A reform agenda to address impediments to super fund investment in infrastructure
Director Investments and Economy
Association of Superannuation Funds of Australia
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I would like to start by acknowledging SMART Infrastructure Facility for organising this conference. We are very happy to be a sponsor of this event and to partner with SMART to deliver a special forum focus on investor perspectives that will be held on Friday.
ASFA believes that of all the areas where superannuation funds invest, infrastructure is unique because of the involvement of government and stakeholders. This forum provides an opportunity for a stakeholder dialogue, which we believe is essential to maximising the role that infrastructure investment can play in driving economic and social outcomes in Australia.
Today, I want to set out what I think can be a pathway to drive future superannuation fund investment in infrastructure. I would stress at the outset that there is no 'magic pudding'. But with collaboration there is an opportunity that superannuation funds can invest in a pipeline of future infrastructure assets that will greatly contribute to our future prosperity.
One of the things that we often hear are statements that we need our superannuation funds to invest in infrastructure. I want to set the record straight on that.
Australian superannuation funds were amongst the first pension funds in the world to invest in infrastructure, investing out of the privatisation of assets in Victoria and the creation of projects such as Melbourne's CityLink.
Australian superannuation funds are invested in infrastructure assets across the country. Airports, ports, toll roads, energy pipelines, wind farms, bus interchanges, desalinisation plants are all owned by Australian superannuation funds.
Australian expertise in infrastructure investment is recognised globally. Our infrastructure investment managers including Industry Funds Management, Colonial First State, AMP and Macquarie are amongst the leading infrastructure investors globally.
Where an infrastructure deal has been put on the table there has been no shortage of superannuation funds that have been willing to invest. In fact, it was a shortage of infrastructure investment opportunities in Australia that led superannuation funds to first look offshore for investments to satisfy the demand funds had.
An important point to stress is that there is no shortage of capital when it comes to infrastructure. There is only a shortage of well-structured deals.
Whilst superannuation funds are willing investors in infrastructure, we do face challenges. I want to spend some time talking about what these are and what we can do about them.
The first challenge that superannuation funds face is liquidity. Despite the fact that most superannuation fund members may not access their superannuation assets for 10, 20 or 30 years, superannuation funds must be able to transfer investments at a member's request from one fund to another within 30 days.
The impact of choice is that superannuation funds are required by our industry regulator APRA to manage the liquidity of their portfolio. The amount of illiquid assets that a fund holds varies according to the demographics and behaviour of fund members.
Many infrastructure investments are structured as unlisted assets. They cannot be quickly sold, and indeed, the reason why superannuation funds want to buy infrastructure is because we don't want to sell. We want to hold assets for long periods of time to provide long-term investment returns for our members.
There are a couple of points to make here.
The first is that the ability of superannuation funds to hold illiquid assets is only going in one direction. As superannuation fund members age, the portion of assets that can be held in illiquid assets is likely to decline, due to the need to preserve cash to meet pension payments. Whilst we are expecting that the growth of the superannuation pool will grow, the total pool for illiquid investments, as a proportion of superannuation fund assets, illiquid investments (with the current regulatory settings) is likely to decline over time.
It is worth pointing out that the need for superannuation funds to invest in liquid assets has the potential to have broader impacts on the Australian economy. Australia has a concentrated equities market dominated by banks and financials. As the size of the superannuation pool grows, the search for liquidity and diversification will drive superannuation funds to increase their exposure to international equity markets.
The second point we would make is that, if Australian superannuation funds were not required to limit their illiquid investments, then it is likely we would see at least some funds change their asset allocation. We do not know how many superannuation funds would change their investment strategies, and by how much, but we do know that there would be change. The fact that some funds would change their asset allocation can be seen as the explicit cost of having choice. This is not to suggest that we shouldn't have choice of funds, but we need to recognise that it does potentially have a cost in terms of diversification and risk-adjusted returns.
The good news is that we are not at the limit of the system's ability to absorb new illiquid investments. The continued cash flow of superannuation contributions into superannuation means superannuation funds remain in a strong position to invest in new infrastructure projects.
However, the fact that our superannuation system has the capacity to absorb more infrastructure investment does not necessarily mean that investment would be in Australia. We need to have the right assets at the right price to invest.
I would like to set out the areas where, from a superannuation perspective, we need to focus on:
Superannuation funds would like to see a pipeline of infrastructure projects. But we also need an agreement on where investors will sit in each project. In the past, as government budgets have waxed and waned, there have been projects that have been built by government that could have involved infrastructure investors. We have also had a number of toll road projects that have been disasters for superannuation funds, which has undermined confidence in PPP models.
