Commonwealth of Australia Explanatory Memoranda Commonwealth of Australia Explanatory Memoranda[Index] [Search] [Download] [Bill] [Help]
2008-2009-2010
THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA
HOUSE OF REPRESENTATIVES
Superannuation industry (supervision) amendment bill 2010
EXPLANATORY MEMORANDUM
(Circulated by the authority of the Minister for Financial Services,
Superannuation and Corporate Law, the Hon Chris Bowen MP)
Table of contents
General outline and financial impact 1
Chapter 1 Limited recourse borrowing arrangements 3
Do not remove section break.
Superannuation fund investment in certain limited recourse borrowing
arrangements
Section 67 of the Superannuation Industry (Supervision) Act 1993
(the Act) prohibits trustees of regulated superannuation funds from
borrowing money or maintaining a borrowing of money subject to
specific exceptions. One exception, introduced in 2007, permits
superannuation fund trustees to borrow money on a limited recourse
basis, provided certain conditions are met, to acquire any asset a
fund is not prohibited from acquiring directly.
Since these amendments, market developments have led to practices
that raise prudential concerns with the use of such limited
recourse borrowing arrangements by superannuation funds.
Schedule 1 of this Bill amends the Act with the purpose of reducing
the risks for superannuation funds investing in limited recourse
borrowing arrangements. Schedule 1 also amends the Act to resolve
uncertainty with the application of the borrowing exemption in
light of concerns raised in consultations on the Bill.
Date of effect: The Bill will formally commence on the date of
Royal Assent.
Proposal announced: The Bill will be announced in conjunction with
its introduction to Parliament.
Financial impact: Nil
Compliance cost impact: These amendments are expected to result in
a slight increase in compliance costs for the finance sector. The
Office of Best Practice Regulation granted an exemption from having
to provide a Regulation Impact Statement.
Chapter 1
Limited recourse borrowing arrangements
Outline of chapter
1. Schedule 1 of this Bill amends the Act with the purpose of reducing
the risks for superannuation funds investing in limited recourse
borrowing arrangements.
Context of amendments
2. The Act prohibits superannuation fund trustees from borrowing
money, subject to limited exceptions, to minimise the risk of loss
to fund assets as a result of a default on the loan. One of these
exceptions permits superannuation funds to borrow on a limited
recourse basis for investment purposes provided certain conditions
are met. This is typically done through a limited recourse
borrowing arrangement analogous to an instalment warrant.
3. An instalment warrant is a form of limited recourse borrowing that
allows an investor to purchase an asset (typically shares) by means
of one or more instalments. The asset is held on trust to provide
limited security for the outstanding loan, but the benefits of
ownership (such as dividends or rent) flow to the investor. If the
investor defaults on the loan the rights of the lender are limited
to the asset which is the subject of the warrant and the investor's
loss is limited to the loss of the beneficial interest in the asset
and the instalment payments made prior to the default.
4. Developments in the superannuation borrowing market have led to
products and practices which raise prudential concerns for
superannuation funds. These include:
. the use of personal guarantees to underwrite the lender's
risk in the borrowing arrangement;
. borrowing arrangements over multiple assets which can
potentially allow the lender to choose which assets are
sold in the event of a default on the loan; and
. arrangements where the asset subject to the borrowing can
be replaced at the discretion of the trustee or the
lender.
Summary of new law
5. Schedule 1 of this Bill amends the Act to make sure that
superannuation fund assets are protected in the event of a default
on a limited recourse borrowing arrangement by ensuring that:
. the recourse of the lender and of any other person against
the superannuation fund trustee for default on the
borrowing is limited to rights relating to the acquirable
asset;
. the asset within the arrangement can only be replaced in
prescribed circumstances that arise from owning the
original asset; and
. the borrowing is referable and identifiable only over a
single asset (excluding money) or in prescribed
circumstances, a collection of assets which are identical
and are treated as a single asset.
