Russell Investment Management Ltd ABN 53 068 338 974 AFSL 247185 Part B Derivative Risk Statement For Russell Funds 10 March 2014
Table of Contents Generic Information...1 1. Responsible Party... 1 2. Funds... 1 3. Objective of DRS... 3 4. Definition of Derivatives... 4 5. Investment Strategy... 4 6. Purpose of the Use of Derivatives... 4 7. Restrictions on the Use of Derivatives... 5 8. Risk Management... 6 8.1 Market Risk... 6 8.1.1 Monthly Compliance Testing by the Administrator... 7 8.1.2 Daily Testing by Russell Operations staff (Seattle)... 7 8.1.3 Daily Testing by the Administrator... 7 8.1.4 Daily Testing by BBH... 8 8.1.5 Weekly Testing by Russell... 8 8.2 Basis Risk... 8 8.3 Liquidity Risk... 8 8.4 Counterparty/Credit Risk... 9 8.5 Counterparty Credit Exposure Management and Documentation... 10 8.6 Operations Risk... 10 9. Investment Managers... 11 10. Currency... 12 11. Personnel Arrangements... 12 12. Assessment of Controls... 13 13. External audit... 13 14. Reporting to the Responsible Entity of the Fund... 13 15. Reporting to Superannuation Clients... 14 16. Date of Approval of Derivative Risk Statement... 15 Schedule 1 Specific Information on Use of Derivatives in the Funds...16 1. Section A... 16 2. Section B... 16 2.1 Investment Managers... 16 2.2 Transition Management... 16 2.3 Russell Funds Investing In Collective Investments... 16
Section A Derivatives Currently Authorised for Use by Russell...18 Section B Derivatives Authorised for External Managers...19
Generic Information 1. Responsible Party Russell Investment Management Ltd ( RIM ) ABN 53 068 338 974 Level 29, 135 King Street SYDNEY NSW 2000 AUSTRALIA 2. Funds This Derivative Risk Statement ( DRS ) covers the following funds: Russell Australian Shares Fund Russell Australian Shares Enhanced Income Fund Russell Australian Opportunities Fund Russell Australian Bond Fund Russell Australian Bond Income Fund Russell Australian Government Bond ETF Russell Australian Semi-Government Bond ETF Russell Australian Select Corporate Bond ETF Russell International Property Securities Fund - $A Hedged Russell Australian Cash Fund Russell Australian Cash Enhanced Fund Russell Inflation Linked Bond Fund Russell International Shares Fund Russell International Shares Fund - $A Hedged Russell International Shares Index Fund - $A Hedged Russell Global Opportunities Fund Russell Global Opportunities Fund - $A Hedged Russell Global Opportunities Fund - $NZ Hedged Russell International Shares Tracker Fund Russell Australian Shares Tracker Fund Russell International Bond Fund - $A Hedged Page 1
Russell Global Listed Infrastructure Fund - $A Hedged Russell Global Bond Fund Russell Emerging Markets Fund Russell Conservative Fund Russell Diversified 50 Fund Russell Balanced Fund Russell Growth Fund Russell High Growth Fund Russell II Portfolio Russell IV Portfolio Russell V Portfolio The Russell Pooled Superannuation Trust* Tower Buy and Hold Sector Fund TAL Australian Bond Fund Russell High Dividend Australian Shares ETF Russell Australian Value ETF Russell After Tax Australian Shares Fund (For Superannuation Investors) PartnerShip Conservative Fund PartnerShip Balanced Fund PartnerShip Growth Fund PartnerShip Debt Management Fund PartnerShip Income Seeker Fund Russell Multi-Asset Growth Strategy Fund * RIM is the investment manager appointed by the Total Risk Management Pty Ltd, the trustee of this Trust. Each of the funds in the above list are referred to as Fund or Funds. The list of funds covered by this DRS may change (e.g. where new funds are established). An up to date list of funds may be obtained from RIM. RIM will update this DRS periodically or where there are material changes to the information contained in it. Page 2
3. Objective of Derivative Risk Statement Russell Investment Management Ltd ( RIM ) is the responsible entity or Trustee for each Fund, except where indicated otherwise above. RIM selects and appoints specialist external investment managers to manage the assets of each Fund. Each investment manager has agreed to manage their derivative positions in accordance with Investment Guidelines established by RIM. The derivatives authorised for use by external investment managers are listed in Section B of Schedule 1. Each of these investment managers has provided its own DRS or other information to RIM. RIM also retains the services of its related company Russell Implementation Services Inc. ( RIS ) to carry out some derivatives trading for the Funds. RIM, RIS, and Russell Investments are collectively referred to as Russell for the purpose of this DRS. The derivatives authorised for use by Russell are listed in Section A of Schedule 1. In certain circumstances, RIM may also invest in a collective investment scheme operated by a body other than RIM. In these circumstances, RIM has obtained a DRS or other information from the operator of the collective investment scheme and is satisfied that it would be appropriate to invest in the collective investment scheme including: Making an assessment of risks involved in the investment, including those resulting from the use of derivatives by the collective investment scheme. Russell s Investment Division ( ID ) takes responsibility for this step; Considering whether the derivative use of the collective investment scheme is in accordance with the overall investment strategy of the Fund. This Part B Derivative Risk Statement summarises the policies in place covering the use of derivatives, controls on their use, and the processes for assessing