NIN 2000/19 - Republication for Comment of Proposed National Instrument 81-104 and Companion Policy 81-104CP - Commodity Pools [NIN - Rescinded]

The Commission, together with other members of the Canadian Securities Administrators (“CSA”), is republishing for comment proposed National Instrument 81-104 Commodity Pools (the “National Instrument”) and proposed Companion Policy 81-104CP (the “Companion Policy”). The National Instrument and Companion Policydeal with the regulatory regime applicable to commodity pools and is a reformulation of Ontario Policy 11.4, which it will replace.

The proposed National Instrument and Companion Policy are initiatives of the CSA. The proposed National Instrument is expected to be adopted as a rule in each of British Columbia, Alberta, Manitoba, Ontario, Nova Scotia and Newfoundland, as a Commission regulation in Saskatchewan and as a policy in all the other jurisdictions represented by the CSA. The proposed Companion Policy is expected to be implemented as a policy in all of the jurisdictions represented by the CSA.

Revocation of Notice

Effective the date that the proposed National Instrument comes into force, NIN#97/25 Proposed National Instrument 81-104 and Companion Policy 81-104CP Commodity Pools¹

¹ June 27, 1997 Weekly Summary

will be revoked. NIN#97/25 is superseded by the matters contained in the National Instrument and Companion Policy.

Background

On June 27, 1997, the Commission, together with the other members of the CSA, published for comment proposed National Instrument 81-104 Commodity Pools (the “1997 Draft Instrument”), and proposed Companion Policy 81-104CP (the “1997 Draft CP”) (collectively the “1997 Drafts”).²

² NIN# 97/25

During the comment period, which ended on October 31, 1997, the CSA received only one comment letter. This comment letter focused on one section of the 1997 Draft Instrument and did not address any of the questions posed by the CSA in their publication for comment.

Since the end of the comment period, the CSA have concentrated on ensuring that the National Instrument and the Companion Policy is appropriate for the regulation of commodity pools in Canada. Staff in some of the jurisdictions represented by the CSA met with each sponsor or manager of the commodity pools managed and sold in Canada to ensure that the proposed regulatory regime addresses the issues associated with commodity pools, yet permits the continued viability of these specialized investment products. These staff also met with representatives of dealers who wish to be able to recommend commodity pools to their clients.

Additional written comments were received as a result of the CSA’s efforts. A list of the commenters and a summary of all comments is attached as Appendix A to this Notice. After considering these comments and assessing the 1997 Drafts, the CSA are proposing amendments to the 1997 Drafts. The CSA are publishing the National Instrument and Companion Policy for a second comment period.

Details of all specific changes to the proposed National Instrument, Forms and the Companion Policy may be found in the OSC Notice relating to the National Instrument at the Ontario Securities Commission website at www.osc.gov.on.ca.

Many of the comments received related to the need for change in the following areas:

• to broaden the definition of “illiquid asset” in National Instrument 81-102 Mutual Funds (“NI 81-102”) to make the definition more relevant for the kinds of derivatives purchased by commodity pools 
  
• to remove prohibitions on commodity pools paying fees to advisers and managers if those parties or affiliates received brokerage commissions from trades made by the commodity pools
  
• to change the proficiency requirements proposed in the 1997 Drafts to more accurately reflect the nature of the proficiency required for those selling commodity pools
  
• to change the form of the statement of portfolio transactions required to be filed by a commodity pool as part of its financial statements to be more relevant to the nature of the transactions of commodity pools. Amendments to Form 52, which is the Form required by s. 113 of the Securities Rules, will be required. The amended Form will be renumbered using the national numbering system and specified by the Executive Director when the National Instrument comes into force.
  
• to adjust the benchmarks required to be attained before an incentive fee could be paid to a commodity pool adviser by a commodity pool.

Compatibility with Other Mutual Fund Rules

The National Instrument is designed to regulate publicly offered commodity pools and will act in conjunction with the mutual fund regulatory regime established by NI 81-102. NI 81-102 came into force on February 1, 2000.

