Recent Developments in the Canadian Structured Products Market

The past few years have seen a number of mutual fund managers enter into the structured product marketplace in Canada. The structured product marketplace is growing quickly; the TSX had 333 retail structured products listed at the end of March 2006 with a market value of more than $53 billion, compared to 93 listings and a value of $12.1 billion five years ago. Some key reasons why the structured product market is presently thriving are:

• Structured products provide a mutual fund manager with access to a different distribution channel and a potentially different set of investors

• Structured products can provide for a much more flexible investment mandate, including greater use of derivatives and leverage

• Compared to mutual funds, structured products may be structured without concern for the detailed rules that apply to mutual funds.

Some of the most significant issues facing the structured product marketplace in Canada today are: regulatory scrutiny; governance; and continuous disclosure.

At a recent securities conference, David Wilson, Chair of the OSC, announced that the Canadian securities regulators plan to review the appropriateness of the prospectus exemption granted to principal protected notes. In particular, the regulators are concerned about the suitability of this exemption for complex structured products sold to retail investors. Many of the financial institutions that sell principal protected notes take the position that they are bank deposits and are therefore not a "security" under securities legislation. The CSA will likely closely examine this conclusion and may consider expanding the definition of a "security". At this point, no further details are available, but we are monitoring this regulatory initiative and will let you know of any important developments.

Proposed National Instrument 81-107 Independent Review Committee for Investment Funds is expected to be published in final form during the summer 2006. When effective, NI 81-107 will apply to most structured products and, based on current expected timing, will require fund managers to establish independent review committees for these funds by early 2007. Managers that offer both mutual funds and structured products will want to consider putting in place a governance regime that works for all of their investment funds.

The continuous disclosure requirements of National Instrument 81-106 Investment Fund Continuous Disclosure apply to all investment funds that are reporting issuers. This includes most structured products. A timetable of the main disclosure and filing requirements for closed-end investment funds under NI 81-106 accompanies this Advisory.

^{1 Send financial statements and management reports of fund performance to all registered and beneficial securityholders by filing deadline OR send requests for standing instructions or annual mailing instructions within a reasonable time before first mailing (obtain from all registered and beneficial securityholders one-time "standing instructions" and send annual reminders thereafter OR obtain annually from all registered and beneficial securityholders delivery instructions). Annual instructions cannot be requested if standing instructions have already been obtained. Obtain beneficial holder information using procedures in National Instrument 54-101, unless information for beneficial holders is known.}

2 Must send first annual management report of fund performance to all registered and beneficial securityholders by the filing deadline, with an explanation of the new disclosure requirements.

In February 2006 BLG applied on behalf of a number of limited partnerships and income trusts that are involved in the funding of mutual fund deferred sales charge commissions ("DSC Funding Vehicles") for relief from a number of the disclosure and filing requirements of NI 81-106. The CSA granted the requested relief in early April 2006. As a result and subject to certain conditions, each of these DSC Funding Vehicles is exempt from the requirements to:

• include a statement of changes in net assets and a statement of investment portfolio in its annual and interim financial statements
• file and deliver annual and interim management reports of fund performance
• prepare and post on its website quarterly portfolio disclosure
• file an annual information form
• establish and disclose proxy voting policies and maintain and make available its proxy voting record.

Our Investment Management Group has been involved in many leading edge transactions in the structured products market in Canada. The accompanying list of selected transactions is representative of the types of transactions in which BLG has participated over the last couple of years. By being creative, persuasive and flexible, we have provided innovative business solutions and have helped our clients achieve their business objectives. We are monitoring regulatory developments in this area and will make information available to you on a regular basis.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.