LIQUIDITY, LICENSING AND SUPER FUNDS:
WHAT’S ON APRA’S AGENDA
RAMANI (SG) VENKATRAMANI
General Manager Specialised Institutions
Australian Prudential Regulation Authority
Conference of Major Superannuation Funds 2008
Monday 17 March 2008
The impressive growth enjoyed by superannuation funds in the past, and most notably in the last
2-3 years, derived from strong contribution inflows and investment returns, has not given rise to
any liquidity concerns, individual exceptions notwithstanding. However this may well change in
future as a result of demographic, legislative and social factors, and Fund Trustees need to
ensure that they have built sufficient flexibility into their respective funds to ensure they can
meet their fiduciary obligations as well as member expectations.
With APRA’s perspective on the industry, I am here today to offer you some thoughts on the
issues and challenges for Trustees and superannuation practitioners with respect to liquidity
management, set out some lessons that we may learn in regard to liquidity management from
the banking industry, and finally, and arguably of most interest, what to expect from APRA in its
ongoing supervision of the superannuation industry.
Defining what we are talking about:
Liquidity - in general terms, refers to the ability of a financial institution [which here we
include superannuation funds] to meet its obligations as they fall due. Liquidity is therefore
critical to the continued operation of an individual financial institution and to the stability of the
financial system as a whole 1 .
For super funds, this obviously refers to the ability to pay members benefits, rollovers and
pension payments as and when required.
Liquidity Risk – is the risk that financial obligations cannot be met as and when they fall due,
without incurring significant unexpected costs. It is the risk of not having enough cash inflows
(after taking into account the available liquid assets) to meet cash outflows over any given time
period, and in the case of superannuation funds, this means the potential inability to meet its
payment obligations to beneficiaries in a timely and efficient manner 2 .
Demographic implications for Liquidity in Superannuation funds
We are all familiar with the bulge in the population pyramid that represents the post war ‘Baby-
Boom’ generation, and that this segment of the community is rapidly approaching retirement
Population structure, Age and sex - Australia - 1987 and 2007p
This ‘bulge’ is further illustrated in the table and comment below, from the Australian Bureau of
“The number of people aged 65 years and over will increase rapidly over the next 50 years, from
2.6 million in 2004 to between 7 and 9 million people in 2051. By then, slightly more than one in
four Australians will be aged 65 years and over (around one in 8 at 2004)” 3 .
Not only will this demographic ‘bulge’ provide challenges for the Government in the coming
years in terms of health care, social security and workforce participation rates, but it will also
create a range of challenges for superannuation funds, not the least being the need for
increased liquidity management so that benefit payment obligations can continue to be met
going forward. You will note from the table below, taken from APRA’s 2006 Superannuation
Bulletin 4 , that members who are already at, or close to Retirement Age (i.e. aged 50 or over),
hold 55% of Vested Benefits. While of course there will be significant differences in these
figures across individual funds, they illustrate the potential for significant movements in fund
assets over time as members move into retirement.
Table 5 Age segmentation of vested benefits
Year end June 2006
Entities with more than four members
< 35 yrs 35 - 49 yrs 50 - 59 yrs 60 - 65 yrs > 65 yrs Total
By functional classification
Corporate 9% 41% 36% 9% 5% 100%
Industry 20% 38% 30% 10% 3% 100%
Public sector a 7% 34% 36% 11% 11% 100%
Retail 10% 28% 30% 18% 13% 100%
Total 11% 33% 32% 13% 10% 100%
Vested benefits are the benefits which are not dependent upon continued membership of the superannuation entity and include
benefits which members were entitled to receive had they terminated their membership at the reporting date.
Due to unfunded components of public sector funds, the sum of vested benefits may be larger than net assets.
Although there is an increasing trend for retirees to retain their superannuation benefits within
the system and draw an income stream, there is a continuing propensity in Australia at least for
a large proportion of benefit payments to be taken as lump sums upon retirement (67% of
benefit payments across the industry in 2006 were lump sums). While the proportion of benefit
payments taken as lump sums will hopefully trend downwards, in dollar terms it is reasonable to
expect that this drain may increase significantly in coming years as more and more ‘Baby
Boomers’ move into retirement, and take their lump sum with them. Note that the taxation of
non-dependents on death has a curious incentive to take the money while alive, for those aged
60 and above.
