valuation of securities (e) task force roll call · valuation of securities (e) task force ....

© 2020 National Association of Insurance Commissioners 1

Date: 6/11/2020

Conference Call

VALUATION OF SECURITIES (E) TASK FORCE Wednesday, July 1, 2020

3:00 p.m. – 4:00 p.m. ET / 2:00 p.m. – 3:00 p.m. CT / 1:00 p.m. – 2:00 p.m. MT / 12:00 pm. – 1:00 p.m. PT

ROLL CALL Robert H. Muriel, Chair Illinois Gary Anderson Massachusetts Doug Ommen, Vice Chair Iowa Chlora Lindley-Myers Missouri Lori K. Wing-Heier Alaska Bruce R. Ramge Nebraska Ricardo Lara California Marlene Caride New Jersey Andrew N. Mais Connecticut Linda Lacewell New York Trinidad Navarro Delaware Jessica Altman Pennsylvania David Altmaier Florida Kent Sullivan Texas Dean L. Cameron Idaho Todd E. Kiser Utah Vicki Schmidt Kansas Scott A. White Virginia James J. Donelon Louisiana Mike Kreidler Washington Al Redmer Jr. Maryland Mark Afable Wisconsin NAIC Support Staff: Charles A. Therriault, Marc Perlman

AGENDA

1. Consider Adoption of a Proposed Amendment to the Purposes and Procedures Manual of

the NAIC Investment Analysis Office (P&P Manual) for Technical NAIC Designation Category Corrections (Doc. ID 2020-019-01) —Kevin Fry (IL), Charles Therriault (NAIC)

Attachment A, A - 1, & A - 2

2. Consider adoption of Amendment to Rename the U.S. Direct Obligations/Full Faith and Credit Exempt List to the NAIC U.S. Government Money Market Fund List and Discontinue the NAIC Bond Fund List (Doc. ID 2019-012-01) —Kevin Fry (IL), Charles Therriault (NAIC), Marc Perlman (NAIC)

Attachment B, & B - 1

3. Receive a Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Map Short-term CRP Ratings to NAIC Designation Categories (Doc. ID 2020-023-01) —Kevin Fry (IL), Charles Therriault (NAIC), Marc Perlman (NAIC)

Attachment C

4. Receive a Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Add Supranational Entities Filed with the SVO to the Sovereign NAIC Designation Equivalent List (Doc. ID 2020-021-01) —Kevin Fry (IL), Charles Therriault (NAIC), Marc Perlman (NAIC)

Attachment D


5. Receive a Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Update Guidance for Working Capital Finance Investments Consistent with the Statutory Accounting Principles (E) Working Group Adoption of Changes to SSAP No. 105R – Working Capital Finance Investments (Doc. ID 2020-022-01) —Kevin Fry (IL), Charles Therriault (NAIC), Marc Perlman (NAIC)

Attachment E, E – 1, & E - 2

6. Receive an SVO Staff Report the Use and Regulation of Derivatives in Exchange Traded Funds (Doc. ID 2020-024-01) —Marc Perlman (NAIC)

Attachment F

7. Adjournment

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Attachment A Valuation of Securities (E) Task Force

7/1/2020

______________________________________________________________________________

© 2020 National Association of Insurance Commissioners Page:1

MEMORANDUM

TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force Members of the Valuation of Securities (E) Task Force

FROM: Charles A. Therriault, Director, NAIC Securities Valuation Office (SVO) Marc Perlman, Investment Counsel, NAIC Securities Valuation Office (SVO)

CC: Eric Kolchinsky, Director, NAIC Structured Securities Group (SSG) and Capital Markets Bureau

RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) for Technical NAIC Designation Category Corrections

DATE: April 30, 2020

1. Summary – With the introduction of NAIC Designation Categories, the 20 granular delineations of creditrisks adopted by the Task Force on Jun. 11, 2018, several policy-based assignments of NAIC Designations did notreceive a mapping. This amendment identifies the appropriate NAIC Designation Category to be assigned for thesepolicy-based assignments.

2. Recommendation – The SVO recommends that the Task Force update the guidance in the P&P Manual toreflect these policy-based assignments of an NAIC Designation Category.

3. Proposed Amendment – The following text in red shows the proposed revisions in Part One, Part Two, PartThree and Part Four.


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© 2020 National Association of Insurance Commissioners Page: 2

PART ONE

POLICIES OF THE NAIC VALUATION OF SECURITIES (E) TASK FORCE

FILING EXEMPTION FOR CERTIFICATES OF DEPOSIT

REPORTED AS BONDS UNDER SSAP NO. 26R

….

65. The NAIC Designation for Certificates of Deposit described above shall be NAIC 1 andthe NAIC Designation Category shall be NAIC 1.A. The NAIC Designation forCertificates of Deposit described above shall be derived by application of the filing exemptconversion process.

…

FILING EXEMPTION FOR U.S. GOVERNMENT SECURITIES

SVO Publishing Conventions for Filing Exempt U.S. Government Securities

67. U.S. Treasury Obligations – U.S. Treasury Obligations are added to the VOS Processautomatically, and they appear in the VOS Product. The NAIC Designation is NAIC 1and the NAIC Designation Category is NAIC 1.A.

Other Filing Exempt U.S. Government Securities

68. A single entry is in the AVS+ Products in its normal CUSIP sequence, followed by thedescription “All Issues” for the securities listed below.

69. Because these securities are Filing Exempt, CUSIP numbers are not published in theAVS+ Products. The securities should, however, be reported with a CUSIP in theappropriate section of Schedule D. The NAIC Designation is NAIC 1 and the NAICDesignation Category is NAIC 1.A.

…


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Filing Exemption for Other U.S. Government Obligations

79. Obligations issued and either guaranteed or insured, as to the timely payment of principaland interest, by the government agencies or government-sponsored enterprises listedbelow are filing exempt. They are not backed by the full faith and credit of the U.S.Government. The filing exemption here is based on an analytical judgment that thecombined creditworthiness of the entity itself and U.S. government support for that entityprovides confidence that the issuer will be able to pay its obligation on a full and timelybasis at the level of an NAIC 1 quality designation and an NAIC Designation Category ofNAIC 1.A. For the avoidance of doubt, preferred stock or similar securities of thegovernment agencies or government-sponsored enterprises listed below are notconsidered guaranteed or insured and hence are not subject of this section.

…


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NAIC DESIGNATIONS

…

NAIC General Interrogatory

66. NAIC 5GI and NAIC Designation Category NAIC 5.B GI is assigned by an insurancecompany to certain obligations that meet all of the following criteria:

Documentation necessary to permit a full credit analysis of a security by the SVOdoes not exist or an NAIC CRP credit rating for an FE or PL security is notavailable.

The issuer or obligor is current on all contracted interest and principal payments.

The insurer has an actual expectation of ultimate payment of all contracted interestand principal.

…


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PART TWO OPERATIONAL AND ADMINISTRATIVE INSTRUCTIONS

APPLICABLE TO THE SVO

…


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COMPILATION AND PUBLICATION OF THE SVO LIST OF INVESTMENT SECURITIES

…

U.S. Treasury Securities Process

9. U.S. Treasury Securities are an Investment Security added to the U.S. Treasury SecuritiesProcess automatically by electronic processes administered by the SVO and assigned anNAIC 1 Designation and an NAIC Designation Category of NAIC 1.A by a policy-basedconvention. Insurance companies shall not report Regulatory Transactions as U.S.Treasury Securities and the NAIC staff shall not add a Regulatory Transaction to the U.S.Treasury Securities Process.

Exempt U.S. Government Securities Process

10. Exempt U.S. Government Securities are an Investment Security reported by the insurancecompany to the NAIC, subsequently added by NAIC staff to the Exempt U.S.Government Securities Process and assigned NAIC 1 Designation and an NAICDesignation Category of NAIC 1.A pursuant to a policy-based convention. Insurancecompanies shall not report Regulatory Transactions as exempt U.S. GovernmentSecurities, and the NAIC staff shall not add a Regulatory Transaction to the Exempt U.S.Government Securities Process.

…


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COUNTERPARTY EXPOSURE; NETTING ELIGIBILITY

NAIC Designation

137. The SVO will convert the counterparty’s or the guarantor’s financial strength ratingsas assigned by an NAIC CRP (e.g., S&P Financial Programs Ratings, Moody’sCounterparty’s Ratings or Fitch Counterparty Risk Ratings) into an equivalent NAICDesignation. In the absence of an NAIC CRP counterparty financial strength rating,the SVO may convert the counterparty’s senior unsecured rating, as assigned by anNAIC CRP, into the equivalent NAIC Designation. In the absence of an NAIC CRPcounterparty financial strength or senior unsecured rating, the SVO will conduct areview of the counterparty’s financial statements to assign an NAIC Designation. Forpurposes of the application of this section, all U.S. domiciled exchanges are assignedan NAIC 1 Designation and an NAIC Designation Category of NAIC 1.A.

…


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PART THREE SVO PROCEDURES AND METHODOLOGY FOR PRODUCTION

OF NAIC DESIGNATIONS


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PROCEDURE APPLICABLE TO FILING EXEMPT (FE) SECURITIES AND PRIVATE LETTER (PL) RATING SECURITIES

…

PL SECURITIES

…

Conditions to Filing Exemption for PL Securities Issued on or After January 1, 2018

…

14. An insurer that owns a PL security that is not filing exempt shall either: (a) file thesecurity with the necessary documentation with the SVO for an analytically determinedNAIC Designation; or (b) self-assign an NAIC 5GI and an NAIC DesignationCategory of NAIC 5.B GI to the security and report using the Interrogatoryprocedure; in either case within 120 days of purchase.

…

20. If the SVO verifies that the security:

Has been assigned a credit rating but that the credit rating is not an Eligible NAICCRP Credit Rating; or

Has not been rated by an NAIC CRP; or

Is no longer subject to a private letter rating

The SVO shall notify the insurer that the security is not eligible for filing exemption. The insurance company shall then either file that security and necessary documentation with the SVO for an independent credit assessment or assign an NAIC 5GI Regulatory Designation and an NAIC Designation Category of NAIC 5.B GI to the security in the related Interrogatory.

21. An NAIC 5GI Designation and an NAIC Designation Category of NAIC 5.B GImay also be used in connection with the designation of PL securities rated by an NAICCRP (i.e., for private letter ratings issued on or after January 1, 2018) when thedocumentation is not available for the SVO to assign an NAIC Designation. Forpurposes of this section, the documentation is not available for the SVO to assign anNAIC Designation if the NAIC CRP credit rating is not included in the applicableCRP credit rating feed (or other form of direct delivery from the NAIC CRP) and theinsurer is unable to provide a copy of the private letter rating documentation necessaryfor the SVO to assign an NAIC Designation.

…


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THE NAIC BOND MUTUAL FUND LIST

Regulatory Treatment of Eligible Funds

263. A bond mutual fund on the NAIC Bond Mutual Fund List is in scope ofSSAP No. 26R—Bonds, reported with an NAIC 1 designation and NAIC 1.ADesignation Category on Schedule D, Part 1 – Long-Term Bonds on the “SVOIdentified Funds – Bond Mutual Funds” line. The insurance company reports anNAIC 1 Designation and NAIC 1.A Designation Category in accordance with AnnualStatement Instructions. These investments are reported at fair value unless theinvestment qualifies for and the reporting entity elects systematic value.


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PART FOUR THE NAIC STRUCTURED SECURITIES GROUP

…


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ANALYTICAL ASSIGNMENTS

…

SECURITIES NOT MODELED BY THE SSG AND NOT RATED BY AN NAIC CRP

OR DESIGNATED BY THE SVO

28. Securities subject to SSAP No. 43R—Loan-Backed and Structured Securities that cannotbe modeled by the SSG and are not rated by an NAIC CRP or designated by the SVOare either: (a) assigned the NAIC administrative symbol ND (not designated),requiring subsequent filing with the SVO; or (b) assigned the NAIC Designation forSpecial Reporting Instruction [i.e., an NAIC 5GI, NAIC Designation Category NAIC5.B GI or NAIC 6* (six-star)].

