On September 13, 2023, the Ontario Securities Commission (OSC) issued Staff Notice 81-734. The Summary Report (Report) offers a comprehensive overview of the operational and policy initiatives undertaken by the Investment Funds and Structured Products Branch (IFSP) during its fiscal year ending March 31, 2023. The Report is a valuable resource for Investment Fund Managers (IFMs), service entities, and other stakeholders, providing insights into key developments affecting investment fund and structured product issuers. This article further summarizes key elements of the Report.
The report is structured into four main sections:
Part A – Operational Highlights - Summarizes key activities, including prospectus reviews, applications for exemptive relief, and continuous disclosure reviews.
Part B – Regulatory Policy Initiatives - Provides details on ongoing policy initiatives, including their status and impact.
Part C – Emerging Issues and Initiatives Impacting Investment Funds - Highlights changes affecting the investment funds industry post-Fiscal 2023.
Part D – Stakeholder Outreach - Describes IFSP's outreach initiatives, fostering engagement with stakeholders.
Responsibilities of IFSP Branch
The IFSP Branch operates within the Ontario Securities Commission's (OSC) mandate to protect investors, foster fair and efficient capital markets, and contribute to financial stability. IFSP's key functions encompass product disclosure reviews, discretionary relief applications, policy-making, stakeholder engagement, issuing guidance through staff notices, and monitoring global regulatory developments.
Structure of IFSP Branch
The IFSP Branch is organized into three dedicated teams:
Product Offerings Team
Regulatory Policy Team
Risk and Analytics Team
Defining Investment Funds
The Report identifies the two main types of investment funds as mutual funds and non-redeemable investment funds (NRIFs). The Report further outlines criteria for evaluating whether a product qualifies as an investment fund, emphasizing factors such as the ability to redeem, the use of net asset value (NAV) calculations, no active management of the underlying investment entities, no control of underlying issuers, the issuer's purpose is not to conduct an operating business, and investor expectations that their funds will be professionally managed.
Investment Funds Market Landscape
Canada's public investment funds, representing over one-third of household financial wealth, totalled approximately $2.3 trillion in assets under management in fiscal 2023 including 83% Conventional Mutual Funds, 15% ETFs and 2% Closed End Funds. Structured notes outstanding stood at about $30.4 billion during this period.
Indicators of Competition
The report details the competitive landscape, showcasing the concentration of market share among the top IFMs for both mutual funds and ETFs. The market share of bank-affiliated IFMs has remained stable since the mid 2000s at around 45%, while small to mid-size IFMs have remained competitive and played a significant role in recent product innovations.
The mutual fund market experienced a decline of $60 billion (about 5%) in AUM during Fiscal 2023, primarily in the balanced asset class with money market funds experiencing positive sales, suggesting increased investor caution. Meanwhile, ETF AUM increased by 4% during the period primarily in the equity and money market asset classes.
Crypto Asset and ESG Funds
The Report provides insights into the rapidly evolving landscape of crypto asset and Environmental, Social, and Governance (ESG) funds. Crypto assets were offered by eight IFMs whose primary registration was in Ontario. Crypto assets declined significantly from $6.9 billion in Fiscal 2022 to 2.85 billion in Fiscal 2023, primarily due to declining market values.
The Report highlights the growing awareness of ESG funds, with AUM totaling $44.7 billion in 2022, up from 41.8 billion in 2021. In January 2023 the Canadian Investment Funds Standards Committee (CIFSC) released its Responsible Investment Identification Framework introducing six new categories for ESG funds. Top of Form
PART A: OPERATIONAL HIGHLIGHTS
In this section, the Report delves into specific operational highlights, regulatory policy initiatives, emerging issues, and stakeholder outreach activities undertaken by IFSP during Fiscal 2023.
1. Prospectus Filings
A key operation function of the IFSP is to review prospectuses for publicly offered investment funds and linked notes. The Report reminds issuers that they “must file and obtain a receipt for a prospectus to “distribute” securities to the public or rely upon a prospectus exemption”.
The IFSP encourages filers with novel products to utilize its confidential pre-file process for prospectus and exemptive relief applications. This process maintains confidentiality while regulatory issues are resolved. Meanwhile, the IFSP reminds issuers that substantive changes to prospectus disclosure after filing may cause delays. Staff encourages early filing to avoid delays and highlights observations of additional review time for material ESG-related disclosures.
Total prospectus filings declined by 11% in Fiscal 2023, mainly attributed to the consolidation of prospectuses by IFMs. The majority were standard reviews for conventional mutual fund and ETF offerings.
