The long-awaited amendments to reduce the regulatory burden on investment funds were published by the Canadian securities administrators (CSA) in final form on October 7, 2021 and take effect on January 5, 2022. The amendments mostly relate to housekeeping matters that reduce very little regulatory burden, while other aspects might actually increase regulatory burden in the short term. We are disappointed that the CSA did not introduce a number of additional changes that would have had a far greater impact on reducing the regulatory burden on industry participants.
The amendments are described by the CSA as eight “workstreams”, the key provisions of which are summarized below. We also have included some of our recommendations for additional changes that were initially provided to the CSA through the consultation process that preceded the final amendments. Most of these recommendations remain relevant in our view.
- Consolidate the simplified prospectus (SP) and annual information (AIF) into a new long-form simplified prospectus.
The disclosure currently contained in the AIF is, for the most part, being moved to the SP to produce a new long-form SP document. The new long-form SP will be mandatory for all mutual fund prospectus filings on or after September 6, 2022 (and optional for filings before that date).
Moving information from the AIF to the SP merely will result in mutual funds filing one very long SP rather than a less long SP and medium-length AIF. Existing mutual funds will need to undergo a one-time rewrite of their prospectus documentation for future filings. The rewrite is likely to trigger some significant redrafting as AIF disclosure tends to be less “plain language” than that used in an SP. (For example, the tax disclosure in an AIF is much more detailed and technical in nature compared to the SP.) The location and content of the disclosure also will need to follow the more prescriptive approach applicable to an SP. A few items currently included in the SP or AIF will be removed in the new format. They are:
- The table currently in Part A of the SP that shows the commissions or redemption fees payable by an investor after 1, 3, 5 and 10 years based on a $1,000 investment with a 5% annual return. This table will become meaningless once the deferred sales charge option is abolished.
- The sentence in Part A of the SP that discloses the previous year’s dealer compensation paid by the manager as a percentage of its management fees.
- Investor suitability disclosure in Part B of the SP. This information already is contained in the fund facts.
- Additional Part B disclosure when a fund had a portfolio turnover rate exceeding 70%.
- Disclosure in the AIF of ownership by any person of more than 10% of any class or series of securities of the mutual fund. This change is welcomed as it will eliminate typically several pages of anonymized unitholder information. Though not included in the draft versions of the amendments, the CSA were persuaded by industry comments to make this deletion in the final version.
Despite similar lengths, the new long-form SP will look much different than the current long-form prospectus used by exchange-traded funds under National Instrument 41-101.
There is much room for regulatory burden reduction in prospectus disclosure and the prospectus filing process. We recommend the following additional changes:
- Remove all remaining time-sensitive information from the long-form SP. This includes disclosure in Part B of the SP of (i) unitholders holding securities representing more than 10% of the net asset value of the fund, (ii) circumstances where a portfolio position exceeding 10% of the net asset value of the fund, and (iii) fund expenses indirectly borne by investors. This information is of little use to investors and quickly becomes stale, while requiring considerable effort to compile. All important time-sensitive information already is contained in other regulatory filings (principally the financial statements and management reports of fund performance), and the time-sensitive information most useful to investors is contained in the fund facts. This change would facilitate our next recommendation.
- Require that the SP be refiled only once every two years, similar to the shelf prospectus of public companies. This would cut in half the costs currently incurred for renewing prospectuses.
- Enable new mutual funds to be launched by a prospectus amendment to the long-form SP, rather than a preliminary and final prospectus filing. Very little information in the long form prospectus is specific to any particular mutual fund, and it can easily be provided in the new fund’s Part B information. All key information provided to investors in the first instance is contained in the fund facts.
- Reduce mutual fund prospectus filing fees to reflect the amount of regulatory review they entail. Currently, prospectus filing fees in most jurisdictions are calculated as a multiple of the number of mutual funds contained in the SP. However, most of that information is common to all funds, and relatively little of that information typically changes materially during the prospectus renewal process. Two different prospectuses of approximately the same length and complexity should not trigger vastly different filing fees based on the number of mutual funds using that common disclosure document.
- Mandatory designated website.
This amendment requires that all managers have an internet website for their funds by September 6, 2022. This likely is not a material new requirement as most (if not all) managers of public investment funds already maintain websites on a voluntary basis. However, the CSA indicated that this requirement will form part of a manager’s obligations as a registrant to have adequate policies & procedures, and therefore the website design and content could be the subject of future regulatory audits.
This new requirement was presented by the CSA as a first step toward more reliance on website disclosure. The CSA had invited comments on which current disclosure could be posted on such a website in lieu of contained in the prospectus. However, the CSA did not implement any of these changes at this stage.
Now that websites for mutual funds will be mandatory, we recommend that the CSA establish a default in securities legislation that information is provided to investors through website posting rather than physical delivery by mail, with an option for investors to specifically request documents. Our recommendation reflects the reality that individuals conduct most of their research on the internet rather than through physical files, and are more likely to save their documents online rather than in hard copies. Our recommendation also would reduce the impact on the environment caused by physical delivery of documents.
- Codification of notice & access relief for unitholder meetings.
One of three codifications contained in the final amendments is permission for investment funds to use the same notice & access approach for unitholder meetings that is used by public companies. Many fund complexes already have obtained this relief so that the codification will not benefit them. A new feature is that the codification also allows notice & access to be used for solicitation by parties other than management. Though this matches a similar functionality among public companies, it would seem of little practical effect in the investment funds context since there are no known cases of proxy fights at an investment fund meeting.
- As mentioned above, we recommend that the principle of notice & access and reliance on website posting be applied to most (if not all) documents required to be delivered to investors.