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American Council of Life Insurers North American Securities Valuation Association

101 Constitution Avenue, NW, Washington, DC 20001-2133 contact: Tracey Lindsey, President

202-624-2324 [email protected] 740-253-1016 [email protected]

www.acli.com

Mike Monahan Tracey Lindsey Senior Director, Accounting President

June 16, 2020

Mr. Kevin Fry, Chair Ms. Carrie Mears, Vice Chair

NAIC Valuation of Securities (E) Task Force NAIC Valuation of Securities (E) Task Force

1100 Walnut Street 1100 Walnut Street

Suite 1500 Suite 1500

Kansas City, MO 64106-2197 Kansas City, MO 64016-2197

Re: NAIC Valuation of Securities (E) Task Force (“the Task Force) Proposal to Amend the Purposes and

Procedures Manual of the NAIC Investment Analysis Office (“P&P Manual”) for Technical NAIC

Designation Category Corrections (“the Proposal”)

Dear Mr. Fry and Ms. Mears:

ACLI and NASVA (“the undersigned”) appreciate the opportunity to comment on the Proposal, which has

a June 17, 2020 comment period deadline, as exposed by the Task Force on May 18, 2020.

The undersigned are supportive of the proposal and its adoption.

Please do not hesitate to contact us should you have any questions. Thank you.

Sincerely,

Tracey Lindsey

Mike Monahan

Senior Director, Accounting Policy President


cc: Mr. Charles Therriault, Director, SVO

Attachment A - 1 Valuation of Securities (E) Task Force

7/1/2020

mailto:[email protected]


Attachment A - 2 Valuation of Securities (E) Task Force

7/1/2020

Attachment B Valuation of Securities (E) Task Force

7/1/2019

____________________________________________________________________________________


MEMORANDUM


FROM: Charles A. Therriault, Director, NAIC Securities Valuation Office (SVO)

CC: Marc Perlman, Investment Counsel, NAIC Securities Valuation Office (SVO) Eric Kolchinsky, Director, NAIC Structured Securities Group (SSG) and Capital Markets Bureau

RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Rename the U.S. Direct Obligations/Full Faith and Credit Exempt List to the NAIC U.S. Government Money Market Fund List and Discontinue the NAIC Bond Fund List

DATE: September 30, 2019

1. Summary – The P&P Manual authorizes the SVO to maintain two special fund list. The first is the NAICU.S. Direct Obligations/Full Faith and Credit Exempt Money Market Funds List. This list of Money Market Funds(MMF) gets special treatment because they can be reported as a cash equivalent on Schedule E, Part 2. The SVOproposes simplifying the title of this list to “NAIC U.S. Government Money Market Fund List.” This is only a titlechange to simplify the title of the list.

The second is the NAIC Bond Fund List, where the SVO reviews that a fund maintains the highest credit quality rating, maintains the highest market risk rating (this rating type that is no longer assigned), and invests 100% of its total assets in U.S. Government securities along with several other restrictive criteria. Only four funds qualify for this list and the four insurers invested in the fund have a combined exposure of $11.8 million BACV in one of the four qualify funds as of December 31, 2018. With the adoption of the Comprehensive Instructions for Fund Investments on April 7th that provided new instructions for Fixed Income-Like SEC Registered Funds and given the limited number of insurers investing in the funds on the NAIC Bond Fund List, the SVO proposes eliminating this list when the four funds come up for renewal in 2020. The funds on the NAIC Bond Fund List would be eligible for NAIC Fixed Income-Like SEC Registered Funds List and the SVO would be willing to allow these fund issuers to apply to be on this new list at their renewal, if they were so interested. This change would require a referral to the Statutory Accounting Principles (E) Working Group as the NAIC Bond Fund List is referenced in SSAP No. 26R – Bonds.

2. Proposed Amendment – The text referencing these instructions for U.S. Direct Obligations/Full Faith andCredit Exempt Money Market Funds List and NAIC Bond Fund List is shown below, edits in red-underline, as it willappear in the 2019 P&P Manual format.


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2019 P&P Manual

Part Three – SVO Procedures and Methodology for Production of NAIC Designations Investment in Funds The NAIC U.S. Government Money Market Fund List U.S. Direct Obligations/Full Faith and Credit Exempt Money Market Funds List

247. Regulatory Treatment of Eligible Funds – A money market mutual fund on the NAIC U.S. Government Money Market Fund List U.S. Direct Obligations/Full Faith and Credit Exempt List is reported as a cash equivalent on Schedule E, Part 2 on the “Exempt Money Market Mutual Funds – as Identified by the SVO” line. These “exempt” money market mutual funds are reported at fair value and incur a zero percent (0%) risk-based-capital (RBC) charge. Other money market mutual funds are also reported as cash equivalents on Schedule E, Part 2 on the “All Other Money Market Mutual Funds” line. The “all other” money market mutual funds are also reported at fair value but incur an RBC charge similar to other cash equivalents.

248. Required Documentation – An insurance company or the sponsor of a money market mutual fund requests an SVO evaluation that a money market mutual fund is eligible to be listed on the NAIC U.S. Government Money Market Fund List U.S. Direct Obligations/Full Faith and Credit Exempt List by submitting the following documentation to the SVO:

The money market mutual fund application form.

Authorization letter requesting review of the fund for the purpose of being added to the List.

The most recent fund:

o Prospectus;

o Statement of Additional Information (SAI); and

o Annual, and if available, the semi-annual report.

Rating letter from an NAIC CRP dated in the year of the filing.

249. Eligibility Criteria – A money market mutual fund is eligible for inclusion on the NAIC U.S. Government Money Market Fund List U.S. Direct Obligations/Full Faith and Credit Exempt List if the fund meets the following conditions:

The fund maintains a money market mutual fund rating of AAAm from Standard & Poor’s or Aaa-mf from Moody’s Investor Services or an equivalent money market mutual fund rating from any NAIC CRP.

The fund maintains a stable net asset value per share of $1.00.

The fund allows a maximum of seven-day redemption of proceeds.

The fund invests 100% of its total assets in securities that are direct obligations of the U.S. Government and/or in securities that are backed by the full faith and credit of the U.S. Government or collateralized repurchase agreements comprised of such obligations at all times. NOTE: Please refer to text below for a list of securities considered to be direct obligations of the U.S. Government and entities that are entitled to the full faith and credit of the U.S. Government.

250. Verification Procedure – Upon receipt of the documentation, the SVO examines the prospectus, schedule of fund portfolio holdings and related materials to verify that the fund meets the established criteria.


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The NAIC Bond Mutual Fund List

251. Regulatory Treatment of Eligible Funds – A bond mutual fund on the NAIC Bond Mutual Fund List is in scope of SSAP No. 26R—Bonds, reported with an NAIC 1 designation on Schedule D, Part 1 – Long-Term Bonds on the “SVO Identified Funds – Bond Mutual Funds” line. The insurance company reports an NAIC 1 Designation in accordance with Annual Statement Instructions. These investments are reported at fair value unless the investment qualifies for and the reporting entity elects systematic value.

252. Required Documentation – An insurance company or the sponsor of a bond mutual fund requests an SVO evaluation that a bond mutual fund is eligible for inclusion on the Bond Mutual Fund List by submitting the following documentation to the SVO:

The bond fund application form.

Authorization letter requesting review of the fund for the purpose of inclusion on the Bond Mutual Fund List.

The most recent fund:

o Prospectus;

o Statement of Additional Information (SAI); and

o Annual, and if available, the semi-annual report.

Rating letter from an NAIC CRP dated in the year of the filing.

253. Eligibility Criteria – A bond mutual fund is eligible for inclusion on the Bond List if the fund meets the following conditions:

The fund shall maintain the highest credit quality rating given by an NAIC CRP.

The fund shall maintain at least the highest market risk rating given by an NAIC CRP to a fund that invests in class 1 bonds that are issued or guaranteed as to payment of principal and interest by agencies and instrumentalities of the U.S. Government, including loan-backed bonds and collateralized mortgage obligations, and collateralized repurchase agreements comprised of those obligations.

The fund shall allow a maximum of seven-day redemption of proceeds.

The fund shall invest 100% of its total assets in the U.S. Government securities listed in the section below, class 1 bonds that are issued or guaranteed as to payment of principal and interest by agencies and instrumentalities of the U.S. Government, including loan-backed bonds and collateralized mortgage obligations, and collateralized repurchase agreements comprised of those obligations at all times.

The fund shall declare a dividend of its net investment income each day prior to calculating its net asset value per share.

The fund shall not invest in any derivative instruments, as that term is defined in the NAIC Accounting Practices and Procedures Manual.

The fund shall not invest in any bonds that receive some or all of the interest portion of the underlying collateral and little or no principal, or in any bonds with coupons which reset periodically based on an index and which vary inversely with changes in the index.

The fund shall not invest in the following types of securities: (a) leveraged or deleveraged notes that pay a multiple or fraction of an index or indices; (b) notes that pay principal or interest linked to foreign currencies, non-U.S. dollar interest rates, equity or commodities indices or any other index that is not composed of U.S. dollar denominated fixed-income instruments; or (c) notes that pay principal or interest linked to more than one index.


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254. Verification Procedure – Upon receipt of the documentation, the SVO examines the prospectus, schedule of fund portfolio holdings and related materials to verify that the fund meets the established criteria.

… g:\secval\data\vos-tf\meetings\2020\july 2020\vostf meeting jul 1 2020\item 02-fund lists\2019-012-01 - task force 2019 amend pp on the fund lists.docx


101 Constitution Avenue, NW, Washington, DC 20001-2133 contact: Tracey Lindsey, President

202-624-2324 [email protected] 740-253-1016 [email protected]

www.acli.com

Mike Monahan Tracey Lindsey Senior Director, Accounting President

December 16, 2019

Mr. Kevin Fry, Chair Mr. Stewart Guerin, Vice Chair

NAIC Valuation of Securities (E) Task Force NAIC Valuation of Securities (E) Task Force

1100 Walnut Street 1100 Walnut Street

Suite 1500 Suite 1500

Kansas City, MO 64106-2197 Kansas City, MO 64016-2197

Re: NAIC Valuation of Securities (E) Task Force (“the Task Force”) Proposed Amendment to the Purposes

and Procedures Manual of the NAIC Investment Analysis Office (“P&P Manual”) to Rename the U.S. Direct

Obligations/Full Faith and Credit Exempt List to the NAIC U.S. Government Money Market Fund List and

Discontinue the NAIC Bond Fund List (“the Proposal”)

Dear Messrs. Fry and Guerin:

ACLI1 and NASVA2 (“the undersigned”) appreciate the opportunity to comment on the Proposal, which has a

December 16, 2019 comment period deadline, as exposed by the Task Force on October 31, 2019.

The undersigned are supportive of the proposal and its adoption. We recommend the Task Force consider

a referral to the Statutory Accounting Principles (E) Working Group to consider attendant updates to

Statement of Statutory Accounting Principles (SSAP) No. 26R - Bonds.

Please do not hesitate to contact us should you have any questions. Thank you.

Sincerely,

Tracey Lindsey

Senior Director, Accounting Policy President


cc: Mr. Charles Therriault, Director, SVO

1 The American Council of Life Insurers (ACLI) advocates on behalf of 280 member companies dedicated to providing

products and services that promote consumers’ financial and retirement security. 90 million American families

depend on our members for life insurance, annuities, retirement plans, long-term care insurance, disability income

insurance, reinsurance, dental and vision and other supplemental benefits. ACLI represents member companies in

state, federal and international forums for public policy that supports the industry marketplace and the families that

rely on life insurers’ products for peace of mind. ACLI members represent 95 percent of industry assets in the United

States. Learn more at www.acli.com.

2 The North American Securities Valuation Association (NASVA) is an association of insurance company

representatives who interact with the National Association of Insurance Commissioners Securities Valuation Office to

provide important input, and to exchange information, in order to improve the interaction between the SVO and its

users. In the past, NASVA committees have worked on issues such as improving filing procedures, suggesting

enhancements to the NAIC's ISIS electronic security filing system, and commenting on year-end processes.

