Choice, Transparency, Care and Trust – what else do investors need beside performance? Speech to Pritchett Partners Annual Function, Sydney

February 4, 2010

It is Government’s responsibility to foster investor confidence and to provide regulatory certainty. It is also the government’s responsibility to foster an atmosphere where people can invest for their future with certainty.  The Coalition believes that these responsibilities can be met by encouraging choice and improving market and institutional competition – and by a light touch on the wheel.

To consider what investors require from the market in general, we need to discuss why people invest in the market and why it needs to be encouraged by Government.

Generations and Choice

Superannuation and market investment is very much a generational thing. Interest in investments had a positive correlation with age and worry about retirement.  Generational attitudes have not changed much today from the days when the class of 79 were preparing to take on the world.  The majority of those involved in Superannuation tend to argue that Australians under 40, and Generation Y in particular, are extremely apathetic towards superannuation and tend to allow their investment to sit in a low-risk default fund.

The Parliament investigated how to improve superannuation for Australians aged under 40 through a Senate Inquiry in 2006. Australians currently under 40 will be the first generation to have benefited from the Superannuation Guarantee during the entirety of their working life.  The inquiry found that superannuation for those aged under 40 will only be adequate in retirement if the individual salary sacrifices additional earnings into their super fund.

Unfortunately, the vast majority of those under 40 do not voluntarily sacrifice into superannuation and this is something Government must encourage to improve adequacy. Adequacy was recently highlighted by the Investment and Financial Services Association, which released modelling that detailed Australia’s retirement savings gap as being close to $700 million.Government must address the shortfall by encouraging higher investment in superannuation.

The Coalition has a policy goal of encouraging investing for retirement as a means of enabling self-reliance in retirement and relieving the pressure on taxpayers from an ageing population. We believe that individual engagement with superannuation and investment choice creates market competition, provides higher returns, and acts as a tool for addressing the adequacy of Australia’s retirement system.  Through the Superannuation Guarantee, 84 per cent of all Australians between 25-54 years of age currently have money invested in Australian markets through superannuation. Yet, only around 23 per cent of Australians choose their own superannuation fund. This is a disappointing percentage.

Australians have the right to decide how they invest the money they earn without being locked into Government or employer decisions regarding their superannuation.  In 2005, the Howard Government implemented Super Choice, which allowed employees to nominate the superannuation investment fund that their Superannuation Guarantee contributions are paid.  Super Choice opened up competition in the investment fund sector. Superannuation funds were forced to minimise fees and improve performance in order to attract employee nominations.

The policy was an example of the type of reform which improves the operation of the market rather than impedes it.  It enabled employees by giving them confidence to actively choose their own investments and it forced superannuation funds to be directly accountable to their customers.  This is what investors need: the confidence to operate in the market and certainty in the regulatory environment.

Confidence and Certainty

It is said that perception is reality. In my view it can be said that perception is the reality of value. Our text books tell us that the value of an investment asset is the present value of the expected future returns – but when investors are heading for the door the discount rate is very high indeed. Irrationally high one could say.  The global financial crisis has proven that if investors have no confidence in the state of the markets or with the Government, they simply will not invest.

In the past, the Rudd Labor Government has not realised that its own actions can have devastating effects on the market.   We saw this in late 2008 when the Government was panicking about how to respond to the GFC, and in its desperation it announced a policy to guarantee bank deposits. As a result, investors flocked out of holding shares, and placed their money into risk-free deposit accounts.  Many investment funds responded to the crash of their portfolios caused by investors moving to deposits by freezing redemptions.

At December last year, $15 billion was still frozen in mortgage funds and investors can only access their money under hardship provisions that were introduced by ASIC.  It is hard to exercise choice in the market when your money is frozen.

In the debate over whether investors approach the market on a rational or irrational basis, the flow from investment funds into guaranteed deposits was arguably rational. The Government offered investors a guaranteed return and zero risk. It is a rational expectation that investors would take up such an offer.  However, what was displayed by the rush into guaranteed deposits is the psychology of the market and the tendency of investors to follow market trends.  Government should not underestimate the power of investors to move market prices rapidly and Government needs to understand that its actions can trigger such rapid movement.

