Public Bank Account Investment Book Credit Policy

Public Bank Account Investment Book Credit Policy March 2014

1 Overview The Western Australian Treasury Corporation (WATC) manages the Public Bank Account (PBA) Investment Book, including the separate pool within the PBA designated as the Future Fund, under a Service Level Agreement with the Department of Treasury (Treasury). All transactions are carried out on an agency basis. In this policy, a reference to the PBA includes a reference to the Future Fund unless the Future Fund is specifically excluded within a particular policy provision. This PBA Investment Book Credit Policy (Policy) aims to manage the State s credit risk in respect of the PBA by setting minimum standards for the credit quality of counterparties and the diversification of credit exposures. Credit risk is the risk of financial loss due to a counterparty not meeting its financial obligations. Treasury endeavours to mitigate this risk by the establishment of this Policy. The key characteristics of the Policy are as follows: Explicit reliance is placed on the credit ratings assigned by Standard & Poor s Corporation (S&P) and Moody s Investors Service (Moody s) including credit watch announcements by these agencies; The types of institutions and the minimum rating requirements for investment counterparties or their parent guarantors are prescribed; Exposure limits are applied in accordance with credit ratings, however, credit watch announcements and geo-political/market factors can be taken into consideration when setting limits; Specific exposure limits are applied to individual counterparties; Investment limits cannot exceed 10% of the issuer s capital; All exposures are recognised from trade date at market value; and Maturity limits apply to the term of transactions. This Policy should be read in conjunction with the Future Fund Investment Framework (WATC, November 2012). Department of Treasury WA 1

2 WATC Responsibilities The WATC has the following responsibilities in respect of the management of the PBA under this Policy: Ensuring that investment activities comply with this Policy; Assessing the credit standing of institutions that do not have a current limit and authorising new limits in accordance with the criteria set out in this Policy; Monitoring the status of institutions with limits assigned under this Policy and amending limits in accordance with this Policy; Ensuring that the PBA credit exposures remain within the maximum exposure limits allowable under this Policy; Reviewing this Policy in conjunction with Treasury at least annually and recommending to Treasury those changes deemed appropriate; and Providing advice to Treasury on credit matters in respect of the PBA as required. 3 Reduction, Cancellation and Reinstatement of Limits In relation to individual counterparty limits, WATC can: Approve new counter-party limits subject to the criteria set out in this Policy; Suspend, cancel or reinstate counterparty limits; Reduce the amount and/or term of counterparty limits; and Reinstate the amount and/or term of counterparty limits. WATC is required to notify the Director, Financial Policy and Operations, Treasury of any change in individual counter-party limits applied under this section. 4 Approval of Category Limits 4.1 Treasurer s Approval Category limits, which are as approved and amended from time to time by the Treasurer, are detailed in Schedule A. 4.2 Operational Approval The Deputy Under Treasurer, Treasury has the Treasurer s authority to: approve increases in exposure limits by up to 25% of the exposure limits set by the Treasurer under section 4.1; and approve increases in term limits by up to the lesser of three months or 25% of term limits approved by the Treasurer under section 4.1. 2 Department of Treasury WA

4.3 Notification of Changes in Category Limits The Director, Financial Policy and Operations, Treasury will notify WATC of any changes to category limits approved under section 4.1 or 4.2. 5 Breach of the Policy Any breach of this Policy, except for a breach of Settlement Limits (see section 8), will be reported by WATC to the Director, Financial Policy and Operations, Treasury. The report will detail the cause of the breach and recommend appropriate action to be taken in regard to the breach. The report requires the approval of the Deputy Under Treasurer, Treasury. The report from WATC and the response from Treasury shall be in such form as agreed to by the Deputy Under Treasurer, Treasury. The notification and actions required in the event of a breach of a Settlement Limits are set out in section 8.3.3 below. 6 Use of Credit Ratings for Investments To be considered for a limit, a counter-party must be rated by at least one of S&P or Moody s. All rating references are to long term issuer or senior, unsecured debt ratings or their equivalent issued by S&P or Moody s. The credit rating criteria exclude structured issue ratings and other non debt subscripted ratings. Where a counter-party has different credit ratings assigned by S&P or Moody s, the counterparty s limits shall be based on the lower of the ratings. Credit watch announcements by S&P or Moody s may be taken into consideration when determining a counterparty category for credit limit purposes. The Public Information rating or its equivalent issued by S&P or Moody s shall be recognised where there is an existing long-term credit rating issued by the other agency. The long-term credit ratings comprising the AA Category are defined as: AA+, AA and AA- as issued by S&P. Aa1, Aa2 and Aa3 as issued by Moody s. The long-term credit ratings comprising the A Category are defined as: A+, A and A- as issued by S&P. A1, A2 and A3 as issued by Moody s. Department of Treasury WA 3

