In the month or so since the federal budget proposed removing the 30% foreign-content restrictions on Canadian pensions and registered plans, some companies have moved quickly to adapt to the expected new environment.

In these cases, companies have eliminated or absorbed the higher management fees that clones charge, or have started to dismantle the clones’ investment structures.
There are several hundred RRSP-clone funds in Canada that charge between 20 and 50 basis points to duplicate the returns of related funds with foreign-based portfolios.

Other companies, however, are waiting for the proposal to weave its way through the legislative process. The measure was passed in the Commons, but new legislation must also receive Senate approval and the Governor General’s vice regal assent before it can become law, although, when all this is accomplished, it will be retroactive to Jan. 1, 2005. However, because the Liberal government is a minority, there is some risk that it could be toppled on some other issue before the foreign property restriction is legally removed.

Foreign content in a registered plan beyond the 30% limit is subject to a penalty tax of 1% a month, usually accumulated and charged at the end of the calendar year. If fund companies move to dismantle clone funds before the restriction is officially rescinded and for some reason it doesn’t happen, clients who have exchanged higher-cost clone funds for genuine foreign content could find themselves over the limit.
“If the government is defeated over another issue, a subsequent government should reintroduce the measure. But if it doesn’t, there are billions of dollars in RRSP-clone funds that could be affected if these funds convert before the legislation is passed,” says Jamie Golombek, vice president of tax and estate planning at AIM Funds Management Inc. in Toronto. “Fund companies as a whole are taking a cautious approach to the repeal of the foreign property rule.”

“virtually nil”

On the other hand, executives at Dynamic Mutual Funds Inc. believe the odds of the budget proposal being defeated “are virtually nil,” says Simon Hitzig, vice president of marketing. Immediately after the budget was announced, the company stopped buying forward contracts in its clones. It takes about 30 days for the contracts to unwind, he says.

“It doesn’t seem fair to unitholders to keep operating the clone funds because of the higher costs,” Hitzig says. “The odds are that, in the remote event that the budget is not passed, it is a reversible decision and we can go back and use derivative contracts as before. We are taking action now; we think it would be wrong not to.”

Dynamic has 15 clone funds with
approximately $130 million in assets.
Because the company does not expect these funds to reach another yearend, it has also stopped accruing the expenses that would go to pay annual legal and audit costs. A separate annual report will no longer be required, for example, if the clones are merged into their foreign fund equivalents.

“Ultimately, the plan is to fold the clones into the underlying funds,” Hitzig says. “We would like to be able to do that without the customary shareholder vote. We expect that either the regulators will allow the funds to be easily merged, or we will talk to our lawyers about other legal options. There is no precedent for it, but if regulators don’t have an appetite for creativity, lawyers might.”

Brandes Investment Partners & Co. of Toronto was the first fund company to react to the budget. It removed the additional 20-bps fee on its clone funds the day after the budget was read, making MERs equivalent to the underlying funds. Leah Humphrey, Brandes’ senior vice president of marketing, says the company is “waiting for something more definitive” from the regulators or for the budget to become law before dismantling its clones.

“The structure can be unwound within a day, and we could simply replace the clone fund units with units in the underlying fund,” she says. “There are no actual securities to be sold.”

Excel Funds Management Inc. of Toronto was also quick to remove the additional 45-bps fee it charges on its Excel China India RRSP Fund to make forward contracts, thus rendering the fund RRSP-eligible.