It is documented in economic theory that investors sometimes act irrationally. For instance, the economists Robert Shiller and George Akerlof partly blame the GFC on ‘irrational exuberance’, which is defined as the tendency for investors to follow market trends without performing due diligence on the viability of individual investments.  There have been many examples of ‘irrational exuberance’ in the sharemarket - The most historical being the South Sea Company Bubble in the 18th century.

The aftermath of the South Sea Company debacle caused Sir Isaac Newtown to famously remark that he could ‘calculate the movement of stars, but not the madness of men’. However, Government was partly to blame for the South Sea Bubble, as it was for the Global Financial Crisis. With regards to the South Sea Company, the UK Government had awarded the company a monopoly to trade in Spanish South America and then convinced Government Bond holders to invest in the company.   The share-price of South Sea skyrocketed due to the privileged position granted by the government as well as rumours spread by the company. South Sea’s share price then crashed as the company failed to pay debts.

Government activity in the market also helped cause the recent Global Financial Crisis. Many commentators blame the 1999 US repeal of the Glass-Steagul Act as a catalyst for the conditions that created the GFC. The Glass-Steagul Act prevented a commercial bank from pursuing an involvement in investment banking. Following its repeal, commercial lenders were able to trade in mortgage-backed securities.  The US Government then got involved in the market by compelling lenders to lend sub-prime mortgages to US citizens who could not otherwise find a homeloan in the market due to a poor credit rating.

The very loan conditions which created the US housing bubble were largely a result of a US Government directive.  The bubble colapsing placed the US securitisation market under strain and led to the collapse of US investment firms like Lehman Brothers.   Yet we have Prime Minister Rudd blaming the GFC on ‘extreme capitalism’ and the absence of Government in the market.

Contrary to the Prime Minister’s views, there is enough historical evidence that Government action can cause significant shocks to the market and is just as dangerous as investor irrationality.  Which leads us to the question as to which is the appropriate level of Government activity in investment markets?  The twin peaks model of regulation in Australia through ASIC and APRA have worked well for some time by providing market guidance and investigation rather than overt intervention. Even the Prime Minister has acknowledged that Australia did well through the GFC because the quality of our regulators has been very strong.

The challenge for Government is to improve how the market works under the current regulatory regime in terms of openness, transparency and competition. For instance, the Coalition supports Government moves to increase Australia’s standing as a financial hub and to open the ASX up to competitive pressures.

The key challenge for the Government in the sector is to foster an environment where the vast majority of investors are “rationally exuberant”. Any change must be light and gradual.  The Government’s tendency to authorise wide-ranging reviews into the sector, combined with its market actions such as the bank guarantee, and the removal of superannuation incentives and choice, have given investors cause to feel nervous about the future state of the market.  As the computer contractor I mentioned earlier said “we don’t want the Government stuffing around with the rules”.

Government Reviews

Tony Abbott said to me long before he became opposition leader that this government certainly hit the ground reviewing.

It is difficult for investors to have confidence in the market when the Government is pursuing over 20 reviews in the areas of Financial Services, Superannuation and Corporate Law.  Investors deserve the right to enter a market without worrying what the regulatory environment will be six months from now.  This year we have already seen the Minister release three consultations on proposed reforms and legislation.

These consultations relate to: the requirement of banks to include information of their Financial Claims Service within PDFs; enhanced regulatory powers for APRA investigations; and a review of corporate insolvency laws.  The Government also released the Johnson Report into Australia’s position as a Financial Hub, and the Productivity Commission’s review on executive remuneration.   This is a Government obsessed with reviews and reports.

The wide-sweeping Cooper and Henry Reviews will generate long debates on the correct regulatory approach to markets, and the danger is that Australians might think twice about making private investors before regulatory certainty is provided by the Government.  The Government is also currently reviewing the Ripoll Report into Financial Products and Services in Australia, and is refusing to comment on its recommendations until after the Cooper Review is complete.  Some of the Ripoll Report’s recommendations are supported by the Coalition, such as the requirement that financial advisers owe a fiduciary duty to their clients.

Investors deserve to trust their financial advisers to provide accurate and timely advice suited to individual circumstances. Strengthening the trust lost in financial advisers as a result of investment fund collapses such as Storm Financial and Opes Prime is an important facet in providing investors with confidence.  The Coalition holds some concern about some of the Report’s recommendations.