Attachment B - 1 Valuation of Securities (E) Task Force

7/1/2019



http://www.acli.com/

Attachment C Valuation of Securities (E) Task Force

7/1/2020

______________________________________________________________________________


EMORANDUM




RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) with Update to the General Mapping of Credit Rating Provider Ratings, Long and Short-term, to NAIC Designations and NAIC Designation Categories


1. Summary – On the Task Force call of May 14, 2020 the North American Securities Valuation Association(NASVA) requested that the table mapping Credit Rating Provider (CRP) ratings for short-term instruments beupdated to also map them to NAIC Designation Categories. The Task Force directed the SVO to draft an update tothis general mapping table. Unlike long term ratings, there is not a direct one-for-one set of rating symbols for short-term investments that map to every NAIC Designation Category. Because there is not a direct one-for-one mapping,SVO staff have used their judgement to map the NAIC Designation Category to the mid-point of the range of longterm ratings covered by each short-term rating. As an example, Moody’s Prime-1 or P1 short-term rating covers thelong-term rating range consisting of Aaa, Aa1, Aa2, Aa3, A1, A2 and A3 (Moody’s - Rating Symbols and Definitions,June 2018). The SVO staff has recommended mapping the Moody’s short-term P1 rating symbol to the mid-point ofthis range or an NAIC Designation Category 1.D. The SVO staff applied this mid-point approach to each short-termrating mapping.

The SVO staff also updated the description of the mappings for both long-term and short-term rating symbols to reflect that these are “Generic Rating Symbols.” CRPs use a variety of symbols; including, combinations of prefixes and suffixes that provide additional information about the rating symbol which are described in the CRP's documentation. There are over 2,000+ unique rating symbols used by CRPs to describe long-term securities. The SVO webpage (https://www.naic.org/svo.htm) maintains a master list of Credit Ratings Eligible for Translation to NAIC Designations.

The SVO does not currently translate short-term security ratings as part of its Compilation and Publication of the SVO List of Investment Securities to produce the NAIC designations incorporated into the NAIC's AVS+ product. If the Task Force would like the SVO to also produce, compile and publish translations for the short-term securities, a separate project will need to be initiated.

2. Recommendation – The SVO staff recommends mapping the short-term CRP rating symbols to the NAICDesignation Category which is equivalent to the mid-point of the range of long term ratings covered by the shortterm rating. The SVO staff also recommends updating the title of the mapping tables to reflect that these are

https://www.naic.org/svo.htm


7/1/2020


“generic” rating symbols, referencing additional sections of the P&P Manual pertinent to the use of CRP ratings and Filing Exemption and adding a footnote describing where to locate the master list of Credit Ratings Eligible for Translation to NAIC Designations on the SVO webpage.

3. Proposed Amendment – The following shows the proposed revisions in Part Three with drafting notesidentifying the changes.


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PART THREE

SVO PROCEDURES AND METHODOLOGY FOR PRODUCTIONOF NAIC DESIGNATIONS


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LIST OF NAIC CREDIT RATING PROVIDERS

… (Table orientation changed for display in this amendment. The two tables below would be deleted.)

NAIC Designation

NAIC Designation

Modifier

NAIC Designation

Category

Moody’s Investor’s Service

Standard and Poor’s Fitch Ratings

Dominion Bond Rating Service

A.M. Best Company

Morningstar Credit Ratings,

LLC Kroll Bond

Rating Agency

Egan Jones Rating

Company

HR Ratings de Mexico, S.A. de

C.V.

1 A 1.A Aaa AAA AAApre, AAA AAA, Pfd-1 (high) aaa AAA AAA AAA HR AAA (G)

1 B 1.B Aa1 AA+ AA+ AA (high), Pfd-1 aa+ AA+ AA+ AA+ HR AA+ (G)

1 C 1.C Aa2 AA AA AA, Pfd-1 (low) aa AA AA AA HR AA (G)

1 D 1.D Aa3 AA- AA- AA (low),Pfd-1 aa- AA- AA- AA- HR AA- (G)

1 E 1.E A1 A+ A+ A (high) a+ A+ A+ A+ HR A+ (G)1 F 1.F A2 A A A a A A A HR A (G)1 G 1.G A3 A- A- A (low) a- A- A- A- HR A- (G)

2 A 2.A Baa1 BBB+ BBB+ BBB (high), Pfd-2 (high) bbb+ BBB+ BBB+ BBB+ HR BBB+ (G)

2 B 2.B Baa2 BBB BBB BBB, Pfd-2 bbb+ BBB BBB BBB HR BBB (G)

2 C 2.C Baa3 BBB- BBB- BBB (low),Pfd-2 (low) bbb- BBB- BBB- BBB- HR BBB- (G)

3 A 3.A Ba1 BB+ BB+ BB (high),Pfd-3 (high) bb+ BB+ BB+ BB+ HR BB+ (G)

3 B 3.B Ba2 BB BB BB,Pfd-3 bb BB BB BB HR BB (G)

3 C 3.C Ba3 BB- BB- BB (low),Pfd-3 (low) bb- BB- BB- BB- HR BB- (G)

4 A 4.A B1 B+ B+ B (high),Pfd-4 (high) b+ B+ B+ B+ HR B+ (G)

4 B 4.B B2 B B B,Pfd-4 b B B B HR B (G)

4 C 4.C B3 B- B- B (low),Pfd-4 (low) b- B- B- B- HR B- (G)

5 A 5.A Caa1 CCC+ CCC+ CCC (high),Pfd-5 (high) ccc+ CCC+ CCC+ CCC+ HR C+ (G)

5 B 5.B Caa2 CCC CCC CCC,Pfd-5 ccc CCC CCC CCC HR C (G)

5 C 5.C Caa3 CCC- CCC- CCC (low),Pfd-5 (low) ccc- CCC- CCC- CCC- HR C- (G)

6 6 Ca CC CC CC (high) cc CC CC CC HR D (G)6 6 C C C CC c C C C6 6 D DDD CC (low) d D D D6 6 DD C (high)6 6 D C6 6 C (low)6 6 D




A.M. Best Company


LLC Kroll Bond

Rating Agency

Egan Jones Rating

Company


C.V.

NAIC Designation

NAIC Designation

Modifier

NAIC Designation

Category

Commercial Paper and

Short Term Counterparty

RatingsCommercial

Paper Commercial

Paper


Short Term Debt


Short Term Debt N/A

Short-Term and Commercial

Paper Ratings Commercial

Paper N/A

1 P1 A-1+, A-1 F1+, F1R1 (high),

R-1 (middle), R-1 (low)

AMB-1+, AMB-1 K1+, K1 A1+, A1, A

2 P2 A-2, A-3 F2, F3R-2 (high),

R-2 (middle), R-2 (low)

AMB-2 K2 A2, A3

3 P3 R-3 AMB-3 K34 B B B B5 C C R-4 C C6 NP SD, D D R-5, D AMB-4 D D

Credit Rating Providers(Pursuant to the guidance in this Manual; particularly, Part One, "The Use of Credit Ratings of NRSROs in NAIC Processes,"

"Filing Exemptions," "Policies Applicable to Specific Asset Classes," and Part Three, "Procedure Applicable to Filing Exempt (FE) Securities and Private Letter (PL) Rating Securities")

Credit Rating Providers(Pursuant to the terms of of Section 4 of Part One and as specifically noted in Part Three, Section One, (vi) List of NAIC CRPs.)


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… (Table orientation changed for display in this amendment. The two tables below would be inserted.)

G:\SECVAL\DATA\Vos-tf\Meetings\2020\July 2020\VOSTF meeting Jul 1 2020\Item 01-ST Ratings Mapped to NAIC Designation Categories\2020-023.01 PP Manual Amend - Mapping ST Ratings.docx

NAIC Designation

NAIC Designation

Modifier

NAIC Designation

Category




A.M. Best Company


LLC Kroll Bond

Rating Agency

Egan Jones Rating

Company


C.V.

1 A 1.A Aaa AAA AAApre, AAA AAA, Pfd-1 (high) aaa AAA AAA AAA HR AAA (G)

1 B 1.B Aa1 AA+ AA+ AA (high), Pfd-1 aa+ AA+ AA+ AA+ HR AA+ (G)

1 C 1.C Aa2 AA AA AA, Pfd-1 (low) aa AA AA AA HR AA (G)

1 D 1.D Aa3 AA- AA- AA (low),Pfd-1 aa- AA- AA- AA- HR AA- (G)

1 E 1.E A1 A+ A+ A (high) a+ A+ A+ A+ HR A+ (G)1 F 1.F A2 A A A a A A A HR A (G)1 G 1.G A3 A- A- A (low) a- A- A- A- HR A- (G)

2 A 2.A Baa1 BBB+ BBB+ BBB (high), Pfd-2 (high) bbb+ BBB+ BBB+ BBB+ HR BBB+ (G)

2 B 2.B Baa2 BBB BBB BBB, Pfd-2 bbb BBB BBB BBB HR BBB (G)

2 C 2.C Baa3 BBB- BBB- BBB (low),Pfd-2 (low) bbb- BBB- BBB- BBB- HR BBB- (G)

3 A 3.A Ba1 BB+ BB+ BB (high),Pfd-3 (high) bb+ BB+ BB+ BB+ HR BB+ (G)

3 B 3.B Ba2 BB BB BB,Pfd-3 bb BB BB BB HR BB (G)

3 C 3.C Ba3 BB- BB- BB (low),Pfd-3 (low) bb- BB- BB- BB- HR BB- (G)

4 A 4.A B1 B+ B+ B (high),Pfd-4 (high) b+ B+ B+ B+ HR B+ (G)

4 B 4.B B2 B B B,Pfd-4 b B B B HR B (G)

4 C 4.C B3 B- B- B (low),Pfd-4 (low) b- B- B- B- HR B- (G)

5 A 5.A Caa1 CCC+ CCC+ CCC (high),Pfd-5 (high) ccc+ CCC+ CCC+ CCC+ HR C+ (G)

5 B 5.B Caa2 CCC CCC CCC,Pfd-5 ccc CCC CCC CCC HR C (G)

5 C 5.C Caa3 CCC- CCC- CCC (low),Pfd-5 (low) ccc- CCC- CCC- CCC- HR C- (G)

6 6 Ca CC CC CC (high) cc CC CC CC HR D (G)6 6 C C C CC c C C C6 6 D DDD CC (low) d D D D6 6 DD C (high)6 6 D C6 6 C (low)6 6 D




A.M. Best Company


LLC Kroll Bond

Rating Agency

Egan Jones Rating

Company


C.V.

NAIC Designation

NAIC Designation

Modifier

NAIC Designation

Category


Short Term Counterparty

RatingsCommercial

Paper Commercial

Paper


Short Term Debt


Short Term Debt N/A

Short-Term and Commercial

Paper Ratings Commercial

Paper N/A1 A 1.A1 B 1.B1 C 1.C A-1+ F1+ R1 (high) AMB-1+ K1+ A1+1 D 1.D P11 E 1.E A-1 F1 R-1 (middle) AMB-1 K1 A11 F 1.F1 G 1.G R-1 (low) A2 A 2.A P2 A-2 F2 R-2 (high) K2 A22 B 2.B R-2 (middle) AMB-22 C 2.C P3 A-3 F3 R-2 (low) A33 A 3.A3 B 3.B R-3 AMB-3 K33 C 3.C4 A 4.A4 B 4.B B B B B4 C 4.C5 A 5.A5 B 5.B NP C C R-4 C C5 C 5.C6 6 SD D R-5 AMB-4 D D6 6 D D





Attachment D Valuation of Securities (E) Task Force

07/1/2020

______________________________________________________________________________


EMORANDUM




RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Permit Supranational Entities Filed with the SVO to be Added to the Sovereign NAIC Designation Equivalent List


1. Summary – The SVO maintains the Sovereign NAIC Designation Equivalent list and publishes it on itswebpage (https://www.naic.org/svo.htm). This list is used to cap the NAIC Designation that can be assigned by theSVO to an investment at the Sovereign Designation Equivalent. The SVO discussed this list with the Task Force atits February 4, 2020 meeting and received instructions from the Task Force to research and develop criteria for anacceptable sovereign rating exception methodology, the SVO is still working on that separate issue. Insurers havebeen using this list to assist them in their reporting of Sovereign NAIC Designation Equivalents on the SupplementalInvestment Risks Interrogatories (SIRI). The SVO has received requests from insurers to include supranationalorganizations or entities on the Sovereign NAIC Designation Equivalent list to assist with this SIRI reporting. Thisamendment proposes adding supranational entities to the Sovereign NAIC Designation Equivalent list if an insurerfiles a request with the SVO and the SVO is able to determine an appropriate NAIC designation equivalent.

