Panel Participation Panel Participation at the AFR Super and Wealth Summit

Thanks very much, Alex and Cosi, for getting us off to such a great start there.

Next up is our big picture panel. With the super sector now controlling more than $4.4 trillion in assets, unexpected liquidity or operational shocks can amplify stress across Australia’s entire financial system.

So how does the sector plan to deal with an expected surge in drawdowns at a time when a 12 per cent superannuation guarantee is being questioned, the threat of AI looms large, and some federal politicians, as Cosi mentioned earlier, want to make it easier for workers to access their retirement savings?

To discuss this and more, please welcome Insignia Financial CEO Scott Hartley, Aware Super CEO Deanne Stewart, Australian Retirement Trust Chief Investment Officer Ian Patrick, and Reserve Bank Assistant Governor of Financial System Brad Jones. Our moderator for the panel is the AFR senior economics columnist James Thompson. Please make them feel welcome.

Well, good morning everybody, and welcome to … I’m not sure if it’s a really nice day out there, Cosi. But it’s a little chilly in the wind. But it’s great to be here in Melbourne, the home of the superannuation sector in this country.

The name of this day today, the title for the summit is The Great Transition. I think there’s a fair bit of that going on just in the last little while. In the last few days, we’ve seen oil prices edge back towards the highs of the Iran war, protesters out on the streets of Paris again, there’s more turmoil in the bond markets, and the midterm elections are just around the corner.

Brad Jones, I know you and your colleagues from the RBA have got a lot on their minds at the moment. You might give us some insights into that a bit later. But at present, how much of this big-picture stuff is keeping you up at night when you think about the superannuation sector?

Yeah, well, obviously our remit includes, but sort of transcends just the super sector. But the issues that we’re trying to wrestle to the ground are multifaceted, and a number of them are quite new that we haven’t had to grapple with for many decades.

So, I think first and foremost is just the changing nature of the geopolitical environment. The word fragmentation gets thrown around, but the way that I’m sort of really thinking about the challenges that are coming at us here is, it’s almost like we’re living through a relapse of the security dilemma, which was this concept that emerged during the height of the Cold War, which said that in an environment where there’s a lot of mistrust and where intentions are hard to discern, the efforts of one country to make themselves more secure can leave others feeling less secure, and that can set off a spiral.

And so, for us, I think that framing helps to explain why we’re seeing a return to sort of 19th-century style mercantilist policies in some parts of the world. Why we see economics, finance, trade, being viewed as like an alternative battle space now. Why we’re seeing interdependence no longer viewed as a basis for cooperation, but a source of vulnerability.

And so a number of things follow from that for the operation of the financial system and the fragmentation of payment systems globally. The different types of shocks that geopolitics can give rise to, not just through traditional financial channels, but particularly through the operational domain. The fragmentation of capital flows around the world along geopolitical lines. These are all sort of new issues that are in the frame and that my colleagues internationally are very engaged in as well, as you can imagine.

I thought I was a bear, Brad. That’s a great list. What about AI? Where is that coming into your thinking? Because we’ve had this sort of concentration in not just global markets, but in global economies around AI. Is that also a potential vulnerability that we haven’t seen before?

Yeah, absolutely, and we think about AI in two or three different respects. One is on the operational side. It’s clearly an accelerant of the types of operational risks that regulators everywhere have become far more concerned about in the last three or five years.

And the issue there is that it’s almost like an arms race. The offensive capabilities are accelerating, but so are the defensive capabilities as well. And so, the operational sphere is one area where all the financial regulators are very engaged.

But then there’s, I think, where you were heading, James, of particular relevance for the super sector, is what’s been priced into markets around AI. There’s clearly, at least up until recently, a lot of exuberance. I don’t want to say it’s irrational, but there is a lot of good news priced into parts of the capital markets. If I can give you one example. The earnings expectations for the US IT sector into perpetuity, beyond the next three years, up until recently, was running at about 45 per cent per annum forever.