Prospectus Reviews of ESG-Related Funds
IFSP staff continued its focused reviews on ESG-Related Funds' prospectuses, in accordance with guidance in CSA Staff Notice 81-334 ESG-Related Investment Fund Disclosure. The reviews emphasized fund investment objectives and name, investment strategies, proxy voting policies, risk disclosure, and suitability disclosure.
Staff conducting reviews primarily encountered concerns regarding investment strategy disclosure, particularly regarding ESG strategies. Most issues related to clarifying the types of ESG strategies utilized, specific ESG factors considered in portfolio analysis, and how these factors are assessed and monitored.
Problems arose when funds without explicit ESG objectives still considered ESG factors to a lesser extent in their investment process. In such cases, Issuers need to distinctly outline the limited role of ESG factors/strategies. Staff also address issues related to fund names, objectives, ESG risk disclosure, and proxy voting policies in prospectuses. Continuous reviews aim to enhance ESG-related fund disclosures per ESG Staff Notice guidelines, including scrutinizing recent sales communications.
2. Exemptive Relief Applications
IFSP reviews exemptive relieve applications to determine whether “granting the requested relief would not be prejudicial to the public interest and makes a recommendation on that basis”.
Routine applications mirror prior decisions, containing similar provisions in the decision document, but some may include substantive new elements that are considered based on the application's context for appropriate relief conditions. Novel applications, distinct or significantly divergent from past decisions, undergo extended review and consultation with the CSA due to their complexity.
Exemptive relief applications decreased by 20% and 25% compared to the previous fiscal year, attributed to amendments reducing regulatory burdens. Routine applications predominated, with novel applications comprising 4% in Fiscal 2023, down from 6% in the prior year.
3. Continuous Disclosure Reviews
The IFSP regularly conducts continuous disclosure reviews based on risk-based criteria, targeted reviews of particular segments or issues, or reviews based on complaints.
In fiscal 2023, continuous disclosure reviews targeted crypto asset funds, specifically those focused on bitcoin and/or ether. Emphasis was on valuation, liquidity risk management, and compliance with continuous disclosure obligations. It focused on 16 crypto funds managed by seven IFMs. As a result of the reviews, IFSP issued comment letters related to areas such as valuation, liquidity risk, management, crypto trading platforms and other continuous disclosure obligations.
An issue-oriented review initiated post-FTX failure focused on the safety of crypto assets held by funds, examining ownership, asset segregation, custodial structure, and post-FTX implications. In collaboration with other branches of the OSC, IFSP staff engaged fund auditors to gain a better understanding of their audit processes and asset custody procedures.
CSA Guidance and Custody Review Results
CSA Staff Notice 81-336 Guidance on Crypto Asset Investment Funds that are Reporting Issuers, published on July 6, 2023, provides guidance for IFMs on complying with securities laws for public investment funds holding crypto assets. Results of custody reviews are incorporated in the guidance.
After issuing the ESG Staff Notice in 2022, IFSP began reviewing continuous disclosure, sales communications and portfolio holdings of ESG-Related Funds focussing on:
Assessing management reports of fund performance (MRFPs) and on fund websites particularly for changes in portfolio composition, progress in meeting ESG objectives, and outcomes of proxy voting and shareholder engagement.
Identifying inconsistent investments per negative screening criteria or conflicting with fund ESG values and addressing where necessary.
Ensuring votes align with IFM proxy voting guidelines for ESG-related shareholder proposals and addressing discrepancies.
Reviewing fund and IFM websites to ensure they align with regulatory documents and are not untrue or misleading.
Verifying IFMs’ policies regarding ESG investment align with their communication claims.
Where issues were identified: the sales communication was removed or revised or the prospectus disclosure was updated to resolve the conflicting information in the sales communication.
Burden Reduction: Simplified Prospectus Length Reduction
The Canadian Securities Administrators (CSA) implemented various measures to alleviate regulatory burdens for investment funds. These changes eliminated redundant requirements, streamlined processes, and formalized exemptions. Notably, the consolidation of the simplified prospectus (SP) and annual information form (AIF) into a revised Form 81-101F1 aimed to simplify filings for continuous distribution investment funds. Initial observations following the implementation showed a substantial reduction in average page lengths of SP filings, indicating a tangible decrease in regulatory burden.