2. Description - A supranational organization is an international group or union in which the power andinfluence of member states transcend national boundaries or interests to share in decision making and vote on issuesconcerning the collective body. The European Union and the World Trade Organization are both supranational entities. In the EU, each member votes on policies that will affect all member nations. The benefits of this construct are thesynergies derived from social and economic policies and a stronger presence on the international stage.

For an organization to be supranational, it must operate in multiple countries. While applicable to multinational corporations, the term in this context is being used only for government entities because they often have regulatory responsibilities within their standard operations. These responsibilities can include the creation of international treaties and standards for international trade. As an entity that operates in multiple countries, a supranational organization is not controlled by a single sovereign country.

3. Recommendation – The SVO staff recommends permitting it to include supranational entities on theSovereign NAIC Designation Equivalent list if an insurer files the supranational entity with the SVO and the SVOcan determine an appropriate NAIC designation equivalent.



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4. Proposed Amendment – The following shows the proposed revisions in Part Three with text in red identifying the changes.


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PART THREE

SVO PROCEDURES AND METHODOLOGY FOR PRODUCTION OF NAIC DESIGNATIONS


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GENERAL CORPORATE AND MUNICIPAL METHODOLOGY FOR INDEPENDENT CREDIT QUALITY ASSESSMENT

…

FOREIGN SECURITIES

Foreign Sovereign Government and Supranational Entities

34. A reporting insurance company that owns a security issued by a foreign sovereign government, an agency or political subdivision of a foreign sovereign government or a supranational entity (entities with more than one sovereign government as a member), or that is guaranteed directly or indirectly by such an entity, must file such security with the SVO accompanied by a prospectus and investment committee memorandum.

35. Insurance companies shall not file issues with the SVO if the issuer does not have a sovereign rating from an NAIC CRP. If the issuer is not rated by an NAIC CRP, proof of a guarantee from an NAIC CRP-rated foreign sovereign government may be submitted. Where a reporting insurance company has filed a foreign security accompanied by an Audited Financial Statement, in English, the SVO will assess the security in accordance with the applicable corporate methodology, but the NAIC Designation it may assign shall be limited by the sovereign rating of the issuer’s country of origin, or the issuing supranational entity, as applicable, as reflected in the Sovereign NAIC Designation Equivalent list. This section should not be read as prohibiting the presentation of transactions structured to eliminate foreign sovereign risk.

36. The insurance company must file all foreign securities for which the information required by this Manual is available. For those foreign securities held by a “Sub-paragraph D Company” as defined in Part One, where the required information is not available for the SVO to value the security, the NAIC Designation may be determined by the reporting insurance company. This determination shall carry an F suffix. In no case shall the NAIC Designation exceed the sovereign rating of the issuer’s country of origin, or the issuing supranational entity, as applicable, as reflected in the Sovereign NAIC Designation Equivalent list. The company shall provide its domestic regulator with a description of the procedure it used to evaluate and assign ratings to these foreign securities. In addition, the company shall retain the documentation supporting each designation assigned by it until the next domestic insurance department examination.

37. The SVO shall maintain and publish a list of Sovereign NAIC Designation Equivalents on its webpage (https://www.naic.org/svo.htm) and may include on that list the NAIC Designation equivalent for supranational entities submitted to it for review by insurers if, in its sole discretion, it is able to determine an appropriate NAIC Designation equivalent.



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G:\SECVAL\DATA\Vos-tf\Meetings\2020\July 2020\VOSTF meeting Jul 1 2020\Item 02-Supranational Entities\2020-021.01 PP Manual Amend - Supranational NAIC Designations v2.docx

Attachment E Valuation of Securities (E) Task Force

7/1/2020

______________________________________________________________________________


MEMORANDUM




RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Incorporate Updates Made to SSAP No. 105R – Working Capital Finance Investments.

DATE: June 15, 2020

1. Summary – The Statutory Accounting Principles (E) Working Group adopted updates to SSAP No. 105R Working Capital Finance Investments on May 20, 2020. These updates originate from industry comments that the SSAP’s fixed approach to a number of legal or structural issues in these transactions, which are routinely handled differently, prevents the SVO from exercising proper analytical discretion. Industry therefore requested the Task Force to update the program requirements that was then referred to the Working Group on March 7, 2019. The revisions adopted by the Working Group incorporate seven of the industry requested modifications to the Working Capital Finance Investments program requirements and are effective on June 30, 2020. Key revisions are summarized as follows:

• Functionally Equivalent Foreign Regulators - Removed the requirement that the Securities Valuation Office (SVO) determine if the International Finance Agent is the functional equivalent of the U.S. regulator.

• Commingling Prohibitions - Removed the finance agent prohibitions on commingling.

• Investor Rights Edit - Removed duplicative text regarding exercising of investor rights.

• Requirements for filer to Certify Perfected Interest – Removed requirements, with revisions allowing the SVO to determine if a first priority perfected interest has been obtained.

• Finance Agent Validation Requirements – Broadened the independent review requirements to allow independent review of the finance agent by either audit or through an internal control report.

• Default Date - Changed the default provisions from 15 to 30 days so the default date and the cure period are consistent.

• Possible Domestic Regulator Approval – Removed the statement that the reporting entity may need to seek approval from the domestic regulator.

2. Recommendation – The SVO staff reviewed the adopted updates to SSAP No. 105R – Working Capital Finance Investments to identify edits needed in the P&P to reflect those changes. The proposed amendments reflect only the SSAP changes that are relevant to the P&P guidance. The SVO recommends exposing this amendment.


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3. Proposed Amendment – The following shows the proposed revisions in Part Three with text in red identifying the changes.


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PART THREE

SVO PROCEDURES AND METHODOLOGY FOR PRODUCTION OF NAIC DESIGNATIONS


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WORKING CAPITAL FINANCE INVESTMENTS

NOTE: See “Specific Populations of Securities Not Eligible for Filing Exemption” in “Procedure Applicable to Filing Exempt (FE) Securities and Private Letter (PL) Rating Securities” above.

Initial Filing Requirements

102. An insurance company requesting an analysis of a proposed Working Capital Finance Program shall provide the SVO with the documentation described in this subparagraph:

An RTAS Application.

The Obligor’s Audited Financial Statements, if the Obligor is not rated for credit risk by a NAIC CRP.

The insurance company’s Investment Committee Memorandum for the proposed Working Capital Finance Program.

The audited consolidated financial statements of the group of which the Finance Agent for the Working Capital Finance Program is a part, and one of the following:

o An annual independent report according to Statement on Standards for Attestation Engagements (SSAE) No. 16 (or functional equivalent), reporting on controls at a service organization related to the administration of the investment.

o An annual audit of the financial statement and internal controls of the consolidated group of which the Finance Agent is part, which does not note any material weakness related to servicing working capital financial investments.

o A Certification from the insurance company’s Chief Investment Office that the insurance company, in its capacity as an Investor, is not affiliated with the Obligor or with any Supplier in the Working Capital Finance Program, and that the Working Capital Finance Program does not include any insurance or insurance related assets.

o A Certification from the insurance company’s Legal Counsel.

In the case of a participation, that it has a commercially reasonable belief that its participation interest meets the Uniform Commercial Code’s standards for creating and preserving first priority security interests in the payments due and in the Confirmed Supplier Receivables.


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In the case of a certificate, note or other manifestation, representing a right to payment from a trust, other special purpose entity, or special purpose pool holding confirmed supplier receivables, that it has a commercially reasonable belief that the documents establishing and governing the Working Capital Finance Program create and preserve interests in the Confirmed Supplier Receivables capable of being enforced by the trustee or other entity holding Confirmed Supplier Receivables as first priority perfected security interests under the Uniform Commercial Code.

NOTE: Please refer to SSAP No. 105—Working Capital Finance Investments for the definition of a “commercially reasonable belief.”

A copy of:

o The document(s) that create the Working Capital Finance Investments (i.e., the short-term receivables) that is the subject of the RTAS – Emerging Investment Vehicle Service Application, and establishes the obligations of the Obligor to, and the protection afforded owners of, Working Capital Finance Investments (including the Investors). This agreement is sometimes referred to as the Invoice Payment Terms Acknowledgement, the Payable Services Agreement or the Paying Services Agreement.

NOTE: Please refer to “The Regulatory Treatment Analysis Service – Emerging Investment Vehicle” in Part Two for guidance regarding the filing of an RTAS Application with the SVO.

o The agreement(s) between the Obligor and the Finance Agent governing the administration of the Working Capital Finance Program and the Working Capital Finance Investments issued thereunder. These agreements may be included in the documents mentioned above or may be a stand-alone agreement which are sometimes referred to as the Settlement Services Agreement or the Invoice-Related Electronic Services Agreement.

o The agreement governing the sale of the Working Capital Finance Investments from the Supplier to the Finance Agent. This agreement is sometimes referred to as the Receivables Purchase Agreement or the Supplier Agreement. The agreement governing the ongoing purchase of Working Capital Finance Investments or an interest in Working Capital Finance Investments by the Investor from the Finance Agent. This agreement is sometimes referred to as the Agency Agreement, the Participation Agreement or the Program Trust Agreement.


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Subsequent Filing Requirements

103. Subsequent filing requirements include:

Copies of any of the documents originally submitted with the RTAS Application subsequently amended.

The audited consolidated financial statements of the group of which the Finance Agent for the Working Capital Finance Program is a part, and one of the following:

o An annual independent report according to Statement on Standards for Attestation Engagements (SSAE) No. 16 (or functional equivalent), reporting on controls at a service organization related to the administration of the investment; or

o An annual audit of the financial statements and internal controls of the consolidated group of which the Finance Agent is part, which does not note any material weakness related to servicing working capital financial investments.

Definitions in SSAP No. 105R—Working Capital Finance Investments

104. Please refer to SSAP No. 105R—Working Capital Finance Investments, for the definitions and associated definitional guidance insurance companies must understand and comply with before applying for an NAIC Designation for Working Capital Finance Programs that would permit them to purchase Working Capital Finance Investments.

105. With the exception of the definitions for Dilution Risk and Operational Risk below, the definitions shown below are summaries of those contained in SSAP No. 105R—Working Capital Finance Investments intended only to facilitate a discussion and in all cases subordinate to the definitions in SSAP No. 105R.

Summary of Key Definitions

106. Confirmed Supplier Receivable – A receivable sold by a Supplier to a Finance Agent or Investor (or by a Finance Agent to an Investor) under a Working Capital Finance Program designated by the SVO that requires the Obligor to confirm to the Finance Agent or Investor, prior to the sale of the receivable from the Supplier to the Finance Agent or Investor, that it has no defenses to payment of the monetary obligation represented by the receivable against the Supplier and, therefore, no defenses to payment of the same monetary obligation to the Finance Agent and/or Investor after such sale. The confirmation by the Obligor that it has no defenses to payment includes confirmation that the Obligor does not have a right to refuse payment that it may have acquired with respect to underlying commercial trade transaction and that, if it has such a right, it will not assert such defenses against the Finance Agent or Investor.


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107. Dilution Risk – With respect to any Working Capital Finance Program, dilution risk refers to disputes or contractual provisions that may reduce the amount of the obligation owed by the Obligor to the Supplier under the original receivable or the obligation owed by the Obligor to the Finance Agent and/or Investor under the Confirmed Supplier Receivable. Examples of dilution risk are credit for returns of defective goods or an allegation of fraud, such as that the invoice is not legitimate or is a duplicate invoice.