7 Controls on Investment Exposure The following arrangements shall apply in order to manage the PBA s credit exposures in respect of its investments. 7.1 Investment Policy Investments shall only be made in accordance with the PBA Investment Policy and in compliance with WATC's Approved Products Register. 7.2 Eligible Investment Counterparties Subject to the limits and credit rating criteria set out in the PBA Approved Investment Credit Limits table in schedule A (as amended from time to time), the following classes of counterparties are Eligible Investment Counterparties for the purposes of investments made by the PBA: Australian Commonwealth or State Governments and statutory entities guaranteed by the Commonwealth or State Governments; Banks as defined under section 5 of the Banking Act; Entities designated as Authorised Deposit-taking Institutions (ADIs) by the Australian Prudential Regulation Authority (APRA); Entities Guaranteed by Foreign Sovereign Governments; Supranational Institutions; and Corporations listed on a recognised stock exchange and their wholly-owned subsidiaries. Subject to the related counterparty criteria set out in section 7.4, entities without a credit rating shall not be considered for a credit limit. 7.3 Investment Exposure Measurement Method With regard to controlling dollar investment exposure, the exposures arising from the investments shall be measured at current market values and shall apply from the settlement date. Exposures guaranteed by the Commonwealth Government shall be applied to the Commonwealth Government limit and not the issuing counterparty s limit. Exposure and maturity limits shall be based on the credit rating of the counterparty. With regard to controlling investment term, the PBA may purchase securities whose term from settlement date to maturity date fully utilises the investment term limit. To facilitate these purchases and accommodate expected variations in the length of the pre-settlement period, a fixed term of up to ten (10) business days shall be added to the investment term limits (whether set by the Deputy Under Treasurer or WATC). The fixed term shall be determined according to the following table: 4 Department of Treasury WA

Investment Term Limit Additional Term to accommodate Pre-settlement period Greater than or equal to 6 months 10 business days Greater than or equal to 1 month, and less than 6 months 5 business days Less than 1 month Nil The maximum limit available to each class of Eligible Investment Counter-party, according to the counterparty credit rating category, is set out in the PBA Approved Investment Credit Limits table in Schedule A (as amended from time to time). The following principles have been applied when setting the limits allocated in this table: The limits for the Commonwealth Government and the Western Australian Government (including WATC) are not subject to credit criteria applied to other counter-parties; Australian and State Governments and their guaranteed entities have been allocated limits two levels higher than their banking equivalents; and The four major Australian banks, ANZ Bank, Commonwealth Bank of Australia, National Australia Bank and Westpac Banking Corporation ( Major Australian Banks ) have been allocated limits one level higher than other similarly rated counterparties because of their significant share of the Australian market and financial market activity. 7.4 Limits for Related Counterparties The exposures for related counter-parties i.e. those with a parent/subsidiary relationship, common parent or a guarantee from the parent, shall be aggregated and subject to the limit allocated to the parent. The exposures for Commonwealth or State Government Guaranteed Statutory Authorities shall be aggregated by jurisdiction and subject to the total limit for that Government. 7.5 Capitalisation Restriction Limits shall be capped at 10% of capital (as represented in the company s balance sheet by shareholders funds or its equivalent) if this amount is lower than the Exposure Limit prescribed under this Policy. This cap does not apply to entities guaranteed by foreign sovereigns or entities guaranteed by the Commonwealth or an Australian State Government. In the case of Australian subsidiaries of offshore banks and corporations, limits shall be restricted to 10% of the capital base in Australia, unless the subsidiary is supported by an acceptable parent guarantee, in which case the capital base of the guarantor shall apply. Equity based limits shall be reviewed at least once a year. Department of Treasury WA 5