Independent Review Committee
IFSP staff conducted a review focused on the Independent Review Committee (IRC) for Investment Funds, examining various aspects such as oversight scope, diversity, and member competencies. Collaboration with another CSA jurisdiction might lead to the publication of staff guidance based on these findings.
Change of Auditor Notifications
Quarterly reviews of change of auditor notifications for investment fund issuers ensure compliance with reporting obligations. The review covered 611 investment funds across 10 IFMs for the fiscal year, with overall satisfactory compliance. IFMs were reminded of their responsibilities upon auditor termination or resignation.
Reports of Exempt Distributions
Filings under the accredited investor exemption for Ontario investors require timely submissions of Form 45-106FI. IFSP staff reviewed submissions to identify issues. The top two flags identified were: Activity fee owing (48.60%) and number of Ontario purchasers differs between 45-106F1 and Schedule (20.79%).
Staff reminded IFMs offering exempt funds “to ensure that the 45-106F1s are filed in a timely manner to avoid late fees, to include the appropriate activity fee payment and to ensure that the information contained on the 45-106F1 reconciles with the information reported in the detailed Schedule 1”.
Standard Continuous Disclosure Reviews
IFSP staff conducted routine randomized reviews of SEDAR filings to assess compliance with disclosure requirements. No significant issues were found among the 217 reviewed funds from 49 IFMs during the fiscal year.
Investment Fund Exposure Analysis
Given recent events surrounding the Credit Suisse AT1 bond write downs and possible effects on the European banking sector, IFSP staff assessed European bank exposure in Canadian investment funds. It found the exposure was relatively immaterial in relation to AUM. Active monitoring of global market developments, including the U.S. banking sector, continues to gauge impacts on the Canadian investment fund market.
Marketing Materials Oversight
Ad hoc reviews of marketing materials addressed complaints about inadequate disclosure on social media platforms. Emphasizing compliance with disclosure requirements under NI 81-102, especially in alternative media, staff highlighted the need for easily comprehensible information and accessible disclaimers. IFMs were advised to review social media use by employees to ensure compliance, providing adequate training and establishing monitoring procedures.
Part 5 of OSC Staff Notice 81-720 Report on Staff’s Continuous Disclosure Review of Sales Communications by Investment Funds provides additional guidance on use of alternative media.
PART B: REGULATORY POLICY
The IFSP continues to prioritize regulatory burden reduction with feedback from stakeholders, including investors. This section outlines completed and ongoing policy initiatives during Fiscal 2023.
1. Access-Based Model for Investment Fund Reporting Issuers
On September 27, 2022 the CSA published for comment proposed amendments for an Access-Based Model for Investment Fund Reporting Issuers. The objective is to modernize delivery practices for continuous disclosure documents of investment funds and enhance online availability and accessibility in line with investor preferences. The result is more timely and environmentally friendly information access, with the option for investors to choose paper or electronic document delivery. Resulting amendments will affect mutual fund issuers only and will amend NI 81-106 Investment Fund Continuous Disclosure and NI 81-101 Mutual Fund Prospectus Disclosure.
2. Investment Fund Settlement Cycle
On December 15, 2022, the CSA published CSA Staff Notice 81-335 Investment Fund Settlement Cycles. The notice indicates that it will not propose to mandate a shorter settlement cycle (T+1) for mutual funds, but rather maintain flexibility for investment funds to determine an appropriate settlement cycle. However, where practicable, mutual funds should voluntarily settle on T+1 in accordance with the proposed Institutional Trade Matching and Settlements (NI 24-101).
3. Proposed Modernization of the Prospectus Filing Model
On January 27, 2022, CSA published for comment proposed modernization of the prospectus filing model allowing mutual funds on continuous distribution to file a new prospectus every two years instead of annually and to repeal the requirement to file a final prospectus within 90 days of the preliminary prospectus.
4. Modernization of Continuous Disclosure Documents
The CSA is reviewing investment fund continuous disclosure requirements to modernize key elements of the regime to make them more useful to investors and less burdensome to investment funds. A main focus is the Management Report of Fund Performance (MRFP).
The CSA engaged a behavioral insight consulting firm to survey retail investors about their preferences and to assess and test the impact of any proposed MRFP modifications. Results are currently under review.
5. Review of Principal Distributor Practices
The CSA is reviewing practices of mutual funds that have principal distributor relationships with registrants. First, the CSA Surveyed IFMs using principal distributors about their arrangements. Secondly, the CSA surveyed the principal distributors identified in the first survey. The CSA working group is currently reviewing survey responses to better understand the sales practices and guide possible regulatory amendments to NI 81-105 Mutual Fund Sales Practices.
