s investigative and enforcement powers;
Providing greater rights for persons or companies affected by the OSC’s examinations and investigations, such as introducing a mechanism to ensure that the OSC’s questions or requests for documents are subject to a “reasonable and proportionate” threshold and enabling affected persons to apply to an OSC adjudicator to clarify investigation and examination-related orders; and
Empowering the Ombudsman for Banking Services and Investments (OBSI) to issue binding decisions requiring a registered firm to pay compensation to harmed investors and increasing the limit on OBSI’s compensation recommendations;
What’s Next? The deadline for comments on the Report is September 7. The Task Force plans to deliver its final report to the Minister of Finance before the end of the year. After that, the Task Force’s proposals will become part of the mix of Ontario and Canada-wide reform proposals, including the OSC’s regulatory burden reduction initiative, establishment of the Cooperative Capital Markets Regulatory System, and the Canadian Securities Administrators’ agenda. We think that initiatives that can be implemented by Ontario authorities on their own could move forward fairly quickly, especially if no legislative or rule changes are required. Other proposals (such as SRO reform) will require coordinated, cooperative and determined actions by multiple parties across the country and are therefore likely to take much more time to achieve, if they are achievable at all.
AUM Law will continue to monitor the Task Force’s work and update you on significant developments. If you are interested in submitting a comment letter or wish to discuss the Report’s implications for your business, please do not hesitate to contact us.
On June 25, the Canadian Securities Administrators (CSA) published a consultation paper (Consultation Paper) seeking feedback on whether the current framework for self-regulatory organizations (SROs) should be reformed. As our readers know, the existing system requires investment dealers to be members of the Investment Industry Regulatory Organization of Canada (IIROC) and requires most mutual fund dealers (except those in Québec) to be members of the Mutual Fund Dealers Association of Canada (MFDA). CSA members directly regulate and oversee exempt market dealers (EMDs), investment fund managers (IFMs), portfolio managers (PMs), and scholarship plan dealers (SPDs).
The Consultation Paper is the latest in a series of publications considering whether the existing SRO system should be reformed. In February, we discussed the MFDA’s proposal that the CSA take over direct oversight of markets while giving up direct oversight of EMDs, SPDs and certain PMs to a new self-regulatory organization (NewCo) that would take on direct responsibility for the registration, business conduct, prudential oversight, policymaking and enforcement functions of the registrants mentioned above, plus those currently overseen by IIROC and the MFDA. More recently, IIROC proposed that IIROC and MFDA be brought together as divisions of a consolidated SRO.
At this stage, the CSA is not recommending any particular regulatory model or reforms. Instead, the Consultation Paper describes the existing SRO framework, summarizes the results of the CSA’s recent consultations with stakeholders, and seeks feedback on the issues raised by those consultations. According to the Consultation Paper, many stakeholders commended the SROs’ specialized expertise and the benefits of their national scope. However, they also raised some concerns about the existing system, including the following:
Product-based regulation: Some stakeholders think that there is an unlevel playing field and potential for regulatory arbitrage because similar products and services are subject to different rules, or differing interpretations of similar rules, depending on which organization’s rules apply.
Duplicative operating costs: There also are concerns that the lack of common oversight standards and differing interpretations of similar rules have led to duplicative operating costs for dealers who operate under both the IIROC and MFDA platforms.
Structural inflexibility: Some stakeholders think that the existing framework makes it harder for dealers to accommodate evolving investor preferences (e.g. to access a wider range of products from a single registrant), creates succession planning challenges for mutual fund dealers and their representatives (because of the limited product shelf they can offer their clients), and/or limits investment dealers’ ability to grow their businesses due to difficulties in attracting mutual fund dealing representatives because of the additional proficiency requirements.
Investor confusion: Investors and their advocates stated that layers of regulation have contributed to investor confusion because investors can’t access a broad range of products from one representative and/or are unsure whom to turn to if an issue arises.
Public confidence in SRO system: Some stakeholders see this project as an opportunity to enhance the SROs’ governance structures to focus on their public interest mandates and strengthen complaint resolution mechanisms.
Although the Consultation is likely to be of particular interest to IIROC and MFDA members, this initiative has the potential to reshape in fundamental ways the regulatory environment for all registrants, including firms and individuals currently subject to direct regulation and oversight by the CSA. The deadline to submit comments is October 23. If you would like to discuss the Consultation and its potential impact on your business, please contact your usual lawyer at AUM Law.
