Key Takeaways
- • On September 22, 2016, the Canadian Securities Administrators (CSA) published a proposal for a "liquid alternatives" framework that would create a new category of prospectus-offered "alternative funds" under NI 81-102.
- • Alternative funds could use strategies currently barred to conventional mutual funds, including up to 50% of NAV in borrowing and short selling, up to 300% gross leverage, and single-issuer concentration of 20% of NAV.
- • The proposal would allow alternative funds to distribute to retail investors under a simplified prospectus, a departure from current access limited to accredited investors through offering memorandums.
- • The CSA set a comment deadline of December 22, 2016, and described the proposal as the final stage of its investment fund modernization project.
Summary
On September 22, 2016, the Canadian Securities Administrators (CSA) published their long-awaited proposal for a "liquid alternatives" regulatory framework, according to the McMillan LLP analysis of the proposal. The proposal primarily amends National Instrument 81-102 Investment Funds (NI 81-102) and creates a new category of prospectus-offered investment funds called "alternative funds." Currently, alternative strategies are generally available only through private pooled funds sold under offering memorandums to accredited investors and other exempt purchasers. Under the proposal, alternative funds could distribute securities on a continuous basis to retail investors under a simplified prospectus.
The proposal also eliminates National Instrument 81-104 Commodity Pools, subsuming that regime into the new alternative fund category. It modifies investment restrictions for conventional mutual funds and closed-end funds, with many new restrictions for alternative funds also imposed on closed-end funds. Key parameters for alternative funds include a 20% single-issuer concentration limit (versus 10% for conventional mutual funds), borrowing of up to 50% of NAV, short selling of up to 50% of NAV (versus 20% for conventional funds), and a combined borrowing and short-selling limit of 50% of NAV. Total gross exposure from borrowing, short selling and specified derivatives may not exceed 300% of NAV, tested daily. Illiquid assets are capped at 10% of NAV after purchase and 15% at any time, with the CSA seeking feedback on whether a higher limit is appropriate for funds offering less frequent redemptions.
The framework also introduces a 10% mark-to-market exposure limit per derivative counterparty, a departure from commodity pool rules, which do not restrict counterparty exposure. Alternative funds are exempt from the designated-rating requirements applied to conventional mutual funds, allowing broader OTC counterparty access. Closed-end funds would face several of these limits as well, including the 20% concentration cap, the 50% combined borrowing and short-selling limit and the 10% counterparty limit.
The proposal is the last part of Phase 2 and the final stage of the CSA's modernization project, following Phase 1 in 2012 and Phase 2 in 2014. Comments are requested by December 22, 2016. Later publicly available commentary indicates that regulated liquid alternative funds were introduced in Canada in January 2019; that development is historical context and was not part of the 2016 proposal itself.
The proposal also eliminates National Instrument 81-104 Commodity Pools, subsuming that regime into the new alternative fund category. It modifies investment restrictions for conventional mutual funds and closed-end funds, with many new restrictions for alternative funds also imposed on closed-end funds. Key parameters for alternative funds include a 20% single-issuer concentration limit (versus 10% for conventional mutual funds), borrowing of up to 50% of NAV, short selling of up to 50% of NAV (versus 20% for conventional funds), and a combined borrowing and short-selling limit of 50% of NAV. Total gross exposure from borrowing, short selling and specified derivatives may not exceed 300% of NAV, tested daily. Illiquid assets are capped at 10% of NAV after purchase and 15% at any time, with the CSA seeking feedback on whether a higher limit is appropriate for funds offering less frequent redemptions.
The framework also introduces a 10% mark-to-market exposure limit per derivative counterparty, a departure from commodity pool rules, which do not restrict counterparty exposure. Alternative funds are exempt from the designated-rating requirements applied to conventional mutual funds, allowing broader OTC counterparty access. Closed-end funds would face several of these limits as well, including the 20% concentration cap, the 50% combined borrowing and short-selling limit and the 10% counterparty limit.
The proposal is the last part of Phase 2 and the final stage of the CSA's modernization project, following Phase 1 in 2012 and Phase 2 in 2014. Comments are requested by December 22, 2016. Later publicly available commentary indicates that regulated liquid alternative funds were introduced in Canada in January 2019; that development is historical context and was not part of the 2016 proposal itself.
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