CLS
Margaret Law, head of client management for Asia Pacific at CLS, explains that while Australia’s superannuation industry is continuing to grow, technology and automation will play a significant role in further development
What is the current landscape like for Australia’s superannuation industry?
The Australian superannuation industry is growing, and it is now the second-largest pensions market in Asia Pacific, after Japan. As Australia’s superannuation industry has continued to grow over the last decade, it has faced increased pressure from its members to expand investments globally, and thus, Australian superannuation funds have boosted asset allocation to foreign investments.
The 2019 National Australia Bank’s (NAB) 9th annual biennial Superannuation Foreign Exchange (FX) Hedging Survey states that on average, superannuation funds had 41 percent of their assets offshore as of June 2019, and 72 percent of respondents indicated that over the next two years, they plan to expand their share of investments in international assets.
The recent COVID-19 pandemic has tested the Australian superannuation industry significantly, with the government announcing a stimulus package on 22 March 2020 to assist businesses and individuals. The stimulus included two superannuation measures where eligible members can get early release of superannuation of up to AUD20,000 tax-free and retirees can reduce their annuity drawdowns by up to 50 percent.
Although initially there were concerns that this would cause a massive strain on the industry, with many Australian super funds concerned about falling asset prices, liquidity pressures and declining investor inflows, the country’s treasury reported that Australia’s superannuation funds have so far not encountered any liquidity issues in connection with the early withdrawal scheme. The Australian Prudential Regulation Authority (APRA) has been constantly monitoring the impact of COVID-19 on the financial and operational capacity of funds by speaking to super funds on a weekly basis to certify that liquidity and stress testing is being completed properly.
However, a continuing economic slump in Australia could cause a reduction in contributions and limit cash flow in the superannuation industry, which would in turn affect investment decisions.
How fast is the industry moving to consolidate Australia’s superannuation industry? What does this mean for custodians?
A recent report by KPMG suggests that industry consolidation may occur sooner than previously forecasted. The research predicts that the 217 APRA-regulated superannuation funds will shrink to 138 within the next five years, with industry funds declining at a faster rate than retail funds. The report also claims that the 38 industry super funds which look after Australians’ retirement savings will have dropped to 21 in five years’ time and that by 2029, only 12 will remain. The industry’s expected consolidation is largely due to increased scrutiny by the Australian government on the superannuation industry regarding under-performing funds and heightened pressure to cut fees and boost returns. Funds are also becoming increasingly more ambitious by targeting large-scale mergers, as well as the typical acquiring of smaller funds by large firms. The impact of COVID-19 will likely cause the rate of consolidation to increase more rapidly with regulators already highlighting the urgent need for consolidation and pushing for under-performing funds to exit the industry.
As a result of the industry’s expected consolidation, custodians likely will have fewer but larger super funds to service. The expectations on value-added services, consultative and collaborative servicing, support for complex alternative assets, timely and more granular reporting, and increased demand on data will likely grow. Larger custodians could possibly leverage their scale of IT systems to gain dominance. However, smaller niche players could also grow market share through their agility and ability to provide unique customised solutions.
What challenges and opportunities are you seeing in this area?
We are seeing various opportunities in the superannuation space, including the opportunity to streamline current processes and review existing outsourcing arrangements. Australian superannuation funds traditionally outsource investments to external managers and related investment operations processes to custodians, but there has been a recent shift toward insourcing across front, middle and back-office functions.
AustralianSuper, the country’s largest superannuation fund, announced in late 2019 that it plans to bring half of its total assets in-house by 2021, citing cost control as a key driver. In 2017-18, AustralianSuper was managing 31 percent of its portfolio internally, and this figure increased to 40 percent in 2018-19.
We are seeing some asset owners increasingly considering whether to bring even more investment operations in-house, particularly for areas of risk reporting and analysis around private equity.
The bigger funds can now afford to hire the necessary expertise rather than rely on external fund managers or custodians to perform their investment and operation functions. In addition, operationally, super funds need to be leaner than ever – hence the drive towards in-sourcing, first of passive equity strategies, then of active local and overseas equities and more complex asset classes.
The migration of functions and processes in-house creates opportunities to review existing processes, risks and controls, especially as supers increasingly focus on operational efficiency, liquidity optimisation and risk mitigation. This leads to further opportunities for funds to adopt best practices such as the FX Global Code of Conduct in relation to their FX trading activities.
What are some of the prominent trends you are seeing from clients and how are you working to help asset owners gain access to CLSSettlement and CLSMarketData?
In recent years, we have seen an increase in buy-side firms becoming more aware of the risks associated with FX settlement. As such, they are choosing to become more involved in how they manage those risks. Our goal, as a systemically important financial market infrastructure, is to reduce systemic risk for all participants in the FX market, and to help educate asset owners on how they can access our services via their custodians. Through this, we are seeing a focus on operational efficiency and a growing need for certainty of payments and protection of principal.
We are also finding that as funds in Australia increase their investments overseas, they hold more foreign currency in their portfolios – exposures they potentially could hedge through FX trading. Against the backdrop of an ever-changing regulatory landscape and heightened pressure to reduce costs, it is important to ensure that FX trading and settlement is executed to the best standards. The superannuation industry’s growth and expanding interest in alternative investments has drawn the attention of regulators, which may lead to new or increased regulation, governance and transparency. The natural response to this additional attention would likely be a focus on operational resilience and risk management.
With this drive for operational efficiencies we anticipate an increased need globally from asset owners for data insights, especially during periods of high market volatility and an unpredictable environment, as we have experienced. This could potentially increase the demand for CLS data, which is the largest single source of executed FX trade data in the market.
In addition, we have recently collaborated with Mosaic Smart Data and MUFG to launch a new free analytics service, FXLIQUIDITY, which has already generated substantial interest from market participants in the region who are trying to navigate the changing FX liquidity landscape and understand more about FX market sentiment in order to better evaluate their trading strategies.
Over the next few years, how do you expect Australia’s superannuation industry to evolve and grow even further?
Over the next few years, Australia’s superannuation industry will further consolidate, likely at a rapid pace. Firms will also continue to grow in-house management capabilities and reduce outsourced mandates. Technology and automation will likely play a significant role in the development of the Australian superannuation industry as it continues to grow. Whilst service providers and regulators are reviewing new technologies, they will need to ensure that the enthusiasm to increase efficiency does not overshadow or degrade current levels of operational resiliency.
During and following the pandemic, the industry will not only continue to prioritise planning, but firms will broaden their considerations when ensuring operational resilience. For financial market infrastructures, specifically, it is not sufficient to merely be operationally efficient. They must also have multiple back-ups and resiliency strategies that address a range of scenarios impacting premises and staff. It will become essential for these strategies to be carefully planned and extensively tested to ensure delivery of service to the standards users expect. For Australia’s superannuation industry to maintain an upward trajectory post-pandemic, funds should demonstrate solid governance and controls, protection of member interests, and safety of assets by using best practices in operations and risk management.
