Reporting Form LRF 210.0

Derivatives, Commitments and Off-Balance Sheet Items

Instruction Guide

Introduction

Form LRF 210.0 Derivatives, Commitments and Off-Balance Sheet Items (LRF 210.0) provides APRA with the necessary information on the potential effects and values of derivative activity, charges or commitments, and non-market related off-balance sheet transactions on the assets of a statutory fund.

This Instruction Guide is designed to assist reporting entities in the completion of LRF 210.0. The Instruction Guide provides:

• general directions and notes regarding preparation and lodgement; and
• instructions relating to specific items.

General directions and notes

Reporting levels

LRF 210.0 must be completed by all life insurance companies, including friendly societies.

The form is to be completed separately for each statutory fund (approved benefit fund), except for a fund solely devoted to investment linked business, in which case the form is not required to be completed.

LRF 210.0 contains three sections:

• Section A: Statement of Derivative Activity;
• Section B: Non-Market Related Off-Balance Sheet Items; and
• Section C: Other Off-Balance Transactions, including Charges and Encumbrances.

Within each section, reporting items are to be completed at total fund level, under the various categories of data required.

Unit of measurement

LRF 210.0 is to be prepared in thousands of Australian dollars (AUD). Amounts denominated in foreign currency are to be converted to AUD in accordance with AASB 121 The Effects of Changes in Foreign Exchange Rates.

Definitions

Definitions for data reporting items required by this form have been provided where appropriate in the instructions under the section headed ‘Instructions for specific items’.

Definitions, unless specified, apply to all life insurance companies, including friendly societies as if each reference to a statutory fund, or shareholders’ fund, were a reference to an approved benefit fund, or management fund, respectively. Likewise, reference to shareholders should be taken to embrace ‘members’ of a mutual association and/or a society. The term ‘life companies’ or ‘life insurance companies’ includes friendly societies unless stated otherwise. This is in line with the usage of terms in the Life Insurance Act 1995.

Reporting period

Life companies are required to report the information in the reporting form on a quarterly and annual basis.

• The quarterly information is to be completed as at the end of each quarter based on the financial year of the life company, not the calendar year.
• The annual information is to be completed as at the end of the financial year of the life company.
• The financial information required in this form is to be reported as at the close of business for the last day of the reporting period.

Basis of preparation

In completing this form, unless specifically stated otherwise, institutions are to follow the basis that is used for the preparation of the annual financial statements in accordance with the Australian accounting standards.

Actuarial valuations and calculations included in, or used in the preparation of, the form must be in accordance with prudential standards.

If additional clarification is required for specific items in this form, reference should be made to the section ‘Instructions for specific items’, which is provided as a guide.

Instructions for specific items

While these instructions apply to all life insurance companies, including friendly societies, not all items may be applicable to both: some items may not be applicable to friendly societies while others may not be applicable to life insurers.

Principal Amount

The principal amount refers to the face value or gross amount of a given off-balance sheet transaction and not the fair value. The principal amount must be reported as a positive value, even for short positions in derivative financial instruments.

Fair value

The fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable and willing parties in an arm’s-length transaction. The fair value should be able to be determined through observation of similar transactions, quoted market prices, independent valuations or if there is no readily observable market, through the ability to liquidate the investment or through assessing the net present value of future cash flows.

Record the aggregate fair (or market) value of the derivative exposure/position by summing the absolute fair value of each exposure, for each of the items listed.

For the purposes of valuing derivative exposures, for this form, fair value should represent an estimate of the amount, which could be expected to be received from the disposal of the derivative instrument in an orderly market, ignoring transaction costs. It is not necessarily related to the nominal value of the derivative.

Market value

Market value is defined for accounting purposes as a subset of fair value and is determined as follows:

(i) the quoted market price in an active and liquid market; or

(ii) when there is infrequent activity in a market, the market is not well established, small volumes are traded relative to the asset or liability to be valued, or a quoted market price is not available – an estimate of a price for the asset or liability in an active and liquid market.

Section A: Statement of Derivative Activity

The Statement of Derivative Activity is for information purposes. Life companies should report all derivative instruments held at the reporting date in the principal (or notional) amount column and the fair value column.

The following sections give examples of the more common derivatives which are traded on exchanges, traded over-the-counter, or not market-traded. This is not intended as an exhaustive list.

Life companies should not generally enter into contracts at off-market prices. This includes historical rate rollovers on foreign exchange contracts. If any contracts are undertaken at off-market prices, life companies should contact APRA to discuss the reasons for such actions. APRA would generally expect that the risk management arrangements for off-market price dealings would be covered in the Risk Management Strategy (RMS) required under Prudential Standard LPS 220 Risk Management.

Breakdown 1: By trade method

The following items form the row headings of the Section A table.

