Beware of unintended consequences. The US corporate bond market has been ravaged by mutual funds selling because investors exercised their “at call” rights to convert to cash. A technical weakness in many big Australian superannuation funds means they are in grave danger of a similar event.
In the UK, Prime Minister Boris Johnson has suddenly abandoned small business tax legislation because it would have been a disaster in the current crisis.
In Australia, we are in danger of making similar mistakes threatening both our innovative research-driven enterprises and those about to be hit by slow paying big companies.
In the US, a vast number of investors put their money into mutual funds, which in turn invested in long and medium-term corporate bonds. But the investors had the right to redeem their securities at short notice, often at a call.
Cash is now king, so the redemptions mean that funds are desperately trying to sell bonds, sending the US corporate bond market into a spiral and making it impossible for medium-sized US enterprises to raise cash.
In Australia, Virgin is a big US dollar borrower and Virgin bonds have been hit hard. The US Federal Reserve is looking to buy bonds to stabilise the market. The real problem is that the mutual funds were investing in long-term assets and should not have had an “at call” redemption clause.
Many of our superannuation funds have made the same mistake by allowing members to switch from equity-based investments to short term cash at short notice; often 72 hours. I warned of the danger last month.
To the extent that any switch to cash is based on the real market value of assets, then remaining equity fund members are not affected.
But these days superannuation funds have large investments in direct property, infrastructure and private equity. The savage decline in the sharemarket will mean that in many cases these non-listed investments are on the books at values above their current values as measured by the stockmarket.
Valuers of these securities often use past transactions, so are way behind real market values after a market slump. That means funds will redeem equity-based units at inflated values, giving remaining long-term equity investors in the fund a long term blow compounding the recent fall. Once people wake up that they can “sell” at pre-stockmarket values there could be an avalanche, as happened with the US mutual funds.
All big superannuation fund trustees in that situation should meet over the weekend to value their unlisted investments at the market values, as set by the stockmarket. It’s not hard, but it’s vital. Sometimes they will find the assets were previously undervalued and so there is no need to change. That will be great news. But if trustees stay asleep over the weekend and there is an asset overvaluation, they will face almost certain personal legal action if there is an “asset switch run” on the funds.
Brake on innovation
Unintended consequences go beyond superannuation funds.
Hundreds of our most innovative companies borrow money to undertake research with the help from top research advisers to make sure they comply with the Act. In former times, the government via AusIndustry would smooth the money flow in its efforts to promote Australian innovation. My anecdotal evidence is that, just when smaller companies have their backs to the wall, the public servants are now refusing to make research grant decisions, almost certainly sending those innovative companies to the wall. Minister Karen Andrews desperately wants extra research but is being misled. She needs to personally review all research applications that have been held up by the public servants.
Similarly, the Australian Taxation Office has the right to stop medium sized enterprises gaining government contracts worth more than $4m if they are in a “dispute” with the ATO.
We are in abnormal times and that means that a “dispute” with the ATO can put a company out of business because it can’t gain desperately needed government work.
It’s too big a penalty, especially as we will find more large enterprises are slowing payments putting enormous pressure on our middle ranking businesses. Treasurer Josh Frydenberg’s $15bn loan scheme should help these enterprises as well as those who need to adjust their business to the new environment. In the spirit of that initiative, I plead with the treasurer to suspend that ATO power for 12 months.
The public servants need clear ministerial policy and direction in times like this.
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