It’s been a big week for the Australian financial services industry. Firstly, there was the unusual decision by the big banks to raise mortgage interest rates in an economic environment which would normally result in no change or even a drop in rates, claiming with some justification that new capital adequacy requirements ‘forced’ them to do it. Secondly, there was the government’s generally positive response to the recommendations of Financial System Inquiry chaired by former CEO of the Commonwealth Bank, David Murray.
While I am supportive of most of the government’s responses, there are at least two that concern me.
The first is the decision to not support the recommendation of the FSI to ban gearing (borrowing) in Self-Managed Superannuation Funds (SMSFs). Typically, this is in the form of limited recourse borrowing to purchase real estate. This is not a marginal issue. The sector accounts for over 99% of all superannuation fund entities (of which, at June 2015, there were over 560,000). SMSFs are also the biggest single sector of the market, controlling over 30% of the $2 trillion in Australian superannuation savings.
Gearing introduces significant risk into the system and in some cases, high risk. While the level of gearing in SMSFs is not large at this stage, the trend is clear. Eventually, there will be individual financial tragedies, if not large scale public scandals. It’s only a matter of time which is why public policy action should be taken before the inevitable financial and political pain demands intervention to clean up the mess.
I respectfully suggest that decision makers have lost sight of why the SMSF sector was allowed to exist as a unique and relatively unregulated category in the first place. SMSFs (then called section 23F or ‘exempt funds’) were originally allowed by government in the 1980s as a simple ungeared safe harbour for Mum and Dad investors to place their retirement funds, in return for which they were promised limited regulatory intervention (in contrast to the heavily regulated APRA funds).
So if we are going to continue to allow gearing in SMSFs (which readers may recall was an unintended consequence of poorly drafted legislation designed to allow the Howard government to sell Telstra to SMSFs via warrants), we must consider whether:
- a) The people of Australia should be subsiding this form of gearing (often negative gearing) through the superannuation system; and
- b) Whether the amount of intervention and regulation by government should be increased to ensure the system isn’t compromised or rorted.
Having lived through 30 years of SMSF reforms, particularly in the early days when they were quite simply tax rorts with the ability to borrow and lend through all manner of direct and obscure techniques, I regret to say that increased regulation of SMSFs is inevitable. Of course, the response from supporters of gearing is simply that the regulator should get rid of the ‘rorters’, the ‘spruikers’ and the ‘bad apples’. That’s an easy thing to say, but as we’ve seen in the financial planning industry in recent years, doing so is never easy and always involves much cost which taxpayers will have to cover.
I suppose we can be at least thankful that the government has announced that it will monitor and formally review SMSF gearing within three years. Of course, we can be sure that changing anything at that time will be much harder, unless by then the industry has come in for a very hard landing (which legislative action in 2015 would avoid). Regrettably, we rarely seem to learn the lessons of the past.
On a more positive note, I was pleased to see the government’s agreement to the FSI’s recommendation to mandate higher education, an industry exam, a professional year and an approved code of ethics for financial planners/advisers. All of these initiatives are worthy courses of action which should be supported. However, we must not lose sight of the fact that ethics is the key to success for the new reforms. A university degree is a good idea because it makes a person more competent (I hope); but it certainly doesn’t make a person ethical and trustworthy. Adoption of (and adherence to) a set of ethical and professional standards does that.
This brings me to my second concern. What will the approved code/s of ethics contain? If they accept the continuity of %-based asset fees (aka commissions paid by clients), life insurance commissions and other product sales incentives allowed in the Future of Financial Advice legislation (2013/14), remuneration conflicts will continue and only a limited amount will be achieved for consumers of financial advice which, after all, is supposed to be the ultimate purpose of these reforms.
I’m reminded of the ‘agri-business’/’tree’ saga of recent sad memory. Many of the offending unethical advisers were members of my profession. That is, they were experienced chartered accountants or CPAs with relevant university degrees. All of them had done an exam (many exams actually), had undertaken a professional year (two years in some cases) and had signed up to a ‘stringent’ (but inadequate and mostly unenforced) code of ethics. So why did it all go so wrong? As always, the answer is the corrupting influence of conflicted remuneration. So this week’s announcement, whilst most welcome, is yet another case of “the devil will be in the detail”.
Good progress has been made. However, I remain concerned that gearing of SMSFs is an accident waiting to happen and that failure to comprehensively remove conflicted remuneration will cause the proposed reforms to fall far short of consumers’ expectations.
Robert M C Brown AM BEc (Syd), FCA
Robert Brown is a Sydney-based chartered accountant with over 30 years of experience in public practice. He is a member of the Australian government’s Financial Literacy Board and a director of Financial Literacy Australia Ltd, a not-for-profit company which provides grants for the development of community-based financial literacy programs. He was awarded membership of the Order of Australia for his work in the superannuation industry.