LRBA loans no ‘material’ super risk, but vigilance remains

Investors using their self-managed super fund (SMSF) to start or expand their property portfolio via limited recourse borrowing arrangements (LRBAs) have been encouraged yet cautioned following the Council of Financial Regulators (CFR)’s latest report into the financial tool.

As LRBAs are loans that SMSFs use to buy property and with quite a few non-banks offering such product, prudential risk analysis has been paramount to the SMSF industry since the 2014 Financial System Inquiry recommended LRBAs be prohibited.

Issued to Treasury late September 2022, the CFR’s latest Report to Government on Leverage and Risk in the Superannuation System in conjunction with the Australian Taxation Office (ATO) has largely garnered support from the SMSF industry, having highlighted key points as to whether and to what extent LRBA’s posed greater economic financial risk.

Consistent with CFR’s first report prepared in 2019, the 2022 report found that: “LRBAs are unlikely to pose a material risk to the superannuation system, or broader financial system, and recommends continued monitoring and reporting on an ‘as needed’ basis to ensure appropriate oversight of these risks.”

However, the report also unearthed that LRBAs “continue to be a significant risk to some individuals’ retirement savings.”

“Given this, the report concludes that the Government may wish to further consider current policy settings, particularly in light of the 2014 Financial System Inquiry’s recommendation that LRBAs be prohibited,” the report said.

Magnitude of the concern and why so

While CFR is the coordinating body for Australia’s main financial regulatory agencies — the Australian Prudential Regulation Authority (APRA); the Australian Securities and Investments Commission (ASIC); the Reserve Bank of Australia (RBA); and the Treasury — it is a non-statutory body.

SMSF trustees are directly accountable to the ATO and generally prohibited from borrowing money “subject to limited exceptions under the super law.”

One of these exceptions are LRBAs where an SMSF trustee takes out a loan from a third-party lender then uses those funds to purchase a single asset or “collection of identical assets that have the same market value” to be held in a separate trust.

As the ATO explained, any investment returns earned from the asset go to the SMSF trustee. However, if the loan defaults then the lender’s rights are limited to the asset held in the separate trust.

Thus, there is “no recourse to the other assets held in the SMSF.”

Industry support for the pro-LRBA outcome

The SMSF Association — representing the self-managed superannuation fund (SMSF) sector, which comprises 1.1 million SMSF members and a range of financial professionals servicing SMSFs — has welcomed the CFR-ATO LRBA findings.

SMSF Association chief executive John Maroney said: “In 2019, our response to the CFR was that an outright ban on LRBAs could be avoided by ‘mitigating’ risks to this SMSF asset class.

“What has occurred in the intervening three years reinforces our view that a ban on LRBAs would be overkill, with the report highlighting that SMSF borrowings remain a small percentage of total SMSF assets and, as such, pose little risk to financial stability while assisting many small businesses, in particular, meet their retirement income goals.”

The association also highlighted that the report downplayed another criticism of LRBAs — their impact on property prices — by stating they “only comprise a small share of total housing credit.”

Mr Maroney explained that the ongoing viability of LRBAs is due, in no small part, to the integrity measures introduced in 2018, including changes to the total superannuation balance and non-arm’s length income rules (NALI).

“In our opinion these measures have greatly improved the system, helping ensure LRBAs are used responsibly,” he stated.

“That said, it is important for SMSF trustees considering an LRBA to get specialist advice as they can be complex arrangements which require [careful] assessment of the risks, benefits and costs.”

Crackdown on cowboys and curtailing their activities

Mr Maroney added that “one-stop property shops” advocating LRBAs and providing “unlicensed personal advice” remained a concern.

“We have long supported a crackdown on their activities and believe ASIC has done much to curtail their nefarious activities,” he explained.

“But the fact they still operate highlights the need for the entire sector to remain vigilant to ensure this debt instrument remains available to the vast majority who use it responsibly.”

LRBAs highlight the importance of quality of advice, and that Michelle Levy’s review — being handed down on 16 December — will hopefully “bring more clarity to this”, Mr Maroney concluded.

[Related: Abolishing LRBAs could ‘unjustifiably disadvantage’ SMEs]