The Reserve Bank's super review

What is the risk of Australian superannuation funds imploding? How much damage would it do? What can be done to minimise the risks?

Systemic risk is a constant background fear for anyone with a superannuation fund. Some verbalise the fear. But most don’t, and often can be suspicious of superannuation to the point of making an assumption that their super fund balance will have been poorly managed, or swindled, down to zero by the time they’re able to get their hands on it, at or near retirement.

Believing your super, particularly for those in Australian Prudential Regulation Authority regulated funds, will have a balance of $0 at retirement because of market volatility or fraud is an irrational fear. And those who do hold that view are often what Jeremy Cooper (former ASIC deputy chairman and former chairman of Australia’s Super System Review) referred to as “the disengaged”.

But the possibility that some parts of the system, under extreme stress, could start popping like popcorn is more realistic.

We’ve just had one of those once-in-a-generation events (the GFC). Outside of market upheaval the only significant implosion in this area was Trio Capital, which was due to fraud and not markets. (APRA-regulated funds have, or will, get their money back due to an industry-wide levy.)

While a government instrumentality and not specifically there for this purpose, the Reserve Bank of Australia is one of Australia’s better, and least-biased, think tanks.

The RBA has released its submission to the upcoming financial system inquiry, to be chaired by former Future Fund and Commonwealth Bank chief David Murray. The report numbers more than 250 pages, but a chapter is devoted to superannuation and the various threats it faces and benefits it provides.

The RBA looked at the links between the superannuation system and its entrenched links with the banking sector. It believes that the risks are fairly small. Indeed, the risks are certainly bigger that the banking system could collapse.

The structure of Australia’s superannuation, says the RBA, means there are several main factors that make the inherent risks of widespread disaster reasonably remote.

They are: low leverage, low concentration, and low interconnectedness.

Low leverage

Outside of SMSFs, which scored a separate mention, Australia’s super funds have little or no direct leverage, “which substantially reduces the risk of superannuation funds’ default, and a subsequent wealth shock to households”. The major impact of the GFC was really surrounding debt markets. The biggest impact on super funds was their exposure to ownership of assets that were geared, predominantly shares and property trusts.

Low concentration

Australia’s super funds, unlike many international pension and retirement funds, are not highly concentrated, so the risk of system-wide problems in the event of a small number of failures is not high. The RBA pointed out that the top five and top 10 funds accounted for 16% and 27% of total assets. (The downside of a broad base of the industry is higher average operating costs, it said.)

“The low level of concentration in the superannuation industry reduces the risk that the asset allocation choices of one or two relatively large superannuation funds could have wider implications for the superannuation industry or the financial system more broadly.”

Low interconnectedness

Through the 90s, banks have made acquisitions of wealth management businesses. However, the direct tie-ups between super funds is much lower than in the banking sector.

“Superannuation funds do not engage in trading with each other, whereas interbank borrowing and lending is significant. Given the low level of interconnectedness, the effects of financial distress of an individual superannuation fund are likely to be largely confined to that fund, and there is limited potential for the impact to spread to other funds and propagate through the broader financial system.” The RBA noted that funds often share the same service providers, such as custodians.

Concerns over recent developments

The bank then listed three major areas of concern in regards to superannuation.

The first was the ability of SMSFs to borrow to invest, particularly that some SMSFs might end up taking greater investment risk than they understand that they are taking. Those who gear, particularly into property, will also end up having concentration in a single asset.

Here, the RBA noted that where banks are lending, they are managing the risks by using prudent loan-to-valuation ratios, directors’ guarantees and minimum fund asset requirements.

Second, super funds have been on a hunt for yield and this could lead them into higher-risk assets such as private equity, hedge funds, unlisted property and infrastructure. “Increased demand for alternative assets could potentially lead to asset prices outstripping market fundamentals.

“Similarly, at least some of the increase in property investment by SMSFs is a new source of demand that could potentially exacerbate property price cycles.”

Third, the RBA commented on the recent increase in chatter about the potential to force super funds to allocate resources to help finance infrastructure assets.

Though not in the chapter on superannuation, the RBA made clear its position there. “The bank does not support suggestions that investment allocations could be imposed to meet funding targets for certain sectors and/or asset classes. Superannuation assets should be managed in the best interests of their members.”

That’s unlikely to quell the rising noise from those who would like to see super tapped for this purpose. But it’s succinct and it’s correct.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au

• The Australian Taxation Office’s new penalty powers could gather millions of dollars from SMSFs, according to Townsends Business & Corporate Lawyers. The firm expects the ATO to collect a minimum of $150 million in fines after July 1 this year when the powers come into effect.
• The Association of Superannuation Funds of Australia (ASFA) and the Australian Institute of Superannuation Trustees (AIST) have both called for tighter regulation of the SMSF sector in the submissions to the Financial System Inquiry. ASFA said SMSF trustees aren’t adequately protected against consumer risk under current regulation, while the AIST highlighted the systematic risk SMSFs pose to the entire sector.
• Meanwhile, the Institute of Chartered Accountants of Australia (ICAA) said any further regulation in the SMSF sector was unwarranted in its submission to the Financial System Inquiry. ICAA said the SMSF sector doesn’t need prudential regulation because it represents a “different model”, which is largely successful and well-functioning.