1. Exchange-Traded Derivatives (traded on recognised exchanges)

Derivatives that are traded on recognised exchanges, as defined in Schedule 7 of the Life Insurance Regulations 1995.

Offsetting positions (e.g. buy a call and write a call with same exercise price and expiry date) can be excluded if both contracts are exchange traded on the same exchange. In all other circumstances, contracts should be reported on a ‘gross’ basis.

2. Over-The-Counter Derivatives

• 2.1 Forwards
• 2.2 Swaps
• 2.3 Bought option positions
• 2.4 Written option positions
• 2.5 Credit derivatives - bought protection
• 2.6 Credit derivatives - sold protection
• 2.7 Other – include all other over-the-counter derivatives not specifically categorised above.

3. Total Derivatives [derived item]

This item is calculated automatically by the form.

Breakdown 2: By contract type

For each category of derivative contract listed below, report the Principal Amount and the Fair Value. Life companies may refer to APRA where they are unclear as to which category is appropriate for a particular derivative when reporting the principal amount and fair value of that derivative.

The following items form the column headings of the Section A table.

Column 1-2: Interest rate contracts

All instruments that have the objective of managing interest rate risk. Do not include contracts which manage both interest rate risk and foreign exchange risk.

Include:

• single currency interest rate swaps;
• basis swaps;
• forward rate agreements;
• interest rate futures; and
• interest rate options purchased.

Column 3-4: Foreign exchange contracts (including contracts involving gold)

All instruments that have the objective of managing foreign exchange risk. Include contracts which manage both interest rate risk and foreign exchange risk.

Include:

• cross currency swaps;
• forward foreign exchange contracts;
• currency futures;
• currency options purchased; and
• hedge contracts.

Outstanding spot transactions should be treated as forward foreign exchange contracts.

Column 5-6: Equity contracts

All derivative contracts based on individual equities or equity indices that have the objective of managing equity price risk

Include:

• swaps;
• forwards;
• futures;
• purchased options/warrants; and

Column 7-8: Other derivative contracts

Include:

• credit derivatives;
• commodity derivatives; and
• any contracts covering other items, that give rise to credit risk.

Section B: Non-market related off-balance sheet transactions

Report the principal amount of all non-market related off-balance sheet transactions that give rise to credit exposures.

The categories of non-market related off-balance sheet transactions are as follows:

4.1. Direct credit substitutes

Any irrevocable off-balance sheet obligations that carry the same credit risk as a direct extension of credit, such as an undertaking to make a payment to a third party in the event that a counterparty fails to meet a financial obligation, or an undertaking to a counterparty to acquire a potential claim on another party in the event of default by that party, constitutes a direct credit substitute (i.e. the risk of loss depends on the creditworthiness of the counterparty or the party on whom a potential claim is acquired).

Include:

• potential credit exposures arising from the issue of guarantees and credit derivatives (credit derivatives where protection is sold);
• confirmation of letters of credit;
• issue of standby letters of credit serving as financial guarantees for loans, securities and any other financial liabilities; and
• bills endorsed under bill endorsement lines (but are not accepted by, or have the prior endorsement of, an ADI).

4.2. Performance-related contingencies

Contingent liabilities that involve an irrevocable obligation to pay a third party in the event that a counterparty fails to fulfil or perform a contractual non-monetary obligation, such as delivery of goods by a specified date, etc (i.e. the risk of loss depends on a future event that is not directly related to the creditworthiness of the counterparty involved).

Include:

• issue of performance bond;

• bid bonds;

• warranties;

• indemnities; and

• standby letters of credit in relation to a non-monetary obligation of a counterparty under a particular transaction.

4.3. Trade-related contingencies

Contingent liabilities arising from trade-related obligations that are secured against an underlying shipment of goods.

Include:

• documentary letters of credit issued;

• acceptances on trade bills;

• shipping guarantees issued; and

• any other trade-related contingencies.

4.4. Sale & repurchase agreements (‘Repos’)

This relates to arrangements whereby a life company sells a loan, security or other asset to another party with a commitment to repurchase the asset at an agreed price on an agreed future date.

4.5. Assets sold with recourse

Include:

• any asset sales (to the extent that such assets are not included in on-balance sheet) by a life company where the holder of the asset is entitled to ‘put’ the asset back to the life company within an agreed period or under certain prescribed circumstances, e.g. deterioration in the value or credit quality of the asset concerned.

4.6. Forward asset purchases

Include:

• commitments to purchase at a future date and on pre-arranged terms; and
• a loan, security or other asset from another party, including written put options on specified assets with the character of a credit enhancement.

Where a life company purchasing the asset has an unequivocal right to substitute cash settlement in place of accepting delivery of the asset, and the price on settlement is calculated with reference to a general market price indicator (and not to the financial condition of any specific entity), the purchase may be treated as a market-related off-balance sheet transaction.