compliance with these controls. In particular, it Describes the controls in place for derivatives entered into by Russell directly; Seeks to outline the compliance testing employed to ensure that Russell and the underlying external investment managers manage their derivative positions in accordance with the Investment Strategies and Investment Guidelines of each Fund as established by RIM; Does not, however, seek to describe the controls in place for derivatives entered into by each of the underlying external investment managers (to obtain this information, please refer to the investment manager s DRS which is available from RIM on request) ; This DRS will be reviewed regularly, at least annually. A copy of this DRS is provided to relevant Russell personnel responsible for managing, monitoring or implementing Russell s investment process. All such Page 3
personnel are required to read, understand and comply with its requirements. On a quarterly basis RIS provides confirmation to the RIML Compliance Department that it has complied with the DRS. 4. Definition of Derivatives Derivatives are defined in the Australian Prudential Regulation Authority ( APRA ) Circular II.D.7 Derivatives ( the former Circular ) as a financial contract whose value depends on, or is derived from, assets, liabilities or indices (referred to as the Underlying Asset ). The former Circular also notes that this definition includes a wide assortment of instruments, including, but not limited to: Forward Currency Agreements; Futures; Options; Share Ratios; Warrants; Swaps and other composites. There are a number of instruments that are, or appear like, derivatives that may arise incidentally from other investment activity. Russell does not generally consider the following securities to be within the former Circular s definition of a derivative: (i) ordinary shares or common stock; (ii) preference shares or preferred stock; (iii) fixed income securities including mortgage backed and asset backed securities; (iv) American Depository Receipts (ADRs); Global Depository Receipts (GDRs) or similar receipts; (v) preference shares or fixed income securities convertible into ordinary or preference shares; (vi) spot foreign currency purchase contracts; (vii) foreign currency forward contracts used for the purpose of settlement of sales and purchases of securities within the normal transaction settlement timeframes; (viii) partly paid shares; or (ix) instalment receipts. 5. Investment Strategy Derivatives are not considered in isolation, but rather as part of the investment strategy for each Fund. Consideration is given to exposures arising from other assets of each Fund and the role that derivatives will play as a component of the overall portfolio. The use of derivatives will be consistent with and subordinate to each Fund s overall investment strategy. The derivatives risk in each Fund is restricted to that Fund. The investment objectives and strategies of the Funds are documented in the Funds offer documents. A copy of these documents is available from RIM. This DRS should be read in conjunction with the relevant offer document. 6. Purpose of the Use of Derivatives As described on page 2 of the Part A DRS, generally it is RIM s policy to allow the trading of derivative instruments (including by external investment managers) for hedging, risk control, implementation of investment strategies or transition management of portfolios. Russell does not intend to leverage the Funds. Both Russell and the external investment managers are required to ensure that the portfolios they manage Page 4
are not leveraged, such that the Funds are not leveraged. The only exceptions where leverage could occur would be in strategic and tactical overlay portfolios where investment decisions are directed by the Fund PM and leverage is managed at the Fund level instead of Portfolio level. A Fund would be leveraged if the net level of market exposure exceeds the net market value of the Fund. The Funds are not permitted to hold "uncovered" derivatives positions. To be viewed as being "covered" the derivatives positions must satisfy one of the following tests. Firstly, where derivatives are used to create an exposure to a market or security the net exposure created must be backed by cash or cash equivalents. Cash is considered as any asset which can be converted into cash within the settlement period but specifically excludes equities. Secondly, where a derivative is utilised to hedge a particular market or security exposure the "cash backing" of the positions consists of the assets for which the derivatives are considered the appropriate hedge provided the underlying assets can be liquidated by T+3. The Fund will not be considered leveraged where from time to time, Russell s implementation of a cost efficient and effective passive hedging strategy leaves an immaterial residual uncovered exposure. Russell does not regard securities lending or borrowing as leveraging the Funds. The derivatives that may be used by Russell directly are exchange traded futures and over-the-counter ( OTC ) Forward Foreign Exchange ( FFX ), options and swap contracts. Derivatives may be used to equitise or overlay cash holdings (or to remove exposures to the market). Derivatives may also be used to obtain or reduce exposure to particular securities. Where appropriate, this cash may be overlaid with FFX contracts to ensure the currency exposure to those markets is also obtained where applicable. The purpose of this is to minimise the performance impact of cash holdings on each Fund. Derivatives are used by external investment managers to: (a) More efficiently create (or remove) exposures which would otherwise be established through the physical market; and (b) Provide a cost effective, more efficient and/or more liquid way to implement investment decisions. 