Specific Questions of the CSA

Incentive Fees

Part 6 of the National Instrument addresses the levying of incentive fees against assets of commodity pools when no benchmark or index exists that would meet the requirements in section 7.1 of NI 81-102. The CSA seek comment on whether the proposed National Instrument should completely exempt commodity pools from the operation of section 7.1 of NI 81-102 and require only disclosure of the incentive fee and the basis on which it is calculated. In responding to this issue, commenters should address whether disclosure alone would provide consumers with enough information to make informed decisions and whether market forces would be able to adequately regulate incentive fees charged by commodity pools. In other words, why should commodity pools be treated differently in this respect than conventional mutual funds?

The CSA note that the primary regulatory purpose in mandating a benchmark or index is to ensure that investors will be able to properly assess whether the fees being charged in respect of their investment are appropriate having regard to the performance of the pool. The CSA have traditionally required that a manager of mutual funds inform investors that it will attempt to out-perform a specified recognized and widely used benchmark or index and if it does so, it will be entitled to fees based on that performance. Will investors be able to make informed decisions about the performance of the commodity pool’s performance without any measure of performance?

Risk Measures

The CSA are proposing that commodity pools provide in their prospectuses, graphic depictions of past performance which are consistent with the requirements for conventional mutual funds set out in National Instrument 81-101 Mutual Fund Prospectus Disclosure. The CSA seek specific comment on whether commodity pools are sufficiently different from conventional mutual funds in their risk profile to warrant the CSA requiring disclosure of a standardized measure of risk. Commenters believing that this disclosure would be appropriate should explain which measure would be appropriate, with a focus on whether this risk measure would be comprehensible to the average commodity pool investor. Does a common measure of risk exist in the commodity pool industry in Canada? Does a common measure of risk exist in the United States?

Risk of Loss of Limited Liability

The National Instrument requires that a commodity pool address the possibility of loss of limited liability in specialized circumstances in its prospectus. Is this risk sufficiently important and material that front page disclosure should be given?

Comments

Interested parties are invited to make written submissions with respect to the National Instrument and Companion Policy. Submissions received by August 4, 2000 will be considered.

Submissions should be sent to all of the Canadian securities regulatory authorities listed below in care of the Ontario Securities Commission, in duplicate, as indicated below:

British Columbia Securities Commission
Alberta Securities Commission
Saskatchewan Securities Commission
The Manitoba Securities Commission
Ontario Securities Commission
Office of the Administrator, New Brunswick
Registrar of Securities, Prince Edward Island
Nova Scotia Securities Commission
Securities Commission of Newfoundland
Securities Registry, Government of the Northwest Territories
Registrar of Securities, Government of the Yukon Territory
Registrar of Securities, Government of the Nunavut Territory

c/o John Stevenson, Secretary
Ontario Securities Commission
20 Queen Street West
Suite 800, Box 55
Toronto, Ontario M5H 3S8
E-mail: jstevenson@osc.gov.on.ca

Submissions should also be addressed to the Commission des valeurs mobilières du Québec as follows:

Claude St. Pierre, Secretary
Commission des valeurs mobilières du Québec
800 Victoria Square
Stock Exchange Tower
P.O. Box 246, 22nd Floor
Montréal, Québec H4Z 1G3
E-mail: claude.stpierre@cvmq.gouv.qc.ca

A diskette containing the submissions (in DOS or Windows format, preferably WordPerfect) should also be submitted. As securities legislation in certain provinces requires that a summary of written comments received during the comment period be published, confidentiality of submissions cannot be maintained.

Comments may also be sent via E-mail to the above noted E-mail addresses of the respective Secretaries of the Ontario Commission and of the Commission des valeurs mobilières du Québec, and also to any of the individuals noted below at their respective E-mail addresses.

Questions may be referred to any of:

Noreen Bent
Senior Legal Counsel
British Columbia Securities Commission
(604) 899-6741
or (800) 373-6393 (in B.C.)
E-mail: nbent@bcsc.bc.ca

Wayne Alford
Legal Counsel
Alberta Securities Commission
(403) 297-2092
E-mail: wayne.alford@seccom.ab.ca

Dean Murrison
Deputy Director, Legal
Saskatchewan Securities Commission
(306) 787-5879
E-mail: dean.murrison.ssc@govmail.gov.sk.ca

Bob Bouchard
Director, Corporate Finance
The Manitoba Securities Commission
(204) 945-2555
E-mail: bbouchard@cca.gov.mb.ca

