1. Overview

1.1 Introduction

The purpose of the MLC Derivatives Policy (the “Policy”) is to provide guiding principles and Policy directives for the use and oversight of derivatives used within the products and investment portfolios (together known as “investment portfolios”) and the hedged asset portfolios (“hedged portfolios”).

1.2. Policy Statement

For the purposes of this Policy, a derivative means a financial contract whose value depends on, or is derived from, assets, liabilities or indices (‘the underlying asset’). Derivatives include a wide range of instruments including but not limited to forwards, futures, options, swaps, warrants and other composites.

1.3. Scope and application

This Policy applies to MLC Investments Ltd (“MLCI”) within the Insignia Financial Ltd (“IFL”) group of companies in its capacity as a Responsible Entity (“RE”) or Trustee of various pooled investment funds and managed investment schemes (collectively referred to as “investment portfolios”) and in its own corporate capacity for the hedged portfolios (i.e., those managed by the Retirement Solutions business).

Investments made via MLC platforms and investor directed portfolio services (“IDPS”) are out of scope for this Policy.

This Policy governs the use of derivatives by:

• MLC Asset Management Services Limited (“MSL”) within the asset pools of the RE for which it acts as investment advisor (“Advisor”) to the RE.
• Appointed investment managers who are responsible for implementing investment strategy of discretely managed investment portfolios in accordance with an Investment Management Agreement ("IMA”) between them and the RE.
• Retirement Solutions as risk managers for the hedged portfolios managed on behalf of MLC Investments Limited operating in its own corporate capacity.

The RE manages investment portfolios in the following ways:

• Through a manager-of-managers approach where specialist investment management companies are appointed to manage assets (including derivatives) within each asset class. Each appointed investment manager must be subject to a rigorous selection process (which includes derivative capabilities) followed by ongoing monitoring and review.
• Through investments in external funds / vehicles (which may include the use of derivatives) which are governed by external fund documentation.

The RE manages its hedged portfolios through Retirement Solutions who acts as risk managers for the hedged portfolios managed on behalf of MLCI operating in its own corporate capacity.

2. Guidelines

2.1. Guiding Principles specific to the use of derivatives

The RE will permit the use of derivatives within its investment portfolios and hedged portfolios only where their use is consistent with:

• The investment return objectives and risk profile of an investment portfolio;
• Disclosures made to investors;
• Governing fund documentation;
• In respect of hedged portfolios, Retirement Solutions Hedging Strategies and Operations Manual;
• Any other legislative or regulatory requirements; and
• This Policy.

2.2. Purposes for which derivatives may be used

Derivatives are an important tool for prudent investment management and are integral to the investment risk management process. Their proper use should enhance the likelihood of meeting the overall investment performance objectives of an investment portfolio or the objectives of a hedged portfolio.

The RE may use derivatives in its investment portfolios for the following purposes:

Hedging:

• Hedging investment portfolio exposures (e.g. to protect the value of an asset in the portfolio and/or minimise the liability from a fluctuation in market values), including the creation of uncovered short positions where these are considered as an appropriate hedge for assets held in the portfolio.

Efficient Portfolio Management:

• Creating investment portfolio exposures to markets, currencies, securities and other financial or economic interests;
• Implementing changes in positions or in investment strategy including shifts in asset allocation between asset classes and/or adjustment to other asset exposures; and
• Reducing the transaction costs associated with the management of investment portfolios.

Investment Return Generation:

• Creating portfolio leverage (either long or short) in line with the investment objectives and risk profile of investment portfolios;
• Seeking to enhance investment portfolio returns including, but not limited to, by exploiting pricing anomalies between derivatives and the equivalent physical securities and efficiently executing directional views in markets, currencies and securities; and
• Creating uncovered short positions for the purpose of generating investment returns.

The use of derivatives to create leverage and/or hedge exposures within an investment portfolio must be consistent with the investment portfolio's approved objectives and risk profile, disclosure documents, applicable governing documents and legislative and/or regulatory requirements.

