Superannuation funds are subject to significant restrictions on borrowing. These have been relaxed in recent years by allowing limited recourse borrowings subject to special conditions to enable funds to acquire geared assets such as property, shares and managed funds. Even before such borrowings were permitted, there was nothing to prevent a super fund from investing in geared managed funds, to access the benefit of leverage in a rising market.
The impact of the legislative restriction on super fund borrowings was most noticeable from the latter part of 2008, when the GFC struck. As confidence dissipated, discretionary flows by way of voluntary post-tax and salary sacrificed contributions dried up due to diminishing returns and confidence. Many mortgage funds stopped redemptions altogether, and this flowed through to the super funds, which invested in them. Many industry funds, which had invested in large and lumpy infrastructure assets, found themselves illiquid, unable to pay lump sum and pension benefits and making intra-fund rollovers.
The affected funds were forced to seek APRA approval to delay or freeze payments, as they realised that they needed liquidity not only at a fund level, but also at investment option level to avoid inequity and transfer pricing issues. APRA had, in reality, no choice but to approve such requests – declining them would have risked destroying market confidence further.
As funds also feared that the situation of ongoing illiquidity could continue indefinitely, they hoarded their investible funds as ‘hot money’ in the banking system.
The memories of such illiquidity are fading as markets recover. Regulatory exhortations about rigorous asset-liability processes, use of specific options as virtual liquidity providers and adequate disclosure tend to be forgotten in normal times.
One solution for super funds which are allowed to borrow to pay benefits under the Superannuation Industry (Supervision) Act, is a line of credit facility that can be activated if the underlying assets have intrinsic value, but insufficient buyers, which should serve to stabilise the market. The terms of such a facility would reflect the asset composition, past market behaviour in times of stress and expected risk of access. Loans could be collateralised on all the underlying assets that would otherwise have been used to pay benefits, in a manner similar to the ‘covered bonds’ being issued by banks. Further collateral could be provided to lenders by factoring a portion of trustee fees payable by members. The lending terms would also have to incorporate the ability to roll-over the facility until repaid.
Such a risk management tool does not appear to have been attempted in the past. However, similar to the existing arrangements between the major banks that they could tap into in the event of a ‘run’, a structure can be put in place to protect the lender with regards to the solvency of the borrower, while stabilising a fund to allow orderly withdrawals.
A solution involving a number of super funds acting together to calm the markets in the event of a ‘run’ on the system would appeal to the authorities as well and would improve proactive risk management. In a sense, given the preserved nature of super, liquidity management should be simpler than in banking, whereby depositors have an unlimited ability to exit.
As the saying goes, 'the best time to repair your roof is when it is not raining’. We cannot afford to wait until the next liquidity crunch.
Will the superannuation industry, which is poised to dominate the financial services landscape in the future due to its continued mandated growth, accept its emerging importance among financial services and innovatively upgrade its risk management practices?
Ramani Venkatramani is a consultant at The Risk Board
