On June 25, 2015, the Ontario Securities Commission (the OSC) issued OSC Staff Notice 81-727 Report on Staff’s Continuous Disclosure Review of Mutual Fund Practices Relating to Portfolio Liquidity. The Notice provides OSC staff’s views on their findings arising out of the 2014/2015 targeted reviews of fund manager practices focused on the liquidity of fund holdings, stress testing of portfolio liquidity and liquidity valuation considerations. In the reviews conducted by staff of the OSC’s Investment Funds & Structured Products Branch, the focus was primarily on three categories of public mutual funds, including exchange-traded funds: 

  1. High yield debt funds, including funds that focused on senior loan investments;
  2. Emerging markets funds; and
  3. Small cap equity funds.

Notwithstanding that the targeted compliance review focused on a narrow sub-set of mutual fund categories, OSC staff direct their recommendations in the Notice more broadly as being applicable to all types of investment funds.

Eight key compliance considerations arise for managers of investment funds (investment fund managers or IFMs) out of the OSC staff recommendations in the Notice.

  1. Conduct liquidity assessments at the time of any investment: IFMs should conduct a liquidity assessment at the time an investment is made by a fund. This assessment should be based on quantitative metrics, such as average daily or weekly trading volumes, bid-ask spreads, number of participants making a market for the holding and outstanding issue size. These liquidity metrics should be tailored for different asset classes.
  2. Conduct ongoing liquidity assessments: OSC staff clearly expect IFMs to do ongoing liquidity assessments of a fund’s portfolio holdings. Portfolio liquidity should be monitored as market activity and conditions vary and decline over time. As with the liquidity assessment applied at the time of investment, quantitative metrics should be tailored for different asset classes.
  3. Reassess holdings of “illiquid assets”: OSC staff express their views on the meaning of the term “illiquid assets” (found in National Instrument 81-102) in the Notice. Simply holding a listed security that has a quoted stock price “is not generally sufficient to conclude that a particular holding is liquid.” In OSC staff’s view, a second test must also be applied: IFMs are urged to consider whether a fund’s investment holding can be readily disposed of within the 3-day redemption settlement period without a significant adverse impact to the portfolio.
  4. Conduct periodic stress testing: OSC staff suggest that IFMs should periodically perform liquidity stress testing on their funds to ensure they can effectively execute redemptions in stressed market conditions. This testing should analyze the order in which assets could be liquidated to minimize the negative impact to the portfolio. Stress testing should incorporate redemption rates that exceed historical redemption patterns and stressed market conditions, such as interest rate changes (in the case of fixed income funds) and geopolitical uncertainty (in the case of emerging markets funds).
  5. Disclose any risks around holding illiquid assets: In the case of funds with higher exposure to potentially illiquid assets, OSC staff suggest additional disclosure in the prospectus or MRFP may be in order. The disclosure should relate to the IFM’s risk management policies, investment restrictions designed to mitigate liquidity risk and various specific risk factors.
  6. Fair Value of Illiquid Assets – OSC staff suggest that in order to measure an investment solely based on a quoted price, there must be an “active market” for the investment. IFRS 13 defines a market as active if transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. IFMs should refer to the guidance in IFRS 13 on when the volume or level of activity on a market may indicate that a transaction price or quoted price does not represent fair value. In these cases, a fair value determination should be made using other inputs and additional disclosure should be included in the relevant fund’s financial statements. The IFRS 13 guidance should also be considered by IFMs in determining whether a fund’s portfolio holding falls within the definition of an “illiquid asset”.
  7. Implement policies and procedures reflecting the OSC guidance – IFMs should have “robust” policies and procedures in place to reflect the guidance in the Notice.
  8. Obtain IRC input on valuation policies and procedures: OSC staff recommend that IFMs refer their valuation policies and procedures, including the valuation procedures regarding illiquid investments, to the IRC for the applicable funds for consideration and standing instructions. OSC staff recommend that the policies and procedures include the circumstances in which the IFM may override valuations provided by external pricing sources.

We recognize that some of the recommendations from the Notice may be controversial. Although the staff views expressed in the Notice are not “law” (that is, they are not rules or official Commission policy), nevertheless we recommend that all fund managers carefully consider the issues raised in the Notice to determine their applicability to their funds. It is not uncommon for OSC staff to conduct targeted reviews of fund managers a few months following release of new guidance and we recommend that IFMs be prepared to explain their approaches in light of the staff views expressed in the Notice. We would be pleased to answer your questions and to assist you in working through the recommendations to enhance your compliance program.

Please contact your usual lawyer in BLG’s Investment Management Group, the authors of this Bulletin or one of the leaders of the Investment Management Group if you have any questions on the Notice and how it may affect your compliance systems, your funds or the disclosure you provide to your investors.


Lynn M. McGrade 

Donna Spagnolo 


Investment Management
Private Funds, Hedge Funds and Alternative Investments
ETFs, Structured Products and Closed-End Funds
Mutual Funds