7.6 Exposure Diversification Limits WATC shall seek to avoid concentration of counterparty exposures within the PBA s investment book by ensuring that no single counterparty s credit exposure exceeds the maximum portfolio share set out in the following table. Table : Exposure Diversification Limits by Exposure Client Exposure Client 2 Maximum Portfolio Share 1 PBA Excluding Future Fund Future Fund Commonwealth Government 100% 20% Western Australian Government 100% 100% New South Wales Government 15% 40% Victorian Government 15% 40% Queensland Government 15% 40% South Australian Government 15% 40% Tasmanian Government 15% 40% Northern Territory Government 15% 15% Major Australian Bank (per bank) 25% 25% - All Other (per exposure client) 15% 15% 1. Portfolio share is calculated as the percentage share of the PBA Portfolio (excluding Future Fund) on a stand alone basis and percentage share of the Future Fund Portfolio on a standalone basis. 2. For the purpose of this limit, a credit exposure of an exposure client guaranteed by another exposure client is to be counted against the credit exposure of the guaranteeing exposure client and shall not be included in the credit exposure of the guaranteed exposure client. It is recognised that a reduction in the overall size of the investment book can give rise to a breach of this limit setting and therefore the immediate unwinding of positions in order to increase the diversification of credit exposures within the investment book may not be appropriate or required. However, where a counter-party s exposure exceeds the specified diversification limit, WATC will report the breach to the Director, Financial Policy and Operations, Treasury. The report will detail the cause of the breach and recommend appropriate action to be taken in regard to the breach and require the approval of the Deputy Under Treasurer, Treasury. The report from WATC and the response from Treasury can be in such form as agreed to by the Deputy Under Treasurer, Treasury. 6 Department of Treasury WA

8 Controls on Settlement Exposure The following arrangements shall apply in order to manage the PBA s dollar credit exposures in the period from trade date to settlement date. 8.1 Eligible Settlement Counterparties The following classes of counter-parties are Eligible Settlement Counterparties for the purposes of investments made by the PBA: Approved investment counterparties; Members of WATC s Domestic Fixed Interest Market Making Panel; Dealers, selling agents, issuing agents or paying agents on WATC's commercial paper or medium term note programs; Managers, arrangers, selling agents, issuing agents or paying agents for bond or note issues; ADIs as designated by the APRA; and Such other counterparties as shall be approved from time to time by WATC. 8.2 Same Day Settlement No intra-day limits shall apply to transactions dealt for same day settlement. 8.3 Settlement Limits Transactions that give rise to a settlement exposure are those that settle after trade date. Two types of exposure arise in relation to such trades in the period between trade date and settlement date (the pre settlement period): 1. Forward Investment Exposure the PBA is exposed to the issuer of the security being purchased regardless of the counterparty involved. The exposure arises from trade date and is calculated as the market value of the security being purchased. 2. Settlement Counter-party Exposure the PBA is exposed to the settlement counterparty to the extent that the market value of the underlying security moves in the PBA s favour as set out in Section 8.3.2 below. 8.3.1 Forward Investment Exposure (Exposure to the Issuer in the Pre-Settlement Period) The maximum exposure to the issuing entity for forward investment transactions shall be set at a net amount equivalent to 50% of the Exposure Limit for that issuer as approved under section 4 of this Policy. Department of Treasury WA 7

