The Government will not be making any changes to SMSF Limited Recourse Borrowing Arrangements (LRBAs), after receiving a report from the Council of Financial Regulators and the ATO, despite a ban being the preferred option of regulators.
The Financial System Inquiry, started by the Coalition Government, recommended returning to a ban on most forms of borrowing inside superannuation – including LRBAs. The Government rejected this recommendation, instead asking for a report from the Council of Financial Regulators (CFR) & ATO after 3 years. The Government has now released the report, which it received earlier in March.
“The regulators agree that the presence of leverage in SMSFs through LRBAs has significant implications for the security of individuals’ retirement savings,” says the CFR/ATO report.
“Other than the regulators’ preferred option of removing the exception to allow SMSFs access to LRBAs, some potential policy interventions could address these concerns. These range from truly limiting the recourse of the lender over the asset by prohibiting the use of personal guarantees, to reducing high leverage and concentration risk within the fund by creating prudential responsibilities for the regulator.”
“Where the regulators’ preferred option to remove the exception to allow LRBAs is not accepted, further monitoring to track the future growth of leverage and identified risks within the SMSF environment is recommended.”
A joint statement by Treasurer Josh Frydenberg and Assistant Treasurer Stuart Robert noted the report found that LRBAs are “unlikely to pose systemic risk to the SMSF system at this time” and comprise a “relatively low” proportion of SMSF assets.
“In light of this, the Coalition Government will not be making any changes to LRBAs and will instead request that the CFR and the ATO continue to monitor LRBAs in the superannuation system and report back again in three years,” said the statement. Although the Government does have legislation before Parliament, the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018, which in some circumstances includes the amount of a LRBA loan in a member’s Total Superannuation Balance.
It is not only the Financial System Inquiry that has recommended banning LRBAs, with ASIC suggesting it last year. Labor has announced a policy of stopping SMSF LRBAs, on a prospective basis.
The CFR/ATO report did find that “LRBAs can represent a significant risk to some individuals’ retirement savings, particularly where they have low-balance SMSFs with high asset concentration and/or personal guarantees”.
The report also notes that market conditions have changed since the Financial System Inquiry report, with major lenders withdrawing from the market in recent years.
“However, SMSFs continue to borrow from a number of other financial institutions and related parties, which are subject to less regulation,” says the report.
But the Government judges that the risks presented by LRBAs can be mitigated through other reforms, so that “consumers are better protected without limiting the investment choices available to SMSFs”.
The statement continued: “Importantly, the Coalition Government and regulators have already taken a number of steps to tighten regulation to reduce the risks of LRBAs, including by strengthening the Australian Prudential Regulation Authority’s lending standards and increasing the Australian Securities and Investments Commission’s scrutiny of responsible lending compliance.”
The Government also pointed to the establishment of FASEA (Financial Adviser Standards and Ethics Authority, proposed product design and distribution obligations, and its response to the Royal Commission.
Labor Shadow Treasurer Chris Bowen, speaking at a summit, said the Government “simply doesn’t have the courage or the fortitude” to make big calls, like banning LRBAs.
“You know a government is behind the curve, when the major banks are out in front on this issue reforming their own borrowing programs for SMSFs,” he said.
“As it stands it will be left to a Labor government to take the responsible decision and adopt the recommendation of the Financial System Inquiry – a report delivered years ago – to restore the prohibition on direct borrowing by superannuation funds on a prospective basis.”
SMSF LRBA risks can be mitigated: SMSF Association
The SMSF Association believes that the risks around LRBAs can be mitigated.
SMSF Association CEO John Maroney said the finding by the CFR that LRBAs do not create a systemic risk was expected by the Association.
“The Association has long held the view that the total size of geared investment by SMSFs, especially regarding property, does not create a systemic risk to the financial system when it is sensibly viewed in the context of the overall Australian property and mortgage markets,” he said.
Though the Association does note the concerns that LRBAs can be an issue in low-balance SMSFs, or when involving personal guarantees.
“The SMSFA has consistently noted the importance of LRBA strategies for small business people investing in business real property and the flexibility they bring when used appropriately and, accordingly, has not supported a total ban of LRBAs.
“However, we have recognised risks pertaining to LRBAs, such as those raised by the CFR, and believe a better approach is to mitigate the risks cited in the Report before considering a ban, and to this end we have recommended two key measures to ensure LRBAs are used appropriately – banning the use of personal guarantees supporting LRBAs and increasing SMSF education requirements for advisers.”
Maroney said that banning personal guarantees for LRBAs could help reduce the number of smaller, and poorly diversified, SMSFs using the structure.
“Stopping the use of personal guarantees by SMSFs would mean that LRBAs are only used by funds that have a fund balance that allows them to achieve better diversification and a broader investment strategy not focused around a highly leveraged single asset,” he said.
“Lenders would also need to be certain that the SMSF is able to adequately service the loan based on the financial circumstances of the SMSF members instead of looking at circumstances and assets outside superannuation.”
The SMSF Association is calling for people advising on SMSFs to have specific SMSF education and qualifications. Maroney also pointed to changes stemming from the Financial Services Royal Commission, including bans on hawking superannuation products, as improving the integrity of LRBAs.
This article has been updated since publication to include comments by Chris Bowen and the SMSF Association.