Written put options expressed in terms of market rates for currencies or financial instruments bearing no credit risk are excluded.

4.7. Partly paid shares and securities

Include:

• any amounts owing on the uncalled portion of partly paid shares; and
• securities that represent commitments with certain draw down by the issuer at a future date.

4.8. Placements of forward deposits

This relates to any agreement between a life company and another party whereby the life company will place a deposit at an agreed rate of interest with that party at a predetermined future date.

4.9. Note issuance and revolving underwriting facilities

This involves arrangements whereby a borrower may draw down funds up to a prescribed limit over a predefined period by making repeated note issues to the market, and where, should the issue prove unable to be placed in the market, the unplaced amount is to be taken up or funds made available by a life company being committed as an underwriter of the facility.

4.10. Other commitments

4.10.1. Loans Approved but Not Yet Advanced

Report the principal amount of loans that are approved but not yet drawn.

4.10.2. Any other irrevocable commitments

The amount of undrawn commitment to be included in calculating life companies’ off-balance sheet non-market related credit exposures is the maximum unused portion of the commitment that could be drawn during the remaining period to maturity. The drawn portion of a commitment forms part of a life company’s on-balance sheet credit exposure.

4.10.3. Commitments that can be unconditionally revoked at any time without notice

4.11. All other non-market related off-balance sheet items

For any non-market related off-balance sheet transactions that give rise to credit risk but are not specifically identified above, a life company should consult APRA on the appropriate counterparty grade to be used for calculating the credit risk component of the resilience reserve for solvency and capital adequacy purposes.

Section C: Other off-balance sheet transactions

5. Off-balance Sheet Liquidity Support Facilities Contracted for Reporting Entity’s Use

This section captures information on liquidity support facilities contracted by the life company to supplement its liquidity requirements.

Column 1: Approved balance available

Include:

• the total approved balance of the facility at the reporting date.

Column 2: Undrawn balance available

Include:

• the balance of the facility that has not been used or drawn down by the life company at the reporting date.

5.1. Standby facilities

These facilities are approved and committed. These generally require written notice by the life company to trigger draw down (access to the funds).

5.1.1. Facilities with same day draw down

Include:

• those standby facilities that can be drawn down (funds accessed) on the same day that notice is given by the life company of its intention to draw down on the standby facility.

5.1.2. Facilities with 2 - 5 day draw down

Include:

• those standby facilities that can be drawn down (funds accessed) within two-five days after notice is given by the life company of its intention to draw down on the standby facility (i.e. a two-five day waiting period).

5.1.3. Facilities with greater than 5 days draw down

Include:

• those standby facilities that can be drawn down (funds accessed) five days after notice is given by the life company of its intention to draw down on the standby facility (i.e. a five day waiting period).

5.2. Bill acceptance/discount facilities

These are another form of liquidity/funding. The funding is provided to the life company by a facility that discounts bills (e.g. bank accepted bills). Principle and interest (discount) owing on the bill is repaid or ‘rolled over’ by the life company on maturity of the bill.

5.3. Letter of credit facilities

This is an irrevocable and unconditional undertaking covering a life company to repay principle and interest of a loan in the event of default by the life company.

5.4. Overdrafts

These are accounts that may be overdrawn up to limits agreed to with an ADI.

5.5. Other liquidity support facilities

All other off-balance sheet liquidity support facilities contracted for the life company’s use that are not included in the categories above.

5.6. Total off-balance sheet liquidity support facilities [derived item]

6. Charges and Encumbrances

Column 1: Purpose of Charge/Encumbrance

The purposes are set out in the Life Insurance Act 1995, Sections 38 and 40.

Column 2: Type of Charge/Encumbrance

The following is not an exhaustive list but is provided as an example:

Fixed charge

A fixed charge is generally given in relation to a specific asset or assets and it will generally limit the ability or right of the life company to deal with those assets.

Floating charge

A floating charge may be given over specific assets or all assets of the life company and may generally only crystallise and become a fixed charge on the occurrence of a specific event that is agreed between the parties (i.e. default on payment, or not maintaining specified interest coverage ratios).

Column 3: Principal Value of the charge

This refers to the principal or face value or amount of the charge or encumbrance given over assets of the life company.

Column 4: Outstanding Value of the charge

This refers to the outstanding value of the charge or encumbrance (as at the reporting date) given over assets of the life company.

Column 5: Value of assets subject to the charge

For each separate charge listed, report in this column the value of the assets that are subject to the charge or encumbrance.

Column 6: Extent of Indebtedness Secured By Assets [derived item]

This field is automatically calculated. For each separate charge listed, the form will calculate the dollar value to which the assets are charged. It equals the minimum of the value of the assets subject to the charge (column 5) and the outstanding value of the charge granted (column 4).