- Regarding the codification process, there is little benefit to industry from codifying exemptive relief after most industry participants have obtained it on a discretionary basis. It causes unnecessary costs to mutual funds, and ties up CSA resources to process such application. We recommend that the CSA adopt an approach to codify exemptive relief soon after the relief has been granted more than once. We believe the United States Securities and Exchange Commission has adopted such an approach.
- Elimination of personal information forms (PIFs) for registered or approved individuals.
Directors and executive officers of the fund manager no longer will need to complete or refresh a PIF as part of the prospectus filing process. The CSA acknowledged that these individuals already have been vetted by relevant CSA due to their connection to a registered firm, and there is no need to duplicate that vetting process.
The change will, indeed, reduce regulatory burden by the CSA. However, it does not address the fact that there continue to be parallel PIF requirements imposed by stock exchanges on funds with listed securities. We recommend that the Toronto Stock Exchange and NEO Exchange make similar changes to exempt from their respective PIF requirements any individual who is exempted from filing a PIF with the CSA, and we believe the CSA can persuade the exchanges of the merits of making this change.
- Codification of conflicts of interest relief
A second codification in the amendments is of relief from various conflicts of interest restrictions relating to: various fund-on-fund investments where at least one of the funds is not public; inter-fund trades where one or both parties is not a public fund; investments by non-public funds in related issuers; and various underwriting conflict restrictions.
This has been the relief most frequently granted and regranted over the past 20 years, and most managers that have confronted these conflicts of interests have already obtained the relief. Their relief will not expire by this codification, and managers may continue to rely on their relief if it contains more favourable terms. One area where this will be essentially is for in specie purchases and redemptions. Though included in the draft codification, the CSA removed this element from the final version, citing liquidity risk management concerns without providing any examples. The CSA also have put industry on notice that any future applications to modify this exemptive relief will be granted on the terms contained in the codification, which could eliminate other more favourable terms in the exemption.
The current conflicts of interest regime is a patchwork of various random and often duplicative restrictions. They are fact-specific and can produce different conclusions based on minor differences in facts. These restrictions were created before managers were required to be registered with the CSA and have adequate policies & procedures for identifying and managing conflicts of interest. It is time for these specific restrictions to be replaced by the duties and standards now imposed on registered fund managers by securities legislation. We recommend that the specific conflicts of interest restrictions which are the subject of this codification be abandoned in favour of a principles-based approach.
- More grounds for CSA pre-approved fund mergers
The most common reasons for requiring CSA approval of a merger of two investment funds are that (i) the merger will be implemented on a taxable basis; (ii) the investment objectives of the merging funds are not sufficiently similar; and/or (iii) the fee structure of the continuing fund is higher than that of the terminating fund. CSA approval in these circumstances is being replaced by prescribed additional disclosure in the information circular to unitholders, together with a requirement that the manager reasonably believes that the merger is in the best interests of the affected funds despite these facts. Unitholder approval of these mergers will continue to be required.
We do not believe there is any need to obtain unitholder approval of this type of merger if the manager has made the determination that the merger is in the best interests of the funds. Like other types of mergers, unitholders not wishing to move to the continuing fund will be adequately protected if they are given 60 days’ advance notice to switch to another fund or redeem their units at net asset value before the merger occurs. Accordingly, we recommend that the requirement to obtain unitholder approval of these mergers be deleted in favour of the same advance notice requirement that applies to other fund mergers.
- Elimination of the need for CSA approval under NI 81-102 for a change of manager or change of control of a manager.
Transactions to acquire control of a manager or to acquire its business typically trigger two parallel approval processes: under section 11.9 or 11.10 of NI 31-103 and also under section 5.5 of NI 81-102. While the applications shared a common fact pattern, the review under NI 31-103 typically focuses on new conflicts of interest of the manager arising from the new ownership, while the review under NI 81-102 typically focused on the potential impact of the transaction on unitholders of the funds. The requirement for CSA approval under NI 81-102 is being deleted.
The CSA have indicated that the scope of review under NI 31-103 will not expand to include those matters currently covered by NI 81-102, but this could change in the future. In particular, it is unclear whether the review under NI 31-103 now will include whether a change of control of the manager is to be treated as effectively a change of manager for NI 81-102 for the purposes set out in OSC Staff Notice 81-710 and subsequent regulatory practice.
OSC Staff Notice 81-710 has been an impediment to merger activity, particularly among smaller managers seeking to achieve greater economies of scale and become more competitive. It expects that either the purchaser will not consolidate with the acquired manager in the short term, or that the parties will pay the costs of seeking unitholder approval of the acquisition. Neither option is reasonable for smaller transactions. OSC Staff Notice 81-710 was introduced without public consultation, and it creates unitholder approval requirements for changes that, in the absence of a contemporaneous acquisition transaction, do not require unitholder approval under NI 81-102 (such as rebranding funds or changing senior executive management of the manager). We recommend that OSC Staff Notice 81-710 be deleted.
- Codification of fund facts and ETF facts pre-delivery relief
This is the third codification included in these amendments and relates to exemptions from pre-delivery of fund facts and ETF facts for various trades associated with auto-rebalancing services, model portfolio programs and automatic switches between series based on sizes of the accounts. It also introduces a new exemption from any delivery where the purchaser is a managed account or permitted client.
The exemption codified by the amendment from delivering fund facts in connection with model portfolio programs only applies to rebalancing trades to return portfolio holdings to their target weightings. It does not extend to other types of trades associated with model portfolios (such as changes to portfolio compositions or target weightings), even though fund facts delivery relief has been granted for those trades. We recommend that this codified exemption be expanded to all forms of trades arising in model portfolio programs so that multiple subsequent applications by other market participants will be avoided. Alternatively, we recommend that the CSA expressly confirm that no fund facts need be delivered to investors in model portfolio programs due to their accounts qualifying as “managed accounts”.