Comparison of key features of new law and current law
|New law |Current law |
|Explicitly defines the |While the Act refers to |
|interpretation of |'asset' in the singular, |
|acquirable asset in the |it is possible to |
|singular. |interpret asset in the |
| |plural. |
|Ensures that the recourse|The Act limits the rights|
|of the lender or of any |over the original asset |
|other person against the |in terms of the direct |
|superannuation fund |lender and associated |
|trustee for default on |borrowing only. |
|the borrowing is limited | |
|to rights relating to the| |
|acquirable asset. | |
|Limits borrowing |Allows borrowing |
|arrangements to a single |arrangements over |
|asset or a collection of |multiple assets which may|
|identical assets together|permit the lender to |
|treated as a single |choose which assets are |
|asset. |sold in the event of a |
| |default on the loan. |
|Clearly defines |Allows arrangements where|
|circumstances under which|the asset subject to the |
|assets can be replaced. |borrowing can be replaced|
| |at the discretion of the |
| |trustee or the lender. |
Detailed explanation of new law
The definition of 'asset'
6. In allowing limited forms of borrowing, the Act refers to 'asset'
in the singular. However, section 23 of the Acts Interpretation
Act 1901 provides that, subject to a contrary intention appearing,
the singular includes the plural.
7. Some limited recourse borrowing arrangements targeted towards
superannuation funds have been designed on the basis that 'asset'
should be interpreted as including the plural.
8. Borrowing arrangements over multiple differentiated assets could
expose superannuation funds to greater risk than if a trustee took
out a number of discrete loans, each relating to, and only
enforceable against, a single asset (or a group of identical assets
treated collectively as a single asset).
9. Item 1 of the Bill inserts the definition of 'acquirable asset'
into section 10(1) of the Act as the meaning given by section 67A,
inserted by item 8.
10. The term 'asset' should now be read in the singular, so that it is
not interpreted as permitting borrowing arrangements over multiple
non-identical assets. However, the definition permits borrowing
arrangements over a collection of assets that are identical and
have the same market value.
11. Reflecting the policy intent to prohibit borrowing arrangements
over multiple assets that can potentially allow the provider to
choose which assets are sold in the event of a default on the loan,
examples of a collection that can be treated as a single
'acquirable asset' include:
. a collection of shares of the same type in a single
company;
for example, a collection of ordinary shares in X Ltd.
. a collection of units in a unit trust that have the same
fixed rights attached to them;
. a collection of economically equal and identical
commodities.
for example, a collection of gold bars, irrespective of
whether they might, for example, have different serial
numbers.
12. Examples of collections that would not be permissible include:
. a collection of shares in a single company that have
different rights;
for example, ordinary and preference shares.
. a collection of units in a unit trust of different classes
that have different rights attached to them or are
potentially subject to differing trustee discretion;
. a collection of shares in different entities; and
. a collection of buildings each under separate strata
title, irrespective of whether the buildings are
substantially the same at the time of acquisition.
Note: A collection of such assets would rarely have the
same market value over time.
13. To ensure that an acquirable asset for the purposes of this
subsection is always interpreted in the singular, the words
'collection' and 'identical' should be interpreted as ensuring that
an acquirable asset is one or more things that within the
arrangement are seen and treated as a whole.
for example, a collection of shares must be acquired and
disposed of as a collection and could not, for example, be
sold down over time.
14. In the case of the purchase of real property for example, a single
title for land and the accompanying house on it would be considered
a single acquirable asset, but additional items such as furnishings
would not be allowed to be purchased through the same limited
recourse borrowing arrangement. Furnishings (or 'non-fixtures' of
the property) can be acquired through separate limited recourse
borrowing arrangements over a single acquirable asset or bought
outright (but not held as security under the borrowing arrangement
over the property).
15. As a further example to guide the interpretation of 'acquirable
asset' in relation to real property, it is not the intention of
this provision to prevent the acquisition of leased property. For
the purposes of section 67A, the lease itself should not be
considered as a separate asset as long as it is dealt with together
with the property under the arrangement (and therefore does not
need to satisfy the requirements of subsection 67A(3)).
16. The definition of acquirable asset excludes limited recourse
borrowing arrangements that involve money as an asset (that is
Australian currency or currency from any other country). This
addresses concerns with limited recourse borrowing arrangements
over multiple assets that are traded for money and managed in a
similar fashion to margin accounts.
Acquisition, refinancing and expenses related to the asset
17. For the purposes of paragraph 67A(1)(a) (inserted in item 8), an
acquirable asset is 'acquired' at the time when the trustee of the
holding trust (security trustee) gains a legal interest in the
asset. At the same time, the regulated superannuation fund (RSF)
trustee gains a beneficial interest in the asset as required by
paragraph 67A(1)(b). The 'beneficial interest' arises on creation
of the security trust over the acquirable asset. The RSF trustee
has a right to acquire the legal interest upon repayment of the
loan. .