This therefore represents one of the major challenges to Trustees in the coming years, and how
they address it will be of much interest to APRA.
Other Factors impacting on Liquidity
Apart from the demographic shifts in fund membership, there have been numerous other
changes in the superannuation landscape that have created challenges for Trustees in the
management of fund liquidity.
Consider the following:
• Volatility in investment markets triggering a possible ‘knee-jerk’ reaction by members.
As we know, many members do not act rationally, despite the opportunity for advice and
educational programs; there is a wider question about the independence of financial
• From July 2007, account-based pensions for those aged 60 and above have no maximum,
so members can now withdraw all or part of their benefits tax free, without committing
to any pre-determined frequency;
• Fund choice and portability have increased the likelihood that money will move from one
entity to another, even though it may remain within the super system, as members chase
better returns or additional services; ‘short termism’ continues to afflict superannuation
despite its long term nature.
• The increasing propensity for funds to invest in difficult-to-value, lumpy, unlisted assets
such as buildings, hedge funds, infrastructure and private equity assets makes short term
realisation of assets problematic;
• While funds have relied on contribution flows as a source in the past, voluntary
contributions (including salary sacrifice) are more susceptible to market sentiment than
compulsory SG, and even SG contributions can be directed to other funds;
• HIH demonstrated that systemic risk is not unique to banking. Other industries, even
super, though protected by preservation, could potentially see the ripple effect of
problems in one industry transmitting to another, in terms of consumer confidence and
• The increasing sophistication of the superannuation industry requires that its asset/
liability processes are more robust than the past;
• The risk that corporate funds and others using wholesale products such as PSTs or Master
Trusts may liquidate and move large amounts of assets at once.
Firstly, isn’t the task of determining liquidity needs a normal and regular part of the ongoing
operational business of running a Fund?
APRA therefore has a reasonable expectation that prudent trustees will understand all or most of
the issues I have outlined above, and already have strategies in place to manage their liquidity
Lessons from the ADI world
However, if we want to further explore the options that are available for liquidity management
in the superannuation industry, perhaps we should consider some of the tools being used in the
ADI (bank/credit union) world.
Australian banking institutions manage liquidity risk through a range of strategies, including
setting limits on maturity mismatches, holding high quality liquid assets above the required
benchmark level, diversifying their liability sources and developing asset sale strategies.
It is worth noting that as part of APRA’s prudential framework, larger banking institutions also
model stress-testing based on 2 scenarios — a ‘going concern’ and a five-day name crisis scenario
— to demonstrate that they have adequate liquidity in both situations 5 .
Many of these banking institutions have also developed stress testing frameworks for liquidity
risk management in addition to those required by APRA, including the severity and duration of a
crisis and the potential impact that market-wide disruptions may have on their liquidity position.
It is further interesting to note that we are also seeing banks and credit unions collaborating to
manage liquidity risk through industry-based pooling arrangements to counteract market panic.
Should the superannuation industry think along similar lines too? I recognise that the existing SIS
framework might hinder similar initiatives, but if the community of researchers could achieve
outcomes that demonstrate net benefits, I am sure that future policy development will take this
Analysis of Fund Demographics
Whilst most superannuation funds have been experiencing significant growth in both assets and
membership, in the Post RSE Licensing world, to date APRA has yet to see many funds
undertaking any significant research into their membership makeup, or extrapolate the ageing of
this membership over time, thereby building up potential scenarios and assessing the impact on
There will of course be marked differences between the member demographics of individual
funds compared to others and the industry as a whole, but the prudent trustee is expected to
have a good understanding of its own membership, and therefore of the risks and issues
particular to that fund.
Strategic Planning that takes these factors into account
Following on from this analysis, the prudent trustee would be developing long term strategic
plans which incorporate the flexibility to adapt to the changes in liquidity demands over time.
This strategic planning could include for example, revised product offerings and strategies to
retain members and their benefits in the fund after retirement.
Strategic Asset Allocation
Over time, in order to cater for the increased liquidity needs arising from the ageing
membership, the prudent trustee will also be reviewing the long term strategic asset allocation
of the various investment options available to members, to ensure each option contains
adequate accessible liquid assets to meet expected demand.
