The Murray Inquiry released on 7 December 2014 has put SMSF trustees on notice that direct borrowing may soon be prohibited. The recommendation contradicts the previous policy move in 2007 which saw section 67A of the SIS Act introduced to permit borrowings through limited recourse borrowing arrangements (LRBA’s). So why the backflip?
More and more Australians are using an SMSF to control the way their retirement savings are invested with over one million Australians now members of an SMSF. Superannuation legislation permits borrowings in specific circumstances and only on a limited recourse basis to minimise the risk of loss to fund assets as a result of a loan default. These limitations aim to ensure losses are quarantined to one single asset and do not place the entire asset pool of the SMSF at risk due to one bad investment.
The Murray Inquiry suggests that trustees are taking advantage of the borrowing provisions to highly leverage property and quotes APRA’s view that “…the risks associated with direct leverage are incompatible with the objectives of superannuation and cannot adequately be managed within the superannuation prudential framework.”
The Murray Inquiry makes a valid observation in that the requirement of lenders to obtain personal guarantees from SMSF trustees can erode the quarantining of losses that LRBA’s seek to achieve. It also correctly remarks that superannuation funds must use diversification to reduce risk.
It is our view that banning borrowing by SMSFs is throwing out the baby with the bathwater. The ATO figures for March 2014 show that SMSFs had $558,553 million invested in Australian and overseas assets. For the same period, limited recourse borrowing arrangements totalled $2,781 million or 0.5% of the total asset pool.
Additionally, trustees are already required to exercise care, skill and diligence, perform their duties and exercise their powers in the best interests of the beneficiaries and to formulate and implement an investment strategy for the fund, having regard to liabilities, risk and return, diversification and liquidity.
While property spruikers continue to sell high risk investment strategies, these are likely to be reduced with further regulation in the financial advice sector.
Some alternate policy initiatives could include:
- Requirements for diversification within SMSFs to ensure there are minimum levels of non-leveraged assets such as cash and bonds.
- Maximum leverage levels at say 70% of a property value to minimise the risk of loss as a result of a fall in the real estate sector.
- Removal of personal guarantees by trustees.
There is some comfort in the recommendation that “funds with existing borrowings should be permitted to maintain those borrowings.” Both the current Government and the Opposition have flagged that they will take the Christmas break to consider the report and any unintended consequences of the recommendations. With the Murray Inquiry set to frame legislative direction for years to come, it is unclear when these recommendations will be debated and what the likely outcome will be.
Watch this space and as always, if you have any SMSF related queries, please do not hesitate to contact our team.