When the richest man in Australia starts a national conversation about how Australia’s $2.6 trillion superannuation pot should be deploying capital into local business lending, people sit up and take notice.
In doing so, Anthony Pratt, executive chairman of Visy Industries Australia and Pratt Industries USA, has, like many before him, refocused the spotlight once more on Australia’s lacklustre corporate bond market. For some reason, the local market has failed to mature over the past few decades, forcing businesses like Pratt’s, to source debt from more liquid offshore markets to fund expansion.
But for other Australian born entrepreneurs following in Pratt’s footsteps, this isn’t a luxury they necessarily have available to them. Instead, they’re stuck with the banks – whose appetite for business lending has waned relative to residential mortgages – and the non-bank lending market, which predominantly services the micro end of the business spectrum. If you’re not particularly interesting to the PE crowd, then businesses that want to raise a serious debt facility aren’t exactly spoiled for choice.
Australia’s pension funds lagging on business financing
Surprisingly this isn’t the case overseas, with pension funds markedly more active in the business lending space.
Pension funds in France are reported to have up to 33% of their asset base in corporate bonds – in the UK that figure stands at 20%. Pratt estimates only 1% of Australia’s $2.6 trillion super pool is currently loaned out to companies.
Pratt’s solution to bridge this gap in Australia is to bring the credit skills of the banking sector together with the fund firepower of the super funds. The added side benefit of this exercise would be increased asset diversification for super fund members. It could be argued their large exposure to equities today is a ticking time bomb.
While in principle this is a straightforward and common-sense approach with huge merit, there are some serious hurdles to be overcome, and they are not necessarily of the product kind. To understand why Pratt and his team face an up-hill battle bringing together two large financial incumbent sectors, you need to understand Australian culture, politics and the ever-present ideological battle between the ‘for profit’ banking industry and the ‘profit for members’ industry superannuation sector.
For a whistle-stop tour on this one, take it from me that you can’t open a mainstream newspaper or sit through a television commercial break without being told how banks and industry super funds despise each other. The industry super funds ‘Fox in the Hen House’ media campaign targeting bank run super funds is an example of how emotive some of the rhetoric is.
And even if a few banks and funds could put their differences aside, any smoke signal of comradery and peace between the two is surely well and truly snuffed out by PR teams as a result of the Banking Royal Commission.
The long-awaited inquiry, which began public hearings just over a week ago, is currently decimating the reputations of Australia’s major four banks. Their less than stellar financial advice units and fee for no service scandals have rocked the community, sending bank share prices south. My educated bet is no super fund will want to go down with that ship anytime soon.
Innovation happens at the edges
So where does that leave Pratt and his vision? Perhaps instead of barking up the traditional banking and super tree, the smarter thing might be to bypass the lot, and investigate whether this sort of initiative could be spun out of a number of fintechs operating in this space.
As we’ve seen across all other areas of financial innovation, incumbents aren’t well placed to disrupt themselves. With the huge shift to investment management amongst the super industry, many funds have become home to a plethora of portfolio managers and analysts, who’s preferred past time is picking stocks, not building credit assessment engines. And why would super fund executive teams rock the apple cart, when the customers keep flowing in, super contributions roll through, and the board seats only have another few years to run?
Banks also have enough headaches to deal with. The Royal Commission isn’t going away anytime soon. It’s hard to find a deep commercial call to action for either of these businesses.
The fintech pincer movement
But a pincer like approach employing Pratt coordinated government lobbying and fintech innovation however might ultimately spur the larger funds into action, a few years down the track. After all competition breeds innovation, and many funds and banks are well aware that they don’t possess the requisite teams and cultures to achieve this on their own. That’s why ecosystems exist.
With open banking hitting Australia soon, superannuation startups emerging at an increasing pace, and some small business banking contenders like Tyro and Judo Capital entering the market, Pratt might find a clean slate is a far better proposition. After all, every startup bank and super fund is hungry for differentiation, and many founding teams are driven by wanting to achieve something that truly impacts the economic fortune of the country, rather than just add to the rent-seeking crowd. After all, that’s what finance should be about. Somehow the industry has collectively forgotten that.