Investment portfolios incorporating leverage and/or uncovered positions will be considered on a strict case-by-case basis and will require approval from the MSL Investment Committee. Investments incorporating leverage made by shareholders funds will require approval from the applicable RE Board.

Retirement Solutions may use derivatives in its hedged portfolios for the following purposes:

Hedging:

• Hedging portfolio exposures to protect the value of an asset in the portfolio and/or minimise the liability from a fluctuation in market values.

The use of hedging within a hedged portfolio must be consistent with the Retirement Solutions Hedging Strategies and Operations Manual, disclosure documents, applicable governing documents and legislative and / or regulatory requirements.

3. Investment Risk Management

3.1. Market Risk

Market risk represents the risk of adverse movements in markets (including asset prices, volatility, currency, or other market variables) for the derivatives or the underlying asset, reference rate or index to which the derivative relates. Market risk is created by holding any physical or derivative security which creates exposure to movements in prices of a market, currency, security or other financial or economic interest.

Market risk must be managed through ensuring investment portfolios are well diversified across investment managers, asset classes, regions, sectors and underlying securities, as appropriate.

In the case of investment managers governed by an IMA and the hedged portfolios managed by Retirement Solutions where derivatives are permitted their use must be monitored to ensure it remains within pre-specified limits. This includes ensuring both the type and overall usage of derivatives remain consistent with pre-specified ranges permitted for their use. These ranges vary by investment portfolio and hedged portfolio and must be determined in accordance with each investment portfolio’s and hedged portfolio’s overall risk profile and investment objectives including target level of expected returns.

Controls

The following controls must be in place in the case of investment managers governed by an IMA and the hedged portfolios managed by Retirement Solutions:

• Compliance with the investment guidelines and hedging strategy (including derivatives) applicable to each investment portfolio and hedged portfolio must be monitored on a regular basis;
• The effective market exposure of all assets (including derivatives) in each investment portfolio and hedged portfolio must be monitored on a regular basis.

For investments into external funds, the Advisor must undertake, to the extent reasonably practicable, periodic reviews to ensure the funds’ use of derivatives is consistent with expectations and the applicable fund’s investment objectives and profile.

3.2. Liquidity Risk

Liquidity risk has two components:

• Market Liquidity Risk: the risk that a particular position may not be able to be, or cannot be easily, unwound or offset at or near the previous market price because of inadequate market depth or because of disruptions in the marketplace.
• Cash Flow Risk: the risk that the future financial obligations of an investment portfolio will not be met as a result of its use of derivatives, for example margin calls on futures contracts.

Controls

The following controls must be in place in the case of investment managers governed by an IMA and the hedged portfolios managed by Retirement Solutions:

• Investment guidelines and hedging strategy must restrict:
  • The purpose for which derivatives may be used;
  • The types of derivatives which may be used; and
  • The limits of derivative use.
• Investment portfolios and hedged portfolios must be required to maintain adequate liquidity to cover margin requirements from derivative use; and
• Specific liquidity requirements must be set on a portfolio-by-portfolio basis, recognising the expected level of derivative use and the nature of the underlying exposure and expected volatility of the derivative contracts being used.

For investments into external funds, the Advisor must undertake, to the extent reasonably practicable, periodic reviews to ensure the funds’ use of derivatives is consistent with expectations and the applicable fund’s investment objectives and profile.

3.3. Counterparty Risk

Counterparty risk (also known as credit risk) is the risk that a counterparty, being the other party with whom a derivative contract is made, will fail to perform contractual obligations (i.e. default, either in whole or part).