108. Finance Agent – A bank, financial institution, financial intermediary or service provider that facilitates the Working Capital Finance Program that arranges the sale, assignment or transfer of the Confirmed Supplier Receivable to the Investor and administers payment.

109. Investor – The insurance company that files the RTAS Application with the SVO in order to obtain an NAIC Designation for a proposed Working Capital Finance Program.

110. Obligor – An entity that purchases the goods or services from the Supplier and thereby generates the original supplier receivable—and which Obligor has, or can be designated, NAIC 1 or NAIC 2 by the SVO or has been assigned an equivalent credit rating by a NAIC CRP.

111. Operational Risk – With respect to any Working Capital Finance Program, operational risk refers to the combined effect of the procedures and parties employed to implement the program and their responsibility under the documents and to the determination by the SVO of whether these procedures and parties will ensure full and timely performance by the Obligor of the payment obligation to the Investor. An example of an operational risk is the confirmation process employed to verify that the Obligor has no defenses to payment.

112. Supplier – The entity that sells the goods or services to the Obligor, obtains a receivable from the Obligor in exchange and subsequently chooses to sell the right to receive the payment associated with the receivable to the Finance Agent or Investor under the terms of a Working Capital Finance Program designated NAIC 1 or NAIC 2 by the SVO.

113. Working Capital Finance Program – The program created for the Obligor and its Suppliers by a Finance Agent the terms of which permits Suppliers to the Obligor to negotiate the sale of a right to receive payment from the Obligor (which is associated with and evidenced by a receivable) to the Finance Agent or an Investor.

114. Working Capital Finance Investment – The right to receive the payment associated with a Confirmed Supplier Receivable purchased by an Investor under a Working Capital Finance Program designated NAIC 1 or NAIC 2 by the SVO and is the subject of SSAP No. 105R—Working Capital Finance Investments.


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NOTE: SSAP No. 105R—Working Capital Finance Investments imposes reporting and statutory accounting requirements on insurance company investments in Working Capital Finance Investments and specifies analytical procedures to be applied or analytical controls to be verified by the SVO that are not detailed above. Insurance companies are strongly advised to become familiar with SSAP No. 105R before filing an RTAS Application with the SVO.

Direction and Program Parameters

115. The SVO may assign an NAIC Designation to a Working Capital Finance Program that would generate Working Capital Finance Investment that meet the criterion and standards identified in this Section.

116. RTAS Submission Required – A request that the SVO assign an NAIC Designation to a Working Capital Finance Program is made by filing an RTAS Application. The RTAS Application is available at www.naic.org/documents/svo_rtas_app.pdf.

117. Upon completion of its risk assessment, the SVO will issue an RTAS Letter indicating a preliminary NAIC Designation; i.e., the NAIC Designation that would be assigned if the Investor enters into a Working Capital Finance Program with a Finance Agent and sought to report it to the SVO.

NOTE: A preliminary NAIC Designation cannot be used for statutory reporting purposes.

118. The SVO shall issue a final NAIC Designation to the Investor for the Working Capital Finance Program and the Working Capital Finance Investments generated thereunder upon receipt of fully executed final copies of the required documentation.

Variations in Structure

119. Working Capital Finance Programs may differ in structure and in the protection afforded the Investor. Structural strength and weaknesses of various structures in such programs will be reflected in the NAIC Designation assigned by the SVO.

Program Quality

120. The SVO shall only assign an NAIC Designation to Working Capital Finance Programs that can be designated NAIC 1 or NAIC 2. Credit quality is measured by reference to a NAIC CRP credit rating or an NAIC Designation assigned by the SVO. The SVO shall withdraw the NAIC Designation assigned to a Working Capital Finance Program on the date the Obligor’s NAIC CRP credit rating or NAIC Designation is downgraded to NAIC 3 or its NAIC CRP equivalent.

NOTE: SSAP No. 105R—Working Capital Finance Investments provides that Working Capital Finance Investments generated under a Working Capital Finance Program of


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an Obligor that falls below the equivalent of NAIC 1 or NAIC 2 becomes nonadmitted.

Process and Methodology

121. An NAIC Designation shall be assigned to a Working Capital Finance Program on the basis of a thorough assessment of credit, dilution, operational and other risks, an assessment of protections provided by operative documents to the Investor and the quality of transaction participants.

Risk-Assessment Process

122. Credit Risk – The NAIC Designation for a Working Capital Finance Program shall be linked to the credit quality of the Obligor, which may be determined by reference to a credit rating assigned by a NAIC CRP or by an NAIC Designation assigned by the SVO. Credit risk is assessed by the SVO analyst in accordance with any permitted methodology set forth in this Manual for corporate obligors.

123. Dilution Risk – To achieve an NAIC 1 or NAIC 2 Designation, the Working Capital Finance Program must eliminate dilution risk in the Working Capital Finance Investment proposed to be eligible for purchase by the Investor. The terms governing the Investor’s Working Capital Finance Investment must eliminate Obligor recourse to its Supplier as a condition to payment of the obligation to the Investor so as to result in an unconditional right to receive payment on a full and timely basis.

124. Operational Risk – To achieve an NAIC 1 or NAIC 2 Designation, all operational risks shall be identified and assessed. Key participants shall have a NAIC CRP credit rating or an NAIC Designation assigned by the SVO at a level at least that of the Obligor.

Legal, Structural and Regulatory Considerations

125. Events of default remedies should provide the Investor at least those rights and privileges, unimpaired, of a trade creditor upon default with no Obligor defenses that could cause dilution of principal.


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126. The SVO shall verify that either, (i) the Finance Agent is must be an entity regulated or supervised by a financial regulator in one of the countries in the List of Foreign (non-US) Jurisdictions Eligible for Netting for Purposes of Determining Exposures to Counterparties for Schedule DB, Part D, Section 1 and that the regulator is the functional equivalent of the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency (OCC) or the Federal Deposit Insurance Corporation (FDIC). In the alternative, or (ii) the SVO shall verify that payments due the Investor are made directly by the Obligor or into an account maintained by a regulated financial institution for the benefit of Investors in the Working Capital Finance Program and, in either case, the Finance Agent cannot be the beneficiary of such payment. with no commingling of funds or assets with those of the Obligor, Supplier, Servicer or Trust Administrator or other Investors.

127. The SVO will verify that the Certification from the insurance company’s Chief Investment Officer confirms that the Investor is not affiliated with Obligor and that Working Capital Finance Investment excludes insurance or insurance-related assets.

128. The SVO will verify that the Certification from the insurance company’s Legal Counsel confirms the existence of a commercially reasonable belief that the documents establishing and governing the Working Capital Finance Program establishes the rights and UCC code standard for preserving first priority perfected interest in Confirmed Supplier Receivables.

129. The remedies available to the participants in the Working Capital Finance Program should be expressly identified in the documentation for the Working Capital Finance Investment.

130. Characteristics that shall be present in a proposed Working Capital Finance Investment include, but are not limited to, the following, or a substantial equivalent:

131. The Obligor makes payments directly to the (a) Investor; (b) Finance Agent; or (c) servicer for the Working Capital Finance Program.

132. The Investor must have the option, and not an obligation, to purchase subsequent Working Capital Finance Investment so as to ensure the Investor can exit the Working Capital Finance Investment by permitting existing investments to mature.

133. SSAP No. 105R—Working Capital Finance Investments provides that the documentation governing Working Capital Finance Programs must provide that disputes arising under the agreements shall be submitted to a court of competent jurisdiction in the U.S. or be subject to an alternative dispute resolution process sanctioned by state law. Given the nature of Working Capital Finance Programs, the SVO anticipates that documentation governing Working Capital Finance Investments will be subject to the laws and jurisdiction of the courts of California, Delaware or New York, or a similar legal jurisdiction with significant exposure to sophisticated institutional financial transactions.


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134. Events of default must be clearly defined, and provide a mechanism that gives the Investor the ability to pursue collection unfettered by actions taken or not taken by participants such as the Servicer or Trustee, or other named persons performing similar functions.


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G:\SECVAL\DATA\Vos-tf\Meetings\2020\July 2020\VOSTF meeting Jul 1 2020\Item 03-Updates to WCFI\2020-022.01 PP Manual Amend - Updates to SSAP No. 105 for WCFI.docx


TO: Kevin Fry (IL), Chair of the Valuation of Securities (E) Task Force

FROM: Dale Bruggeman (OH), Chair of the Statutory Accounting Principles (E) Working Group

DATE: June 4, 2020

RE: Updates to Working Capital Finance Program Requirements

During its May 20, 2020 conference call, the Statutory Accounting Principles (E) Working Group finalized consideration of a referral from the Valuation of Securities (E) Task Force, pertaining to Working Capital Finance program requirements. With the action taken, the Working Group adopted substantive revisions to SSAP No. 105R—Working Capital Finance Investments and Issue Paper No. 163—Working Capital Finance Investments Updates. The revisions incorporate seven of industry requested modifications to the Working Capital Finance Investments program requirements and are effective on June 30, 2020. Key revisions, which are reflected as tracked changes in the attached, are summarized as follows:

1. Functionally Equivalent Foreign Regulators - Removed the requirement that the Securities ValuationOffice (SVO) determine if the International Finance Agent is the functional equivalent of the U.S.regulator.

2. Commingling Prohibitions - Removed the finance agent prohibitions on commingling.

3. Investor Rights Edit - Removed duplicative text regarding exercising of investor rights.

4. Requirements for filer to Certify Perfected Interest – Removed requirements, with revisions allowingthe SVO to determine if a first priority perfected interest has been obtained.

5. Finance Agent Validation Requirements – Broadened the independent review requirements to allowindependent review of the finance agent by either audit or through an internal control report.

6. Default Date - Changed the default provisions from 15 to 30 days so the default date and the cure periodare consistent.

7. Possible Domestic Regulator Approval – Removed the statement that the reporting entity may need toseek approval from the domestic regulator.

With the action taken, the Working Group also directed notification to the Valuation of Securities (E) Task Force for purposes of coordinating corresponding revisions to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual). Please contact NAIC staff of the Statutory Accounting Principles (E) Working Group with any questions.

Cc: Charles A. Theriault, Julie Gann, Robin Marcotte, Jim Pinegar, Fatima Sediqzad and Jake Stultz

Attachment: SSAP No. 105R.

G:\FRS\DATA\Stat Acctg\1. Statutory\E. Referrals\2020\2020 SAPWG to VOS -WCFI adoption.doc

Attachment E - 1 Valuation of Securities (E) Task Force

7/1/2020

Ref# 2019-25

© 2020 National Association of Insurance Commissioners 105R-1

Statement of Statutory Accounting Principles No. 105R

Working Capital Finance Investments

STATUS

Type of Issue .........................................................

Common Area

Issued .........................................................

December 15, 2013; Substantively revised May 20, 2020

Effective Date .........................................................

January 1, 2014; Substantive revisions documented in Issue Paper No. 163 effective June 30, 2020

Affects .........................................................

No other pronouncements

Affected by .........................................................

No other pronouncements

Interpreted by .........................................................

INT 06-07

Relevant Appendix A Guidance .........................................................

None

STATUS ....................................................................................................................................................... 1

SCOPE OF STATEMENT ......................................................................................................................... 1

SUMMARY CONCLUSION ...................................................................................................................... 2

Working Capital Finance Program - Definitions and Conditions ................................................................. 2 Confirmation Process .................................................................................................................................... 3 Program Requirements .................................................................................................................................. 4 Exclusions ..................................................................................................................................................... 5 Accounting and Reporting ............................................................................................................................. 5 Default ........................................................................................................................................................... 6 Impairment .................................................................................................................................................... 6 Disclosures .................................................................................................................................................... 7 Effective Date and Transition ........................................................................................................................ 7

REFERENCES ............................................................................................................................................ 8

Relevant Issue Papers .................................................................................................................................... 8

SCOPE OF STATEMENT

1. This statement establishes statutory accounting principles for working capital finance investments held byreporting entities. This statement amends SSAP No. 20—Nonadmitted Assets (SSAP No. 20) to allow workingcapital finance investments as admitted assets to the extent they conform to the requirements of this statement.