7. Restrictions on the Use of Derivatives Russell s checking, supervision and review procedures are designed to ensure that derivatives are used in a manner consistent with the offer documents of the Funds and the Investment Guidelines agreed with each investment manager assignment within each Fund. The Investment Guidelines cover derivatives trading by each investment manager. Derivatives used, either by Russell or by the external investment managers, which are inconsistent with the investment strategy, offer document and Investment Guidelines are not permitted. These checks are carried out by Page 5
the Funds Administrator or designate on at least a monthly basis (as described under Market Risk section). Russell may use futures, options and/or swaps, in the various markets in which each Fund operates to equitise or overlay cash holdings, and where appropriate to also overlay this cash with FFX contracts to ensure the currency exposure to those markets is obtained. The Risk Management section outlines control procedures employed for derivative positions managed directly by Russell. A description of controls adopted by an external investment manager may be found in the DRS or other information prepared by that manager. The Risk Management section outlines the compliance testing undertaken by the Administrator or designate, at the external investment manager level. 8. Risk Management Risk is inherent in any portfolio, regardless of whether or not derivatives are used. The key to managing risk, with or without derivatives, is the establishment of effective Investment Guidelines and the selection of external investment managers skilled in assessing the risk characteristics of the securities and instruments they buy and the portfolios they build. RIM has developed a set of Investment Guidelines for each of its external investment managers, compliance with which is required and monitored by RIM via ID and Investment Operations. These Investment Guidelines include governing the use of derivatives by investment managers. They take into account both physical and derivative exposures. In setting these Investment Guidelines for the different investment managers in a fund, ID (the Portfolio Manager) ensures that the overall combined effect of those Investment Guidelines on the Fund as a whole is in accordance with the investment objective and strategy as stated in the Fund s offer document, including ensuring there is no leverage. A Portfolio would be considered leveraged if the net level of market exposure exceeds the net market value of the Portfolio The risks associated with derivatives vary widely, but generally fall into the following categories: 8.1 Market Risk Market risk is the risk of loss due to adverse moves in the market in which the Fund invests. Derivatives provide means of obtaining an investment exposure to a specific market or security. Consequently, derivative positions must be subject to the same Investment Guidelines that apply to traditional Fund investments. RIM has instructed its external investment managers, ID and RIS to ensure that the impact of all derivative positions complies with their individual Investment Guidelines. The primary responsibility for market risk management lies respectively with each external investment manager, Russell s ID and RIS. In determining Page 6
whether each party has complied with the part of the Fund s investment strategy and Investment Guidelines that they are contracted to implement, derivatives are taken into account on an effective exposure basis. All investments, including derivatives, are valued daily by the Administrator for the purposes of determining the current unit value of the Fund and reported to Russell on a daily basis. Derivative instruments are valued from independent sources where possible. Exposures to derivatives not independently priced are monitored by RIM s Security Valuation Committee. 8.1.1 Monthly Compliance Testing by the Administrator For derivative positions traded by Russell and external investment managers a Fund level leverage compliance review is conducted at least monthly by the Administrator. Derivatives are accounted for by the Administrator on a net effective exposure basis. For example, in the case of futures, the effective or equivalent physical exposure is defined as the number of futures contracts multiplied by the relevant multiplier for each contract, multiplied by the market price. In the case of options, exposure is measured on a delta weighted basis. The accounting treatment of derivatives reporting applied by the Administrator is in line with the former Circular. For single sector funds, compliance testing as described above is performed for the purpose of ensuring that the net exposure of the total fund to the relevant asset class does not go outside the ranges set out in the Fund s investment strategy (i.e. the Fund is not leveraged). For multi-sector or balanced funds Russell performs regular checks for the purpose of ensuring that the net exposure of the total fund to the relevant asset class does not go outside the ranges set out in the Fund s investment strategy. The multi-asset funds, where derivatives are traded, are included on the daily testing performed by the administrator (8.1.3). These results are reviewed by Sydney Fund Operations and reported to Compliance as per process. 