Given the rapidly changing financial environment arising from the COVID-19, and the impact it is having on asset prices and liquidity matters, it is no surprise that the regulators were quick to engage with industry to remind them of their ongoing obligations.
ASIC wrote to the funds management industry in mid-March 2020, reminding responsible entities of their various obligations, including the need to actively monitor redemption levels, review redemption terms, monitor the valuation of scheme property and actively assess the liquidity status of schemes. This letter was shortly followed by a joint letter from APRA and ASIC to superannuation trustees in early April 2020. The joint letter contains advice for superannuation trustees on how to manage the challenges they might face as a result of COVID-19, while at the same time continuing to meet their duties and obligations to members, many of which are set out in extensive APRA guidance. The result is that superannuation trustees will be put to the test: they must determine whether their liquidity management and asset allocations remain appropriate while having to consider matters such as appropriate valuations and member switches and withdrawals.
The joint letter notes that liquidity has been one of the primary areas of regulatory focus in recent weeks. The global sell-off in equities has resulted in many members switching their retirement savings into cash. Meanwhile, the recent announcement by the Government to allow some individuals early access of up to $20,000 of their superannuation savings has placed added liquidity stress on funds, particularly those funds whose membership comprises a large number of members employed on a part-time or casual basis. Further, funds are seeing an increase in compassionate payment and financial hardship applications, which continue to apply.
Adding to the liquidity issues faced by superannuation funds are those funds with a homogenous membership base heavily exposed to industries which are currently facing the biggest economic pressure and so have ceased receiving superannuation contributions (for example, hospitality or retail) and those superannuation funds that have a high level of concentration in unlisted assets such as infrastructure, property, private equity, structured credit and alternatives.
What superannuation trustees need to do
Unsurprisingly then, in their joint letter to industry, APRA and ASIC advised that liquidity must be a top priority for trustees. According to APRA and ASIC, superannuation trustees should be:
- undertaking regular and detailed liquidity stress-testing, ensuring that scenarios reflect changes in future net cash flows of the superannuation fund, member behaviour and market conditions;
- identifying areas where that could give rise to increased liquidity risk and addressing them, including increased member switching or deterioration in the liquidity profile of investments;
- determining whether liquidity issues could impact their liabilities or contractual arrangements, such as currency hedging programs, and reviewing their securities lending arrangements; and
- ensuring that valuations of unlisted and illiquid assets remain appropriate and considering whether any assets need to be revalued.
Liquidity is regularly a key concern for superannuation trustee and is not a new obligation (although COVID-19 has certainly put a spotlight on its importance, particularly when markets are not behaving as usual). For example, superannuation trustees are required to comply with the "investment covenant" in section 52(6) of the SIS Act, which requires superannuation trustees to formulate, review regularly and give effect to an investment strategy which has regard to, amongst other things, the liquidity of the investments covered by the strategy (in light of expected cash flow requirements in relation to the superannuation fund). This covenant is also supported by APRA Prudential Standard and Guide 530: Investment Governance which sets out APRA's expectations regarding a number of investment governance matters including liquidity management. In particular, SPG 530.168 notes that:
"APRA expects a prudent RSE licensee to have a substantial understanding of the liquidity of its investment options. In particular, APRA considers that a prudent RSE licensee would have an awareness of the potential for an investment option to become illiquid in adverse circumstances, how this might affect the value of the investment option and the RSE licensee’s ability to meet portability and benefit payments obligations in such circumstances. This would cover liquidity monitoring arrangements that assess the impact of market conditions or events on relevant liquidity positions."
APRA Prudential Practice Guide 233: Pandemic Planning also considers the impact of a pandemic on fund liquidity.
In terms of fund valuations, this is particularly interesting, in an environment where unlisted (illiquid) assets are not valued regularly and are often difficult to value. The impact of not having appropriate valuations however is significant, having regard to the fact that members could be switching, exiting or withdrawing and taking excess value with them (leaving remaining members with not enough value). The SIS Act caters for this, in that section 155 of the SIS Act imposes restrictions on a trustee from redeeming an interest in a superannuation fund, other than at a price that is fair and reasonable as between the redeeming member and the beneficiaries. This would likely mean that until a trustee has appropriate valuations, switches, exits and withdrawals would not be facilitated.
Superannuation trustees will also be concerned with ensuring compliance with APRA Prudent Guide 531: Valuation which specifically notes in respect of the valuation of unlisted investments, APRA expects superannuation trustees to consider whether there have been any material changes or other factors that may have caused or are causing the existing valuation of an unlisted investment to now be in appropriate, and undertake a valuation to determine a more appropriate value.
Communications with members
While superannuation trustees consider what action they need to take in the current COVID-19 environment, the joint letter reminded trustees of the need to communicate clearly with members. Both Regulators stated that the ability for trustees to respond promptly and accurately to members' questions should be a key operational focus for them and subject to ongoing monitoring and adjustment.
Beyond this however, trustees must be mindful of what representations they have made to members including in any Product Disclosure Statements (PDS), to ensure that the information in those documents remain up to date and appropriate. In particular, information contained in PDSs relating to risk disclosure, liquidity, asset allocation and fees should be carefully considered, and may be out of date following the impacts of COVID-19. In respect of the latter, an increase in transaction activity may lead to a material increase in fees and costs, including buy / sell spread which will need to be considered in the context of the current PDS disclosure (and may require updating / notification to members).