On May 20, the Canadian Securities Administrators (CSA) issued substantially harmonized blanket orders giving investment funds and other issuers temporary relief from certain regulatory and filing obligations. The conditions of relief are similar to the blanket orders issued in late March, except that the relief applies only to issuers with filing deadlines as noted below:
Investment fund issuers: The OSC’s blanket order for investment funds (Funds Blanket Order) provides a 60-day extension for certain filing, delivery and prospectus renewal requirements normally required to be made between June 2 and September 30, 2020. If an investment fund wishes to rely on the Funds Blanket Order, it must, as soon as reasonably practicable and in advance the relevant delivery, filing or renewal deadline: (a) notify its regulator by email that it is relying upon the Funds Blanket Order and each requirement for which it is relying upon that order; and (b) post a statement on its public website or public website of its investment fund manager indicating that it is relying upon the Funds Blanket Order and listing each requirement for which it is relying on upon that order.
Non-investment fund issuers have a 45-day extension for certain filing, delivery and base shelf prospectus renewal obligations normally due or required to be made between June 2 and August 31, 2020.
Issuers can’t further extend pre-June 2 deadlines: An issuer cannot rely on the blanket relief to further extend a deadline occurring before on or before June 1.
On May 29, the CSA issued substantially harmonized blanket orders giving registrants and certain unregistered capital markets participants relief from certain financial statement and information delivery deadlines. The blanket orders provide a 60-day extension for periodic filings normally required to be made between June 2, 2020 and September 30, 2020 by registrants and, in Ontario, unregistered capital markets participants that rely upon certain registration exemptions such as unregistered investment fund managers (IFMs) and unregistered exempt international firms. The extension applies automatically, without any terms and conditions. Registrants and unregistered capital markets participants that have already used the prior relief to extend their deadline for any financial statement or information delivery requirements occurring on or before June 1, 2020, cannot use this relief to further extend that deadline.
Please contact us if you have any questions about the blanket orders described above. We can help you assess your options and, if necessary, engage with regulators on your behalf.
Last November, we wrote about the Ontario Securities Commission (OSC) report Reducing Regulatory Burden in Ontario’s Capital Markets. On May 27, the OSC published a progress report (Report) on these initiatives. Of the 107 initiatives described in the original report, 27% have been completed, 36% are on track, and 37% of them are delayed (nine of them due to COVID-19). We think the following updates will be of particular interest to our readers:
Registrant Regulation: The good news is that 23 of the 30 registrant-related initiatives are complete (14) or in progress and on-track (9). All the initiatives relating to compliance reviews are complete. Delayed initiatives include:
Developing a rule to exempt international dealers, advisers and sub-advisers from registration under the Commodity Futures Act (Ontario) (CFA); and
Evaluating options to reduce duplication in certain regulatory processes for firms that are members of the Investment Industry Regulatory Organization of Canada (IIROC).
Investment Funds: Unlike the registrant regulation-related initiatives, a majority (16) of the 24 investment funds-related initiatives have been delayed, while five have been completed and four are in progress and on-track. The delayed items include changes to the investment funds prospectus regime and some of the continuous disclosure initiatives. Most of the completed items relate to discrete projects such as:
Finalizing an exemptive relief precedent to allow an investment fund to have more than one custodian;
Codifying relief to allow any body corporate that is an investment fund manager (IFM) to act as a trustee of any pooled fund organized as a mutual fund trust in Ontario that it manages; and
Adopting an internal process at the OSC to ensure the use of sunset clauses in exemptive relief decisions only where appropriate.
Derivatives Participants: Of the eighteen initiatives concerning derivatives participants, only two are complete, while eight are in progress and on-track, and eight are delayed. Among other things, the OSC expects to:
Complete its review of how proficiency requirements apply to registered advising representatives (ARs) advising in recognized options and determine whether to provide clarification (Fall 2020); and
Complete its review of the existing registration regime to determine whether regulatory gaps can be addressed by measures less burdensome than an over-the-counter (OTC) derivatives registration rule (Spring 2020).
AUM Law will continue monitoring the progress of the OSC’s burden reduction initiatives and keep you informed.
On May 12, the Financial Services Regulatory Authority of Ontario (FSRA) issued guidance (Guidance) for mortgage administrators (Administrators) and mortgage brokers (Brokers) regarding their disclosure and other obligations in respect of mortgage-based investments during significant market disruptions, such as the COVID-19 pandemic.