8.1.2 Daily Testing by Russell Operations staff (Seattle) Russell Operations staff (Seattle) performs a calculation daily to ensure that derivative positions entered into by Russell, on an effective exposure basis, do not exceed 100% of the cash or cash equivalents in the Fund which Russell is equitising or effecting a fixed interest overlay on a given day. If futures positions exceed this limit, they will notify the derivatives desk which will then reduce the Fund s derivative exposure. 8.1.3 Daily Testing by the Administrator The Administrator also performs daily tests for funds where Russell regularly trades derivatives, for the purpose of monitoring that there is no leverage at fund level. The Administrator notifies Sydney Compliance and Sydney Fund Page 7
Operations of the results. Sydney Fund Operations monitors that overexposures are investigated as required, reported to the Compliance Manager and appropriately resolved. 8.1.4 Daily Testing by BBH Daily compliance testing is performed by BBH (Brown Brothers Harriman) at the external investment manager level for specified investment manager accounts. These tests, based on information readily available to the BBH, are to monitor whether investments are made in accordance with the Fund s investment strategy and Investment Guidelines. 8.1.5 Weekly Testing by Russell External investment manager guideline monitoring for specified investment manager accounts (not already monitored by BBH) is performed by Russell on a weekly basis. These tests, based on information readily available to Russell, are to monitor whether investments are made in accordance with the Fund s investment strategy and Investment Guidelines. 8.2 Basis Risk A related form of market risk is basis risk, which is the risk that a derivative position will not move in line with an underlying physical position. Basis risk is managed by Russell by assessing whether the derivatives it is trading are suitable proxies for the assets they are intended to replicate. Russell may use index futures and/or swap contracts to equitise or overlay cash holdings and OTC FFX contracts to gain currency exposure on those cash holdings where appropriate. Instruments are chosen which most closely represent the relevant asset class market exposure being replicated. External investment managers appointed by RIM have their own procedures, as referred to in their respective DRS or other information. 8.3 Liquidity Risk Liquidity risk is the risk that it may not be possible to unwind illiquid positions and/or that market price instability affects the Fund s ability to meet margin payments. Liquidity risk varies widely. Some derivatives, such as many exchange traded futures contracts, options and FFX, are highly liquid and these are primarily the derivatives used by Russell. However, liquidity conditions can change rapidly during times of market distress. Similarly liquidity is typically reduced in the case of exotic and more specialised instruments. RIS, responsible for trading, receives cash balances, cash flow, and trading information from the Fund s custodian, from Sydney Fund Operations, and the Portfolio Manager (as applicable). Based on current market data, RIS calculates the number of contracts necessary to equitise or overlay cash Page 8
holdings except for trades instructed by the Portfolio Manager (as applicable). Positions are opened or closed accordingly. The Funds are not permitted to hold "uncovered" derivatives positions. To be viewed as being "covered" the derivatives positions must satisfy one of the following tests. Firstly, where derivatives are used to create an exposure to a market or security the net exposure created must be backed by cash or cash equivalents. Cash is considered as any asset which can be converted into cash within the settlement period but specifically excludes equities. Secondly, where a derivative is utilised to hedge a particular market or security exposure the "cash backing" of the positions consists of the assets for which the derivatives are considered the appropriate hedge provided the underlying assets can be liquidated by T+3. As indicated under Market Risk above, Russell Operations staff (Seattle) performs a calculation daily to ensure that derivative positions entered into by Russell, on an effective exposure basis, do not exceed 100% of the cash or cash equivalents in the Fund which Russell is equitising or effecting a fixed interest overlay on any given day. If futures positions exceed this limit, they will notify RIS which will then reduce the Fund's derivative exposure. Liquidity risks are also managed through the establishment of Investment Guidelines with the external investment managers that outline the types of derivatives that are permitted in the Funds. External investment managers appointed by RIM have their own procedures, as referred to in their respective DRS or other information. 8.4 Counterparty/Credit Risk Counterparty risk is the risk of loss due to counterparty default. Generally derivatives that trade through recognised clearing corporations or exchanges have less counterparty risk than OTC derivatives such as OTC FFX and swaps. However, for OTC derivatives, Russell s procedures help address the amount of exposure that exists at any point in time, including margins and daily mark-to-market requirements. Russell directly invests using exchange traded futures and/or swap contracts and OTC FFX contracts which are held for the purpose of achieving currency exposure. The policies and procedures covering the use of exchange traded futures and/or OTC derivatives including FFX and swap contracts are as follows: Approval of bank counterparties is managed centrally and is assessed on a regular basis Russell assesses the creditworthiness of the counterparty to determine the potential fundamental credit risk. Through this process, counterparties are assigned an internal credit rating based on a scale and according to their relative fundamental credit strength. Counterparties are also monitored on an on-going basis and internal Page 9