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Ref# 2019-25 SSAP No. 105R Statement of Statutory Accounting Principles


SUMMARY CONCLUSION

2. Working capital finance investments represent a confirmed short-term obligation1 to pay a specified amountowed by one party (the obligor) to another (typically a supplier of goods), generated as a part of a working capitalfinance investment program currently designated by the NAIC Securities Valuation Office. Pursuant to the workingcapital finance investment program, this short-term obligation has been transferred by the entity entitled to payment(typically a supplier of goods) to a third party investor.

3. Working capital finance investments held by a reporting entity represent a right of the reporting entity toreceive future payment. This Statement provides accounting and reporting guidelines for the right to receivepayment under working capital finance programs that meet particular criteria.

Working Capital Finance Program - Definitions and Conditions

4. A “working capital finance program” is an open account program under which an investor may purchaseinterests, or evidence thereof, in commercial non-insurance receivables. A working capital finance program iscreated for the benefit of a commercial investment-grade obligor and its suppliers of goods or services, andfacilitated by a finance agent.

5. A working capital finance program transfers a right to payment to an investor from a short term obligationand arises from transactions among:

a. a buyer of goods or services that becomes an obligor to the supplier of goods or services,

b. the supplier(s) of those goods or services,

c. a finance agent, and

d. an investor.

6. A “working capital finance investment” is an interest in payment(s) from a confirmed supplier receivableissued pursuant to a working capital finance program. The payment (maturity) date must not exceed one year fromthe date of invoice from the supplier to the obligor. This investment is created when the investor purchases from aworking capital finance program that is currently designated as NAIC “1” or “2” by the NAIC Securities ValuationOffice, any of the following:

a. One or more confirmed supplier receivables;

b. in case of a participation, a participation interest in one or more confirmed supplier receivablesissued by the finance agent or lead lender holding confirmed supplier receivables; or

c. a certificate, note or other interest manifestation, documented in a way that is verifiable byregulators, representing a legally enforceable interest in a right to payment payment either directlyto the investor or from a trust, other special purpose entity or pool holding confirmed supplierreceivables.

7. “Obligor” is the party that purchases the goods or services that generates the original supplier receivable(and which is the payable for thatthe Obligor). The obligor must be a single entity, which hashave an NAICdesignation of “1” or “2” or a Credit Rating Provider equivalent. The obligor must confirm the supplier receivabledescribed in paragraph 11 as described in the confirmation process in paragraphs 12-1314.

1 All references to short-term obligations in this statement to refer to obligations not exceeding one year.


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Working Capital Finance Investments Ref #2019-25


8. “Supplier” is the party that sells the goods or services to the obligor. The supplier sells the confirmedsupplier receivable in accordance with the terms of the working capital finance program designated by the NAICSecurities Valuation Office at a price agreed to by the finance agent and/or investor.

9. “Investor” is the party purchasing a working capital finance investment in accordance with the terms of theworking capital finance program designated by the NAIC Securities Valuation Office.

10. The “finance agent” is a bank, financial institution, other financial intermediary, or service provider thatfacilitates the working capital finance program, arranges the sale, assignment or transfer of the confirmed supplierreceivable to the investor for a fee and administers the payment mechanism. In the case of participation, the financeagent must inform the reporting entity investor of a default or event of default as soon as it becomes aware of suchdefault or event of default. For the working capital finance program to qualify under this SSAP, the finance agentmust meet the requirements of either paragraph 10.a. or 10.b.:

a. The finance agent is directly regulated by, or falls under the supervision of, a financial regulator ofits domiciliary country provided that such country appears on the Purposes and Procedures Manualof the NAIC Investment Analysis Office List of Jurisdictions Eligible for Netting and that theSecurities Valuation Office determines that the regulator is the functional equivalent of the Boardof Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, or theFederal Deposit Insurance Corporation; or

b. Payments from the obligor must 1) be paid directly to the reporting entity (investor) or into anaccount maintained by a regulated financial institution for the benefit of investors in the workingcapital finance program and, in either case, cannot flow through the finance agent cannot be thebeneficiary of such paymentand 2) there can be no commingling of payments or assets with thoseof the obligor, supplier, servicer or trust administrator or other investors.

11. A “confirmed supplier receivable” is a first priority perfected security interest or right to payment of amonetary obligation from the obligor arising from the sale of goods or services from the supplier to the obligor thepayment of which has been confirmed by the obligor committing and stating that the obligations under theagreement and any payment shall not be affected by the invalidity, unenforceability, existence, performance or non-performance of the underlying commercial trade transaction or any related contract or undertaking nor that it willnot protest, delay, or deny, nor offer nor assert any defenses, personal or otherwise, against payment to the supplieror any party taking claims, interests, or rights to payments made by the supplier.

a. The confirmed supplier receivable must be sold, assigned or otherwise transferred in a manner thatresults in an absolute, irrevocable and legally enforceable obligation that has been confirmed bythe Obligor.

b. In the case of a participation, the certificates or other evidence of participation provide an absolute,irrevocable, and legally enforceable obligation of the finance agent or holder of the confirmedsupplier receivable to pay to the reporting entity investor all of the amounts due to it under theconfirmed supplier receivable, without reduction or delay arising from any claims that the financeagent may have against the reporting entity investor. The reporting entity investor’s ability toexercise its rights as creditor, or to direct the finance agent to exercise the rights of a creditor on itsbehalf, shall not be subject to the discretion of the finance agent or other lenders or investors. Thereporting entity investor’s ability to exercise its rights as creditor, or to direct the finance agent toexercise the rights of a creditor on its behalf, shall not be subject to, other than during a cure periodnot to exceed thirty days, the discretion of the finance agent or other lenders or investors.

Confirmation Process

12. In the case of a purchase, the investor shall verify, prior to the sale that the obligor has confirmed therespective amounts, payment dates and related invoice numbers’ specified dates and has waived all defenses to


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payment. In the case of a participation, the finance agent must verify that the obligor has confirmed the respective amounts, payment dates and related invoice reference numbers’ specified due dates, and has waived all defenses to payment in accordance with the confirmation process.

13. The obligor must commit and state that upon confirmation of a supplier receivable it is obligated to payto the investor, the finance agent, or any third party acting as agent or trustee for the investor, a sum equal to thefull amount of that confirmed supplier receivable(s) on a date certain stated in the confirmation and that it waivesany right of setoff or other defenses to avoid or delay the full and timely payment of that Confirmed SupplierReceivable. The documents establishing the working capital finance program or the confirmation must state andconfirm that the obligation to pay must be independent of any other contracts or claims that might be raised indefense arising from any transaction financed in connection with the WCFPWCFI program, the confirmed supplierreceivable, or any other courses of performance or courses of dealing with the supplier.

14. In the case of participation, the investor must certify that it has a commercially reasonable belief that itsparticipation interest meets the Uniform Commercial Code’s standards for creating and preserving first prioritysecurity interests in the payments due and in the confirmed supplier receivables. Commercially reasonable beliefshall mean the SVO deems the investor’s belief reasonable in light of the systems, policies, or practices commonlyrecognized in the field of investing in participations. The investor must be able to demonstrate to a regulator or tothe SVO, upon either’s request, the basis for its commercially reasonable belief that the WCFP creates and preservesthe investor’s ability to enforce a first priority perfected security interest in the confirmed supplier receivables.

15. In the case of a certificate, note, or other manifestation, capable of verification, representing a right topayment from a trust, other special purpose entity, or special purpose pool holding confirmed supplier receivables,the investor must certify that it has a commercially reasonable belief that the documents establishing and governingthe working capital finance program create and preserve interests in the confirmed supplier receivables capable ofbeing enforced by the trustee or other entity holding confirmed supplier receivables as first priority perfectedsecurity interests under the Uniform Commercial Code. The investor must be able to demonstrate the basis for suchbelief to a regulator or to the SVO upon either’s request. Commercially reasonable belief shall mean the SVO deemsthe investor’s belief reasonable in light of the systems, policies, and practices commonly recognized in the field ofinvesting in securitizations, loan-backed, structured, or trust-issued securities.

Program Requirements

16.14. The working capital finance program investor must provide in its annual filing with the Securities Valuation Office an annual audit of the consolidated financial statements of which the finance agent is part, which does not report any qualifications related to servicing, and one of the following:

a. An annual independent report according to Statement on Standards for Attestation Engagements(SSAE) No. 16 (or functional equivalent), reporting on controls at a service organization related tothe administration of the investment; or

b. An annual audit of the financial statements and internal controls of the consolidated group of whichthe finance agent is part, which does not note any material weaknesses related to servicing workingcapital financial investments.

The NAIC Securities Valuation Office would review the materiality of the report findings in making their determination of the assignment of a designation.

17.15. If the credit rating of the working capital finance program or obligor falls to non-investment grade (below the equivalent of NAIC designation “1” or “2”), the reporting entity shall nonadmit, the working capital finance investments obtained under the related working capital finance program and/or the related obligor. Due to the short-term nature of these investments, once an investment is nonadmitted due to the credit rating of the working capital finance program or the obligor, those investments will continue to be nonadmitted.


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18.16. Reporting entity investors must have the ability to monitor the working capital finance program and the credit-related activities of the obligor. Reporting entity investors must provide information as requested to the state of domicile indicating that they have the ability to monitor on an ongoing basis the activities of the working capital finance program. Initial permission to invest in Working Capital Finance Investment Programs may be required by the domiciliary commissioner.

19.17. All contracts or agreements that are a part of or that together constitute a working capital finance program must provide that if a dispute arises among any of the parties under any of the contracts or agreements that are a part of or that together constitute the working capital finance program, each party agrees that the dispute will be submitted to a court of competent jurisdiction in the United States or a constituent state thereof or of an alternative dispute resolution process recognized thereby. All contracts or agreements that are a part of or that together constitute a working capital finance program must provide that any dispute arising under any of the contracts or agreements that are a part of or that together constitute the working capital finance program must be resolved pursuant to the laws of the United States or a constituent state thereof that address the substance of the dispute but excluding those laws addressing conflicts of law.

Exclusions

20.18. A working capital finance investment excludes any receivables financed through:

a. Factoring: the purchase of receivables in bulk from a supplier where the receivables represent thepayment obligations of potentially thousands of buyers to a single supplier, in which the buyershave no relationship with or contractual obligation to pay the factor and retain all legal defenses topayment they may have against the supplier;

b. Forfaiting: the purchase of one or a series of receivables from exporters by a forfaiter to enable theexporter (seller) to finance a commercial transaction with a buyer in which the Obligor has norelationship with or contractual obligation to pay the forfaiter and retains all legal defenses to payit may have against the seller; or

c. Invoice discounting: the advancement of funds by a finance company to a business entity with thefunds advanced limited to a defined percentage of the business entity’s eligible and outstandingreceivables.

21.19. Eligible Confirmed Supplier Receivables must not:

a. Include insurance or insurance related assets;

b. Be impaired or in default at the time of purchase;

c. Have a payment (maturity) date longer than one year from the date of the invoice from the Supplierto the Obligor giving rise to the confirmed supplier receivable, and the maturity date must not besubject to change or rolling; nor

d. Include any receivable of any parent or affiliate of the reporting entity investor, and neither theObligor nor any Supplier may be affiliated with the reporting entity investor. Working CapitalFinance Investments that have obligors or vendors that are affiliated with the investor are ineligible,and therefore, nonadmitted assets.

Accounting and Reporting

22.20. The right to receive payment generated by a working capital finance investment issued under a working capital finance program is considered to meet the definition of an asset as defined in SSAP No. 4—Assets and Nonadmitted Assets, and is an admitted asset to the extent the investment conforms to the requirements set forth in this Statement and the Purposes and Procedures Manual of the NAIC Investment Analysis Office. For programs that


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comply with all of these elements, working capital finance investments shall be valued and reported in accordance with this Statement, the Purposes and Procedures Manual of the NAIC Investment Analysis Office, and the designation assigned in the NAIC Valuations of Securities product. Programs that do not comply with the elements set forth in this Statement, or the provisions set forth in the Purposes and Procedures Manual of the NAIC Investment Analysis Office are nonadmitted. Working capital finance investments are reported as other invested assets in the financial statements.

