CSA propose operational requirements for closed-end funds

Joel Binder -

The Canadian Securities Administrators yesterday proposed changes to National Instrument 81-102 Mutual Funds (NI 81-102) that would introduce core operational requirements for publicly offered non-redeemable investment funds generally analogous to the requirements applicable to mutual funds.

This "Phase 2" of the CSA's Modernization of Investment Fund Product Regulation Project involves significant changes to the regulation of non-redeemable investment funds. Key elements of the proposals include (i) extending the application of investment restrictions under NI 81-102 to non-redeemable investment funds; (ii) imposing a 10% concentration restriction (with fixed portfolio ETFs permitted to exceed this limit); (iii) limiting investments in physical commodities and specified derivatives with underlying interests in physical commodities; (iv) imposing a cash borrowing limit of up to 30% of NAV (and permitting borrowing only from "Canadian financial institutions" and limiting borrowing activities to cash borrowing only); and (v)limiting investments in mortgages to guaranteed mortgages only. In addition, dilutive securities issuances would be prohibited with specific prohibitions on the ability to issue warrants or similar securities.  

Non-redeemable investment funds would also be prohibited from investing in other non-redeemable investment funds (fund-of-funds) while a larger portion of fund assets would be permitted to be invested in illiquid assets. The proposals would also impose a framework for securities lending, repurchases and reverse repurchases similar to that applicable to mutual funds and introduce new requirements for the manager to bear the organizational costs of launching a new fund, as well as prescribe requirements governing conflicts of interest and circumstances where regulatory and/or securityholder approval will be required for certain fund or management changes. Changes are also proposed to requirements for custodianship of assets, redemptions and prescribed prospectus disclosure.

While the proposals relate principally to non-redeemable investment funds, some of the proposed amendments would also impact mutual funds.

The proposals form part of Phase 2 of the CSA's investment fund modernization project. Phase 1 of the project, which codified exemptive relief frequently granted in recognition of market and product developments, came into force in 2012. The purpose of Phase 2 is to "identify and address any market efficiency, investor protection or fairness issues" arising as a result of the different regulatory regimes that apply to different types of funds.

Included in Phase 2 is the creation of a more comprehensive alternative fund framework through amendments to National Instrument 81-104 Commodity Pools, which would apply to mutual funds and non-redeemable investment funds that use alternative investment strategies not be permitted under NI 81-102. While specific amendments to NI 81-104 are not proposed at this time, the CSA have raised a number of questions on which feedback is requested.

The CSA is accepting comments on their proposals until June 25, 2013.

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