Part C: Emerging Issues and Initiatives Impacting Investment Funds
This section outlines the key initiatives and developments in the regulatory policy domain, reflecting a commitment to modernization and stakeholder feedback in shaping investment fund regulations.
1. Changes to OSC Fees Rule
On March 2, 2023 Amendments to OSC Rule 13-502 Fees came into force with the following relevant amendments for investment fund issuers:
Introduction of late fees on covered documents, calculated on a calendar-day basis versus business day basis.
Maximum late fee linked to affiliated entities for each covered document and not just a single issuer.
In addition to the above amendments two amendments, exempt distributions under NI 45-106 included an amendment to reduce the filing fee for form 45-106F1 to $350.
2. Transition to SEDAR+
SEDAR+ went live on July 25, 2023. CSA adopted NI 13-103 System for Electronic Data Analysis and Retrieval +. As a result, IFMs required to have a profile in SEDAR+, with each investment fund having an independent profile.
3. Cessation of Canadian Dollar Offered Rate (CDOR)
On February 28, 2023 CSA published Staff Notice 25-309 Matters Relating to the Cessation of CDOR and Expected Cessation of Bankers’ Acceptances. OSC and Autorité des marchés financiers authorized the cessation.
Market participants are urged to prepare for the cessation of CDOR publication after June 28, 2024 and the issuance of Bankers’ Acceptances with a potential impact on money market funds.
4. Investment Fund Survey (IFS)
OSC launched the 2023 IFS on January 11, 2023. As in prior years, it seeks collection of data on fund size, holdings, leverage, ownership, liquidity profiles, and more.
Approximately 5,700 prospectus-qualified and exempt investment funds, managed by more than 400 IFMs provided data.
The objective of the survey is to collect detailed fund-level data and thereby generate new insights into the Canadian Investment Fund Industry. This data is shared and updated annually on the OSC Investment Fund Survey data landing page.
The January 2024 version of the survey will require:
IFMs registered in Ontario to complete the IFS for all Investment Funds for which they act as IFM including labour-sponsored investment funds and scholarship plans with net assets under $10 million; and,
Require IFMs to report the annual net performance returns, the management expense ratio, the performance fees charged, if any; and the fund Risk Rating.
5. Cybersecurity Breaches
Increased reliance on technology exposes IFMs to cybersecurity threats. IFMs are required to disclose cybersecurity risks in the “What are the Risks of Investing in the Fund” section of the prospectus; to establish, maintain and apply risk management policies and procedures; and, to maintain sufficient supervisory controls and disaster recovery capabilities.
The Report reminds firms that they remain responsible for due diligence of outsourced activities. CSA Staff Notice 33-321 Cyber Security and Social Media provides guidance to firms on their cybersecurity policies and procedures.
As best practices, the CSA encourages IFMs to conduct periodic risk assessments, have effective incident response plans, and develop communication strategies. In addition, the CSA encourages breach reporting depending with consideration to the magnitude of the breach. Where client information and assets are at risk or the breach could affect multiple IFMs affected parties and regulators such as the OSC must be notified.
PART D: STAKEHOLDER OUTREACH
This section highlights significant emerging issues and initiatives impacting investment funds, encompassing regulatory changes, technological transitions, financial benchmark cessation, survey developments, and cybersecurity risk management.
1. IFSP Landing Page on OSC Website
The IFSP landing page on the OSC website serves as a comprehensive resource hub for investment fund issuers and their IFMs. It covers types of investment funds, prospectus offerings, operating an investment fund, disclosure requirements, marketing, IFSP eNews publications, discretionary relief, investment fund survey, and more.
2. IFSP eNews
IFSP eNews, a web-based publication, offers timely regulatory information to investment fund issuers and advisors. Articles cover regulatory news, issues, and relevant updates. Archived content includes relevant articles from the discontinued Investment Funds Practitioner. Subscribers receive articles through email blasts. Registration for email subscription can be done here.
3. Investment Funds Technical Advisory Committee (IFTAC)
IFTAC provides a platform for stakeholders to engage with the OSC, contributing to effective regulation in investment funds and structured products. IFTAC Advises OSC staff on technical compliance challenges, emphasizing alignment between investor, industry, and regulatory goals. IFTAC meets four times a year
Prepared by SGD Compliance Consulting in conjunction with David Borenstein, President, Borenstein Consulting Inc. Expert in Securities Industry and Regulatory Investigations, Policy Development and Training.
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