Rebecca Cowdery
Manager, Investment Funds
Capital Markets
Ontario Securities Commission
(416) 593-8129
E-mail: rcowdery@osc.gov.on.ca

Anne Ramsay
Accountant, Investment Funds
Capital Markets
Ontario Securities Commission
(416) 593-8091
E-mail: aramsay@osc.gov.on.ca

Darren McKall
Legal Counsel, Investment Funds
Capital Markets
Ontario Securities Commission
(416) 593-8118
E-mail: dmckall@osc.gov.on.ca

Ann Leduc
Conseillère en réglementation
Direction de la recherche at du développement des marchés
Commission des valeurs mobilières du Québec
(514) 873-2150, ext. 4572
E-mail: ann.leduc@cvmq.com

DATED at Vancouver, British Columbia, on May 31, 2000.


Douglas M. Hyndman
Chair

Ref: NIN #97/25
NI 81-102
Form 52
NI 81-101
Securities Rules, s. 113

This NIN refers to other documents. These documents can be found at the B.C. Securities Commission public website at www.bcsc.bc.ca in the Policy Documents database.

In June 1997, the Canadian Securities Administrators (CSA) released for public comment proposed National Instrument 81-104 Commodity Pools (the 1997 Draft NI) and proposed Companion Policy 81-104CP Commodity Pools (the 1997 Draft CP). During the comment period which ended on October 31, 1997, the CSA received one comment letter from Meighen Demers.

As outlined in the Notice of Proposed Changes, since no comments were received during the comment period that addressed the issues raised by the CSA in the 1997 Notice, the CSA considered it important to contact each of the existing commodity pools in Canada to ensure that the proposed regulatory regime for commodity pools is appropriate and reflects the commodity pool industry in Canada. As a result of that contact, the CSA received additional written comments from:

AGF Management Limited
The Di Tomasso Group
Dorsey & Whitney LLP on behalf of Friedberg Mercantile Group
Fogler, Rubinoff on behalf of Friedberg Mercantile Group
Merrill Lynch Canada Inc.
Mondiale Asset Management Ltd.
Russell & DuMoulin

Copies of the comment letters may be viewed at the office of Micromedia Limited, 20 Victoria Street, Toronto, Ontario (416) 312-5211 or 1- (800) 387-2689; the office of the British Columbia Securities Commission, 200-865 Hornby Street, Vancouver, British Columbia (604) 899-6660; the office of the Alberta Securities Commission, 10025 Jasper Avenue, Edmonton, Alberta (780) 427-5201; and the office of the Commission des valeurs mobilières du Québec, Stock Exchange Tower, 800 Victoria Square, 22nd floor, Montréal, Québec (514) 940-2150.

The CSA have considered the comments received on the 1997 Drafts and thank all commenters for providing their comments.

The attached Table contains a summary of all comments received, together with the response of the CSA to those comments.

Note: In this Table, "1997 Draft" means the proposed version of NI 81-104 and Companion Policy 81-104CP published for comment in June 1997; "Revised NI" means the proposed revised version of NI 81-104 and Companion Policy 81-104CP; "CSA" means the Canadian Securities Administrators.

