By Partner Geoff Sanders and Associate Stephanie Malon
The vast pool of capital held in Australian superannuation funds (now approximately A$1.8 trillion) has long been touted as a natural solution to Australia's infrastructure funding deficit. With the stable long-term cash flows characteristic of infrastructure assets providing a natural fit to the liability profile of the typical superannuation fund, the two seem a perfect match. However, in the words of Shakespeare, 'the course of true love never did run smooth'.
The barriers to increased direct investment in domestic infrastructure by Australian superannuation funds, many of which have long been discussed, have received renewed attention in submissions to the Financial System Inquiry. With the release of the Inquiry's interim report just around the corner (due 15 July 2014), we take a look at some of the key perspectives arising from submissions that the Inquiry may consider on matchmaking Australian superannuation funds and infrastructure investment.
One of the most commonly cited barriers to direct infrastructure investment by Australian superannuation funds is that liquidity obligations constrain their ability to hold illiquid assets, such as infrastructure assets, having a long-term investment horizon.
Australian superannuation funds are subject to legislative requirements for timely rollovers (when members switch either between funds, or between investment options within funds) and withdrawals (when members either draw down their pensions or take lump sum payments). In addition, the prudential regulation overlay requires Australian superannuation funds to manage liquidity so that each investment option within can independently meet its ordinary payment obligations, and cope with extreme stress scenarios. While these obligations provide members with comfort that their super funds will be able to honour rollovers and withdrawals even in the case of a systemic liquidity event, the result is that funds are naturally cautious in allocating large portions of member savings to long-term investments, such as infrastructure. To illustrate – the Association of Superannuation Funds of Australia noted in its submission to the Inquiry that (based on earlier research) only one third of superannuation funds invest in infrastructure, with just five per cent of total superannuation assets under management allocated to infrastructure investment.
A broad range of submissions to the Inquiry suggested that some form of government liquidity facility could allow Australian superannuation funds to play a greater role as long-term investors in the economy (and at the same time achieve a higher return to members), while maintaining, or even increasing, members' confidence that their funds will be able to honour rollover and withdrawal payments.
At its heart, a superannuation liquidity facility would be an external pool of liquid assets which is made available to superannuation funds to draw upon should their cash reserves or liquid assets be insufficient to meet their liquidity requirements at a given time.
The most common framework suggested by submissions for a general systemic superannuation liquidity facility was one based on the Reserve Bank of Australia's repurchase agreement facility currently enjoyed by banks, with the Reserve Bank able to determine the securities eligible for superannuation fund repurchase transactions. Alternative models were also flagged, such as a backstop liquidity facility for qualifying infrastructure debt assets where the government acts as a buyer of last resort at market price.
However, other submissions doubted the potential impact of any such facility on increasing superannuation fund allocation to infrastructure investment, citing a view that most superannuation funds would probably manage their investment programs to avoid the use of a government liquidity facility. For example, this can be seen in the current reluctance to rely the section 67 of the Superannuation Industry (Supervision) Act 1993 (Cth) exception to the general prohibition on borrowing (which allows funds to borrow an amount equivalent to 10 per cent of the fund's assets for up to three months if necessary to pay benefits). Some submissions also indicated that, at least for larger funds, liquidity pressures are not presently viewed a major impediment to increasing investment in infrastructure – rather, it is a lack of suitable investment opportunities and/or current procurement processes that currently pose the greatest practical barrier (see the next section below).
Nonetheless, the Financial System Inquiry is likely to at least give some serious consideration to the merits (and form) of a potential liquidity facility, given the relatively broad spectrum support for the concept.
Another longstanding view of a number of superannuation industry participants is that the procurement process for public private partnerships (PPPs) (particularly for greenfield projects) poses a significant deterrent to Australian superannuation fund investment.
The traditional PPP procurement model in which a consortium (typically led by investment banks and contractors) is formed to bid together for all aspects of a project (including the equity, construction, operations, maintenance and financing roles) has been criticised for contributing to lengthy and costly bidding processes and for creating a perceived bias towards short-term rewards earned by financiers and contractors rather than the long-term success of a project.
Unsurprisingly, a number of participants used their submissions to the Inquiry to advocate a review of the current procurement processes. The submission by Industry Super Australia, which represents a large number of industry super funds, offered the most detailed solution for consideration by the Inquiry, namely the 'inverted bid' model, which comprises the following two-step process:
- Firstly, the government tenders for the long-term equity owner-operator (such as a superannuation fund), ideally based on bids for margin over the other project capital, operating and financing costs.
- Secondly, once funded by long-term equity, the project special purpose vehicle would be responsible for conducting a separate bid process for construction, operation, maintenance and debt for the project.
Industry Super Australia argued that this model would increase superannuation fund appetite for participating in greenfield PPPs by:
- Lowering bid costs and decreasing procurement timeframes – as long-term equity investors will initially bid on return only, there will be no need for them to devote time and money to structuring consortium arrangements with detailed design and plan development before winning a bid. Once appointed, long term equity investors can reap potential cost and time savings by competitive tendering of construction, operation, maintenance and debt based on more precise project specifications. Overall, the time to delivery is estimated by Industry Super Australia to improve from an average of 17 months to 12 months under the inverted bid model.
- Removing the bias towards short-term financiers and contractors – the earlier involvement of long-term equity increases the likelihood of long-term success of a project because long-term equity investors are motivated to price risk accurately and make decisions on the basis that they will own the asset over its life span.
In its draft report on Public Infrastructure (released 13 March 2014), the Productivity Commission gave qualified support to the concept of an inverted bid model. However, it suggested that there were a number of key implementation issues that needed to be addressed, including methods to appropriately allocate risk between government and long-term equity and to what extent the benefits of consortia (such as risk-sharing, management expertise and economies of scale) can be preserved under such a model.
The hurdles to be overcome before government and the market can be comfortable with an inverted bid procurement model should receive a good airing in both the final Productivity Commission report (currently awaiting release by Government) and during the course of the Financial System Inquiry.
One mooted method of increasing Australian superannuation investment to support infrastructure needs which found little support in submissions to the Inquiry was mandating a minimum level of investment allocation, for example by requiring each super fund to invest a minimum percentage in infrastructure projects.
There was a sense from submissions that a minimum investment mandate would effectively allow governments to treat Australian superannuation funds as cash cows to be raided for government projects, while potentially decreasing member returns.
Several submissions also made the important point that such a requirement had the real potential to conflict with the fundamental common law and statutory duty of superannuation fund trustees to act in the best interests of beneficiaries, given the potential that superannuation funds may be forced to forego other investment opportunities with a more desirable risk/return profile in favour of infrastructure investments just to meet the mandated levels of infrastructure investment. Equally, it is difficult to see how a minimum infrastructure requirement would be implemented in practice, given the divergence in superannuation fund structures and investment policies.
Regardless of whether careful legislative drafting could provide clarity on how a minimum investment mandate would sit with the 'best interests' duty and how it would work in practice across the diverse superannuation industry, it seems that any recommendation by the Inquiry for such a 'forced marriage' between super funds and infrastructure investment is unlikely to be well received by funds.
We should have a good idea of how the Financial System Inquiry might play cupid for Australian superannuation funds and infrastructure investment from its interim report due on 15 July 2014. The final Productivity Commission report on Public Infrastructure, which should be released by Government shortly, is also likely to offer further suggestions on how public policy could help the relationship to develop.