By Greg Bright
APRA has picked a sore which has troubled the industry for years: ‘who is making what out of cash?’. And it’s a good thing to raise the question, but APRA perhaps should look a little deeper with its investigations. Perhaps bigger issues are not what the definition of cash should be, but rather what the real return for members should be, the real liquidity of the offering and/or the real asset backing.
Hopefully, we will now get an open discussion on this complex topic. Believe it or not, cash is not a simple asset class. For instance, most big super funds probably don’t know how much cash they are holding at any one time. They have various definitions of cash from an investment point of view and various definitions from the vague, it has to be said, regulatory point of view. Super funds hold cash in several bank accounts for both operational and strategic reasons. And then they have their separate member investment options. Let’s give this a run around the block.
APRA wrote to its regulated funds, which number just over 200 in theory but, given the amount of outsourcing to Russell Investments, Willis Towers Watson and the like by the remaining corporate funds, could be better estimated at about 70. The regulator wrote, on June 29, to tell the funds it had done a “desktop review” of their cash investment options.
It should be noted that super fund investment options have undergone a massive upgrade in the past few years and the new-style member-directed investment options (MDIOs) are far different from the options introduced in the early 2000s under the “member investment choice” campaign. They don’t, for instance, always invest through unit trusts. The really big ones allow their members to keep all the advantages of their individual investment status once they enter the MDIO space. APRA saw some irregularities. Here is it’s letter.
One of the anomalies of cash is that individual investors have an advantage over big institutions in terms of the rates and flexibilities they are usually offered. This is thanks to the global regulatory regime known as Basle III. Under this regulation, banks and other financial institutions subject to capital requirements have to treat their client segments differently. Large clients, such as super funds and other bank-backed platforms, actually get less for their cash, while individuals get more. At least, that’s how it should be.
There are no innocent parties in this story. The fact is that cash, because of its ubiquity and its low return, with nonetheless best asset backing and best liquidity, in theory, has been used by most, if not all, players in the super industry to garner unnoticed profits for years. The members, of course, tend to miss out.
The sore APRA picked, and will be followed up with other investigations, may reveal much more important things than what the regulator considers ‘non-cash investments’ in the cash options strategies. It may reveal that there are too many fingers in the cash pie.
The official cash rate is 1.5 per cent at the moment. This is the rate about which all others are set, subject to various supply and demand issues. Big super funds have only in the past few years focused on the rate they should be getting from their various cash service providers, such as custodians and the two-or-three banks with which they each deal.
Because big funds have a strong positive cashflow of money coming through lots of intermediaries, including direct from employer members, they struggle to not only invest the money as either instructed or as they have the discretionary ability to do so, they also struggle to garner a reasonable return from it while it is in transit.
To make matters worse, big super funds will tend to charge a healthy administration fee on handling that cash. A strategic asset allocation to cash tends to be mixed up in the melee for this ‘risk-free’ asset class.
If the fund has outsourced its MDIO to a platform provider which is owned by a bank, or even one which is independently owned, the cash component returns are likely to be a lot less than the fund could otherwise obtain for its members if it had constructed the option differently and also less than the member could have obtained on his or his own. The rates differ even on the same product between whether it has been offered by a big super fund or direct from the platform.
In the wholesale platform game the situation on cash rates is looking increasingly problematic for providers. Cash rates have recently gone as low as 27bps on one major platform. Smaller platforms are almost as bad. Theoretically, those individual investors should be receiving closer to 200bps.
So, the super funds aren’t handling the physical cash particularly well and they are often getting a lower return than they should. They should be managing their cash just as actively as they manage equities, with a weekly, or even daily, auction with the major and minor banks to obtain the best rates. Once the documentation between each of the banks on a panel and the super fund is set up, the auction and transfers between the banks should only take an hour or so. What banks are prepared to pay for cash varies according to their own positions.
The retail funds, the big ones of which own the cash system providers (banks), are simply providing rates for their customers which are too low and with little regard for rationality across their product range. There is no active management there.
There is an increasing number of industry insiders in the cash/fixed interest/currency field who believe that these super fund options, at least, on big super fund MDIO platforms, should be close to a ‘pass-through’ process for members. That is, members should get more than they are getting, at least with physical cash.
But, thanks to APRA, that’s not the end of the ‘cash’ story. Members also should be given the product they think they have bought. APRA told big super funds in its letter that such a cash product needed to be readily accessible without change in value.
APRA’s definition of cash under reporting standard SRS 30 is: “…Represents cash on hand and demand deposits, as well as cash equivalents. Cash equivalents represent short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.”
But APRA’s desktop review found examples of fund cash options containing investments which it believes the members would not ordinarily think of as cash and would not fit its definition. These include asset-backed and mortgage-backed securities, commercial bonds and hybrid debt instruments, credit default swaps, loans and other credit instruments. The regulator said it intended to follow up with funds which the review had identified and monitor cash options in its supervisory process.
APRA is not the only institution which grapples with what investors, large and small, may think of as cash. Stock exchanges, for instance have their own definitions of cash as do security lending firms which need collateral from borrowers.
The ASX, with its cash ETFs, for instance has no specific rules for “cash and cash equivalents”, except a general rule that they must be “true to label”. ASX says: “The application for each new ETF product must be accompanied by a legal characterisation of the underlying assets. If a product proposed “cash or cash equivalents” in its PDS which did not satisfy APRA’s definition, or ASIC’s guidance on money market funds, the ETF would not be admitted unless corrective disclosure was made.”
It looks like the returns from cash options provided by some super funds are about to go even lower. APRA should also examine the rates being paid by the options, in particular those of the commercial funds, and perhaps design a best-practice guideline for the management of cash generally.
Then it can do the same with foreign exchange, which is another complex problem.