18. Item 8 inserts subparagraph 67A(1)(a)(ii) to clarify that the
trustee can refinance an existing limited recourse borrowing.
Refinancing may allow the RSF trustee to minimise the risk of
default on a borrowing resulting from a temporary inability to make
a repayment (for example, the fund is facing solvency issues due to
benefit payment obligations).
19. Associated expenses in acquiring the underlying asset can be
included as part of the borrowing. Item 8 inserts subparagraph
67A(1)(a)(i) to allow expenses that are considered to be
intrinsically linked to the purchase of the acquirable asset. The
examples provided in the subparagraph are specifically allowed as
part of the borrowing arrangement.
20. The reference to 'any other laws' in subsection 67A(2) (inserted in
item 8) captures all applicable laws, including the various Trustee
Acts of the state and territory governments.
Replacement assets
21. In prescribing the terms to which a borrowing arrangement must
adhere, paragraph 67(4A)(b) of the Act provides that the borrowing
must be used or maintained to acquire 'the original asset, or
another asset (the replacement)'.
22. The broadness of the existing definition creates uncertainty over
what constitutes the replacement asset and this uncertainty gives
rise to arrangements that could place fund assets at risk.
23. For example, a lender may require a trustee to replace an asset
within an arrangement if its value falls below a certain level,
with an asset of greater value than the outstanding loan.
24. Consistent with the original policy intention and to provide
greater clarity regarding eligible replacement assets, item 8
inserts section 67B into the Act to list specific circumstances
permitting a replacement asset. Those listed are the only
circumstances where replacement assets will be allowed.
25. To avoid any confusion with the circumstances listed, guidance
regarding the use of 'company' and 'instalment receipt' for the
purposes of this subsection follows.
26. 'Company' is to be interpreted as having its commonly understood
and used definition. The use of 'company' in this subsection is
for the sole purpose of allowing 'shares' as they are commonly
understood, and is not intended to limit investment choice. To be
clear, borrowing arrangements for, and subsequent replacement of,
shares in foreign companies are permitted, so long as they meet the
requirements of the amended legislation.
27. Item 3 amends subsection 10(1) of the Act to define 'instalment
receipt'. As is commonly understood, an instalment receipt is a
product that does not ordinarily involve a borrowing; rather, it is
the purchase of another asset by instalments. When 'instalment
receipt' is specifically referred to in the context of replacement
assets, it means a limited recourse borrowing arrangement over an
'instalment receipt' as the acquirable asset. This is not to be
confused with a superannuation fund using an instalment receipt to
purchase an asset in the absence of a borrowing, which is not
relevant to the borrowing exemption.
28. The amended legislation provides for the regulations to prescribe
additional circumstances permitting a replacement asset.
29. Examples of circumstances not permitting a replacement asset
include:
. securities liquidated or traded or both for different
assets only as a consequence of implementing an investment
strategy;
. money or cash is not eligible as a replacement asset under
any circumstances;
- includes circumstances where the original asset would
otherwise be replaced with an eligible replacement asset
plus cash for example shares in X Ltd replaced by shares
in Y Ltd and a pool of cash as a result of a takeover of
X Ltd by Y Ltd;
. replacement asset arising from an insurance claim covering
the loss to the original asset;
. the replacement by way of improvement of real property;
. a series of titles over land replacing a single title over
land that has been subdivided; and
. a replacement of a title over real property as a result of
Government action such as the resumption of all or part of
a property or re-zoning.
30. Item 8 inserts subsection 67B(2) to ensure that the requirements
pertaining to the original asset also apply to eligible replacement
assets.
31. Item 8 inserts subparagraph 67A(1)(a)(i) to clarify that money
under a limited recourse borrowing arrangement applied for the
acquisition of an asset can be used for expenses incurred in
maintaining or repairing the asset, to ensure that its functional
value is not diminished, but not to improve the asset, as this
would fundamentally change the nature of the asset used as security
by the lender, potentially increasing the risk to the fund.
32. The terms 'maintain', 'repair' and 'improve' have their ordinary
meanings.
33. While subparagraph 67A(1)(a)(i) will have limited practical
application to assets other than physical or real property in
respect of maintenance and repairs, it applies to all eligible
acquirable assets.
34. Item 8 inserts subsection 67A(4) to allow regulations to further
specify circumstances in which an acquirable asset ceases to be
one, to deal with specific situations where an alteration to an
asset may result in it ceasing to be the original acquirable asset
.