The trustee would also need to assess the impact of a higher allocations to liquid assets on the
overall investment performance of the various options, and the consequent impact on member
A particular focus in developing strategic asset allocations would be expected to be on the
fund’s default strategy given that the vast majority of members continue to invest in this option.
APRA’s 2006 Superannuation Bulletin gives a snapshot of the asset allocation of the default
strategies across all funds, and shows the average allocation to Cash across all fund types is 8%,
but varying between 5% and 13% in the various market sectors, and obviously far more widely if
we were to look at individual funds.
Asset Liquidation Plan
The prudent trustee is expected to have in place a plan for the orderly, prioritised sell down of
assets to meet liquidity requirements.
By having such a forward plan which prioritises the sale of investments to enable the fund to
meet its liquidity needs, the Trustee averts the need to conduct a ‘fire-sale’ of assets at less
than optimum prices. This is an obvious key to maintaining the intrinsic value of the fund as a
whole and therefore of benefits for remaining members.
Exposure to illiquid assets
Related to the strategic asset allocation is the Fund’s exposure to assets that are difficult-to-
value, lumpy or unlisted assets such as buildings, hedge funds, infrastructure and private equity.
The trustee needs to weigh up the trade-off between investing in illiquid long term growth
assets and the need to realise liquid assets in a relatively short time frame. This issue is
particularly problematic where a fund offers an investment option that is heavily weighted to
such illiquid assets. Think CDO.
Liquidity Management factored into the Risk Management Framework
Given that liquidity management — the ability to meet financial obligations as they fall due — is
critical to a fund’s continued operation, the prudent trustee would be recognising this and
incorporating it into the risk management framework.
So, what are APRA’s expectations?
Liquidity Risk is one of the key risks that APRA expects to see being addressed by Trustees, and
factored into their operational and strategic planning.
In terms of APRA’s supervision and assessment of inherent Liquidity Risk, the following factors
are taken into account:
• Firstly, APRA expects that all Trustees will be able to demonstrate an appropriate level
of understanding of the liquidity requirements for their particular fund, after all, the
management of a fund’s liquidity needs should be a normal operational function,
incorporated into the Trustee’s business planning.
• APRA further expects Trustees to have developed and give evidence to having
appropriate measures in place to ensure effective ongoing liquidity management – as set
out in APRA’s Superannuation Circular No. II.D.1 Managing Investments and Investment
Choice. The investment strategy must have regard to the liquidity of the fund’s
investments having regard to its expected cash flow requirements; and to the ability of
the fund to discharge its existing and prospective liabilities. In assessing the Trustee’s
processes, APRA has on occasions required the Trustee to provide details of the processes
used to monitor and manage cash flows, including the tools used, where we have
concerns over the adequacy of these processes.
• Trustee development and analysis of models or potential scenarios – short term liquidity
risk scenarios such as large scale retrenchments, resignations or wind ups, as well as
alternative long term demographic changes in fund membership. The liquidity
requirements within a fund will obviously differ for a mature fund with a large number of
pensioners receiving regular payments, or a fund with a large proportion of members who
are close to or have reached early retirement age, or a Fund with a majority of younger
members who may be less ‘sticky’ but also have smaller balances. Trustees should also
consider the frequency with which pension payments are made (eg monthly, quarterly)
and whether there are ‘lumpy’ periods of high liquidity needs. Note that there is no legal
obligation to withdraw funds at a defined frequency, and those over 60 can draw all their
savings as a ‘pension’ (ie no maximum).
• Accuracy and robustness of the liquidity models or scenarios is obviously important in
determining liquidity exposure and management of liquidity during a crisis. Most
importantly the assumptions used in the model should be realistic.
• Saleability of assets - many factors can influence the relative ease, and hence the price
discount relative to perceived ‘fair value’ with which different types of assets can be
realised at short notice in order to cover unanticipated temporary cash shortfalls.