	1997 Draft Reference	Revised NI Reference	Comment	CSA Response
1.	Definition of “illiquid asset” in NI 81-102	S. 1.3(2)	Commodity pools should be permitted to invest in inter-bank forwards and options for which there is a counterparty prepared to and capable of making a market without regard to whether these transactions are restricted by the “illiquid assets” rules provided for in NI 81-102.	Change made. Subsection 1.3(2) of the proposed National Instrument excludes interbank forwards and options for which there is a counterparty prepared to and capable of making a market from the definition of “illiquid asset” for commodity pools.
2.	Definition of “underlying market exposure” in the 1997 draft of NI 81-102	N/A	The definition of “underlying market exposure” in the June 1997 published draft of NI 81-102 does not include all derivative instruments that may be used by a commodity pool. As a result, the look-through provision used to calculate concentration in one issuer for the concentration restriction will not operate to include all derivatives that may be used by a commodity pool.	The final version of NI 81-102 addresses this discrepancy. The term “underlying market exposure” was replaced by the term “underlying interest of that specified derivative” in subsection 2.1(3) of NI 81-102.
3.	S. 1.3	DELETED	Section 1.3 of the 1997 Draft should be clarified to ensure that all references to “permitted derivatives” in NI 81-102 are read as references to “specified derivatives” for commodity pools.	The comment was addressed in the final version of NI 81-102 which only uses the term “specified derivatives”. All references to “permitted derivatives” were removed from the final rule.
4.	S. 2.1	S. 2.1	The 10 percent concentration restriction should not apply to commodity pools. The use of leverage will cause a commodity pool to easily exceed the 10 percent concentration restriction. This result would not be consistent with a commodity pool’s ability to leverage and speculate. E.g., a commodity pool with net assets of $1 million that purchases forward contracts with market exposure of $300,000 (30 percent of the net assets) may only need to deposit $12,000 margin (2 to 4 percent of underlying market exposure).	No change made. The 10 percent concentration restriction in s. 2.1(1) of NI 81-102 restricts commodity pools from investing in any one issuer more than 10 percent of the net assets of the pool. Commodity pools should not use leverage to gain more than 10 percent exposure to any one issuer. The general rules applicable to mutual funds should apply to commodity pools. The concentration restriction would not preclude a commodity pool from exposing more than 10 percent of its net assets to a commodity (such as gold).
5.	S. 3.2(1)(a) & (b)	S. 3.2(1)(a) & (b)	Clause 3.2(1)(b) forbids the issuance of any units prior to receiving subscriptions aggregating not less than $500,000. This prohibition precludes the issuance of units for the seed capital money invested.	Clause 3.2(1)(b) was amended to reflect this comment.
6.	S. 3.2(2)	S. 3.2(2)	The prohibition on removal of the initial seed capital (until the commodity pool is terminated or dissolved) is not necessary if the commodity pool is well established and has grown very large.	No change made. The CSA believe that the seed capital should remain in the commodity pool for the duration of the commodity pool’s existence.
7.	S. 4.1	DELETED	No restrictions should be placed on a commodity pool’s ability to pay a management fee to parties receiving or participating, directly or indirectly, in brokerage commissions. In addition, a manager not acting as portfolio adviser to the commodity pool will not control portfolio turnover (or “churning” activities) - as a result, the conflict of interest provision should not apply to a manager that does not provide portfolio advice.	The prohibition was removed. Commodity pools are now treated in a like manner to conventional mutual funds on this issue. Investors can evaluate the performance of the commodity pool after management and brokerage fees are paid and can redeem units if the net returns of the pool are not acceptable.
8.	5.1	4.1	The Canadian Securities Institute ("CSI") proficiency courses proposed in the 1997 Draft for salespersons and supervisors are not appropriate courses. The courses aim at proficiency requirements for those trading in individual futures accounts. Commodity pools differ from the individual futures accounts as the pools are professionally managed by advisers with the requisite proficiency and experience. Also, the qualifications suggested are rare, particularly for representatives of mutual fund dealers. Since the distribution channels will be limited, a majority of the public in Canada will be deprived of an opportunity to participate in commodity pools. Why impose additional proficiency requirements for commodity pools, when no such additional specialized knowledge is mandated for conventional mutual funds specializing in niche markets, for example, or using derivative instruments.	Section 4.1 has been changed. The additional proficiency requirements for both the salesperson and the supervisor would be to successfully complete the Derivatives Fundamentals Course offered by the CSI. This course provides a knowledge base in derivatives that the CSA believes is appropriate for anyone seeking to sell commodity pools. This course reflects the additional knowledge required to sell a professionally managed commodity pool which uses derivatives to create leverage and to speculate. A six month transitional period is proposed in respect of this requirement.