credit ratings are reviewed periodically and updated as needed. Credit Risk Management maintains the internal credit ratings which are reflected on an Approved Counterparty List and distributed to Russell s Portfolio Managers and Traders. Russell manages counterparty credit risk based upon Credit Risk Management approved policy. Any maximum exposure limits for OTC derivatives are governed by the investment management agreement. 8.5 Counterparty Credit Exposure Management and Documentation Russell s internal credit rating scale facilitates Russell s counterparty exposure management process. Total exposure to counterparties is monitored regularly and against established limits as appropriate. Russell s Credit Exposure Management follows the Credit Risk Committee approved standards and procedures. Prior to dealing with a counterparty, Russell ensures there is an appropriate contract with that counterparty which sufficiently sets out the terms of the transaction(s) to be undertaken. The counterparty is required to provide a representation that they have the power to enter into the contract and to perform their obligations. All contractual documentation is kept securely by Russell to minimise possibility of document loss through misplacement, fire, theft and fraud. Specific details of the types of derivatives contracts permitted for investment by Russell and external investment managers and any maximum exposure limits for OTC derivatives are documented in agreed investment parameters or procedures established for the Fund/portfolio concerned. External investment managers appointed by RIM have their own counterparty credit risk management and exposure procedures, as referred to in their respective DRS or other information. 8.6 Operations Risk Operations 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 might, for example, be caused by human error, system failures, inadequate procedures, or a lack of internal management controls. The risk of loss from system failures is reduced through system backups and disaster recovery (contingency) procedures put in place by Russell, which aim to ensure the maintenance of Russell s critical data availability. RIM maintains an appropriate authorised signatories list of staff who are authorised to give instructions concerning the Funds assets. Page 10
Russell aims to ensure that individuals are not able to manage all parts of any process without adequate supervision. Broadly, investment management duties at Russell are segregated into the areas of ID including Alternatives, RIS, and Fund Operations. The trading function is supervised by RIS, as is trade order generation. The administration of accounts and settlement of transactions is performed by the Administrator and Custodian respectively. The Investment Operations Department is functionally separate from ID and performs a separate check on derivative positions held directly by Russell as well as oversight testing on a daily basis for those derivative positions entered into directly by Russell. Exchange-traded derivatives are priced and reconciled daily to the broker in a manner which is consistent with current industry practice. Prices for exchange traded derivatives are sourced from the relevant exchange via the Administrator s pricing vendor. These functions are performed by the Administrator. A description of how external investment managers address this risk can be found in their respective DRS or other information. 9. Investment Managers RIM retains the services of both internal investment managers and external investment managers to manage the Funds investments. These investment managers are required to manage the assets of the Funds in accordance with Investment Guidelines determined by RIM. RIM may at any time change investment managers for any of the Funds as part of its ongoing monitoring of investment managers. An up-to-date list of investment managers and the area of investment strategy delegated to each manager is available from RIM. Where RIM makes changes to investment managers or material changes to strategies delegated to investment managers, RIM will generally notify superannuation clients of these changes as soon as practicable after the changes occur. Cash and cash equivalents of the Funds may be internally managed by Russell, or an appointed investment manager. Russell or its associates may also directly manage any other portion of the investments of the Funds. The external investment managers have their own procedures for risk management and have provided a DRS or other information to RIM. These documents are available for inspection at the offices of RIM during office hours. As referred to under Risk Management section, compliance testing is conducted at least monthly by the Administrator or designate of the Fund and is reported to Russell, to monitor compliance with manager level guidelines. Page 11