In particular the recommendation that the Government investigate a fund of last resort to pay investors in failed schemes would have impacts upon market risk and the level of return for investors willing to place their money in riskier ventures.  The Coalition is also concerned that the Government has a tendency to ignore its own reviews and arbitrarily make decisions beyond the scope of previously tabled reports. The current Superannuation Clearing House legislation is a prime example.

In the original discussion paper released in November 2008, the Government proposed to allow private companies to tender for the contract to operate the Government’s promised ‘Superannuation Clearing House’ at a cost of $16 million.  After receiving submissions and completing the review, Minister Bowen announced in November last year that the Government had decided to allow Medicare to deliver the service rather than a private provider.   I am aware that sections of the superannuation industry feel misled by the Government announcing that the house would be operated by the private sector, and then awarding it to Medicare.

The way forward

The Government has effectively admitted that not enough Australians are investing for their retirement. The Prime Ministers recently announced that Australia will need to increase its productivity to manage our ageing population.   And yet, in the 2009 Budget the Government made some significant cutbacks to incentives which encouraged Australians to invest more of their earnings in superannuation.   For staters, the Government halved the maximum limit on Concessional Contributions from $100,000 to $50,000 for those aged 50 or more, and from $50,000 to $25,000 for those aged under 50. The limits apply from July 1 2009. After 2011-12, all Australians will be subject to annual contribution caps of $25,000.

The Government also cut the Co-Contribution Rate by a third in the 2009 Budget.  The Co-Contribution scheme was introduced by the Howard Government for low-income Australians who want to sacrifice some of their salary into Super as a means of planning for their future.  The Labor Government reduced its matching of super contributions by workers earning less than $60,342 from $1.50 for every dollar invested to $1 for the next three years. It will pay a $1.25 co-contribution for a further two years before the full co-contribution comes back in 2014.

The Coalition believes that the Government is undermining efforts to create self-sufficient retirees and will ultimately be placing additional pressure on Australia’s publicly funded retirement system.   And unlike the Government, we will work towards encouraging Australians to invest more for their future.

The changes in last year’s budget will see less investment in superannuation. We see dramatic falls in the levels of personal contributions. Whilst turbulence on financial markets no doubt played a part but the budget decisions by the Government have clearly impacted on personal contribution levels.

The Coalition will also protect choice in the market.   Labor has allowed the Australian Industrial Relations Commission to begin writing default superannuation funds into modern awards.   This means that favoured investment funds are automatically receive superannuation payments from a large proportion of the 77 percent of Australians who do not exercise a choice of superannuation funds.  The Coalition believes that competition is the only way to achieve an efficient investment market. Default funds have no encouragement from competition to improve their operations and to deliver the best value for members.

Finally, I would like to address one of the Government’s better reviews, the Johnson Report, which is entitled “Australia as a Financial Services Hub”.   The Coalition enthusiastically welcomed the Johnson report and the opportunities it contains to increase the exports and imports of financial services in Australia.   There is a real need to clarify and streamline the taxation treatment of investments with a foreign component to encourage overseas investments and expand the opportunities available to the industry.

These proposals are examples of policy which would improve competition and functioning of Australian markets rather than impeding it.   It was disappointing to see Prime Minister Rudd down play the potential the proposals gave for reform despite the enthusiasm shown by Minister Bowen.  Yet again we have a report with no certainty as to how the Government plans to approach it.

Conclusion

Confidence in the market is what the Government needs to foster if we are to engage investors and to encourage choice in superannuation, particularly amongst younger generations.   Governments do not inspire confidence by arbitrarily getting involved in the market and by hanging industry-changing reviews over the heads of those in the sector.

In Government, the Coalition will take a light touch to positive regulatory changes. Any proposals will be dealt with transparently and consultatively.  Australia needs investors with the confidence to back the Australian economy. Government must provide them with choice, transparency, care and trust through regulatory certainty.

The Prime Minister has been preoccupied with what is happening in 2050 as he conducted is barn storming national tour prior to the return of parliament however by his actions in the superannuation and financial services space he has actively taken decisions that make saving for retirement less attractive and his endless reviews have certainly scared the horses.  The Coalition is committed to the three tiers approach to retirement funding of SGL, voluntary super contribution and the aged pension safety net.

Labor is big on rhetoric with regard to planning for 2050 but its actions are such that the aged pension safety net for form a larger part of retirement funding than it should be.

 

 

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