9.	5.1	4.1	The additional proficiency requirements for selling commodity pools should not apply to SRO members as their general requirements are higher.	Changes described above made. SRO members are not exempt at present from the requirements described above. The CSA are of the view that SRO members should also have specialized knowledge about derivatives to sell commodity pools, notwithstanding the additional courses they take.
10.	5.1	4.1	The proposed National Instrument should include an exemptive relief provision for proficiency requirements.	No change necessary. Applications for exemptive relief from provisions of the proposed National Instrument can be made under section 11.1.
11.	Pt 5	Pt 4	It is difficult for the mutual fund dealer to monitor whether the dealer or salesperson selling a pool is properly registered. The National Instrument should provide clear direction that the onus to ensure proper registration in on the salesperson. Clear liability for the failure to comply must be set out explicitly in the National Instrument or by reference to a stated provision.	No changes were made. The CSA do not believe that the proposed National Instrument regulating commodity pools should restate or contribute to the existing penalties for non-compliance with registration requirements.
12.	S.7.1	S. 7.1	Is it intended that a change in [redemption] policy is a material change, requiring a unitholder meeting if the policy is amended?	The proposed National Instrument permits commodity pools to set redemption policies that are consistent with, if not, less restrictive that previous policy statements. Each commodity pool must determine how it will comply with the National Instrument once it comes into force and must decide for itself what approvals it must seek and obtain.
13.	S. 7.3	S. 7.3	Supports allowing commodity pools additional time to redeem units (i.e.15 days rather than 3 days for conventional mutual funds). Is the “15 days” business days or calendar days?	The 15 days are calendar days.
14.	Pt 7 & 8	Pt 7 & 8	Rationale for reducing the time periods for redemptions (30 days to 15 days) and frequency of calculation of the NAV (once per week to daily) is clear and acceptable. However, these changes will result in significant back-office system changes; will require time and money; and may be difficult for some distributors to implement.	Commodity pools facing undue hardship should seek exemptive transitional relief once the National Instrument comes into force. However, commodity pools have been given a long period of notice of these proposed changes (since June 1997) in which to change their affairs. Any commodity pool seeking exemptive transitional relief should explain why this lengthy period of notice has not been sufficient.
15.	Pt 9.2	Pt 9.2	The requirement for quarterly interim financial statements is not appropriate. It is onerous and costly. A quarterly investment update should be substituted for quarterly interim financial statements.	No changes made. Due to the ability for commodity pools to use leverage and their inherent volatility, the CSA believe that semi-annual financial statements are not sufficient. Also, the quarterly interim statements are not required to be audited statements and costs associated with such audits do not need to be incurred on a quarterly basis.
16.	S 9.4	S 9.4	Preparing and filing of statements of portfolio transactions and statements of investment portfolio are of no utility to investors in a commodity pool.	Section 9.4 of the proposed National Instrument incorporates a revised statement of portfolio transactions for commodity pools. The statement will provide aggregate disclosure of the contracts purchased and sold by the commodity pool during the period. This information will allow investors to evaluate the level of leverage used, the turnover of assets and level of liquidity of the contracts being traded. The regulations applicable to mutual funds and Statements of Investment Portfolio are proposed to apply to commodity pools.
17.	(New)	S. 6.1	In requiring compliance with section 7.1 of NI 81-102, a commodity pool manager must base an incentive fee charged to a commodity pool on the pool’s performance relative to a representative benchmark. There is no such representative benchmark for a highly leveraged investment fund such as a commodity pool. The current requirement would preclude the use of incentive fees by commodity pool managers in Canada. If Canadian commodity pool managers are precluded from charging incentive fees, this fact would impact on the availability of top-ranked U.S. commodity trading advisers and the viability of commodity pools in Canada. The U.S. model allows for incentive fees to be charged without regard to a benchmark, if the fees are fully described to the investors. As 65 - 80 percent of a commodity pool’s assets are generally invested in treasury bills, a government treasury-bill rate would be consistent with section 7.1 of NI 81-102. A treasury-bill rate benchmark is easily measurable and applicable to all types of commodity pools.	Section 6.1 was added to the proposed National Instrument. Section 6.1 permits a commodity pool to pay an incentive fee based on performance, where the pool’s performance is based on a 90-day Canadian or US government treasury-bill rate benchmark, if a more appropriate benchmark is not available.
18.	S. 6.8 of NI 81-102	S. 6.8 of NI 81-102	Section 6.8 of NI 81-102 is not broad enough to accommodate all types of derivatives that commodity pools might use. Section 6.8 of NI 81-102 should be broadened in the proposed National Instrument to accommodate all types of derivatives that a commodity pool might use. Commenter focussing on section 6.8 of the June 1997 version of NI 81-102.	No changes made. The CSA believe that the custodial provisions do accommodate the expanded use of derivatives by commodity pools. Changes made to section 6.8 of NI 81-102 since the June 1997 publication.