With banks’ appetite for funding infrastructure projects likely to decline due to the proposed liquidity requirements of Basel III, superannuation funds seem ideally placed to assume a greater role in infrastructure investment. However, this will require an investment framework incorporating appropriate regulation and commercial risk allocation.
Australian superannuation funds have been important private investors in infrastructure projects for some time but regulated superannuation funds have only around five per cent of their asset allocation in this sector.
With banks’ appetite for funding infrastructure projects likely to decline due to the proposed liquidity requirements of Basel III, superannuation funds seem ideally placed to assume a greater role in infrastructure investment. However, this will require an investment framework incorporating appropriate regulation and commercial risk allocation. This framework will need to address issues such as trustees’ duties in respect of prudent infrastructure investment, investment returns and risk assumptions, the size of superannuation funds and their access to expertise, the kind of disclosure on which trustees may be able to rely and the taxation treatment of infrastructure investment.
The duties of trustees of superannuation funds in respect of investment are expected to be overhauled in the near future by the enactment of the Superannuation Legislation Amendment (Trustee Obligations and Prudential Standards) Bill 2012 (Trustee Obligations Bill).
As the law stands, a trustee must under both the general law of trusts and under certain covenants deemed to be included in the trust deed under the Superannuation Industry (Supervision) Act 1993 (SIS Act), act honestly, in the financial interests of beneficiaries after careful consideration, and with reasonable care, in the exercise of its powers whether to approve investments. Trustees must also comply with any restrictions on powers of investment under their trust deeds.
When forming a view as to the beneficiaries’ best financial interests and in discharging its duty of care in relation to investment proposals, the trustee should consider:
- the expected future cash flows of the investment and rates of return
- the tax implications of the investment
- any regulatory or commercial risk implications for the superannuation fund, and
- the alternatives to the proposed investment.
In addition, if the investment impacts on the investment strategy for the fund, under the SIS Act, the trustee must consider:
- the risk and likely return from the investment, having regard to the fund’s investment objectives
- the composition of the fund’s investments as a whole, including their diversification
- the liquidity of the entity’s investments having regard to its expected cash flow requirements, and
- the ability of the entity to discharge its existing and prospective liabilities.
If enacted, the Trustee Obligations Bill will result in the statutory reinforcement of key implications of existing duties.
In particular, under the proposed laws trustees:
- must promote the financial returns (net of fees, costs and taxes) of default (MySuper) beneficiaries of the fund (that is, those members who have not chosen a specific product within the fund)
- must determine on an annual basis whether the financial interests of their MySuper beneficiaries are adversely affected, compared to MySuper beneficiaries of other funds, because the number of relevant members is insufficient, or because the relevant pool of assets is insufficient
- are required to exercise the same degree of care, skill and diligence as a professional superannuation trustee would on behalf of the beneficiaries for which it makes investments
- of superannuation funds that offer a MySuper product will be required to formulate and update each year an investment return target and a level of risk appropriate to those assets in respect of MySuper assets, and
- of all regulated superannuation funds will be required explicitly to consider whether reliable valuation information is available in relation to the investments, and the expected tax consequences and costs of the investments in formulating investment strategies.
Duties of directors
It is also important to note proposed s 52A of the SIS Act which, if enacted, would introduce substantive new duties on the directors of superannuation trustees. This is currently only applicable at the corporate trustee level. In conjunction with s 55(3) of the SIS Act, and the reduction in the scope of the current defence for investment losses under s 55(5), superannuation directors’ duties will be more closely aligned with those of responsible entities of registered managed investment schemes in respect of directors’ direct accountability to beneficiaries for investment losses due to their personal breach of duties.
Access to expertise and the scale of superannuation funds
The ‘scale’ requirement to be introduced with the Trustee Obligation Bill, will lead to greater consolidation of superannuation funds. We can expect trustees to determine that members would be better served by participation in a fund with a larger membership and a wider pool of assets to spread the fund’s fixed costs such as management and administration fees. Larger funds may also be able to achieve reductions in variable costs. Recent APRA research indicates that the performance of not-for-profit funds improves with fund size.
An increase in fund size has the potential to provide superannuation funds with greater access to specialised investment expertise and resources. Superannuation funds will need to build up experienced teams of investment professionals if they are to directly invest in infrastructure. Alternatively, superannuation funds may partner with asset managers who have the requisite skills and knowledge to access infrastructure investment opportunities, and/or enter into joint venture arrangements with other superannuation funds for infrastructure investing.
Disclosure requirements for issuers
A recent discussion paper from Treasury on the retail corporate bond market: streamlining disclosure and liability requirements suggests a number of changes to the disclosure requirements for corporate bonds to reduce the costs of promoting these products to retail investors.
Bond issuances by infrastructure entities to finance projects, could promote a deeper and more liquid market for infrastructure finance which may indirectly be helpful to superannuation investors.
The management of liquidity and availability of reliable valuation information are of increasing importance to trustees’ investment governance. The increased availability of reliable valuation information may mean that initiatives to stimulate wider demand for corporate bond issues will be conducive to superannuation funds’ greater investment in infrastructure bonds.
Taxation treatment for infrastructure investment
The 2011 Federal Budget announced a new infrastructure tax incentive to promote private investment in nationally significant infrastructure projects.
The changes are intended to allow the value of carry forward losses attributable to such projects to be uplifted by the 10 year government bond rate. Also, tax losses in such projects will be exempt from the continuity of ownership and same business tests that are applied to carry forward losses. These proposals are intended to address the delay between incurring establishment costs and generating revenues in large and capital intensive projects.
It is possible that these proposals will stimulate direct investment by superannuation funds in national infrastructure projects.
Other taxation issues that are relevant to the promotion of infrastructure investment may include the lack of a level playing field between debt and equity investment.
Other obstacles to superannuation fund investment
Other perceived barriers to investment in infrastructure by super funds include:
- the perceived mismatch between super funds’ need for liquidity and the long-term nature and size of infrastructure investment
- the tender process for infrastructure investment, which often runs to 18 months or more and means that super funds must be committed to spending considerable time and money in the absence of investment certainty
- as conservative investors, super funds are more inclined to invest in developed or ‘brownfield’ assets which can demonstrate proven returns prior to investment, and
- the absence of a clear and transparent long term pipeline of future investment opportunities, partly due to the political sensitivity surrounding infrastructure planning.
Attracting investment in infrastructure projects by superannuation funds will require a significant rework of the framework that is currently in place.
Proposed reforms to trustee governance arrangements, including stricter duties upon trustees and directors will have a bearing on the attractiveness of infrastructure investment. Other investment governance reforms may also be conducive to infrastructure investment. While it is still too early to tell the reaction of superannuation trustees to the changes, and their real impact on the attractiveness of infrastructure investment, initiatives to promote fund scale economies are clearly favourable.
Other reforms to taxation, to promote a deeper and more liquid corporate bond market, and to the disclosure of the pipeline of forthcoming infrastructure projects, are favourable, but there remains some way to go. It is possible that astute structuring of infrastructure projects and products will assist in addressing these issues in a way which allows superannuation funds to play a greater part in infrastructure investment in the future.
The full version of Braydon’s paper: Superannuation and Financing Australian Infrastructure, is available on our website at http://www.hdy.com.au/Publications.html