Trustees of superannuation funds are finding it increasingly difficult to identify appropriate investment opportunities for the substantial resources now invested in superannuation.
Recent changes made to section 67 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) to allow fund trustees to invest in instalment warrants without breaching the prohibition on borrowing have clarified the capacity of fund trustees to invest in instalment warrants, a relatively common investment product for fund trustees wanting to buy listed securities using leveraged arrangements. Interestingly, the amendments are not expressly limited to instalment warrants, but apply to any arrangement that has the following characteristics:
- a limited recourse loan to the fund trustee;
- a security trustee that holds the underlying asset on trust; and
- the fund trustee holding a beneficial interest in the relevant asset, with the capacity to obtain legal title on the repayment of the loan.
A fund trustee that enters into an arrangement with these features relating to an asset the fund trustee could invest in directly without breaching the in-house asset rules, will not breach the prohibition on borrowing. A consequential amendment has been made to the SIS Act so the security trustee that holds legal title to the asset can be a related party of the fund trustee without the arrangement constituting an investment in a related trust in breach of the in-house asset rules.
As the legislation does not require the arrangement to be an instalment warrant, fund trustees can utilise the amendments in other geared arrangements to purchase substantial assets, provided the arrangement complies with the amendments in section 67(4A) and the other prudential standards of the SIS Act discussed below. There may even be some capacity for the entire arrangement to be undertaken “in-house” between entities within the same corporate group, with the entities related to the fund trustee acting as security trustee and the issuer of the loan.
Despite the increasing investment opportunities afforded by these amendments, trustees must still be mindful of other regulatory requirements under the SIS Act when considering such investments, notably the sole purpose test and the fund’s investment strategy. It is clear from the guidance notes released by APRA (and more recently, by the ATO in relation to self-managed superannuation funds) that a fund trustee’s continuing compliance with the sole purpose test in section 62 of the SIS Act is inextricably linked with its obligations under the investment strategy covenant in section 52(2)(f). The fund trustee must have regard to the core purposes for which the fund is established when considering any investment of fund assets. In addition, section 52(2)(f) explicitly states that a fund trustee must have regard to issues of risk and return, diversification, liquidity and its capacity to discharge its liabilities when determining the investment strategy for a fund. The most likely application of section 67(4A) of the SIS Act will be in the geared acquisition of real property. As the investment will generally be an illiquid asset, the fund trustee will have to carefully consider the impact the investment will have on the fund’s portfolio balance.
The kind of geared property acquisitions that can be made under section 67(4A) will be considered derivatives(if structured as warrants rather than credit facilities), both for the purposes of the licensing and disclosure obligations under Chapter 7 of the Corporations Act 2001 (the Act) and under the SIS Act. An “in-house” arrangement structured to comply with section 67(4A) of the SIS Act will fall outside the scope of Chapter 7 of the Act if it involves special purpose vehicles that do not conduct a financial services business. And while a warrant will not be the type of derivative regulated by SIS Regulation 13.15A, the trustee will still need to ensure that its Risk Management Strategy (RMS) addresses the matters set out in Superannuation Circular II.D.7 for fund trustees that invest in derivatives. We would expect that the RMS would consider issues of risk exposure and liquidity resulting from the geared investment, as well as the fund trustee having a direct exposure to tax liabilities and interest rate risk that it may not be subject to when investing through interposed vehicles such as pooled superannuation trusts.
The changes to superannuation brought about by the Better Super reforms mean there is likely to be an increasing pool of fund members with vested benefits that can make substantial lump sum withdrawals at short notice. Fund trustees have to be conscious of the levels of liquidity within their funds to ensure they can meet demands for withdrawals.
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