Rachel Alembakis talks to Ross Jones of the Australian Prudential Regulation Authority about how it has coped with the economic downturn
Rachel Alembakis: From APRA’s perspective, what have been the biggest challenges about two years of volatility in markets for superannuation funds?
Ross Jones: Liquidity risks overall and solvency risks for defined benefit funds have been the crucial issues. One of the issues is that many of the funds haven’t thought about liquidity before – they’ve been so busy thinking about fund choice and portability and all the other things going on over the past few years, they hadn’t given a lot of thought to liquidity. We sent updated guidance to the industry late last year on the liquidity issues.
With regards to the defined benefit (DB) funds, it’s been different. For DB funds, the issue has been about solvency. With declining stock values and some employers under pressure, that’s been one of the real focuses with DB funds now. We’re looking at quarterly surveys of their positions, and we’re looking more at sub-funds within the funds these days as well.
In a volatile market, if markets bounce back very quickly, the solvency position bounces back that much faster
Some superannuation funds, depending on the nature of the fund, have been a hybrid with some defined benefit funds within the overall superannuation fund. In the past we looked at the fund at the portfolio level, but now going down to the sub-fund level. The solvency of DB funds has always been a issue, and now more so with substantial falls in shares markets. There are also a larger number of sub-funds now than before because of consolidation.
Rachel Alembakis: Are there any defined benefit funds that are technically insolvent?
Ross Jones: There aren’t any funds that can’t pay benefits, but some funds are technically insolvent in that they have fewer assets than can meet the minimum benefits. That’s not surprising, simply given the way the accounting processes work for DB funds, plus there has been a substantial fall in share markets.
We’ve been asking for more information to look at their strategies, their investment policies and how long they predict it will take for the defined benefit fund to return to solvency. Keep in mind, in a volatile market, if markets bounce back very quickly, the solvency position bounces back that much faster.
Rachel Alembakis: What have APRA’s biggest concerns been around the prudential management of superannuation funds? Have the past two years highlighted any new concerns?
Ross Jones: Once again, I would say liquidity. For so long, many of the trustees thought that liquidity isn’t an issue. Funds are long-term investors and have been getting the superannuation guarantee (SG), and were thinking, given the SG, what sort of liquidity concerns can we have?
Because people can move between fund options and between funds thanks to choice, liquidity is something that has to be managed. You now find, that some of the funds are moving more from the straight accumulation phase to reaching into the payout phase, so what we’re finding is that there’s a greater focus needed on the area.
Another area we’re looking at is the applications for relief. Under the 30 day rule, if the fund finds they can’t meet the 30 day rule for portability, they have to apply to APRA for relief. Some 22 trustees have applied for relief, that’s about 50 funds. There are 300 (APRA licensed) trustees and the number of funds is significantly greater than that. At the same time, the switching activity still has been very low by volume. There was switching late last year from higher risk options into cash – but that seems to have slowed down; people have been quite sensibly advised that switching into cash right now is a bad idea; you’ve left it too late.
The other area of focus has been valuation risk associated with unlisted assets. More and more funds have increased their exposure to private markets. The assets are difficult to value and the risk of inaccurately valuing them rises when markets are volatile. That has an impact on members going in and coming out. We’re encouraging funds to in fact look at valuations more frequently as circumstances demand for unlisted assets.
Rachel Alembakis: From APRA’s perspective, have superannuation funds done enough to guarantee reserves to cover operational errors?
Ross Jones: In a general sense, it’s good to see funds have started to look at this as an issue to provide reserving for operational errors. Whether they’ve done enough depends on individual circumstance. I’m sure the funds would say, if they’ve had no errors, then the reserves aren’t necessary. I think there’s no doubt that the funds are more aware of this than they have been in the past.
Rachel Alembakis: APRA were ahead of the curve last year in warning/assessing the industry about liquidity concerns. A year on, is APRA satisfied with superannuation funds’ responses to liquidity risks?
Ross Jones: It’s true that we anticipated issues early on, and that was good. It was good to be ahead of the curve and anticipate the issues. In terms of the information we received (by surveying the superannuation funds in early 2008), we would have found it useful to keep more up to date info as well... It was quite a comprehensive survey and we’ve learned a lot from it. It also encouraged the funds to look far more closely at the nature of their liquidity risk management issues, particularly given the events of recent months, I think it was good we went out early last year.
Rachel Alembakis: Will APRA send out another survey to trustees to follow up on liquidity issues?
Ross Jones: That’s something that’s being built more into the regular prudential reviews, something certainly that will be on the radar now on a regular basis... I think, it’s a fair enough point to make that not every fund was aware of liquidity management as it could have been.
Rachel Alembakis: APRA’s supervisors are responsible for monitoring and communicating with superannuation funds – each supervisor has as certain number of funds on their case load. Did the model work in terms of keeping track of funds during the volatile market periods?
Ross Jones: What we found that the funds have been very cooperative during the crisis. The relationship is quite good in the sense that the funds have been quite willing to talk to the supervisors about any circumstances that they may have experienced.
Rachel Alembakis: With two years of negative returns and various government reports/investigations into the superannuation industry, there has been an underlying uncertainty around the industry, as expressed by confidence polls. From APRA’s perspective, are there concerns about the sustainability of the superannuation industry?
Ross Jones: Our approach is the quality of supervision rather than the government reports and so on. I think, there’s no doubt that the poor performance of superannuation impacts on people’s view on it, but those views turn around when markets pick up.
I think one of the really positive things is we introduced a system of licensing from 2004 to 2006. As part of that license, trustees had to have far more complex risk management approaches than they had previously. This has held the funds in good stead. What we finished up with at the end of the licensing period were quality trustees. That’s held us up well, I think, over the past 18 months.
Rachel Alembakis: What are the most pressing issues short and long term that the superannuation industry must address?
Ross Jones: I think that liquidity is going to be an important issue for some time to come. Super funds will have to address liquidity at the investment option level. Liquidity will have to be managed at that level as well, which will introduce extra issues for the fund.
It comes to that earlier point – a lot of funds hadn’t given a great deal of thought to liquidity because the emphasis was on money coming in and giving adequate return on the money coming in.
As the funds get larger and larger, the funds themselves become more systemically important – as the big funds become major financial institutions, they’re going to be supervised as if they were major financial institutions. It will be more in line with the type of supervision that major banks experience. A long way to go until we get to, say, 50 large funds, but consolidation will keep on going. That’s just natural.
I think there’s going to be an expectation that the nature of the investments will change as funds become larger – they will become more complex. The quality of the management will need to step up as they get into more complex products and so will the nature of our supervision, I think. We’ve already seen that. As the industry gets into far more complex financial products, as the industry gets into more and more unlisted products, the nature of the funds change, and consequently the nature of the supervision has to change accordingly.
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