Regulators crash the SMSF party

It’s the midnight hour and the party’s in full swing; drinks are flowing and music is blaring. But a loud knock on the door suggests trouble. Sure enough, through the window flashing blue lights illuminate the darkness. Someone has called the cops.

Similarly, after years of inactivity, regulators are now paying attention to the rising noise level – and increasing incidents – in the SMSF segment.

Trio Capital was the wake-up call. The PJC report showed that many SMSF trustees had little understanding of investment strategy requirements, and particularly that no compensation was available to SMSFs in the event of fraud. The new financial year appears to have brought with it a new focus:

– ASIC disciplinary actions against advisory firms: red flags include low balances being used to establish an SMSF, inadequate comparisons with existing arrangements and non-SMSF alternatives, and inadequate consideration of clients’ long term objectives. That sounds awfully like flogging SMSFs with limited regard to investor circumstances.

– Growing concern about the spruiking of geared real estate schemes to SMSFs. It’s getting pretty hard to ignore – such as a recent campaign offering free holidays to Hawaii to SMSFs trustees who purchased a geared real estate package.

– First mention in the RBA minutes (September 3 edition) of real estate gearing in SMSFs as being of concern and needing monitoring.

– ASIC’s issue of CP216 “Advice on SMSFs” (we’ll look at this more closely in a future edition).

So the regulators have finally turned up at the party. Right now, they’re just checking a few IDs while the party goes on around them. But the free-for-all is surely winding down now. Sooner or later they will get to the backyard, turn off the jukebox, take away the punch bowl and make a few arrests – so to say.

It’s going to take time so the party will rock on for a while yet. Unsurprisingly, some industry stakeholders are labelling ASIC as a Chicken Little, pointing to investment data showing that SMSF exposures to real estate, and the use of gearing, remains low.

The problem with this critique is the age of SMSF data. Comprehensive data is only collected via SMSF tax returns and released 18 months in arrears. As of right now, the most current data is June 2011. A lot can happen in two years when a product push is on.

More current indicators can be seen in lending data. The RBA’s March 2013 Financial Stability Review noted that bank lending to SMSFs had greatly increased in recent years. At still <1% of total loan portfolios though, this represents only limited risks to bank performance.

Another data point which caught our eye was the recent issue of the first commercial mortgage-backed security (CMBS) since 2011. CMBS are securities over a pool of commercial mortgages, but two aspects of this particular issue were eye-catching:

– 27% (~$70m of the $250m pool) comprised SMSF loans.
– The issuer was Liberty Financial.

Liberty Financial is a finance company (not an ADI) – a specialist lender to typically non-prime borrowers, at relatively high interest rates (its SMSF loan has an interest rate ~100bps higher than the major banks). To us it suggests that if a small lender like Liberty is already securitising SMSF loans, there is a fair bit of movement at the SMSF gearing ranch.