One of Aotearoa New Zealand’s largest challenges, over the coming decade, will be how to finance to the transition to the low-emissions, climate-resilient future, envisioned under the Climate Change Response (Zero Carbon) Amendment Act 2019 and other initiatives.
That will include both climate-change mitigation initiatives like increased renewable energy generation, and climate-change adaption initiatives such as more resilient building and transport infrastructure. The Secretary to the Treasury in 2022 cited New Zealand’s Climate Change Commission as estimating at least $34 billion of additional investment across key areas of the economy is needed by 2035 [1].
A key question is what part the investments by New Zealand’s KiwiSaver providers may play, particularly given a key part of any private sector financing will take the form of non-traded equity (referred to as private assets). According to The Centre for Sustainable Finance: Toitu Tahua (CSF) [2], to date, there has been a very low exposure to private assets in KiwiSaver schemes to date, which differs markedly from global patterns where retirement savings funds in many countries are significant investors in less liquid asset classes. G20 governments plan to rely more on private investment to develop green and transformative infrastructure. Institutional investors, such as pension funds, are expected to double their allocation to private market assets over the next five years, with non-listed infrastructure investments likely to increase substantially. By contrast, that will not be the case in Aotearoa New Zealand unless historical patterns in KiwiSaver investment change.
Building on those concerns, CSF commissioned MinterEllisonRuddWatts and Chapman Tripp, to consider the legislative and regulatory barriers that may be contributing to the low rates of investment in private assets by KiwiSaver providers, and issue a joint opinion of their conclusions.
While the joint opinion confirmed there were no outright legal barriers preventing KiwiSaver providers from investing in private assets, it identified three key disincentives that may be actively discouraging KiwiSaver providers, and contributing to the disparity compared to overseas pension funds.
These disincentives are:
- the need to maintain liquidity to meet account portability obligations and permitted early withdrawal entitlements, and meet regulator expectations;
- the practical requirement for daily pricing of assets, to support that liquidity; and
- the requirement for fees not to be “unreasonable”, which is bench-marked primarily by reference to publicly traded investments.
In particular, the joint opinion focussed on the mandatory obligations under the KiwiSaver Act 2006 to transfer member account balances from one KiwiSaver scheme to another within ten business days of a request, and members’ entitlements to various early permitted withdrawals and the fact these entitlements cannot be waived (including with member consent). That means providers prefer assets that can be sold rapidly in the event of member transfers. It is not possible for members to contract out of that transfer right, even if they want to.
The increasing regulator expectations for liquidity management were also examined. The view of the co-authors was that the perceived need for liquidity would be increased by the current Financial Market Authority’s (FMA) Liquidity Risk Management Good Practice Guide (soon to be updated), because the range of liquidity management tools generally available to other managed investment scheme (MIS) managers (for example, fund suspension or redemption gates) are not capable of being utilised by KiwiSaver providers, due to the overriding entitlement to account portability or permitted early withdrawal mechanisms under the KiwiSaver Act 2006.
The opinion also examined the requirement for daily pricing (a necessity where a fund allows applications, redemptions, or other withdrawals, on a daily basis) and the potential for equity considerations between investors if private assets are not able to be valued sufficiently frequently.
The perceived focus of the FMA on low manager fees was also raised as another significant feature potentially discouraging private asset investment, compared to market-traded investments. The potential cost associated with making private asset investments (because of the relative complexity in managing and administering these assets) meant providers who did so may need to charge fees commensurately higher than, and therefore comparatively “out-of-step” with, benchmarks set by reference to those funds with solely market-traded investments, which could make those fees vulnerable to classification as “unreasonable”. This was thought to be one of the most powerful facts, especially for larger providers.
The opinion went on to propose changes to the existing KiwiSaver regulatory environment, to help address the disincentives, including:
- tackling liquidity bias, by enabling investors to opt out of account portability and early withdrawal entitlements with appropriate disclosure and investor consent;
- allowing for the creation of “private asset funds” within KiwiSaver schemes with long-term investment horizons;
- establishing a more efficient means of accommodating and adopting long- term asset valuation methodologies into KiwiSaver scheme trust deeds; and
- greater FMA recognition that higher fees are legitimately associated with private asset investment including clarification that such fees would not be “unreasonable”, and may be justified by expected higher returns.
