SMSF LRBAs should be a financial product, says Cavendish

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Cavendish - Financial System Inquiry (FSI) - SMSF borrowingCavendish, the SMSF administrator, has argued for a number of changes to LRBAs rather than a ban on SMSF borrowing, in a submission to the Financial System Inquiry.

SMSF borrowing

Cavendish draws a distinction between “traditional style” borrowings and the limited recourse borrowing arrangements (LRBAs) of SMSFs. “These differences mean the level of systemic risk posed by direct SMSF leverage is not the same as the level of systemic risk posed by direct leverage outside of superannuation,” said Cavendish.

“Given the legislative restrictions imposed on LRBAs and the conservative lending practices of the major financial institutions, we don’t believe the systemic risk posed by leveraged investments outside of superannuation is comparable to the systemic risk posed by LRBAs,” said Cavendish.

Cavendish also questions the effect a ban on SMSF borrowing would have on related investments, such as instalment warrants. “If superannuation funds were permitted to invest in instalment warrants, and no other form of leveraged investment, where do we draw the line between instalment arrangements with embedded leverage which are permitted and those which are not?,” said Rice Warner.

Instead of a ban Cavendish recommends several measures in order to improve the set up and operation of LRBAs.

Firstly the submission recommends that regulations making LRBAs a financial product under the Corporations Act be revisited, which would “stamp out unlicensed and unqualified LRBA advice being provided to superannuation funds.”

Cavendish finds it “inconceivable” that the ability of SMSFs to borrow would be repealed without first passing these regulations and, “some time after, assessing their effectiveness.”

Secondly, to strengthen the consumer protections, Cavendish recommends that “at least one party to the arrangement should hold a recognised SMSF accreditation.”

Finally Cavendish recommends that the SIS Act and regulations be amended to “prohibit related party borrowings as part of a LRBA.”

“The ability of related parties to lend money to their SMSF on non-commercial terms is an overly generous concession which erodes the integrity and ultimately the confidence in the SMSF sector,” said the submission. This would mean that all LRBAs would be “subject to appropriate and conservative lending disciplines.”

Cavendish believes there is “ample time” to implement these measures and test their effectiveness before the “total value of LRBAs held by SMSFs becomes a concern.”

SMSF operating costs

Cavendish does not believe that the high operating costs of some SMSFs is cause for concern.

“We believe cost, when considered in isolation, is not an appropriate proxy for determining whether or not an SMSF is right for an individual,” said Cavendish.

“The cost of establishing and running an SMSF is only one factor which should be considered when determining whether an SMSF is appropriate for the needs of the individual.”

Cavendish argues, as some other submissions have, that people may choose to bear higher costs because a SMSF may provide other benefits. The submission gives the examples of “unique investment opportunities” and the ability to meet complex estate planning needs in a “blended or complex family” structure.

Equally there may be situations where an SMSF may be the lower cost option but a person may choose another fund because they “may lack the time, knowledge and desire to be an SMSF trustee.”

“We don’t believe it is appropriate for limitations or minimum balance limits to be imposed on the establishment of SMSFs,” said Cavendish. Such requirements are “likely to be arbitrary and a highly subjective exercise.”

Instead Cavendish believes the “most appropriate way of ensuring SMSFs are being established in the right circumstances is to ensure individuals have access to competent SMSF advice.”

The Financial System Inquiry is progressively releasing submissions received as part of the second round of consultation on its website.

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