So Mr Pratt, if you happen to be reading this, I’ve put some thought toward your opinion piece and commentary in the Australian financial press. I like where you’re heading, so I decided to build on your ideas a little further, with some of my own.
Firstly, you’re certainly onto something when you suggest ‘the solution to this dilemma is to design new finance products that will combine the credit skills of the banks with the assets of the super funds to deliver long-term loans to Australia businesses.’ Co-operation and partnerships are key in the modern financial ecosystem.
But these days, credit assessment skills aren’t exclusive to banks – in fact, better models are now being built outside of banks, by combining the skills of data and financial engineers who are willing to look outside the traditional risk assessment box. Let’s not forget, assessing risk on SMEs at scale has never really been retail bankers’ strong point. That’s why they’ve always defaulted to building their residential loan books instead.
Once the credit assessment is out of the way, the next piece is relatively straight forward – you suggest a brokerage model, where super funds do all the lending, or a club deal where debt funding is spilt 30/70 between bank and super fund.
But the last suggestion you make, the creation of new financial instruments is probably the most exciting, and where you have the chance to get behind some pioneering financial innovation.
I see two interesting plays here – one at the micro end of the market, and another in the mid-tier space. I’m sure there are more.
Kill two birds with one super stone – helps SMEs access risk priced, fast and affordable growth capital, and build business owners retirement savings at the same time
Did you know over one third of SMEs in Australia don’t contribute to their superannuation? This is due to a growing misconception that a business will fund the owner into their golden years. However I needn’t tell you most small businesses only survive because they are owner operated, meaning once the owner is gone, it can be difficult to sell. And with business models chopping and changing faster than ever, future proofing a business for sale is getting harder and harder, even before you take the owner out of the picture.
So with this in mind, how do we get overly optimistic business owners to put some extra cash aside in the form of super, just in case the golden goose doesn’t lay? Perhaps the answer is to reward good super-saving habits with cheaper access to capital.
If those same super contributions are supporting the funding source indirectly, this is a win-win, and with the right risk modelling and profiling, could de-risk the fund proposition for all members of the fund, regardless of whether they are borrowers or not.
I think the product trick here is to incorporate super payments with cash-flow and daily/weekly takings. When the lender clips the ticket for the loan repayment, it should also automatically squirrel away super. To encourage the right behavior, there should be some kind of offset principle here, reducing your loan interest payments based on how much super you save. Holistic financial products that reward healthy financial habits.
Help employees fund their employer
Employers are defaulting hundreds of thousands of Australians into superannuation funds every year, with everyday Australians by default supporting local and global companies they’ve never heard of, some they possibly wouldn’t care much for even if they did know.
What if instead, employees of an SME were able to choose to invest in a super fund that included corporate bonds for their actual employer? There would need to be a financial upside here, comparative to the broader retirement savings market, but these things can be structured. It would be akin to creating a more liquid and instantaneous employee share option program, where earnings can be captured far sooner by staff, in a tax effective manner, straight into their super!
The other irony, that is an absolute product opportunity, is the fact employees are often unaware their super payments are being used as an indirect source of cash flow funding by their employer. This is because by law, employers need only pay employees once a quarter. Around $3B goes unpaid entirely, according to tax office data.
Why not acknowledge this shadow lending market and let employees opt-in to lend their super contributions to their employers prior to the quarter lodgment date, and capture a little extra return? Sometimes the best way to solve a problem isn’t to upend the behaviour, but to understand and empathise with why it exists, avoid demonizing it, and then find a way to create a product that modifies the behavior, so everyone wins.
A super startup clean slate
Like Pratt’s vision, both of these ideas are bold, undoubtedly come with regulation challenges, and certainly embody a degree of naivety to even presuppose they could actually exist. That sounds to me like the exact kind of primordial idea soup we know startups flourish in.
So Mr Pratt, if you’re looking for someone who us up for the challenge in helping you make the vision a reality, just drop me a line.
Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech. Jessica Ellerm is a thought leader specializing in Small Business and the Gig Economy and is the CEO and Co-Founder of Zuper, a new superannuation startup in Australia.