Anyone responsible for product design and pricing in the superannuation industry needs an understanding of the revised Australian Prudential Standard (APS 210) on bank liquidity. There are implications for deposits placed with banks regardless of the maturity.
On 6 May 2013, APRA released its latest version of the bank liquidity risk management framework to apply to Australian banks (and other ADIs). The previous version was issued in November 2011, and has been the subject of heated debate in Cuffelinks.
As Cuffelinks is focussed on the wealth management industry, this paper is not a general summary of the proposals, which can be found here. Rather, we comment specifically on the implications for financial advice, investments, superannuation, SMSFs and portfolio construction.
The most important points are:
- The Basel Committee recently announced it was allowing a gradual phase-in of the major liquidity requirements, delaying full introduction until 2019. However, APRA is sticking to the original timetable, due to the strength of Australian banks, with introduction of the Liquidity Coverage Ratio (LCR) on 1 January 2015, without any phase-in. Banks are already changing their products and pricing as a result.
- After the November 2011 APRA release, there was conjecture about the favourable treatment given to SMSFs versus public superannuation funds. However, there was not much lobbying by the publicly-offered super fund industry and APRA has confirmed the previous advice.
A reminder of what the issue is. The proposed Prudential Standard is designed such that deposits from large publicly offered superannuation funds will be considered volatile, wholesale money, against which banks will be required to hold expensive liquid assets under the LCR test. This will make the banks less willing to pay competitive interest rates on deposits from major public super funds. But SMSFs have been granted a special exemption which categorises them as retail deposits, giving them a regulatory free kick.
This is the most important point, and the one made in my submission to APRA. Here is their exact response:
“A number of submissions argued for amendments to the treatment of funds received via an intermediary as that treatment would result in differential outflow rates being applied by ADIs to an equivalent customer depending on the source of the deposit. This issue was raised, in particular, in relation to deposits received from SMSF customers rather than via APRA-regulated superannuation funds.”
That's a clear statement of the issue, and this is APRA’s decision (from the Discussion Paper):
“For deposits sourced via an intermediary, where the intermediary retains investment responsibility or has a fiduciary duty to the underlying customer, APRA considers it is appropriate to assume the intermediary will observe the responsibility and duty in a time of liquidity stress. This fiduciary duty is not removed when customers have an investment discretion when initiating an intermediated deposit. Accordingly, these deposits are most appropriately classified as being sourced from a financial institution, regardless of the nature of the customer placing funds with the intermediary. This interpretation will not affect SMSF deposits; SMSF deposits are considered to be those of a natural person and not sourced via an intermediary.”
This interpretation will not affect SMSF deposits, which are judged to be from a natural person and not sourced via an intermediary.
When Cuffelinks reported on this issue previously, some people claimed I had misunderstood, but APRA has made my interpretation clear. Banks will need to hold expensive liquid assets to support any deposit from a public super fund which matures within 30 days. This includes billions of dollars of at-call deposits placed in super funds in recent years.
- APRA divides retail deposits into stable (with a 5% run-off assumption) and less stable (with a run-off assumption of up to 25%). SMSFs will be in the less stable category for the following reason:
“A self-managed superannuation fund (SMSF) depositor is considered to be a self-selected, financially sophisticated individual who is undertaking an asset allocation investment choice.
This activity is not consistent with the description of typical activity under a transaction account, as outlined in paragraph 36 (b) in Attachment A of APS 210. As a result, the deposit of an SMSF customer is to be g categorised as less stable.”
But it will still receive the favourable retail treatment, and this should not be confused with the issue that a public superannuation fund is assumed to have a 100% run off inside 30 days.
- The classification of superannuation funds as financial institutions while SMSFs are retail not only has implications for the calculation of the Liquidity Coverage Ratio (LCR), but also a longer term standard, the Net Stable Funding Ratio (NSFR). Again, any deposit classified as retail will qualify as a long term deposit, while those from a financial institution are more volatile short term. This is important because the NSFR treatment will apply to term deposit with maturities longer than 30 days.
- There are other implications of APS210 for term deposit offers, especially on superannuation platforms which offer bank deposits. Here is APRA’s view (Attachment A of APS210):
“Retail fixed-term deposits
The maturity of fixed or time deposits with a residual maturity or withdrawal notice period of greater than 30 days will be recognised (i.e. excluded from the LCR) if the depositor has no legal right to withdraw deposits within the 30-day horizon of the LCR, or if early withdrawal results in a significant penalty that is materially greater than the loss of interest.
If an ADI allows a depositor to withdraw such deposits despite a clause that says the depositor has no legal right to withdraw, the entire category of these funds would then have to be treated as demand deposits.”
How will a public super fund which allows online withdrawals from all its products cope with this? With the development of platforms and wraps, most currently allow immediate access to both managed funds and term deposits, but this will need to be prohibited for term deposits in order to achieve the favourable liquidity treatment. Furthermore, this is not simply a matter of form over substance, and APRA has indicated it will test whether banks are actually giving early access even if the investor has no legal right. This is a bigger issue than simply a systems redesign, as it goes to the heart of access to funds via a platform, including switching and rebalancing facilities.
Timing and implications
APRA intends the new prudential standard to come into force on 1 January 2014, with the LCR on 1 January 2015 and NSFR on 1 January 2018. However, the consequences will be felt much earlier in product design and pricing, as banks move to adjust their funds transfer pricing systems to send the right signals.
Management of the LCR obligations will take many forms, but some early product responses include:
- Offering a ‘cash’ deposit with a 31 day withdrawal notice period. This development has already surfaced, driven by the changing rules. For example, Investec has a product called a Liberty Notice Account that offers a higher rate and no fees provided 32 days withdrawal notice is given.
- A superannuation fund could make an agreement with a bank not to call a deposit inside 31 days, but allow clients to access the funds ‘at call’. This involves a maturity risk that would need careful management, such as holding a liquidity buffer to meet client withdrawals based on estimated net outflows, which would be tested by an unexpected run of short term withdrawals. In one conversation with APRA, this structure was not well received, and was called a ‘device’.
Bottom line is that public superannuation funds offering bank deposits may face worse rates from the banks than retail deposits and SMSFs, and they will have to exercise their creativity to avoid a new product structure raising the ire of APRA.