The first notice, Mortgage Administrators – Responses to Market Disruptions (Administrator Notice), sets out FSRA’s interpretation of Administrators’ obligations under Mortgage Brokerages, Lenders and Administrators Act 2006 (MBLAA) to protect investors/lenders in mortgages/mortgage investments during significant market disruptions. For example:
Notify investors/lenders:The Administrator must promptly notify investors/lenders of a borrower defaulting under the mortgage or any significant change to circumstances affecting a mortgage. If an investor/lender is a mortgage investment corporation (MIC) or other mortgage investment entity (MIE), the Administrator must notify that entity. The Administrator Notice includes examples of events that trigger this disclosure requirement, such as potential forbearance, a material delay in the development of a project being funded by the mortgage, or a change in the ability of investors or lenders to redeem prior to the mortgage investment’s maturity. The Administrator Notice also describes good practices that an Administrator should follow to keep current on the financial status of the mortgages and underlying properties in the portfolio and to communicate effectively with investors/lenders.
Adhere to administration agreements:During the COVID-19 pandemic, more borrowers are requesting modifications to their mortgage terms. Administrators should review their administration agreements to confirm the scope of any discretion that they have to modify mortgage terms and they must adhere to those terms. They also should carefully document any exercise of such discretion. If the agreement does not authorize them to modify mortgage terms, an administrator faced with a request from the borrower to modify terms must review the requirements under the MBLAA and related regulations regarding the notice to be provided to the investors / lenders and obtain approval for the modifications.
Disclose material risks arising from the current market disruption to investors in non-qualified syndicated mortgage investments (NQSMIs); and
Consider the current market disruption when assessing the suitability of an NQSMI to an investor.
The Broker Notice includes a non-exhaustive list of risks associated with a market disruption that FSRA considers material. These are similar to the “significant changes in circumstances” outlined in the Administrator Notice. The Broker Notice also emphasizes that Brokers must consider whether any property appraisals prepared for syndicated mortgage investments (SMIs) before the market disruption reflect the property’s market or current value and make investors/lenders aware of the risks of relying on any appraisal that either predates the market disruption or does not consider the market disruption’s impact on the property valuation. Also, if the appraisal contains any limitation statements, the Broker must bring those statements to the attention of the investor/lender. The Broker Guidance also states that Brokers must take into account the potential impacts of a market disruption on an SMI, its probable future performance, and the investor/lender’s unique circumstances when they assess the suitability of an SMI for an investor-lender.
Although not directly applicable to exempt market dealers (EMDs), the Guidance also may be useful to firms conducting suitability assessments with respect to MIE securities. Likewise, firms that operate MIEs might want to consider the Guidance when assessing whether to update the descriptions in their offering documents regardig risk factors, descriptions of the MIE’s mortgage portfolio, and/or changes to redemption rights.
AUM Law can help you assess the impact of the Guidance on your business, advise you on your disclosure obligations and help you prepare the required disclosures, as well as update your policies and procedures to incorporate these publications. Please do not hesitate to contact us for assistance.
On April 17, the Canadian Securities Administrators (CSA) issued blanket orders permitting mutual funds that invest a portion of their assets in fixed income securities to engage in additional short-term borrowing between April 17 and July 31, 2020. Ordinarily, mutual funds that engage in short-term borrowing to accommodate redemption requests are subject to a limit on that borrowing of 5% of the fund’s net asset value at the time of the borrowing. That limit is being temporarily increased to 10%, provided that certain conditions are met, such as having strict controls around the additional borrowing, disclosing the use of any additional borrowing to investors, ensuring that the additional borrowing is in the best interests of all investors. If you are managing a mutual fund that you think would benefit from these blanket orders, AUM Law can advise you on the criteria for exemptive relief and related matters.
In light of the COVID-19 pandemic, the Canadian Securities Administrators (CSA), including the Ontario Securities Commission (OSC), have been providing blanket exemptive relief and taking other steps to relieve burdens for market participants. The situation is fluid and additional actions are being taken as new challenges arise, so the summary below can only be a snapshot as of the publication date of this bulletin.
Compliance Reviews: In its March 16 news release, the OSC stated that its on-site compliance reviews have been postponed until further notice. Its normal course compliance activities are continuing as planned but the OSC has signalled its willingness to be flexible on deadlines for information.
