Proposed superannuation borrowing rule changes

Craig Day examines the introduction of the new superannuation bill and its proposed changes to borrowing rules.

On 26 May the Federal Government introduced Superannuation Industry (Supervision) Amendment Bill 2010 to repeal the instalment warrant borrowing exemption in section 67(4A) of the Superannuation Industry (Supervision) Act 1993 and replace it with a new limited recourse loan exemption.

The Government stated that the purpose of the changes was to reduce the risks associated with super funds investing in these types of borrowing arrangements.

While the new limited recourse borrowing rules will still require similar trust arrangements to be established to allow the fund to borrow, they differ from the existing instalment warrant rules in that they include additional details to clarify a number of issues which were previously uncertain.

These include:

• what a borrowing can be used for;
• in what circumstances additional guarantees can be provided;
• when a loan can be refinanced; and
• when an asset acquired with a borrowing can be replaced with another asset.

Borrowing can only be used to acquire a single acquirable asset

The new rules will require that a borrowing can only be used to acquire a single acquirable asset. Under the existing rules it is possible for a borrowing to be used to acquire multiple non-identical assets, such as a parcel of shares in a range of different companies.

This potentially allows the lender to cherry pick which assets are sold in the event of a default — leaving the fund with the poorest performing assets.

To prevent this, the new rules explicitly require that a borrowing can only be used to acquire a single acquirable asset.

The new rules will prohibit a borrowing arrangement over a parcel of different assets, such as over a parcel of shares in different companies or over a parcel of different types of shares in the one company.

However, the definition will permit borrowing arrangements over a collection of assets that are identical and have the same market value, such as a parcel of shares of the same class in the one company.

As a result, where a fund wishes to use a borrowing arrangement to invest into a portfolio of shares, the trustee would need to establish a separate loan and security trust arrangement for each parcel of shares in each different company.

Depending on the costs involved this may be impracticable in most circumstances. In this case, people may instead borrow to invest into managed and exchange traded funds that give exposure to a portfolio of shares.

Related expenses and refinancing

The Bill also confirms that a borrowing can be applied to cover expenses that are intrinsically linked to the borrowing or acquisition of the acquirable asset. For example, the following expenses could be included as part of the borrowing:

• conveyancing fees;
• stamp duty;
• brokerage; and
• loan establishment costs.

The new rules also clarify that borrowings will be able to be used to pay for expenses incurred in maintaining or repairing the asset to ensure its financial value is not diminished.

However, the Bill specifically confirms that a borrowing cannot be used to improve an asset, because this would fundamentally change the nature of the asset being held as security.

The ban on the borrowing being used to fund improvements also brings into question whether any form of development activity could be carried out on the asset, regardless of how it is funded.

For example, if the fund used its own resources to improve or develop an asset acquired with a borrowing, it could result in the borrowing arrangement failing the requirements as it could result in a fundamental change in the nature of the asset held as security.

Refinancing

The Bill also clarifies that a trustee will be allowed to refinance a borrowing used to acquire an acquirable asset. This confirms that a trustee will be able to change lenders or to renegotiate an existing loan with their current lender.

For example, this may allow a trustee to refinance an existing loan where the trustee is at risk of default due to changed circumstances.

Limit on replacement assets

Under the existing rules a trustee can replace the asset acquired with the borrowing (the original asset) with another asset (a replacement asset).

As a result, a lender could require a trustee to replace an asset within an arrangement where its value falls below a certain level with another asset of greater value than the existing loan.

To prevent such arrangements, the new rules will generally only allow a share (or a collection of shares) in a company or a unit (or collection of units) in a trust to be replaced with shares or units in the same company or trust of the same value.

Therefore, where the original asset was some other form of asset, such as real property, the trustee would be prohibited from replacing that asset with another asset — even where the replacement asset was of the same asset class.

Personal guarantees and indemnities

Under existing arrangements some lenders are requesting a third party, such as a fund member, to provide additional guarantees to underwrite the lender’s risk.

In the event of default, the lender may then exercise their rights under that guarantee to recover any losses, since they are not rights against the trustee of the fund.

However, in this situation the guarantor will generally have a common law right to recover any losses from the trustee as the principal debtor. As a result, such arrangements would effectively result in a full recourse loan.

To prevent such a situation, the Bill introduces amendments to ensure that the rights of the lender, or any other person (ie, the guarantor) against the super fund trustee are limited to rights relating to the acquirable asset.

This ensures that no guarantee or right of indemnity can be enforced against the trustee other than rights relating to the acquirable asset.

New laws not retrospective

The Bill also confirms that the new rules will only apply to limited recourse borrowing arrangements entered into from the day the Bill receives Royal Assent, and will not apply retrospectively to existing arrangements.

Therefore, existing borrowing arrangements will not need to be restructured or unwound where they don’t comply with the new amendments.

Additionally, clients currently considering entering into a borrowing arrangement may wish to consider whether it is be better to speed up the establishment of the borrowing arrangement or to delay it so it is treated under the new rules.

Craig Day is senior technical services manager at Colonial First State.