10. Currency Currency derivatives are subject to the policies and procedures outlined in this DRS. They are used where allowed by each Fund s investment strategy. Each Fund may be hedged in a manner consistent with the investment strategy outlined in the Fund offer documents and Investment Guidelines relating to each appointed investment manager. Russell uses OTC FFX contracts to obtain currency exposure in certain Funds, where RIS equitises or overlays cash holdings of those Funds. OTC FFX contracts are also used to hedge currency exposure with certain Funds. Details of particular investment managers who are permitted to use currency derivatives can be provided upon request. A description of controls adopted by external investment managers may be found in the DRS or other information prepared by that manager. RIS performs investment guideline monitoring for internally managed FX derivative exposures. 11. Personnel Arrangements All of the activities, including those of Russell s ID, RIS and Investment Operations, described above are performed by personnel who have received proper training and who are considered by Russell as sufficiently experienced, skilled and qualified to perform their responsibilities. The duties of ID, RIS and Investment Operations are separate. Personnel of ID are responsible for formulating Investment Guidelines for each investment manager. All personnel are managed by supervisors and managers who have overall responsibility for ensuring the procedures are properly performed. Trading & Operations staff who are responsible for trading derivatives are not involved in the formulation of Investment Guidelines under which they operate. RIM maintains an appropriate authorised signatories list of staff who are authorised to give instructions concerning the Funds assets. This DRS has been provided to and brought to the attention of all personnel involved with processing, monitoring or trading of derivative instruments. All such personnel are required to read, understand and comply with its requirements. All personnel receive a base salary and, in many cases, participate in an incentive scheme. The allocation of the scheme to each employee is based upon the overall performance of the firm and their performance in their allotted role and is contingent on their complying with the terms and conditions of their employment with Russell Investments. Russell evaluates each employee through an annual performance appraisal process. This appraisal process measures each employee s performance against agreed upon key result areas. The appraisal process contributes to each employee s remuneration and future career development. Page 12
No employee of Russell in the ID, RIS or Investment Operations receives any remuneration, bonus or other inducement related to the use of derivatives or to the turnover of any portfolio. Russell encourages continuing education for all employees. Accordingly, relevant training and ongoing education programs are provided to all staff involved in dealing with derivatives. 12. Assessment of Controls Russell will assess the DRS on an annual basis to ensure its continued adequacy. This will be done by both assessing the types of derivative transactions being used and considering whether the internal controls are adequate for those types of derivatives. Internal control procedures will be reviewed before introducing a new type of derivative instrument, where such an instrument is being considered for use directly by Russell. Any necessary adjustment to controls will take place prior to the introduction of new derivative instruments. Internal control procedures will be reviewed where Russell considers necessary. Management of key controls and performance measurement is accomplished through routine reporting on investment activities and internal audit review. Systems provide reports which enable the ongoing monitoring of trading and investment activity against assigned limits, including counterparty limits. The Board of Directors of RIM: has reviewed and approved this DRS; believes that the processes outlined in this DRS are sufficient in managing and controlling the type of derivatives managed directly by Russell; and believes the DRS satisfies the APRA former Circular for Derivative Risk Statements. 13. External audit The Funds external auditors will be asked, on an annual basis, to sign off that the DRS exists, that major procedures laid down in the DRS have been followed and any changes have been approved. The DRS audit will be carried out in accordance with the Australian Auditing Standards and former Circular. 14. Reporting to the Responsible Entity of the Fund RIM has monitoring and reporting procedures relating to the Funds investments, including the use of derivatives in the Funds. The reports provided to RIM are set out below: Monthly (or more frequent) Compliance undertaken by the Administrator - Tests relating Fund leverage are performed at least Page 13
