Canadian securities regulators are gearing up to release new proposals later this year that will require exchange-traded funds (ETFs) to provide investors with their own version of Fund Facts disclosure documents, as well as a review of mutual funds’ distribution policies, short-term trading fees and the structured notes, according to an Ontario Securities Commission (OSC) report.
The OSC Summary Report for Investment Fund and Structured Product Issuers – 2014, published at the end of February, outlines last year’s activities in the investment fund and structured products market. It follows the January 2015 CSA Staff Notice 44-305 Structured Notes Distributed under the Shelf Prospectus System (SN 44-305), which updated the Canadian Securities Administrators' (CSA) views on disclosure and other issues that providers should consider when structuring and administering their note programmes.
“As these and other investment and structured products increase in number, and as the use of ETFs by retail investors continues to grow, the OSC will continue to assess and respond to product developments and innovations with a view to promoting investor protection and assessing the sufficiency and consistency of the regulatory treatment of different investment fund products,” stated the OSC report. “We will continue to consider what gaps may exist under our regulatory approach to structured notes and whether more formal regulatory requirements may become necessary to ensure we are regulating like products in a consistent way to achieve investor protection and fair and efficient capital markets.”
The report details the regulator’s ongoing policy priorities, emerging issues, compliance reviews and its outreach efforts, and noted that the OSC met with staff from the investment management and derivatives divisions of the US Securities and Exchange Commission (SEC) “to discuss investment fund trends, novel products and emerging issues that are common to our respective jurisdictions” to ensure that regulatory approaches to product development are consistent and that opportunities for “regulatory arbitrage between our markets are minimised”.
The report reminds structured note issuers to ensure that their disclosure provides sufficient transparency regarding fees, including any financial benefits the issuer may embed when structuring and pricing notes. Structured notes supplements, stated the report, will be required to include a cover page disclosing the issuer’s estimate of fair value based on its valuation of the economic components that could be combined to provide the same exposure as the structured note, as well as a brief explanation that the fair value of the note is based on the issuer’s estimate of the value of the note’s economic components and a brief description of what those components are.
In addition, issuers of structured notes in Canada will be required to provide an explanation of why the issuer’s estimate of the note's fair value may be different from the offering price, including whether the offering price includes an estimated profit for the issuer and what fees, costs or other amounts that the issuer adds to its estimate of the note’s fair value; and an explanation that the issuer’s estimate of the note’s fair value may differ from the price at which an investor can sell the note in the secondary market and why.
In relation to underlyings, reference asset must be sufficiently publicly transparent to enable the issuer to satisfy the full, true and plain disclosure requirement.
“Prospectus supplements must provide sufficient information regarding a note’s underlying interest or reference asset in order to allow investors to make an informed decision. This is relatively straightforward when the underlying interest or reference asset is a public entity that is subject to some form of continuous disclosure regime,” it said.
However, the regulator acknowledged that underlyings for which providing full, true and plain disclosure may be particularly difficult include some proprietary indices established by the issuer or an affiliate of the issuer; hedge funds and hedge fund replication strategies; and reference assets or interests for which there is no information in the public domain such as, for instance, a private discretionary managed account or portfolio of investments.
On the use of quantitative models, the regulator said it has asked issuers to provide disclosure regarding the quantitative model, including: methodology and financial criteria; the initial portfolio holdings under the model and the initial portfolio value; how transactions in the portfolio will be valued even when the portfolio only exists on a notional basis; and how investors may access ongoing information regarding the portfolio free of charge.
The report also reveals that the CSA expects to publish proposed amendments later this year that will establish a new requirement disclosure document for ETFs.
Click here to read the CSA Staff Notice 44-305 – 2015 Update – Structured Notes Distributed Under the Shelf Prospectus System. Click here to read the 2014 Summary Report for Investment Fund and Structured Product Issuers (SN 44-304).
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