Supplementary Submission to the Financial System Inquiry 4. Superannuation

The Reserve Bank endorses the focus of the Interim Report on the efficiency of the superannuation system. In particular, the Bank supports consideration of measures to lower costs and fees, optimise liquidity management, and limit leverage. Above all, superannuation assets should be managed in the best interests of members.

4.1 Costs and Fees

The Interim Report finds little evidence of strong fee-based competition in the superannuation sector. The Bank supports the Inquiry's wideranging consideration of measures to enhance competition and hence reduce costs. This could include the performance of back-office functions, including by administrators and custodians, and whether current practices are exposing members to more risk than the members realise.

As noted in the Bank's initial submission, disengagement among members, as well as complexity and difficulty in comparing fees across funds all likely contribute to the relatively high cost of Australia's superannuation system. However, costs in the superannuation system should not be considered in isolation. Measures that reduce costs may create additional risks to members' retirement incomes, government and employer finances, and financial stability. For instance, although there is some evidence that countries with a privately managed defined contribution system and a large number of small funds, such as Australia, typically have higher operating costs than countries with a few relatively large funds offering defined benefit schemes (OECD 2013), the latter structure may place additional pressure on government and employer finances. In countries that are dominated by defined benefit schemes, an ageing population can expose employers or governments to shortfall risk, if growth in pension liabilities outpaces that of employers' revenue or the tax base (Broadbent, Palumbo and Woodman 2006).

4.2 Liquidity Management

Liquidity management is a key challenge for superannuation funds and is well worth the Inquiry's consideration. This should include the efficacy of the current requirements to allow portability between funds and investment switching. The portability requirements, in their current form, may result in individual funds holding more liquid assets than is optimal given the nature of superannuation as long-term savings to fund retirement incomes. Regardless of whether these requirements change, it is important that superannuation funds continue to assess the potential liquidity risks associated with a sudden sell-off of a particular asset class, as well as the liquidity implications of an ageing population.

The Reserve Bank agrees with the Inquiry's view that providing superannuation funds with access to a dedicated liquidity facility at the Reserve Bank would not be an appropriate way to address their normal liquidity challenges. First, superannuation funds that meet certain requirements can already participate in repurchase agreement (repo) auctions conducted by the Reserve Bank in its open market operations, and can access liquidity through this mechanism. Second, a significant use of repos to draw on a liquidity facility would lever superannuation funds, potentially increasing vulnerabilities in the financial sector (albeit on a competitive basis). More generally, any leverage for liquidity purposes needs to be limited.

4.3 Leverage

The Bank endorses the observation that leverage by superannuation funds may increase vulnerabilities in the financial system and supports the consideration of limiting leverage. As emphasised in the Bank's initial submission, the general absence of leverage in superannuation was a key source of resilience in the Australian financial system during the financial crisis (RBA 2014, p 171). Furthermore, the compulsory and essential character of retirement savings implies that it should remain largely unlevered. While still in its infancy, the use of leverage by superannuation funds to enhance returns appears to have been mainly taken up by self-managed superannuation funds (SMSFs). The Bank has previously commented on the risks that may arise from geared property investment through SMSFs, which may act as an additional source of demand that exacerbates property price cycles (RBA 2013b). Nonetheless, some limited leverage for liquidity management purposes may be appropriate.