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Insurance and Superannuation Commission discussion papers on derivatives



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I n s u r a n c e and S u p e r a n n u a t i o n C o mmi s s i o n

DISCUSSION PAPERS ON DERIVATIVES

1995/3

$~><2.(Lur i -H<2S . The Insurance and Superannuation Commission (ISC) has issued three separate discussion papers on the prudent use of derivatives. The first relates to superannuation entities; the second paper applies to general insurance companies; and the third to life insurance offices.

The object of the papers is to facilitate discussion and comment amongst the industries concerned, and the general public, with a view to developing ISC Circulars for each industry sector later this year.

The ISC's major policy objective for the use of derivatives is to ensure that insurance and superannuation entities have in place adequate controls, and adequate internal and external checks on compliance with those controls. The papers set out a suggested method of developing these controls, which meets the ISC goal of protecting the

interests of insurance policyholders and superannuation fund members.

Key features of the ISC’s preferred method are:

• the development of satisfactory risk management practices, as evidenced by a Risk Management Statement (RMS);

• inclusion in the RMS of the entity's derivatives policy (including objectives), limits on exposures (across both physical and derivatives positions) and monitoring and reporting procedures; and

• annual reporting by an external auditor on an entity’s compliance with the RMS.

The ISC is particularly concerned to ensure that an entity’s derivative exposure is considered in the context of its overall investment strategy and the risk/retum characteristics and liability profile of all assets in the portfolio. Derivative exposure combined with physical exposure should not result in a net exposure which is

inconsistent with the entity’s investment strategy as adopted and endorsed by the trustees/Board of Directors.

Derivatives can be used imprudently to create risk, for example, through leverage and speculation. The imprudent use of derivatives for what is, essentially, a form of gambling, is not appropriate in the insurance and superannuation sectors.

The three discussion papers follow the same broad approach, but differ in some minor respects due to substantive differences between the various industries and the legislative, reporting and supervisory requirements which apply.

Comments are invited on the proposal contained in the discussion papers by Friday, 12 May 1995.

The ISC has been considering regulatory issues associated with the use of derivatives by financial institutions for some time against the background of active debate amongst financial supervisors in Australia and overseas on derivatives regulation.

The ISC has also noted the calls of the Senate Select Committee on Superannuation to examine the use of derivatives by superannuation entities.

Copies of the discussion papers can be obtained by telephoning Mr John Larkin on (06) 267 6892 or by writing to the ISC at the following address:

GPO Box 9836 CANBERRA ACT 2601

Contact Officers for technical enquiries:

Michael Burt (06) 267 6900 Insurance and Superannuation Commission

Keith Chapman (Superannuation) (06) 201 8566 Insurance and Superannuation Commission

Tom Karp (Life Insurance) (06) 267 6947 Insurance and Superannuation Commission

Eric Chalmers (General Insurance) (06) 267 6810 Insurance and Superannuation Commission

27 March 1995