So, far be it for me to opine on whether that’s irrational or not. But clearly there was a lot of good news in the price, and coupled with that, what we were starting to see, and are starting to see, is increasing use of debt, which is different from the late ‘90s tech boom, which was principally equity financed. And a lot of that debt is starting to take more opaque forms. There’s all sorts of vendor financing structures, circular financing creeping into this space. So yeah, valuations are punchy, and increasing use of debt means that financial sector regulators everywhere are looking very closely at this space.

And the last point here that’s maybe relevant is that the share of market cap that is accounted for by a very, very small number of stocks. You’ve basically got to go back to the 19th century to find a similar period in history. So, what we’re trying to do is shine a light on the financial risks that are just starting to percolate, while being very clear this is transformative technology. And one possibility here is that just like the late ‘90s, early 2000s period, where you had the financial markets kind of run away from reality for a while and then correct back while the underlying technology just kind of did its own thing, the internet ended up being hugely valuable for society. But there was a big blowout in that period between the late ‘90s and the early 2000s. And so that’s just an issue that we’re obviously leaning into.

(panel discussion)

Brad, I imagine the RBA models lots of things around super. Have you ever modeled what might happen if there’s early release and inflationary pressures build because of that?

Not that scenario specifically, but what I can say on the early release side, where we have done some work, is to have a look at the unexpected nature of early release back during the COVID period and to see how the super sector was able to navigate through that.

What we found was that there are a number of funds at that time that had net outflows equivalent to about 5 or 6 per cent of assets, which is a very sizable number. That was not the majority. The majority, you’re talking 1 to 2 per cent. Had JobKeeper not taken effect when it did, it’s quite possible that the outflows were even larger in the end. But because labour market attachment was sort of maintained through most of COVID, it meant that the outflows weren’t as large as what they could have been. So just purely through a financial stability lens, the way that we think about early releases, it’s the unexpected nature of it that could create real problems for the super fund sector.

If there’s a policy change that is articulated well in advance before it actually takes effect, that it’ll be up to the sector to make adjustments to the types of products they offer. It’s more just opening the system up in an unexpected way in the middle of a crisis when liquidity conditions in financial markets might be very strained. That’s the sort of environment where obviously the dynamics become more challenging.

Yeah. Just on that, what you learnt from the COVID period. And I guess one of the messages that’s come from the RBA and other regulators is the super sector acts as a really important stabiliser for the broader economy during those periods. Were we to have some sort of big correction, will super be able to play that role again, do you think?

Yeah. It’s a good question, James. So you’re right. Historically, so there’s good news and then there’s a but in respect to your question. The good news is that your characterisation is accurate. Historically, the super sector has been a countercyclical stabilising force, including in 2008 and in 2020, when we actually saw the sector be a net buyer of domestic equities, for instance, during that period. Ourselves and APRA have also done a fair amount of stress testing of the sector in the last couple of years, and by and large, as of today, it looks like the sector’s in a pretty reasonable position to withstand some pretty significant stress.

The but. The but is that when you’ve got $1 to $2 billion of net inflows coming into the sector each week, that can get you out of a lot of strife. And so when we look out over the horizon, our job is to think about how the future might be different from the past. That’s where we see some bigger challenges. So, it’s the fact that the sector’s just becoming a larger net owner of domestic asset classes. We’ve seen that, for instance, in bank bills over time. More funds moving into net cash outflow positions. The system will become less of a closed loop as a greater share of members move into the deaccumulation phase. And FX hedging liquidity demands are going to grow through time.

So when we look at all of that, what have been some very powerful tailwinds are going to start to become headwinds and just require more astute management. There’s also the operational risk dimension. Deanne spoke a little bit to that. There’s a fair amount of concentration in some parts of the service provision for the sector fund administrators, custody, and so on. And the other issue that we’re very alert to, where the future could be different from the past, is where you have major financial market disruptions coalescing with a big operational event. And April last year was maybe a first shot across the bow that we, as a sector, we need to be thinking about how could major operational shocks coincide with major financial stress events to really make life interesting.

That was when we had Liberation Day and some issues with credential stuffing. You’re making me even more bearish here, Brad. It’s great. I’m really enjoying it.

(panel discussion)

(panel ends)