CSA Extends Certain Filing Deadlines: On March 23, the OSC and other CSA members published blanket orders providing temporary relief from certain filing requirements. We have summarized below key provisions in the OSC blanket orders concerning registered firms and investment funds.
Fee Filings and Payments
Who: Registered firms and unregistered capital markets participants that are required to pay capital markets participation fees to the OSC.
What: If the firm paid its 2019 capital markets participation fee based on an estimate of its 2019 specified Ontario revenues, it ordinarily would have to re-calculate those revenues and the relevant participation fee based on its final 2019 financial information. If the recalculated fee exceeded the estimated fee paid at the end of 2019, the firm ordinarily would have to pay the balance owing and file an updated Form 13-502F4 Capital Markets Participation Fee Calculation or Form 13-503F1 (Commodity Futures Act) Participation Fee Calculation by March 30, 2020.
Extension: The deadline has been extended for 45 days from the original deadline.
Financial Statements / Calculations of Excess Working Capital
CSA members have issued substantially harmonized blanket orders providing registered dealers, advisers and investment fund managers (IFMs) with a 45-day extension from the original deadline for certain financial statements if the deadline originally fell between March 23 and June 1. The extension applies automatically, without any terms and conditions.
Dealers: annual financial statements, completed Form 31-103F1 Calculation of Excess Working Capital (Form 31-103F1), and interim financial information;
Advisers: annual financial statements and completed Form 31-103F1; and
IFMs: annual financial statements, completed Form 31-103F1, completed Form 31-103F4 Net Asset Value Adjustments (Form 31-103F4), and interim financial information.
IIROC and MFDA Firms: Firms that are members of the Investment Industry Regulatory Organization of Canada (IIROC) or the Mutual Fund Dealers Association of Canada (MFDA) have been granted similar relief in respect of the regulatory financial questionnaires coming due.
Investment Fund Filing, Delivery and Prospectus Renewal Requirements (Funds Blanket Order)
Filing and Delivery Deadlines Extended 45 days: CSA members have issued substantially harmonized blanket orders providing investment funds with a 45-day extension on various filing and delivery deadlines for materials such as annual financial statements and auditor reports, interim financial statements, annual custodian compliance reports, annual mutual fund compliance reports, annual information forms, independent review committee (IRC) reports to securityholders, and annual and interim management reports of fund performance.
Prospectus Renewals: An investment fund distributing securities under a prospectus with a lapse date that occurs between March 23 and June 1, 2020 may add 45 days to that lapse date.
Fund Must Notify Regulator and Public: If an investment fund wishes to rely upon the Funds Blanket Order, it must, as soon as reasonably practicable and in advance the relevant delivery, filing or renewal deadline:
Notify its regulator by email that it is relying upon the Funds Blanket Order and each requirement for which it is relying upon that order; and
Post a statement on its public website or public website of its investment fund manager that it is relying upon the Funds Blanket Order and each requirement for which it is relying on upon that order.
Requests for Comment: The CSA indicated in their March 18 news release that all CSA proposals currently out for comment will have their comment periods extended by 45 days.
Risk Assessment Questionnaire (RAQ): In its March 16 news release, the OSC indicated that the RAQ is postponed until further notice.
Other Exemptive Relief: CSA members have also granted temporary relief to other categories of market participants (e.g. such as reporting issuers) and signalled regulatory flexibility regarding certain other requirements (such as the operation of annual general meetings).
Please contact us if you have any questions about the blanket orders described above, other requirements and temporary exemptions, and/or other operational changes adopted by CSA members that may affect your business. We can help you assess your options and, if necessary, engage with regulators on your behalf.
On February 3, the Mutual Fund Dealers Association (MFDA) released A Proposal for a Modern SRO (Special Report) and an accompanying Guiding Framework. The MFDA recommends that the Canadian Securities Administrators (CSA) take over direct regulation of markets while giving up direct oversight of exempt market dealers (EMDs), scholarship plan dealers (SPDs), and certain portfolio managers to a new self-regulatory organization (NewCo). NewCo would take on direct responsibility for registration, business conduct, prudential oversight, policymaking and enforcement functions in relation to the registrants mentioned above, plus those currently overseen by the MFDA and the Investment Industry Regulatory Organization of Canada (IIROC).
The Special Report is just one perspective on whether and how to reform self-regulatory structures for capital market participants. The CSA plans to publish its own consultation paper on the self-regulatory structure later this year. We will monitor developments in this area and keep you informed.