The final report of David Murray
’s Financial Systems Inquiry (FSI) has advised the government to prohibit certain direct borrowing arrangements by superannuation funds.
The report recommended that the government should restore the general prohibition on direct borrowing for limited recourse borrowing arrangements (LRBA) by superannuation funds, by removing Section 67A of the Superannuation Industry (Supervision) Act 1993
According to the Inquiry, there is an emerging trend of superannuation funds using LRBAs to purchase assets. Over the past five years, the amount of funds borrowed using LRBAs increased almost 18 times, from $497 million in June 2009 to $8.7 billion in June 2014. Although the level of borrowing is still relatively small, if direct borrowing by funds continues to grow at high rates, Murray warns it could pose a risk to the financial system over time.
“Borrowing, even with LRBAs, magnifies the gains and losses from fluctuations in the prices of assets held in funds and increases the probability of large losses within a fund. Because of the higher risks associated with limited recourse lending, lenders can charge higher interest rates and frequently require personal guarantees from trustees.
“In a scenario where there has been a significant reduction in the valuation of an asset that was purchased using a loan, trustees are likely to sell other assets of the fund to repay a lender, particularly if a personal guarantee is involved.”
As superannuation funds use diversification to reduce risk, selling the fund’s other assets in such a scenario will concentrate the asset mix of the fund. This reduces the benefits of diversification and further increases the amount of risk in the fund’s portfolio of assets, according to the Inquiry.
The report does state, however, that the exception of temporary borrowing by superannuation funds for short-term liquidity management purposes should remain. This ensures that superannuation continues to be a savings vehicle for retirement income, rather than a broader wealth management vehicle.
The Australian Institute of Superannuation Trustees (AIST) said the move to ban recourse borrowing was sensible.
“A major benefit of super for the Australian financial system is that it is not leveraged and is not significantly exposed to residential property, which households, banks and insurers are to a very high degree,” AIST CEO Tom Garcia said.
While the SMSF
Professionals’ Association of Australia said they don’t believe there is scope to prohibit LRBAs in the current environment.
“SPAA remains firmly of the view that there is scant evidence of abuse of LRBAs to date, but can appreciate the FSI’s position if leverage in superannuation did grow to a level where it could be a threat to people’s retirement savings,” Graeme Colley, Director of Technical and Professional Standards at SPAA said.