The recommendation by the FSI panel to remove direct leverage from superannuation may have delivered the final blow to limited recourse borrowing arrangements (LRBAs). Concerns about the growing use of leverage inside superannuation raised the attention of the FSI panel, in particular focusing on the increase in risk on Australia’s financial system that direct borrowing provides. With Australia’s retirement system built on a foundation of savings, not leverage, the recommendation by the FSI panel is to remove section 67A of the SIS Act prospectively. This reference aims to reinstate the existing borrowing provisions contained within section 67 to simply short-term liquidity management purposes (eg. settlement of securities and payment of benefits).
The FSI panel has noted the continued interest and growth of LRBAs, with total amounts borrowed increasing from $497 million in June 2009 to $8.7 billion in June 2014. The recommendation seeks to address the issue, as the FSI Panel believes, that whilst leverage is in its infancy within superannuation, further growth of direct borrowing would over time, increase risk in the financial system.
The limited recourse nature of these borrowing arrangements delivered protections for superannuation monies by limiting the exposure of member’s retirement savings to the acquired asset. However, because of these higher risks associated with such lending, lenders had the ability to charge higher interest rates and frequently required personal guarantees from trustees. Even with mechanisms in place to limit a fund’s exposure, the panel highlighted that under financial duress with these arrangements, it is likely that the trustees will sell other assets of the fund to repay the lender, particularly where a personal guarantee is involved. As a result, LRBAs are generally unlikely to be effective in limiting losses on one asset from flowing through to other assets, either inside or outside the fund. The fact that this potential ‘downside’ is effectively being underwritten by taxpayers through the Age Pension system is also of concern.
Stability of Australia’s largely unleveraged superannuation system was important throughout the global financial crisis (GFC). The absence of leverage broadly benefited fund members and enabled the superannuation system to have a stabilising influence on the broader financial system and economy during the GFC. Although the level of direct leverage is relatively small, if left to continue to grow at current rates (18 times growth over last five years) it could pose a risk to the financial system in the future. The Reserve Bank of Australia (RBA) stated that “The Bank endorses the observation that leverage by superannuation funds may increase vulnerabilities in the financial system and supports the consideration of limiting leverage”. In addition, such direct borrowing could also compromise the retirement incomes of individuals. The Australian Prudential Regulation Authority (APRA) was of the view that “… the risks associated with direct leverage are incompatible with the objectives of superannuation and cannot adequately be managed within the superannuation prudential framework.”
Overarching these concerns, the panel also expressed the view that borrowing by some superannuation funds also provided scope for members to circumvent contribution caps and accrue larger assets in the superannuation system in the longer term.
As a result, the FSI panel has concluded that direct borrowing by superannuation funds should cease and be restored to the original prohibition (prior to 24 September 2007). It is inconsistent with the objectives of superannuation to be a savings vehicle for retirement income, and discontinuing direct borrowing would preserve the strengths and benefits of the super system and limit the risks to taxpayers.
Whilst acknowledging proposed alternatives to reduce the risks surrounding borrowing, it was found that such alternatives would impose additional regulation, complexity and compliance costs on the superannuation system.
Should the federal government look to implement this recommendation, funds with existing borrowings should be permitted to maintain those borrowings. Funds disposing of assets purchased via direct borrowings would be required to extinguish the associated debt at the same time.
So, is this the end of the road for LRBAs? The 44 recommendations have now been released by Treasury for public consultation until 31 March 2015. I suspect the white flag by the super industry hasn’t been fully raised yet, but it would appear that a significant amount of work will be required for it to survive.
This originally appeared on Aaron Dunn’s blog, The Dunn Thing.
If
1) leverage (interest rate risk) and
2) lack of diversification (concentration risk)
are the risks the FSI wishes to address, getting rid of LRBA’s will address neither. Investors set on investing in leveraged property will still be able to have 100% of their funds exposed to property and those wishing to access leverage assets can access by purchasing investment vehicles permitted to leverage.
How about simple prudential guidelines? Say no more than 75% of a fund NAV in a single asset class; No more than 30% of fund NAV in leverage..? Then superannuation playing fields, SMSF v industry v institutional will be the same.
If they ban LRBAs it would be just as logical to ban investment by SMSFs – and all superfunds – in Australian public companies with borrowings. After all, isn’t that what limited liability is?
But far more serious is the threat to imputation. Imputation helped Australia survive the GFC. It is logically sound.
To abolish it would be to drive a flood of money offshore.
Lets try this. Wherever the word SMSF, super or fund is replace it with individuals. Then ask would we ban this if it was done by individuals, as it can currently being done. Also how do you circumvent the contribution caps, as the caps are still in place, all you are doing is borrowing and using todays dollars and repaying them out of future dollars. No cap circumvention. Anyone who has done a LRBA with a bank recently knows that the risks are no higher for the bank due to LVR and the requirements to satisfy the loan. These are generally tighter than for loans taken out by individuals.
This is just a policy driven by public offer and industry funds to try and preserve their funds under management. The retirement savings of individual will not be compromised as the individuals who want to do this will do it outside of super if they cannot do it inside of super where the benefits of higher super savings increases benefits to the country by lower or no centrelink age pension
If the all knowing powers-that-be:
. remove borrowing within SMSF’s
. remove negative gearing
. remove being able to withdraw a lump sum
. they will have destroyed SMSF’s
. keep shifting the goal posts
. then I will close my SMSF down.
Two simple rules
1) bank can only receive monies from the settlement of the property sale to satisfy its debt from the SMSF or funds/sources genuinely outside SMSF 90 plus days before settlement.
Most people will not be able to withdraw other SMSF funds as too young.
2) Back up rule to say if monies for personal guarantee were sourced from sale of other SMSF assets either via illegal early release or pension bank has to refund to SMSF which will become clear at SMSF audit time if not earlier.
Highly likely bank with LRBA also has the SMSF cheque account so they will see if guarantees were funded by other SMSF asset sales. This strikes me as a very very easy thing to solve. Certainly if critics are going to say that this is too complex then boy oh boy are there a lot of rules in SIS act that need scrapping on basis of complexity before the above.
Overarching these concerns, the Panel also expressed the view that borrowing by some superannuation funds also provided scope for members to circumvent contribution caps and accrue larger assets in the superannuation system in the longer term
So if I read that correctly they are concerned by gearing and increasing potential gains people will retire with too much super. Wow I have never heard the words I have too much superonly too little super .
The banks are caught in the middle here. On one hand the loans are good for them. They have large LVR , property has never fall by 20 % in Australia and most of the payments are funded by SGC so even if investor terrible saver it is paid ? However they are losing money out of their wealth management arms .
People should be given the option to do it if they like and if t banks see them as a good risk stop protecting industry funds
Yet another attack on SMSFs! It may be true that some SMSFs have struggled but is this a good reason to ban it altogether? As it is only around 65% of the purchase price can be borrowed: Isn’t that a sufficient buffer? Will mortgage brokers be banned from arranging loans for 100% of the purchase price of a property?