Protection of fund assets against guarantees and related borrowings
35. Several providers of limited recourse borrowing arrangements are
requiring trustees, or third parties such as fund members, to
provide guarantees of the borrowing to underwrite the provider's
risk from the limited recourse nature of an instalment warrant
arrangement.
36. The Act does not prevent a lender exercising rights under a
guarantee given by a third party since the lender's rights under
such guarantees are not rights against the trustee of the fund.
Accordingly, the lender has rights against the guarantor's assets
if there is a default on the borrowing. The guarantor subsequently
has a common law right to recover losses (which may exceed the
value of the asset which was the subject of the borrowing) from the
principal debtor - the trustee - and the trustee may then arguably
seek indemnity out of the fund's assets.
37. It is also unclear, where a guarantee is given by a trustee in its
personal capacity, whether a lender's entitlement to recourse
against the trustee's personal assets may lead to the trustee
claiming indemnity out of the fund's assets.
38. Item 8 inserts paragraph 67A(1)(b) to maintain the requirement that
the acquirable asset must be held in trust. The trust structure is
a feature of traditional instalment warrants and helps to
quarantine the other assets of the superannuation fund from the
investment risk that the limited recourse borrowing arrangement
represents.
39. Item 8 also inserts paragraphs, 67A(1)(d), (e) and (f), which seek
to protect fund assets from such claims by limiting the rights of
the lender or any other person against the RSF trustee, for or in
connection with or as a result (direct or indirect) of a default on
a borrowing or charges related to the borrowing, to rights relating
to the acquirable asset. In this way, a guarantor's rights against
the RSF trustee are limited as the rights of the lender are
limited, so that no claim against the RSF trustee should arise
which could give rise to a claim for indemnity from fund assets.
That is, a charge may be given over an asset that is acquired
through a borrowing arrangement in order to secure that borrowing,
but no other charge is permitted.
40. Paragraph 67A(1)(d) will ensure that the rights of the lender or
any other person against the RSF trustee are limited to rights
relating to the acquirable asset. No guarantee arrangement can be
enforceable against the RSF trustee other than the rights relating
to the acquirable asset.
41. Paragraph 67A(1)(f) will ensure that the acquirable asset cannot be
subject to any other charge than that associated with the direct
borrowing arrangement.
42. With the exception of the asset that is the subject of the
borrowing arrangement, the assets of the superannuation fund cannot
be given as security for a borrowing without breaching regulation
13.14 of the Superannuation Industry (Supervision) Regulations
1994.
43. This Bill does not explicitly refer to guarantees given the variety
of ways that collateral agreements might be used to circumvent the
limited recourse nature of the arrangement.
RSF trustee breach of duty
44. Item 8 inserts subsections 67A(5) and 67A(6) to ensure that the
amendments of the Bill do not inadvertently prohibit members and co-
trustees from being able to claim damages against a trustee that
makes a decision to acquire an asset under a limited recourse
borrowing arrangement in breach of its obligations as trustee,
noting that the trustee in this situation is prevented from seeking
any indemnity against fund assets by sections 56 and 57 of the Act.
Other amendments
45. Items 2, 4, 5, 6, 9, 10, 11, 12 and 13 make consequential
amendments to related sections of the Act and item 7 formally
repeals the existing borrowing exemption for instalment warrants.
Application provision
46. The amendments all commence on the day after the Bill receives the
Royal Assent.
47. Item 14 inserts an application provision, which states that this
Bill, and therefore the revised Act, will apply to all limited
recourse borrowing arrangements entered into on or after the
commencement date.
48. To avoid any reduction in the value of the 'property' owned under
limited recourse borrowing arrangements entered into prior to the
day after the Bill receives the Royal Assent, the Bill will not
apply retrospectively to existing arrangements.
49. As noted in the application provision, an arrangement that is a
refinancing of a borrowing of money under an arrangement entered
into before, on or after that commencement, will be subject to the
amended legislation.
50. A re-negotiation of a borrowing with the same lender that is simply
a variation of a loan contract that continues to exist will not be
subject to the Bill. However, where the re-negotiation amounts to
a rescission or replacement of the original contract this is to be
regarded as a refinancing and the application provision and
therefore the amended legislation will apply to the arrangement.
51. Refinancing is not the only way that a new arrangement may arise to
which the application provision applies. For example, a change to
the terms and conditions of an arrangement that fundamentally
alters the character of the arrangement may result in a new
arrangement to which the application provision applies.