23.21. A working capital finance investment shall be recorded on the trade date. At acquisition, the Working Capital Finance Investment shall be initially reported at cost, excluding brokerage and other related fees, and all other costs (internal costs, or costs paid for origination, purchase or commitment to purchase such investments), which shall be expensed as incurred.

24.22. After initial acquisition, the Working Capital Finance Investment shall be reported at amortized cost until the specified maturity date, unless the investment, or a portion thereof, is deemed uncollectible or when an other-than-temporary impairment has occurred. In the event that a working capital finance investment is purchased by a reporting entity investor at a premium (amount to be received by the entity under the confirmed supplier receivable is less than the price paid for the investment), the excess paid by the reporting entity investor in comparison to the amount receivable under the confirmed supplier receivable must be immediately expensed.

25.23. For reporting entities required to maintain an Interest Maintenance Reserve (IMR), the accounting for realized capital gains and losses from working capital finance investments shall be in accordance with SSAP No. 7—Asset Valuation Reserve and Interest Maintenance Reserve (SSAP No. 7). For reporting entities not required to maintain an IMR, realized gains and losses from working capital finance investments shall be reported as net realized capital gains or losses in the statement of income. For reporting entities not required to maintain an AVR, unrealized gains and losses shall be recorded as a direct credit or charge to unassigned funds (surplus).

26.24. A Working Capital Finance Investment may provide for a prepayment penalty or acceleration fee in the event the working capital finance investment is liquidated prior to its scheduled termination date. Such fees shall be reported as investment income when received.

27.25. SSAP No. 34—Investment Income Due and Accrued shall be followed for determining and recording investment income earned on working capital finance investments acquired at a discount. In accordance with SSAP No. 34—Investment Income Due and Accrued, investment income shall be reduced for amounts that have been determined to be uncollectible, however amounts more than 15 days overdue are nonadmitted.

Default

28.26. A working capital finance investment payment that is uncollected by the reporting entity within fifteen thirty days after the due date shall be considered in default and nonadmitted. If the reporting entity has any other working capital finance investment assets from the same defaulting counterparty, all other working capital finance investments from that counterparty shall be nonadmitted. All working capital finance investments from a counterparty identified in default shall be evaluated for impairment.

Impairment

29.27. An other-than-temporary impairment(INT 06-07) shall be considered to have occurred if it is probable that the reporting entity will be unable to collect all amounts due according to the contractual terms of a confirmed supplier receivable including the payment on the established due date. Pursuant to this guidance, assessment of other-than-temporary impairment shall include an evaluation of the financial condition and short-term prospects of the obligor. If it is determined that a decline in the fair value of a working capital finance investment below book/adjusted carrying value is due to an other-than-temporary impairment, an impairment loss shall be recognized as a realized loss equal to the entire difference between the working capital finance investment’s carrying value and fair value as of the reporting period for which the assessment is made. Fair value shall be determined in accordance with SSAP


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No. 100R—Fair Value (SSAP No. 100R), and reflect the price to sell the asset in an orderly market between market participants. As such, the fair value shall reflect the assumptions market participants will use in pricing the asset, including assumptions about risk.

30.28. For reporting entities required to maintain an AVR/IMR, the entire amount of the realized loss from the other-than-temporary impairment shall be recorded through the AVR, in accordance with SSAP No. 7.

31.29. Upon recognition of an other-than-temporary impairment, the fair value of the working capital finance investment on the measurement date shall become the new cost basis of the working capital finance investment and the new cost basis shall not be adjusted for subsequent recoveries in fair value. Once an investment is determined to be other-than-temporarily impaired, until all expected payments are received, the reporting entity must re-evaluate the investment quarterly and reassess fair value, with recognized realized losses for the difference between the book/adjusted carrying value and the current fair value. This process shall continue until either all expected payments are received, or the entity has recognized a realized loss for the entire uncollected carrying value.

Disclosures

32.30. The financial statements shall include the following disclosures:

a. Fair value in accordance with SSAP No. 100R.

b. Concentrations of credit risk in accordance with SSAP No. 27—Off-Balance-Sheet and Credit RiskDisclosures (SSAP No. 27) in the annual audited statutory financial reports only.

c. Information regarding the aggregate book/adjusted carrying value of working capital financeinvestment by designation including gross assets with nonadmitted and net admitted amountsannually. (Note that programs designated 3-6 are nonadmitted.)

Gross Asset CY Non-Admitted

Asset CY Net Admitted

Asset CY WCFI Designation 1 WCFI Designation 2 WCFI Designation 3 WCFI Designation 4 WCFI Designation 5 WCFI Designation 6 Total

d. Annual and quarterly information regarding the aggregate book/adjusted carrying value maturitydistribution on the underlying working capital finance investments by the categories of maturitiesup to 180 days and 181 to 365 days.

e. Any events of default of working capital finance investments during the reporting period.

33.31. Refer to the Preamble for further discussion regarding disclosure requirements.

Effective Date and Transition

34.32. This statement is effective for years on or after January 1, 2014. Substantive revisions documented in Issue Paper No. 163—Working Capital Finance Investments Updates are effective for financial reporting periods on or after June 30, 2020. A change resulting from the adoption of this statement shall be accounted for as a change in accounting principle in accordance with SSAP No. 3—Accounting Changes and Corrections of Errors.


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REFERENCES

Relevant Issue Papers

Issue Paper No. 147—Working Capital Finance Investments Issue Paper No. 163— Working Capital Finance Investments Updates

G:\FRS\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2020\5-20-20\Adoptions\19-25 - SSAP No. 105 final 5-20-20 .docx


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Attachment F Valuation of Securities (E) Task Force 7/1/2020

MEMORANDUM


FROM: Marc Perlman, Investment Counsel, NAIC Securities Valuation Office (SVO)

CC: Charles A. Therriault, Director, NAIC Securities Valuation Office (SVO) RE: SVO Staff Memorandum on the Use and Regulation of Derivatives in Exchange Traded Funds

DATE: July 1, 2020

The SVO is providing this report on the use and regulation of derivatives in exchange-traded funds (“ETFs”) at the request of the Valuation of Securities (E) Task Force (“VOSTF”), made December 2019 at the NAIC’s Fall National Meeting. This report explains the current use of derivatives by ETFs, current regulations and proposed Rule 18f-4, released by the U.S. Securities and Exchange Commission (SEC) on November 25, 2019 which could change the way derivatives in ETFs are regulated.

Use of Derivatives by ETFs

ETFs, like other SEC registered fund types, use derivatives to manage both exposure to specific investments and risk as part of their investment strategies. The SEC permits an ETF to use derivatives to increase, maintain, or reduce exposure to a market, sector, or security more quickly, and with lower transaction costs and portfolio disruption, than investing directly in the underlying securities. An ETF may also use derivatives to obtain exposure to reference assets for which it may be difficult or impractical for the ETF to make a direct investment, such as commodities. ETFs may also manage risk by employing derivatives to hedge interest rate, currency, credit, and other risks, as well as to hedge portfolio exposures.

Derivative transactions, such as futures, swaps, and written options, involve leverage or the potential for leverage because they enable the ETF to magnify its gains and losses compared to the ETF’s investment, while also obligating the ETF to make a payment or deliver assets to a counterparty under specified conditions. Losses on derivatives therefore can result in counterparty payment obligations that directly affect the capital structure of an ETF and the relative rights of the ETF’s counterparties and shareholders.

At the same time, an ETF’s SEC permitted derivatives use may entail risks relating to, for example, markets, operations, liquidity and counterparties, as well as legal risks. An ETF’s portfolio manager, therefore, must manage, and the board of directors oversee, the ETF’s derivatives use, consistent with the ETF’s investment objectives, policies, restrictions, and risk profile. Furthermore, an ETF’s portfolio manager and board of directors must adhere to the requirements of Section 18 of the Investment Company Act of 1940 (the “Act”), as well as the Act’s other requirements, when considering the use of derivatives.

Regulation of Derivatives in ETFs and other Funds

Section 18 of the Investment Company Act of 1940 Section 18 of the Investment Company Act is designed to limit the leverage a fund can obtain or incur by imposing limits on the ability of funds to issue “senior securities.” According to the SEC, protecting investors against the potentially adverse effects of a fund’s issuance of senior securities, and in particular the risks associated with

Attachment F Valuation of Securities (E) Task Force

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excessive leverage of investment companies, is a core purpose of the Act. “Senior security” is defined, in part, as “any bond, debenture, note, or similar obligation or instrument constituting a security and evidencing indebtedness.”

Section 18 generally limits leverage by prohibiting an investment company from issuing any class of senior security or selling any senior security of which it is the issuer, that represents indebtedness, unless immediately after such issuance or sale the investment company will have asset coverage of at least 300%.

General Statement of Policy (Release 10666) In a 1979 General Statement of Policy (Release 10666), the SEC considered the application of Section 18’s restrictions on the issuance of senior securities to reverse repurchase agreements, firm commitment agreements, and standby commitment agreements. In Release 10666, the SEC stated that, for purposes of section 18, “evidence of indebtedness” would include “all contractual obligations to pay in the future for consideration presently received.” The Commission recognized that, while section 18 would generally prohibit funds’ use of reverse repurchase agreements, firm commitment agreements, and standby commitment agreements, the Commission nonetheless permitted funds to use these and similar arrangements subject to certain constraints. These constraints relied on funds’ use of “segregated accounts” to “cover” senior securities, which were intended to limit the investment company’s risk of loss. The SEC also stated that segregated accounts function as “a practical limit on the amount of leverage which the investment company may undertake” and that it would “assure the availability of adequate funds to meet the obligations arising from such activities.”

The SEC explained that its views were not limited to the particular trading practices discussed (e.g. reverse repurchase agreements), but that the SEC sought to address the implications of comparable trading practices that could similarly affect funds’ capital structures. Since the Release’s issuance, the SEC staff has issued more than thirty no-action letters to funds concerning the maintenance of segregated accounts or otherwise “covering” their obligations in connection with various transactions otherwise restricted by Section 18. The SEC has taken the position that reverse repurchase agreements, firm commitment agreements, standby commitment agreements, short sales, written options, forwards, futures, and certain other derivatives transactions may involve the issuance of a senior security subject to the prohibitions and asset coverage requirements of Section 18.

In response to the Release 10666, funds have developed asset segregation practices to cover their derivatives positions, based at least in part on the SEC’s no-action letters and guidance. Practices vary based on the type of derivatives transaction. The SEC recognizes that as a result of these asset segregation practices, funds’ derivatives use—and thus funds’ potential leverage through derivatives transactions—does not appear to be subject to a practical limit as the SEC contemplated in Release 10666. Additionally, the SEC recognizes, first, that current asset segregation practices may not assure the availability of adequate assets to meet funds’ derivatives obligations and, second, the segregated assets may be more likely to decline in value at the same time as the fund experiences losses on its derivatives, potentially forcing the fund to sell portfolio securities to meet its derivatives payment obligations during stressed market conditions, including at times when prudent management could advise against such liquidation.

