Easing the pain as managers launch new funds

The intricacies of the Canadian investment fund market can be somewhat daunting for asset and wealth managers not familiar with this market. RBC Investor & Treasury Services’ Sheila Bowyer, a 25-year veteran of the Canadian asset servicing business, discusses some key considerations for managers looking to launch new funds in Canada.

Rarely a month goes by that I don’t receive an inquiry from an asset or wealth manager asking: “How do I go about choosing the right structure for my new investment fund in the Canadian market?” The somewhat perplexed look on their faces or the frustration that comes across in the managers’ emails are certainly understandable, given the inherent complexity of Canada’s investment landscape—particularly for managers who are new to this market.

Canada’s investment landscape can be frustrating for some managers

For example, securities regulation in Canada is a provincial responsibility. Each of the 10 provinces and three territories has their own sets of regulation. While there is significant alignment among the various jurisdictions, certain aspects of the securities laws are unique to each provincial regime. This can create confusion among fund managers.

Offering broad retail access

In responding to managers about the different fund structure options, I am quick to mention an important securities rule that is common to all Canadian jurisdictions. In the absence of an exemption, fund issuers are required to develop a prospectus for each new fund offering in Canada and obtain approval from a “principal” regulator—the provincial regulator that is deemed to be closest to the issuer.

The prospectus option provides a gateway to the retail market

This process typically requires a significant amount of time and effort but once the prospectus is approved by the principal regulator, the manager can opt to have it become effective in other provinces and territories through a passport-type arrangement among the various jurisdictions. The “cleared” prospectus enables the issuer to distribute the fund to members of the public in the respective provinces and territories. The prospectus could also qualify a mutual fund in which the manager wishes to utilize alternative investment strategies through the alternative mutual funds regulatory regime—also known as “liquid alts”—that was introduced during the early part of 2019.

It is important to note that, since the prospectus facilitates broad distribution of the fund to retail investors, managers face rigorous compliance and reporting requirements that stem from the regulators’ investor protection mandate.

Relying on exemptions

As alluded to above, the manager can take a different route than the prospectus, opting to instead rely on exemptions to the prospectus requirement—a simpler and less-expensive way of distributing securities in Canada. The exemptions enable distribution of securities through a private placement, which is typically not reviewed by the provincial regulators, and tends to have less onerous compliance and reporting requirements compared to the prospectus offering.

Private placements limit access to a smaller group of investors

However, under a private placement, the fund’s potential investors are limited to the exempt market—usually high-net-worth and institutional investors—and the fund cannot be marketed to retail investors. The exempt market also tends to be more illiquid as a result of restrictions to buying and selling fund units on public markets. 

Making the final decision

There is no right or wrong answer regarding the optimal regulatory structure for a manager’s new investment fund. The final decision largely comes down to a trade-off that is driven by the manager’s business strategy and objectives.

The final decision comes down to a trade-off for managers

Does the fund issuer deem it worthwhile to go through the relatively costly and often lengthy process of developing and seeking approval for a prospectus that will provide access to retail investors? Or is the manager looking to save time and money by focusing on the exempt market, which is generally more illiquid and limits access to a smaller target audience? It depends on the manager’s priorities.

Finding a reputable lawyer

As a final note, I should emphasize that, regardless of the ultimate outcome regarding the fund structure, it is imperative for managers to consult with an experienced Canadian law firm that focuses on the investment fund business, including securities and tax law. And this needs to be done at the very outset of the process. There are many excellent firms in the market, and I would be pleased to provide a list of potential contacts.

So, the next time that a puzzled and somewhat frustrated asset or wealth manager reaches out to me in their quest to determine the optimal regulatory structure for their new investment fund, I hope this explanation of some of the first steps in the decision-making process—and the accompanying checklist of key considerations—will help to ease the pain.

Manager checklist

Following is a list of key considerations for asset and wealth managers looking to distribute investment funds in Canada:

1. Identify target investors

  1. Retail
  2. High net worth
  3. Institutional

2. Determine type of product offering

  1. Private placement exemption
  2. Mutual funds

3. Agree on investment mandate

  1. National Instrument 81-102, segregated or fund-of-funds
  2. Physical assets or depository-eligible assets
  3. Shorting and leverage

4. Decide on fund structure

  1. Trust, corporation or limited partnership structure
  2. Tax efficiencies
  3. Management Expense Ratios (MERs)
  4. Performance fees
  5. Multi-class/series

5. Engage Canadian law firm with securities law and tax expertise

6. Determine in-house or external expertise

  1. Investment managers
  2. Compliance, marketing and administration services
  3. Prime broker or execution broker
  4. Custodian
  5. Auditor

7. Decide on distribution strategy

  1. Broker compensation
  2. Fundserv
  3. Investment Industry Regulatory Organization of Canada (IIROC) (now the New Self–Regulated Organization of Canada (New SRO)) bare trustee agreement
  4. Dealer agreements

8. Determine regulatory requirements

  1. Independent Review Committee, in-house portfolio advisor, etc.
  2. Registration requirements and licenses

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