Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 14

APRA confirms SMSFs as retail but public funds stranded

 

Anyone responsible for product design and pricing in the superannuation industry needs an understanding of the revised Australian Prudential Standard (APS 210) on bank liquidity. There are implications for deposits placed with banks regardless of the maturity.

On 6 May 2013, APRA released its latest version of the bank liquidity risk management framework to apply to Australian banks (and other ADIs). The previous version was issued in November 2011, and has been the subject of heated debate in Cuffelinks.

As Cuffelinks is focussed on the wealth management industry, this paper is not a general summary of the proposals, which can be found here. Rather, we comment specifically on the implications for financial advice, investments, superannuation, SMSFs and portfolio construction.

The most important points are:

  • The Basel Committee recently announced it was allowing a gradual phase-in of the major liquidity requirements, delaying full introduction until 2019. However, APRA is sticking to the original timetable, due to the strength of Australian banks, with introduction of the Liquidity Coverage Ratio (LCR) on 1 January 2015, without any phase-in. Banks are already changing their products and pricing as a result.

  • After the November 2011 APRA release, there was conjecture about the favourable treatment given to SMSFs versus public superannuation funds. However, there was not much lobbying by the publicly-offered super fund industry and APRA has confirmed the previous advice.

A reminder of what the issue is. The proposed Prudential Standard is designed such that deposits from large publicly offered superannuation funds will be considered volatile, wholesale money, against which banks will be required to hold expensive liquid assets under the LCR test. This will make the banks less willing to pay competitive interest rates on deposits from major public super funds. But SMSFs have been granted a special exemption which categorises them as retail deposits, giving them a regulatory free kick.

This is the most important point, and the one made in my submission to APRA. Here is their exact response:

“A number of submissions argued for amendments to the treatment of funds received via an intermediary as that treatment would result in differential outflow rates being applied by ADIs to an equivalent customer depending on the source of the deposit. This issue was raised, in particular, in relation to deposits received from SMSF customers rather than via APRA-regulated superannuation funds.” 

That's a clear statement of the issue, and this is APRA’s decision (from the Discussion Paper):

“For deposits sourced via an intermediary, where the intermediary retains investment responsibility or has a fiduciary duty to the underlying customer, APRA considers it is appropriate to assume the intermediary will observe the responsibility and duty in a time of liquidity stress. This fiduciary duty is not removed when customers have an investment discretion when initiating an intermediated deposit. Accordingly, these deposits are most appropriately classified as being sourced from a financial institution, regardless of the nature of the customer placing funds with the intermediary. This interpretation will not affect SMSF deposits; SMSF deposits are considered to be those of a natural person and not sourced via an intermediary.”

This interpretation will not affect SMSF deposits, which are judged to be from a natural person and not sourced via an intermediary.

When Cuffelinks reported on this issue previously, some people claimed I had misunderstood, but APRA has made my interpretation clear. Banks will need to hold expensive liquid assets to support any deposit from a public super fund which matures within 30 days. This includes billions of dollars of at-call deposits placed in super funds in recent years.

  • APRA divides retail deposits into stable (with a 5% run-off assumption) and less stable (with a run-off assumption of up to 25%). SMSFs will be in the less stable category for the following reason:

  “A self-managed superannuation fund (SMSF) depositor is considered to be a self-selected, financially sophisticated individual who is undertaking an asset allocation investment choice.

   This activity is not consistent with the description of typical activity under a transaction account, as outlined in paragraph 36 (b) in Attachment A of APS 210. As a result, the deposit of an SMSF customer is to be g   categorised as less stable.”

  But it will still receive the favourable retail treatment, and this should not be confused with the issue that a public superannuation fund is assumed to have a 100% run off inside 30 days.

  • The classification of superannuation funds as financial institutions while SMSFs are retail not only has implications for the calculation of the Liquidity Coverage Ratio (LCR), but also a longer term standard, the Net Stable Funding Ratio (NSFR). Again, any deposit classified as retail will qualify as a long term deposit, while those from a financial institution are more volatile short term. This is important because the NSFR treatment will apply to term deposit with maturities longer than 30 days.

  • There are other implications of APS210 for term deposit offers, especially on superannuation platforms which offer bank deposits. Here is APRA’s view (Attachment A of APS210):

 “Retail fixed-term deposits

 The maturity of fixed or time deposits with a residual maturity or withdrawal notice period of greater than 30 days will be recognised (i.e. excluded from the LCR) if the depositor has no legal right to withdraw deposits within the 30-day horizon of the LCR, or if early withdrawal results in a significant penalty that is materially greater than the loss of interest.

 If an ADI allows a depositor to withdraw such deposits despite a clause that says the depositor has no legal right to withdraw, the entire category of these funds would then have to be treated as demand deposits.”

How will a public super fund which allows online withdrawals from all its products cope with this? With the development of platforms and wraps, most currently allow immediate access to both managed funds and term deposits, but this will need to be prohibited for term deposits in order to achieve the favourable liquidity treatment. Furthermore, this is not simply a matter of form over substance, and APRA has indicated it will test whether banks are actually giving early access even if the investor has no legal right. This is a bigger issue than simply a systems redesign, as it goes to the heart of access to funds via a platform, including switching and rebalancing facilities.