Proposed Rule 18f-4: The possible future of the regulation of derivatives in ETFs The SEC has stated that “funds’ [including ETFs’] current practices regarding derivatives use may not address the undue speculation and asset sufficiency concerns underlying section 18.”1 As such, the proposed rule is “designed to address the investor protection purposes and concerns underlying section 18 of the Act and to provide an updated and more comprehensive approach to the regulation of funds’ use of derivatives and the other transactions.” The Rule would replace the catalogue of SEC no-action letters and guidance produced in the wake of Release 10666. The Rule would be an exemptive rule and therefore would generally permit funds, including ETFs, to enter into “derivative transactions”2 notwithstanding the restrictions under Section 18, so long as the fund complies with

1 The proposed Rule defines a “fund” as a registered open-end or closed end company or a BDC [business development company], including any separate series thereof. The Rule would therefore apply to mutual funds, ETFs, registered closed-end funds, and BDCs. The Rule’s definition of a “fund” would, however, exclude money market funds regulated under rule 2a-7 under the Investment Company Act. 2 The Rule defines the term “derivatives transaction” to mean: (1) any swap, security-based swap, futures contract, forward contract, option, any combination of the foregoing, or any similar instrument (“derivatives instrument”), under which a fund is or may be required to make any payment or delivery of cash or other assets during the life of the instrument or at maturity or early


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certain conditions and disclosures. The proposed Rule does not include a specific asset segregation requirement for derivatives or other financial transactions to which the Rule would apply. The SEC explains that it believes the Rule’s requirements, such as a derivatives risk management program and VaR-based limits on leverage, make asset segregation unnecessary. “Limited derivative users,” however, would be exempt from several of these requirements. The proposed Rules conditions and disclosures include the following:

Limit on Fund Leverage Risk with Value-at-Risk (VaR) Calculation A fund relying on the proposed Rule would have to comply with an outer limit on fund leverage based on the fund’s value-at-risk (“VaR”)3. Specifically, the fund’s VaR would not be permitted to exceed 150% of the VaR of the fund’s designated reference index (the “relative VaR test”), or, if the fund’s derivatives risk manager is unable to identify an appropriate designated reference index (“DRI”) 4, the fund’s VaR would not be permitted to exceed 15% of the value of the fund’s net assets (the “absolute VaR test”). The DRI is intended to provide an appropriate baseline VaR that approximates the VaR of the fund’s unleveraged portfolio; it would need to be disclosed in the fund’s annual report. The proposed rule would require a fund to determine its compliance with the applicable VaR test at least once each business day.

If a fund determines that it is not in compliance with its applicable VaR test, it must become compliant within three business days after such determination or it becomes subject to additional requirements including (i) the derivatives risk manager reporting and explaining to the board of directors how and when the derivatives risk manager expects the fund will return to compliance, (ii) the derivatives risk manager determining what caused the compliance breach

termination, whether as margin or settlement payment or otherwise; and (2) any short sale borrowing. The SEC explains that the purpose of the definition is ”designed to describe those derivatives transactions that involve the issuance of a senior security, because they involve a contractual future payment obligation. When a fund engages in these transactions, the fund will have an obligation (or potential obligation) to make payments or deliver assets to the fund’s counterparty. This prong of the definition incorporates a list of derivatives instruments that, together with the proposed inclusion in the definition of “any similar instrument,” covers the types of derivatives that funds currently use and that the requirements of section 18 would restrict. This list is designed to be sufficiently comprehensive to include derivatives that may be developed in the future.” and “[The] definition also provides that a derivatives instrument, for purposes of the proposed rule, must involve a future payment obligation. This aspect of the definition recognizes that not every derivatives instrument imposes an obligation that may require the fund to make a future payment, and therefore not every derivatives instrument will involve the issuance of a senior security. A derivative that does not impose any future payment obligation on a fund generally resembles a securities investment that is not a senior security, in that it may lose value but will not require the fund to make any payments in the future.” 3 According to the proposed Rule, “Value-at-risk or VaR means an estimate of potential losses on an instrument or portfolio, expressed as a percentage of the value of the portfolio’s net assets, over a specified time horizon and at a given confidence level, provided that any VaR model used by a fund for purposes of determining the fund’s compliance with the relative VaR test or the absolute VaR test must: (1) Take into account and incorporate all significant, identifiable market risk factors associated with a fund’s investments, including, as applicable: (i) Equity price risk, interest rate risk, credit spread risk, foreign currency risk and commodity price risk; (ii) Material risks arising from the nonlinear price characteristics of a fund’s investments, including options and positions with embedded optionality; and (iii) The sensitivity of the market value of the fund’s investments to changes in volatility; (2) Use a 99% confidence level and a time horizon of 20 trading days; and (3) Be based on at least three years of historical market data.” The SEC explains that “VaR is a commonly-known and broadly-used industry metric that integrates the market risk associated with different instruments into a single number that provides an overall indication of market risk, including the market risk associated with the fund’s derivatives transactions.” 4 “The proposed Rule would define a “designated reference index” as an unleveraged index that is selected by the derivatives risk manager, and that reflects the markets or asset classes in which the fund invests. The proposed definition also would require that the designated reference index not be administered by an organization that is an affiliated person of the fund, its investment adviser, or principal underwriter, or created at the request of the fund or its investment adviser, unless the index is widely recognized and used. Additionally, the designated reference index must either be an “appropriate broad-based securities market index” or an “additional index” as defined in Item 27 of Form N-1A. A fund would have to disclose its designated reference index in the annual report, together with a presentation of the fund’s performance relative to the designated reference index.”


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and, if appropriate, amending the derivatives risk management program accordingly and (iii) the fund becoming ineligible for new derivative transactions other than those designed to remedy the compliance breach.

Derivatives Risk Management Program The proposed Rule would require a fund that engages in derivatives transactions, other than a limited derivatives user, to adopt and implement a written derivatives risk management program (“Program”), which would include policies and procedures reasonably designed to manage the fund’s derivatives risks. The Program would be expected to identify and manage leverage, market, counterparty, liquidity, operational and legal risks, in addition to any other risks deemed material by the Derivatives Risk Manager. The fund’s board of directors would not be required to approve the Program or any amendments to it, but the Derivatives Risk Manager would be required to keep the board of directors regularly apprised of the Program.

The proposed Rule would require reasonable segregation of the functions of the Program from the fund’s management, rather than a complete firewall, to allow for the derivatives risk manager to work with the portfolio manager in implementing the Program requirements. The derivatives risk manager must have a direct line of communication with the board of directors.

The Program shall be administered by a derivatives risk manager, a new position which must be approved by the board of directors. A fund’s derivatives risk manager can be an individual (who is not also a portfolio manager) or a group (but a majority of the group cannot also be portfolio managers), and the derivatives risk manager must have relevant experience regarding derivatives risk management.

The Program requirements are intended to result in a program with elements that are tailored to the particular types of derivatives that the fund uses and their related risks, as well as how those derivatives impact the fund’s investment portfolio and strategy. The Program shall include the following elements:

• Risk identification and assessment. The Program would have to identify and assess a fund’s derivatives risks, accounting for the fund’s derivatives transactions and other investments.

• Risk guidelines. The Program would have to provide for the establishment, maintenance, and enforcement of investment, risk management, or related guidelines that provide for quantitative or otherwise measurable criteria, metrics, or thresholds related to a fund’s derivatives risks. The Rule would not require funds to disclose their risk guidelines, or report guideline breaches, either publicly or with the SEC.

• Stress testing. The Program would have to provide for weekly stress testing of derivatives risks to evaluate potential losses to a fund’s portfolio under stressed but plausible market conditions. The Rule would require stress test information to be provided to the board of directors, but it would not be required to be disclosed publicly or with the SEC.

• Backtesting. The Program would have to provide for daily backtesting of its VaR calculation model in order to monitor the its model’s effectiveness. The backtesting would entail comparing the fund’s gain or loss with the corresponding VaR calculation for the day and identifying instances where the fund experiences losses greater than the VaR calculation’s estimated loss.

• Internal reporting and escalation. The Program must provide for the regular or frequent reporting of certain matters relating to a fund’s derivatives use, such as guideline breaches and stress test results, to the fund’s portfolio management and board of directors.

• Periodic review of the program. A fund’s derivatives risk manager must review the Program, at least annually, to evaluate the program’s effectiveness and to reflect changes in risk over time. The periodic review must include a review of the fund’s VaR calculation model and an evaluation of the whether the DRI remains appropriate.

Board Oversight and Reporting The proposed rule would require specific oversight and reporting obligations, including: (a) a fund’s board of directors approval of the designation of the fund’s derivatives risk manager, and (b) the derivatives risk manager providing regular written reports to the board of directors describing the Program’s implementation and effectiveness, any instances in which the fund exceeded its guidelines, and the results of the fund’s stress testing and backtesting. The Rule does not require the fund’s board of directors to approve the Program.


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Exception for Limited Users of Derivatives. The proposed rule provides an exception from the derivatives risk management program requirement and the VaR-based limit on fund leverage risk for a fund that either (a) limits its derivatives exposure 5 to 10% of its net assets, or (b) uses derivatives transactions solely to hedge certain currency risks. A fund that relies on the proposed exception would still be required to adopt policies and procedures that are reasonably designed to manage its aggregate derivatives risk. Reverse Repurchase Agreements and Unfunded Commitment Agreements Reverse repurchase agreements and similar financing transactions are not treated as derivatives transactions under the Rule because, as the SEC explains, such agreements and transactions “have the economic effects of a secured borrowing, and thus more closely resemble bank borrowings with a known repayment obligation rather than the more-uncertain payment obligations of many derivatives.” As such, the Rule would treat them differently than derivatives and would allow a fund to enter into a reverse repurchase agreement or other similar financing transaction so long as the fund meets the relevant asset coverage requirements of Section 18.

Proposed Rule 18f-4 would also allow a fund to enter into “unfunded commitment agreements,”6 if the fund reasonably believes, at the time it enters into such an agreement, that it will have sufficient cash and cash equivalents to meet its obligations with respect to all of its unfunded commitment agreements, in each case as they come due. The proposed Rule states that a fund should consider its unique facts and circumstances when determining whether such a reasonable belief exists, and the proposed rule prescribes specific factors that the fund must take into account when making such a determination.

Comment Period and Transition The comment period on proposed Rule 18f-4 expired in the first quarter of 2020. In conjunction with adoption of the new Rule, the SEC has also proposed rescinding Release 10666 and withdrawing several of the existing, topical, no-action letters. If Rule 18f-4 is adopted, as proposed or as amended based on comments, following its publication in the Federal Register, a one year transition period would be provided for funds, broker-dealers and investment advisors to prepare for compliance with the new rule.

Rule 18f-4’s impact on SVO analysis of ETFs The Purposes & Procedures Manual directs the SVO to undertake a Speculative Characteristics Analysis as part of each ETF review. The Speculative Characteristics Analysis includes (a) an “assessment of the fund’s use of leverage including, but not limited to, its use of derivatives, financial commitment transactions and borrowings, to examine the impact the fund’s use of leverage may have on the fund’s portfolio cash flow” and (b) “a review and evaluation of the fund’s policy and approaches to covering leverage obligations in relation to current and potential future guidance on the issue provided by the SEC. As used herein potential future guidance refers to proposed SEC Rule 18-f-47.” The Purposes & Procedures Manual then clarifies that, “The purpose of an analysis of speculative characteristics is to determine whether the fund’s cash flow is inconsistent with a fixed income like determination.” The SVO’s primary analytic focus will remain the determination of whether an ETF’s cash flows, accounting for its use of derivatives, is fixed income like. It is possible that derivatives risk management programs and VaR limits testing could provide increased transparency about an ETFs use of derivatives which could instruct the SVO’s determination of whether an ETF’s cash flow is fixed income like. However, since ETFs on the SVO-Identified Bond ETF and SVO-Identified Preferred Stock ETF Lists should “predominantly hold” bonds or preferred stock, respectively, pursuant to the Purposes & Procedures Manual, most ETFs the SVO adds to those lists likely already fall under the exception for limited users of derivatives and may not need to comply with all requirements of Rule

5 According to the proposed Rule “derivatives exposure” means the sum of the notional amounts of the fund’s derivatives instruments and, in the case of short sale borrowings, the value of the asset sold short. In determining derivatives exposure a fund may convert the notional amount of interest rate derivatives to 10-year bond equivalents and delta adjust the notional amounts of options contracts. The Rule does not define notional amount. 6 The proposed Rule defines “unfunded commitment agreement” to mean a contract that is not a derivatives transaction, under which a fund commits, conditionally or unconditionally, to make a loan to a company or to invest equity in a company in the future, including by making a capital commitment to a private fund that can be drawn at the discretion of the fund’s general partner. 7 This reference is to the never-enacted 2015 version of proposed Rule 18f-4


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18f-4. Additionally, while the Rule proposes changes to the regulation of leveraged/inverse ETFs, the SVO does not provide NAIC designations for those funds since they are not fixed income like. G:\SECVAL\DATA\Vos-tf\Meetings\2020\July 2020\VOSTF meeting Jul 1 2020\Item 06-ETF derivative use\2020.024.01 ETF Derivative Use SVO Staff Memo.docx

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