If we want investors to finance Australian infrastructure, and not overseas infrastructure, we need to send a consistent message about the role of investors in infrastructure assets.
There has been much discussion around government recycling capital. The NSW Ports deal demonstrated that super funds are very interested in stable, mature assets. For sales to be electorally sustainable, there needs to be a demonstration that recycled capital is invested into new projects.
Superannuation funds are also interested in investing in greenfield assets. To maximise investment, we need to construct deals that align to what superannuation funds are seeking. This can be done through take-off arrangements and floors on demand projects.
Price for externalities
One of the challenges building new infrastructure is the funding mechanism. Asking the electorate to pay for roads is always difficult. We need to recognise the limitations of user pricing models that charge for instance road users to use a toll road. Consumers can support user pricing, but support is not inexhaustible and subject to the budget constraints that families face. User pricing also has the potential to have social equity issues, particularly where public transport alternatives are not available. Social issues are important to superannuation funds because it is ultimately the general public that are our members. We need to have a conversation about the positive externality benefits that come from infrastructure, and who is best placed to capture those externalities. If we are able to broaden out the funding base, we open up the possibility of developing new infrastructure assets that may otherwise not have been built.
We need to have a better understanding of the restrictions that we are placing on liquidity. There have been a number of suggestions, including the Reserve Bank establishing a liquidity facility for super funds or relaxing borrowing requirements for super funds enabling, for instance, the banking sector to provide liquidity through commercial facilities. We should not rush into a quick fix. We know super funds are funding infrastructure at the moment so there is no immediate capacity constraint. Before making any change, we need to ensure we understand of the implications including moral hazard issues. Whilst reform around liquidity may be possible, we need to recognise that the Australian system is likely to remain a system that is focused on liquidity. Whilst listed structures demonstrably failed investors in the past, this does not mean that we should give up on listed markets. Encouraging the development of listed companies, with a focus on infrastructure, should be part of the mix of solutions.
Small scale infrastructure
Our focus in Australia is overwhelmingly on large-scale infrastructure. Small-scale infrastructure has the capacity to deliver significant economic and social outcomes. We are currently missing this opportunity. We need a different approach for small-scale infrastructure. We need to address both the lack of skill and expertise in local government, and the cost of due diligence for superannuation funds.
Self-managed superannuation funds
Currently, a third of our superannuation system is effectively locked out of investment in infrastructure. There are ways we can open up this market. Infrastructure debt provides the best opportunity because we can anticipate that SMSFs will increasingly demand low-risk products. There are opportunities to either establish infrastructure bonds or commercial products that provide a diversification of projects. Government has a role to play to facilitate infrastructure debt markets.
Super funds are not looking for taxation incentives to invest in infrastructure. What we are looking for is good projects. That said, there needs to be more consideration of how taxation impacts international investments, and the overall investment environment in Australia. The issue for superannuation funds is not just the rate of return on an investment, but whether to invest or not. In a world where governments are likely to be fiscally constrained, government support should be regarded as a scarce commodity. Government support can be used not just to make a project commercial by providing capital but to address investors' core issues around risk. Government guarantees on investment, particularly in small-scale infrastructure, need to be considered in more detail.
We need better mechanisms for collaboration if we are to avoid the Groundhog Day conversation around infrastructure. At the moment, the focus is primarily on the next deal. We all need to spend more time - including superannuation funds - on considering the overall investment environment.
In closing we recognise that the debate on infrastructure is not going to go away. It is only going to intensify, particularly as the US addresses its ageing infrastructure assets, and as Western governments face fiscal constraints that are only going to intensify as population aging increases health and pension costs.
Next year, the G20 will consider infrastructure as one of its core areas of focus. We can anticipate that private investment will be a significant part of the discussion. Ensuring that there is an understanding of the way in which pension funds approach investment in infrastructure will be critical to making progress.
We need a mechanism for debating ideas. We will be dedicating Friday's forum to exploring ideas. We do not want this to be another Groundhog Day conversation but one that ends with concrete outcomes. We see SMART Infrastructure Facility as having a pivotal role in this debate.
ASFA is the peak policy, research and advocacy body for Australia's superannuation industry. It is a not-for-profit, sector-neutral, and non-party political national organisation whose aim is to advance effective retirement outcomes for members of funds through research, advocacy and the development of policy and industry best practice.