1. Overview

1.1 Introduction

The purpose of the MLCI 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”) where MLC Investments Limited (“MLCI”) is the Responsible Entity (“RE”) or Trustee and the hedged asset portfolios (“hedged portfolios”) where MLCI acts in its own corporate capacity.

1.2. Policy Framework

The Policy details MLCI’s principles and policy in relation to the permitted use of derivatives, having regard to the portfolios’ investment strategy, governing fund documentation and regulatory requirements. This Policy outlines the mechanisms MLCI has in place to monitor and manage the potential risks associated with using derivatives.

1.3. Scope and application

This Policy applies to MLCI within the Insignia Financial Ltd (“IFL”) group of companies where it acts as a RE or Trustee of investment portfolios (including various pooled investment funds and managed investment schemes and in its own corporate capacity for the hedged portfolios.

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

MLCI 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.

MLCI manages its hedged portfolios through Retirement Solutions who acts as manager on behalf of MLCI trading in its own corporate capacity.

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 manager for the hedged portfolios.
   

2. Guidelines

2.1. Definition of Derivatives and Guiding Principles to the use of Derivatives

For the purposes of this Policy, a derivative is defined in accordance with the Australian Accounting Standards Board as a financial instrument or other contract with all of the following characteristics:

1. its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index or prices or rates, credit rating or credit index, or other variable. In the case of a non-financial variable, the variable is not specific to a party to the contract (the “underlying”);
2. it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and
3. it is settled at a future date.

MLCI 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 MLCI 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 impact of fluctuations 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

This section details the key risks associated with the use of derivatives and the controls MLCI uses to monitor and manages these risks.

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. Exposure to market risk occurs 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 / 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

There are generally two types of Liquidity risk:

• 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 (the other party with whom a derivative contract is entered) 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 ISDAs (or equivalent);
• All futures and exchange traded derivatives must be cleared through trustee appointed 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 of loss resulting from inadequate or failed internal processes, people, systems or from external events. These risks can encompass a wide range of issues, such as deficiencies in procedures/controls, system failures, human errors, fraud, legal risks and external events like natural disasters.

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 MLCI’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 MLCI through its Advisor or Retirement Solutions.

3.5. Reporting Risk

This risk relates to non-compliance with the reporting obligations for OTC derivatives under the ASIC Derivative Transaction Rules (Reporting) 2024 (“Rules”). This risk applies to MLCI as a reporting entity which has OTC derivatives transacted in its investment portfolios and hedged portfolios.

Controls

MLCI manages reporting risk for the reportable OTC derivative transactions through the following measures:

• Review the reporting obligations under the Rules and the ASIC Regulatory Guide 251 (“RG251”) on a regular basis.
• The reporting delegation arrangement is formalized with appointed investment managers or via reporting agreements with counterparties.
• Establish controls to ensure that the appointed reporting delegates are performing the reporting in accordance with the Rules, including operational due diligence reviews, compliance attestations and reconciliation of the reported OTC transaction data.
   

4. Related Policies & References

This Policy supports compliance with the requirements of:

• s912A(1)(h) of the Corporations Act 2001 (Cth) (Act) (obligations to maintain adequate risk management systems)
• ASIC Regulatory Guide 259: Risk management systems of fund operators
• ASIC Regulatory Guide 104: AFS Licensing: Meeting the general obligations
• ASIC Derivative Transaction Rules (Reporting) 2024
• ASIC Regulatory Guide 251: Derivative transaction reporting
   

5. Review and approval

This Policy is 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 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, MLC Asset Management.