Controls

The following controls must be in place in the case of investment managers governed by an IMA and the hedged portfolios managed by Retirement Solutions:

• All OTC derivatives must be executed with approved OTC Counterparties;
• All OTC derivatives must be executed under industry standards agreements such as ISDA’s (or equivalent);
• All futures and exchange traded derivatives must be cleared through approved clearing entities;
• Futures must be traded on a relevant exchange and must be fully collateralised daily in accordance with exchange requirements;
• Where counterparty exposure limits are stipulated by investment guidelines or hedging strategies, these must be monitored; and
• The use of authorised OTC Counterparties must be monitored.

For investments into external funds, the Advisor must undertake, to the extent reasonably practicable, periodic reviews to ensure the funds’ use of derivatives is consistent with expectations and the applicable fund’s investment objectives and profile.

3.4. Operational Risk

Operational risk is the risk that deficiencies in the effectiveness and accuracy of information systems or internal controls will result in a material loss. Such material loss may be caused by human error, system failures, inadequate procedures, or a lack of internal management controls.

As part of the investment manager selection and ongoing monitoring process, the Advisor must assess each investment manager’s operational risk, including in respect of derivative use. Where investments are made through external funds, the Advisor must also assess the operational risk of these investments.

In the case of investment managers governed by an IMA and the hedged portfolios managed by Retirement Solutions all transactions must be settled by the RE’s appointed Custodian. The value of all assets, including derivatives is where practicable marked to market daily by the Custodian using independent valuation sources. Where the Custodian is unable to readily value particular assets, including derivatives, advice may be sought from the RE through its Advisor or Retirement Solutions.

3.5. Personnel Management

The Advisor and Retirement Solutions must ensure that all staff responsible for reviewing investment managers, managing investment portfolios and hedging portfolios and marketing investment management services are appropriately qualified and experienced. Staff must be supervised as appropriate to their areas of responsibility and their performance must be reviewed periodically.

All senior management and staff involved in monitoring derivative exposures must have appropriate training and must have an understanding of derivatives and all aspects of this Policy.

All representatives must be encouraged to undertake additional training in the interests of maintaining a satisfactory level of professional expertise in regard to derivatives usage.

3.6. Assessment of Controls

The Advisor’s key internal controls are reviewed and tested by the Line 1 Risk team on an annual basis.

The internal auditor periodically assesses the Advisor and Retirement Solutions internal control environments and procedures must be in place to monitor the results of these audits, and must ensure that, where relevant, recommendations are implemented on a timely basis.

3.7. Reporting

The Advisor and Retirement Solutions must provide such reports as are considered necessary by the RE to enable the RE to fulfil its responsibilities under this Policy and its Australian Financial Services License (“AFSL”). Such reporting must include investment and Policy breaches, breaches of derivative and effective exposures and OTC counterparty exposures. Reporting with respect to compliance matters must have due consideration to materiality, with escalation of any material incident to the RE.

4. Related Policies & References

4.1. Corporations Act Obligations

• S912A(1)(h) (obligations to maintain adequate risk management systems).

4.2. Related Policies

• RE & IDPS Entities Risk Appetite Statement; and
• Unit Pricing Policy

4.3 Key regulatory principles and industry standards

The key regulatory principles and industry standards governing asset valuations include:

• Regulatory Guide 259: Risk management systems of fund operators;
• Regulatory Guide 104: AFS Licensing: Meeting the general obligations; and
• Regulatory Guide 94: Joint ASIC & APRA Unit Pricing: Guide to Good Practice

5. Review and approval

This Policy will be reviewed annually by the Policy Owner, together with management and submitted to the MLCI Board at least triennially for review and approval, in accordance with the IFL’s Policy and Document Governance Framework (February 2022), to ensure it remains appropriate with regard to the changing nature of legislation, change in our business operations or business environment.

Any material changes must be approved by the RE Board. Non-material amendments to this Policy may be approved by the Head of Office of the Responsible Entity ("ORE") as delegated by the MLCI Board.

All documents should be updated more frequently if there is a change in legislation, regulation, or operating environment.

6. Contact Details

The Policy Owner is the Chief Investment Officer, Asset Management.