Editorial - Super changes . . . are they warranted?

Back on 24 September 2007, amendments to the Superannuation Industry (Supervision) Act relaxed the borrowing restrictions on trustees of super funds by allowing the use of instalment warrants to fund the purchase of a broad range of investments. Instalment warrants allow super fund trustees to borrow money on a limited recourse basis to buy an asset that is to be held on trust for the super fund. If the super fund defaults on this type of borrowing, only the asset acquired with the borrowed money will be at risk. The super fund’s other assets are unaffected if the trustee wants to walk away from its investment funded through the use of an instalment warrant.

The lender’s security is limited to the investment asset only.

The breadth of these changes was unexpected and came without warning to those in the industry. Many are questioning whether the Howard government, which introduced the change in policy, went too far. Most expected the changes to legalise the use of instalment warrants over shares. Until this point the use of instalment warrants to purchase shares had grown rapidly but had no legislative support and was permissible only because of a longstanding administrative practice by APRA.

On 4 April 2008 the Tax Office finally released guidance on how self managed super funds (SMSFs) could use instalment warrants to buy investments other than shares. The Tax Office, as the regulator of Do it Yourself SMSFs, had to as a matter of course publicly communicate its interpretation of the present law. In doing so, it also reminded trustees of SMSFs that aggressive practices associated with the policy changes would not be tolerated.

Since the changes there have been a plethora of commercial organisations offering instalment warrants on all sorts of investments. Gearing in some of these products can be quite high whilst others are more conservative. Financial organisations and planners have another product to sell into the burgeoning SMSF market and are taking advantage of this opportunity. There are quite a number of firms which have set up geared property investment products that operate similarly to instalment warrants and which do not now breach the prohibition on borrowing by super funds.

The main advantage of the changes for trustees is the ability to gear directly into investments such as property instead of through structured vehicles that were internally geared (such as geared managed funds or unit trust arrangements).

The Minister for Superannuation and Corporate Law, Senator Nick Sherry, has highlighted the danger associated with using “sophisticated” financial investment products that are increasingly being marketed to SMFSs. He also acknowledged his responsibility to monitor this area and did not rule out the possibility that the Labor Government may make further changes. Senator Sherry has already instigated a review of the DIY SMSF industry and has called for submissions to be made by the end of April.

This review could quite easily make changes or reverse the borrowing prohibition altogether, so the current relaxation of the rules may be short-lived. At the end of the day, does the Government want to allow geared investments in super funds, and if so, for what type of products will gearing be permissible? Gearing any investment introduces more risk but offers greater rewards and this is the trade-off that needs balancing to maintain the security of superannuation savings.