Amongst the most important are the number and diversity of active and prospective
participants in the particular asset market, and the extent of supporting market
• Liquidity profile of member-directed investment options, and the ease of transfer
between options - some investment options may have a lower liquidity profile due to the
nature of the asset composition and investment objectives, for example, direct property
and other unlisted assets. Other investments may include a lock-up period where the
investment cannot be redeemed within a certain time-frame. The Trustee needs to gain
comfort that there is sufficient liquidity within these particular investment options, and
also consider the liquidity impact of the ability of members to switch between different
investment options eg whether there are any delays in the case of less liquid asset
• Any contracted cash contributions to investments - funds that invest in alternative assets
or have a relatively high asset allocation to unlisted asset classes may be required to
make ongoing additional contributions to the investment over time, as well as partly paid
instruments. Trustees should consider a fund’s contractual obligations to make initial and
additional cash contributions to investments, and whether there is any flexibility for the
fund to extract itself from these obligations and the costs thereof (eg., instalment
• Cash monitoring - APRA will assess the processes put in place by the trustee to monitor
cash inflows and outflows across all the investment options of the fund, including the
processes involving the custodian, and the controls around this external provider.
• Contingency planning - Asset liquidity levels are not constant. It can change dramatically
at short notice in response to events or changing economic conditions. An investment
that can be bought or sold quickly and without a significant price concession is
considered liquid. The more uncertainty surrounding the time element and the price
concession required, the greater the liquidity risk. The level of mismatch between
expected asset and liability cash flows under normal and stressed operating conditions
should be established and also the processes to deal with any material ‘unexpected
event’ such as wind up or successor fund transfers (ie where greater liquidity is
• Internal and external audit oversight of liquidity risk - APRA will look at whether a Fund’s
internal audit and/or external audit conduct testing or analyses around the controls and
limits of liquidity risk functions. This may incorporate review of the audit reports, audit
scoping documents or the management letters from the external auditor. APRA pays
particular attention to any issues that the Auditors identify and highlight to the Board,
and the Board’s actions on these issues.
• Risk Management Function and the oversight of liquidity risk. As you are aware, APRA
places a high priority on effective risk management for our regulated entities. In the
situation we have considered today, APRA’s review will assess the effectiveness of the
risk management function and controls around liquidity risk – i.e. the systems and
processes in place to ensure that liquidity controls and limits are adhered, and the
reporting functions around these processes so that the trustee and management are
confident that operational management have the capacity and tools to identify, monitor,
and report liquidity risks. This is expected to then be articulated in the risk management
framework. In the end, it is through the development, monitoring and review of the risk
management framework that trustees will be able to address the issues and challenges
with respect to liquidity management.
• Reputational issues: for a conglomerate while the super funds are legally distinct from
other parts, any issues in one part will inform and influence public perception and
behaviour. There is thus scope for liquidity troubles in one part to be transmitted across
the group. On the other hand, the obligations of the governing board to each entity and
the need to transact on arms-length would place pressures on the relevant board.
Finally, super trustees should not presume that APRA will routinely exercise its power to
freeze redemptions unless warranted in the best interests of members.
Table 8 Financial performance by fund type
Year end June 2006
Entities with more than four members
Corporate Industry Public sector Retail Total
Total assets 2005 52,245 119,413 129,010 244,529 545,197
Employer 2,887 13,059 11,653 13,038 40,637
Member 338 2,145 3,090 13,919 19,492
Other 38 234 288 534 1,094
Total contributions 3,263 15,437 15,031 27,491 61,222
Contribution tax and surcharge 545 2,010 703 2,426 5,684
Inward 829 19,005 12,793 46,743 79,369
Outward 9,075 12,775 12,742 36,425 71,017
Net rollovers -8,246 6,230 51 10,318 8,352
Lump sums 642 2,418 3,827 11,238 18,125
Pensions 301 346 7,021 3,742 11,410
Total benefit payments 943 2,763 10,849 14,980 29,535
Net contribution flows -5,925 18,903 4,233 22,829 40,040
Sound Liquidity Management Principles – Opening Remarks - JF Laker
APRA Sound Liquidity Management Principles Conference - May 2007
APRA’s Risk rating of superannuation funds PAIRS – APRA Insight - Q1 2004
APRA Superannuation Bulletin – June 2006 (issued 22 March 2007)
The Evolution of Risk and Risk Management – A Prudential Regulator’s Perspective - JF Laker
Presentation to RBA Conference The Structure and Resilience of the Financial System - August 2007