Super the backbone of stressed financial ecosystem: APRA

The Australian Prudential Regulation Authority (APRA) has unveiled key findings from its inaugural system risk stress test (SRST), highlighting the resilience and stability of the financial market depends heavily on the superannuation sector.

The SRST, which focussed on links between the banking and super systems, deployed a 12-month scenario involving liquidity pressures exceeding any experienced by large Australian banks over the past 50 years, and found member withdrawals and switching significantly surpassing levels observed during COVID-19.

Although super funds' willingness to provide capital to banks during the period "illustrates their ability to dampen risk and support financial stability", the super sector itself also bears "severe" liquidity pressures.

Participating funds experienced, on a monthly aggregate, heightened liquidity demand from members at around $30 billion during the test, while cumulative demands surged to $174 billion, or just under 16% of net assets.

In response, most funds were selling offshore listed assets to accommodate the shock but avoided unlisted asset sales to help limit fire-sale losses. They have, instead, increased exposure to private assets for some members to rebalance portfolios, even as liquidity stress peaked and their own internal risk metrics and thresholds indicated high liquidity stress on their portfolios.

They also observed an abundance of members switching from non-cash options into cash options, which amounted to between about 8% and 15% of net assets of funds, varying based on different member profiles and investment mixes at each fund.

Average daily member switching peaked in the fifth month, slightly exceeding most funds' COVID-19 experience, which resulted in a significantly greater cumulative impact.

Despite the immense pressure the scenario enforced, super funds were able to generate sufficient cash to meet the member and investment liquidity outflows, generating some $92 billion in liquidity from the sale of both equities and fixed-income assets, APRA confirmed.

"Funds met liquidity demands using a combination of existing cash and asset sales. While cash provided an initial buffer, most liquidity was generated through substantial sales of offshore listed equities, which trade in deep and liquid markets," APRA said.

"The Australian dollar value of offshore assets received support from the depreciation of the Australian dollar in the second period of the scenario, which also informed the decision to reduce exposures to international assets."

Yet, members' losses were inevitable, as the scenario portrayed a significant decline in average member balances by around 25% for the median fund, highlighting the need of having robust valuation policies to support "fair and appropriate" member outcomes.

"Allocations to illiquid assets in MySuper options (the default option for members) increased substantially compared to the change in other investment options for most funds," APRA explained.

"While this supported fund-level liquidity management and helped avoid crystallising further losses on illiquid assets, it shifted a greater share of liquidity and sequencing risk onto MySuper members, particularly toward the end of the stress scenario."

Commenting, APRA chair John Lonsdale said the SRST produced valuable insights that would inform its policy and supervision priorities.

"As our financial system becomes more interconnected, decisions made in one part of the system not only impact other financial institutions in the same sector, but those in different sectors as well as service providers," Lonsdale said.

"With superannuation expected to keep growing its share of the financial system in coming years, it's essential we gain deeper insights into how super funds are likely to respond to a severe stress event - and how their decisions may impact other parts of the financial system.

"The findings of the stress test demonstrate the ability of our banks and superannuation funds to respond to financial stress and operational disruption. However, they also highlight areas where banks and super funds will need to invest more effort to further build up their resilience."

He added the regulator will use the findings to propose amendments for related entities via multiple consultations and initiatives over the next 12 months.