Sometimes we just don’t get it. We lobby strenuously against sensible reforms, knowing that worse outcomes may well await us. And yet we persist, seeking to relieve short-term political pressures. There is no better example of this than lobbying against the recommendation to ban gearing in self-managed super funds (SMSFs) made by the Murray Financial System Inquiry (FSI).
Inevitably, the government decided to do nothing, principally on the grounds that borrowing by SMSFs isn’t widespread and dodgy (yet). Some in government also suggested that such a ban would be an unreasonable intervention in the so-called free market. This is a truly ironic position, since the superannuation market is anything but free, given its compulsion, its regulation and its generous tax protection.
I have even heard it argued that borrowing by SMSFs is a marginal issue. It isn’t. The sector accounts for more than 99 per cent of all superannuation entities (of which at June 2015, there were over 560,000). SMSFs are also the biggest single sector of the market, controlling more than 30 per cent of the more than $2 trillion in Australian superannuation savings.
Gearing introduces significant risk into the system, and in some cases, high risk. While the amount of gearing in SMSFs is not large at this stage, the trend is clear. And the fact that some of the mainstream banks are pulling out of lending to SMSFs should make us more concerned, not less. Who will fill the void? “Mezzanine lenders” perhaps? Remember what happened last time that occurred. History teaches us that it’s only a matter of time before there are individual financial tragedies, if not large-scale public scandals, involving SMSF gearing – which is why public policy action should be taken now, before the financial and political pain demands intervention to clean up the mess.
Why we’re here
I respectfully suggest that industry leaders have forgotten why the SMSF sector was allowed to exist as a unique and relatively unregulated category in the first place. SMSFs (then called section 23F or “exempt funds”) were originally allowed by government in the 1980s as a simple, ungeared safe harbour for mum and dad investors to accumulate their retirement savings, in return for which they were promised “light touch” regulation (in contrast to the heavily regulated Australian Prudential Regulation Authority funds).
So if we are going to continue to allow gearing in SMSFs (which was an unintended consequence of poorly drafted legislation designed to allow the Howard government to sell Telstra to SMSFs via warrants), we must consider whether:
a) The people of Australia should be subsidising this form of gearing (often negative gearing) through the tax-protected superannuation system, or
b) The amount of intervention and regulation by government should be increased to ensure the system isn’t compromised or rorted.
Having lived through 30 years of SMSF reforms, particularly in the early days when they were quite simply tax rorts with the ability to borrow and lend through all manner of direct and obscure techniques, increased regulation of SMSFs is inevitable. The response from supporters of gearing is that the regulator should get rid of the rorters, the spruikers and the bad apples, after which all will be well. That’s easy to say, but hard to do, and always involves additional regulation and cost which taxpayers will have to cover.
We can at least be thankful that the government has announced it will monitor and formally review SMSF gearing within three years. Of course, changing anything at that time will be much harder, unless by then the industry has come in for a very hard landing. Regrettably, we rarely seem to learn the lessons of the past.
A note of optimism
On an optimistic note, I was pleased to see the government’s agreement to the FSI’s recommendation to mandate higher education, an industry exam, a professional year and an approved code of ethics for financial planners and advisers. All of these initiatives are worthy courses of action that should be supported.
However, we must never lose sight of the fact that “ethics” is the key to success for these reforms. A university degree is a good idea because it should make a person more technically competent; but it certainly doesn’t make a person ethical and trustworthy. Adoption of a set of robust ethical and professional standards does that. Therefore, the key question must be: what will the approved codes of ethics contain? If they allow the continuity of asset fees, life insurance commissions and other product sales incentives allowed in the Future of Financial Advice (FoFA) legislation (as most of the industry will want), remuneration conflicts will continue and only a limited amount will be achieved for consumers of financial advice.
I’m reminded of the agri-business saga of recent sad memory. Many of the offending unethical advisers were members of my profession. That is, they were experienced chartered accountants or certified practising accountants with relevant university degrees. All of them had done an exam (many exams actually), had undertaken a professional year (two years in some cases) and had signed up to a “stringent” (but inadequate and mostly unenforced) code of ethics.
So why did it all go so wrong? As always, the answer is the corrupting influence of conflicted remuneration. So the government’s response to the FSI, while welcome, is another case of waiting to see the details that will ultimately decide the effectiveness of these initiatives.
How much simpler our professional lives would be if we formed our collective views about these issues based solely on the public interest, rather than vainly trying to appease a multitude of vested interests. Then we would demonstrate that we truly get it, and we would be readily accepted by the public as the profession to which we aspire.