monthly by the Administrator based on information readily available to the Administrator. These test results are reviewed by Russell s Fund Operations. Breaches are escalated to and investigated by Sydney Compliance in a timely manner and appropriate follow up action taken. Daily and Weekly Compliance - Tests relating to external investment managers adherence with agreed Investment Guidelines are performed based on information readily available. The daily monitoring is completed by BBH and weekly monitoring is completed internally at Russell in Seattle. These test results are reviewed by Russell s ID. Breaches are investigated by ID in a timely manner and appropriate follow up action taken. Compliance is notified of breaches and monitors remediation. The results of these tests are subsequently provided to the RIM Board each quarter for review. Quarterly Compliance Sign offs - Where appropriate, investment managers provide a quarterly sign-off on their compliance with their investment management agreement, guidelines and DRS. These are reviewed by RIM s Compliance Department. Daily Testing by Russell Operations staff (Seattle) - Tests relating to derivatives managed directly by Russell are performed daily by Russell s Operations staff (Seattle). Breaches are investigated by Russell Operations staff (Seattle) in a timely manner and appropriate follow up action taken. The results of these tests are subsequently reported to the RIM Board in respect of each quarter. Daily Tests by the Administrator - The Administrator performs additional daily tests for funds where Russell trades derivatives. Breaches are investigated by Russell Fund Operations (Sydney) in a timely manner and appropriate follow up action taken. The results of these tests are also subsequently reported to the RIM Board in respect of each quarter for review. External Auditors Report - Report on the external audit on the adherence to the major procedures set out within this DRS. 15. Reporting to Superannuation Clients This DRS will be provided to the Board of each superannuation client, both initially and when there are subsequent material changes. The DRS is also available to non-superannuation clients, at their request. Asset exposures including those achieved through the use of derivatives are reported to superannuation clients and disclosed in Fund offer documents and quarterly Fund reports. RIM will report to the trustee of superannuation clients when RIM judge there has been a significant occurrence in relation to a Fund s use of derivatives. Action will be taken to rectify a breach of the DRS. RIM will notify superannuation clients of any material breaches of the DRS. Page 14
16. Date of Approval of Derivative Risk Statement The Board of Directors of RIM approved this Derivative Risk Statement on 10 March 2014. Page 15
Schedule 1 Specific Information on Use of Derivatives in the Funds 1. Section A This section describes the derivatives currently authorised for use by Russell on a regular basis. This list may change and up-to-date information about derivatives that are used by Russell for particular funds can be requested from Russell. 2. Section B 2.1 Investment Managers This section lists generally the types of derivatives external investment managers are authorised to trade. This may change and up-to-date information about derivatives that are used for particular funds can be requested from Russell. Further information on the types of derivatives that each particular fund is permitted to trade and particular limits that are prescribed by RIM can be provided upon request. A description of the processes and controls of a particular investment manager is contained in the DRS or other information provided by that manager to RIM. 2.2 Transition Management Russell may use derivatives from time to time for purposes of transition management in the Funds. Transitions include significant portfolio changes such as large inflows or outflows, in-specie capital flows, manager terminations or hires, and changes in manager weights or strategies. Futures and/or swaps may be used to introduce (or remove) market exposure during these transitions, for purposes such as timely and efficient implementation of the change or to maintain market exposure at times of significant cash holdings. Additionally, OTC FFX contracts may be used to affect appropriate currency exposures. The processes and controls outlined in the main body of this DRS and sections A and B of this Schedule apply to the use of derivatives during transition management for all Funds. 2.3 Russell Funds Investing In Collective Investments Russell Funds may invest in collective investments operated by RIM or by other parties, as described in the offer document of the particular Fund. Where the underlying collective investment is operated by RIM and uses Page 16
derivatives, a description of the derivatives used in each of the underlying funds operated by RIM can be found at sections A and B of this schedule. Where the underlying fund is a collective investment operated by a party other than RIM, the authorised derivatives are those authorised by the offer documents of the underlying collective investment. The operator of the collective investment is responsible for monitoring compliance and risk management of the collective investment. In these circumstances, RIM has obtained a DRS or other information from the operator of the collective investment scheme and this can be obtained from RIM on request. Page 17
Section A Derivatives Currently Authorised for Use by Russell This may change and up-to-date information about derivatives that are currently authorised for use by Russell for particular funds can be requested from Russell. Futures Options OTC FFX contracts Swaps TBAs Page 18
Section B Derivatives Authorised for External Managers This may change and up-to-date information about derivatives that are currently authorised for use by Russell for particular funds can be requested from Russell. Futures Options OTC FFX contracts Swaps Repurchase Agreements Structured Notes Swaptions TBAs Page 19