The joint opinion also called on regulators and the Government, as well as providers, to play a role in acknowledging and addressing the potentially unintended effect of current regulatory settings nudging providers away from private investments.
The authors of the legal opinion readily acknowledge that the legal impediments are not the only reasons why less than 2% of the approximately $100 billion in total value of KiwiSaver funds are invested in unlisted shares, far less than retirement savings scheme providers in other jurisdictions, eg 18% of Australian superfunds in private assets. Other factors include, as identified in the CSF Recommendations Paper, KiwiSaver managers’ capacity and capability to undertake private investment, the organisational and market challenges posed by private assets, and KiwiSaver members’ expectation and financial literacy. But the legal impediments are, in their opinion, clearly a factor. If addressed, that would contribute to both New Zealanders benefiting from investment options that have the potential to deliver higher financial returns, and which may also bring long- term positive environmental, social, and economic outcomes for Aotearoa New Zealand and the planet [3].
As MinterEllisonRuddWatts Senior Partner, Lloyd Kavanagh, a co-author of the opinion, said: “At a time when New Zealand needs large amounts of capital to build sustainable infrastructure, it seems unfortunate that some of the KiwiSaver regulatory settings are having the unintended consequence of discouraging some providers from investing in private assets. As a result, New Zealand trails well behind other countries, such as Australia, both in the proportion of retirement savings invested in private assets, and the returns earned by those retirement savings.”
New Zealand trails well behind other countries, such as Australia, both in the proportion of retirement savings invested in private assets, and the returns earned by those retirement savings.
Kavanagh commented that “modifying the legal and regulatory environment to reduce those disincentives would serve a dual purpose of delivering better long-term value to KiwiSaver members and providing local capital to build much-needed infrastructure – especially to meet the risks and opportunities presented by climate change.”
Chief Executive at the Centre for Sustainable Finance: Toitū Tahua, Jo Kelly also comments: “Many KiwiSaver investors have long investment horizons (20 plus years), but they have little option to take advantage of their long investment horizon by way of investing in private markets. This means many New Zealanders aren’t benefiting from investment options that can provide potentially higher financial returns and may also bring long-term positive environmental, social, and economic outcomes.”
The opinion comes at a pivotal moment for the KiwiSaver regime (now almost 17 years old), with funds under management now over $100 billion, and the Minister of Commerce and Consumer Affairs, Hon. Andrew Bayly, proposing a review of the KiwiSaver settings later this year.
CSF’s goal is to enable a resilient, sustainable Aotearoa New Zealand, and its work is anchored in the Sustainable Finance Forum’s 2030 Roadmap for Action, which calls for changing mindsets, transforming finance and financing transformation. Its concern is that while much of the required investment to achieve this end is necessarily in non-traded private assets, most KiwiSaver schemes remain invested in highly liquid, market-traded investments, with little-to-no private market exposure. Making it easier for KiwiSaver providers to invest in private assets could help direct more domestic capital into investments like renewable energy, climate solutions, and social housing, which would benefit both KiwiSaver members and Aotearoa New Zealand. MinterEllisonRuddWatts and Chapman Tripp are both partners of the CSF.
Copies of the joint opinion and the recommendations paper can be found on the CSF website. Commerce and Consumer Affairs Minister Andrew Bayly has also received a copy of the opinion.
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Footnotes
1. Speech delivered by Caralee McLiesh, Secretary to the Treasury, at the Financing and Investment session at the Climate Change and Business Conference, Auckland, 19 September 2022.
2. See the technical working group of CSF Partners publication Investing in Private Assets: Joint Paper on Key Recommendations to Reduce Barriers and Challenges for KiwiSaver Funds to Invest in Private Assets, May 2023 (CSF Recommendations Paper)
3. See SCF Recommendations Paper (ibid).