 

Timing and implications

APRA intends the new prudential standard to come into force on 1 January 2014, with the LCR on 1 January 2015 and NSFR on 1 January 2018. However, the consequences will be felt much earlier in product design and pricing, as banks move to adjust their funds transfer pricing systems to send the right signals.

Management of the LCR obligations will take many forms, but some early product responses include:

  1. Offering a ‘cash’ deposit with a 31 day withdrawal notice period. This development has already surfaced, driven by the changing rules. For example, Investec has a product called a Liberty Notice Account that offers a higher rate and no fees provided 32 days withdrawal notice is given.
  2. A superannuation fund could make an agreement with a bank not to call a deposit inside 31 days, but allow clients to access the funds ‘at call’. This involves a maturity risk that would need careful management, such as holding a liquidity buffer to meet client withdrawals based on estimated net outflows, which would be tested by an unexpected run of short term withdrawals. In one conversation with APRA, this structure was not well received, and was called a ‘device’.

Bottom line is that public superannuation funds offering bank deposits may face worse rates from the banks than retail deposits and SMSFs, and they will have to exercise their creativity to avoid a new product structure raising the ire of APRA.

3 Comments
Greg Einfeld
May 10, 2013

The benefit of SMSF's over retail funds you are describing already exists today, and I'm surprised it doesn't get more publicity. The defensive part of a retail balanced fund is usually invested into government bonds, earning say 3.2% p.a. on a prospective basis. SMSF's usually invest the equivalent into term deposits, earning say 4.2% p.a. One might ask - "why don't the retail funds invest into term deposits?". The answer is: The banks don't want institutional money for liquidity reasons. Imagine the AMP Super Fund walked into a Westpac branch and asked to withdraw $1 billion. The implication is that SMSF's can earn 1% more on the defensive part of their portfolio than retail funds. Another win for SMSF's, and another reason that SMSF trustees should think carefully before investing into managed funds.

Chris
May 10, 2013

Greg, this article is referring to member-directed deposits. Most Superfunds offer more than just balanced and growth funds. They offer members the ability to take control of their super and allocate their investments across a variety of options, including at call cash and term deposit options. In some instances, they also offer the member the ability to self-select into shares. What this article relates to is where a member self-directs into a deposit, irrespective of whether they are an SMSF or a member of a large super fund, that APRA should treat the depsoits on the same basis.

Greg Einfeld
May 10, 2013

Chris - thanks for your comment, yes I am well aware of the purpose of this article. The fact is that most members of public offer funds have most of their assets in diversified funds, where they are investing around 30% in government bonds that are earning less than what they could earn in term deposits. You are correct in stating that some public offer funds do offer term deposits as an investment option. However, as the article describes, banks will need to hold additional capital to support those term deposits, which will reduce the return that public offer funds can offer to their members. And rightly so - it would be dire for a bank if the trustees of a large public offer fund suddenly removed the ability for members to re-invest their deposits with that bank.

 

Leave a Comment:

     

RELATED ARTICLES

Is this the end of the traditional term deposit?

Health warning: long and technical discussion for bank liquidity geeks only

APRA helps SMSFs but large super funds left hanging

banner

Most viewed in recent weeks

How to enjoy your retirement

Amid thousands of comments, tips include developing interests to keep occupied, planning in advance to have enough money, staying connected with friends and communities ... should you defer retirement or just do it?

Results from our retirement experiences survey

Retirement is a good experience if you plan for it and manage your time, but freedom from money worries is key. Many retirees enjoy managing their money but SMSFs are not for everyone. Each retirement is different.

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Fear is good if you are not part of the herd

If you feel fear when the market loses its head, you become part of the herd. Develop habits to embrace the fear. Identify the cause, decide if you need to take action and own the result without looking back. 

Latest Updates

Economy

The paradox of investment cycles

Now we're captivated by inflation and higher rates but only a year ago, investors were certain of the supremacy of US companies, the benign nature of inflation and the remoteness of tighter monetary policy.

Shares

Reporting Season will show cost control and pricing power

Companies have been slow to update guidance and we have yet to see the impact of inflation expectations in earnings and outlooks. Companies need to insulate costs from inflation while enjoying an uptick in revenue.

Shares

The early signals for August company earnings

Weaker share prices may have already discounted some bad news, but cost inflation is creating wide divergences inside and across sectors. Early results show some companies are strong enough to resist sector falls.

Property

The compelling 20-year flight of SYD into private hands

In 2002, the share price of the company that became Sydney Airport (SYD) hit 80 cents from the $2 IPO price. After 20 years of astute investment driving revenue increases, it sold to private hands for $8.75 in 2022.

Investment strategies

Ethical investing responding to some short-term challenges

There are significant differences in the sector weightings of an ethical fund versus an index, and while this has caused some short-term headwinds recently, the tailwinds are expected to blow over the long term.

Investment strategies

If you are new to investing, avoid these 10 common mistakes

Many new investors make common mistakes while learning about markets. Losses are inevitable. Newbies should read more and develop a long-term focus while avoiding big mistakes and not aiming to be brilliant.

Investment strategies

RMBS today: rising rate-linked income with capital preservation

Lenders use Residential Mortgage-Backed Securities to finance mortgages and RMBS are available to retail investors through fund structures. They come with many layers of protection beyond movements in house prices. 

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.