The net exposure shall be determined by deducting any sales of securities from the exposures arising from investments (purchases). 8.3.2 Settlement Counter-party Exposure (Exposure to the Settlement Counter-party in the Pre-Settlement Period) Exposure to the settlement counter-party arises in the pre settlement period: Where the amount payable by the PBA at settlement is less than the current market value of the security being purchased, the exposure is calculated as Market Value minus Settlement Amount; and Where the amount receivable by the PBA at settlement exceeds the market value of the security being sold, the exposure is calculated as Settlement Amount minus Market Value. Subject to the Related Counter-parties criteria under section 7.4, the maximum net dollar exposure to any settlement counter-party shall be: $1,000,000 for trades made for the PBA (excluding the Future Fund) $2,000,000 for trades made for the Future Fund. 8.3.3 Consequence of a Settlement Limit Breach In the event of a breach of the settlement limits set out in section 8.3, the following shall apply: 1. Existing transactions with the relevant counterparty may remain in place; 2. No increase in exposure to the relevant counter-party as a result of new transactions shall be permitted; 3. WATC will notify the Director, Financial Policy and Operations, Treasury of the breach and the actions needed (if any) to prevent such breaches occurring in the future. The notification shall be in such form as agreed to by the Director, Financial Policy and Operations, Treasury. 8 Department of Treasury WA

Schedule A: Public Bank Account Approved Investment Credit Limits Limit Category Credit Rating Exposure Client PBA excluding Future Fund Exposure Maturity Limit Limit No Limit 3 Years No Limit 3 Years Future Fund Exposure Limit Maturity Limit A Western Australia (including WATC) Commonwealth Government No Limit 20% of the 12 Years 12 Years portfolio B AA/Aa2 or better Commonwealth Government Guaranteed Statutory Authorities $1,000 m 3 Years $ 600 m 12 Years AA/Aa2 or better State or Territory Governments $1,000 m 3 Years $ 600 m 12 Years AA/Aa2 or better State or Territory Govt. Guaranteed Statutory Authorities $1,000 m 3 Years $ 600 m 12 Years AAA/Aaa Major Australian Banks $1,000 m 3 Years $ 275 m 5 Years C AA-/Aa3 State or Territory Governments $ 800 m 3 Years $ 500 m 12 Years AA-/Aa3 State or Territory Government Guaranteed Statutory Authorities $ 800 m 3 Years $ 500 m 12 Years Double-A Category Major Australian Banks $ 800 m 3 Years $ 225 m 5 Years AAA/Aaa Banks or Authorised Deposit Taking Institutions $ 800 m 3 Years $ 225 m 5 Years AAA/Aaa Entities Guaranteed by Foreign Sovereigns $ 800 m 3 Years $ 225 m 12 Years AAA/Aaa Supranationals $ 800 m 3 Years $ 225 m 12 Years AAA/Aaa Corporations $ 800 m 3 Years $ 225 m 5 Years D Single-A Category State or Territory Governments $ 400 m 3 Years $ 250 m 7 Years Single-A Category State or Territory Govt. Guaranteed Statutory Authorities $ 400 m 3 Years $ 250 m 7 Years A+/A1 Major Australian Banks $ 400 m 3 Years $ 125 m 5 Years Double-A Category Banks or Authorised Deposit Taking Institutions $ 400 m 3 Years $ 125 m 5 Years Double-A Category Entities Guaranteed by Foreign Sovereigns $ 400 m 3 Years $ 125 m 5 Years Double-A Category Supranationals $ 400 m 3 Years $ 125 m 5 Years Double-A Category Corporations $ 400 m 3 Years $ 125 m 3 Years E A+/A1 Banks or Authorised Deposit Taking Institutions $ 200 m 3 Years $ 75 m 3 Years A+/A1 Entities Guaranteed by Foreign Sovereigns $ 200 m 3 Years $ 75 m 3 Years A+/A1 Supranationals $ 200 m 3 Years $ 75 m 3 Years A+/A1 Corporations $ 200 m 3 Years $ 75 m 3 Years F A-/A3 or better Banks or Authorised Deposit Taking Institutions $ 200 m 6 Months $ 75 m 1 Year G BBB-/Baa3 or better Banks or Authorised Deposit Taking Institutions $ 30 m 11am Call $ 10 m 11am Call Department of Treasury WA 9