“It is the hope of this committee that the government will commence implementing recommendations as soon as possible even if done separately as each recommendation will result in unleashing the considerable power of the corporate bond market in Australia,” – Conclusion of the Standing Committee on Tax and Revenue in “The Development of the Australian Corporate Bond Market: A Way Forward”
The Development of the Australian Corporate Bond Market report is here
On 25 October 2021, the Standing Committee on Tax and Revenue (Committee) released its report; “The Development of the Australian Corporate Bond Market: A Way Forward” (Report). The Report follows a referral in February 2020 from the Federal Treasurer, The Honourable Josh Frydenberg MP, and is the end result of an inquiry commenced by the Committee into the Australian corporate bond market. Central to the Committee’s inquiries was the question of why, despite more than a decade of regulatory change, the Australian corporate bond market remains small compared to those of other countries.
Although the submissions received by the inquiry highlighted a range of issues for the Committee’s consideration, the most significant theme to emerge was the continued impediment that Australia’s regulatory framework imposes on the development of the Australian corporate bond market.
What is new?
This is not the first time that Australia’s retail corporate bond market has been the focus of reforms. This latest inquiry and Report follow reforms initiated by the Government over a decade ago in response to the 2009 Report of the Australian Financial Centre Forum ‘Australia as a financial centre: Building on our strengths’ , and more recently, the Government's 2014 Financial System Inquiry which among other reforms resulted in the introduction of a new regime for ‘simple corporate bonds’ (SCBs).
The Report differs from the previous reports in two key respects; firstly, it is the only report to cover a stand-alone inquiry into the Australian corporate bond market and secondly, while previous reports have focused on streamlining Australia’s regulatory disclosure framework, the recommendations in the Report are more wide ranging and tackle issues that have not been canvassed in earlier reports.
Although several of the recommendations lack detail, and require further steps to be taken, others are more specific, such as recommendations to amend the SCB regime to permit early redemption of SCBs, introduce more flexibility in relation to standardised financial ratio disclosures and streamline the two-part disclosure requirements.
A number of other recommendations have broken new ground, including recommendations to review regulatory settings impacting tax incentives, superannuation investment, trustee responsibilities, the availability of credit ratings and the ability of smaller investors to access the unlisted corporate bond market. These were accompanied with more specific recommendations, for the first time, to improve pricing transparency for investors and promote more market awareness of the benefit of corporate bonds. Finally, the Report recommends a review of the regulatory reforms implemented in New Zealand’s corporate bond market to determine if the Australian market can learn from these.
Which recommendations are likely to be implemented?
The Committee has signalled strong support for the early implementation of the recommendations, possibly over a number of stages. An easy first run on the board, that would have immediate impact, would be the implementation of the SCB regime recommendations discussed above. Current restrictions in these areas have significantly limited the attractiveness of the SCB market, particularly for issuers. Amendments to Chapter 2L of the Corporations Act 2001 (Cth) (Corporations Act) to strike a more commercial balance between the risk/reward analysis for trustees and the needs of retail investors could also be implemented in conjunction with any SCB reforms. Given very few trustees are willing to service the retail bond market under the current Chapter 2L, this parallel reform will be essential to ensure that issuers seeking to issue under an amended SCB format are not frustrated by trustee supply constraints.
What are the detailed recommendations in the Report?
The Report made twelve recommendations to address the issues raised in the submissions:
The Committee recommends for the Australian Government to ensure investors have access to timely and useful information about corporate bonds so they can make informed decisions, and increase the transparency around the trading of corporate bonds.
Several submissions raised concerns about the opacity of Australia’s corporate bond market where there is limited price transparency to investors. According to these submissions, the lack of readily available information regarding corporate bonds has negatively impacted the growth of Australia’s corporate bond market.
The Committee recommends that the Australian Government engages with universities and the financial advisory industry to educate and raise awareness about the benefits of corporate bonds, and retail corporate bonds in particular, both for investors and issuers.
A number of submissions highlighted a general lack of investor understanding of corporate bonds, which in turn contributed to low investor confidence in corporate bonds as an investment product.
The Committee recommends lowering the minimum investment parcel to $1,000 for corporate bonds to improve access to more investors and recommends that the Australia Government provides incentives for fixed income service providers to act as intermediaries for retail investors.
Several submissions noted restrictions on the ability of smaller investors to access the unlisted corporate bond market, even where they are legally entitled to purchase unlisted bonds. This recommendation appears to be directed at these concerns, but would benefit from further clarification on how the proposed measures will address this issue.
The Committee recommends that the Australian Government reviews the licensing regime for credit rating agencies with a view to minimise access barriers for small and medium enterprises, issuers and retail investors.
This recommendation aims to minimise access barriers for small and medium enterprises (SMEs), issuers and retail investors. Multiple submissions noted that the fees charged by credit rating agencies could act as a significant barrier to entry into the corporate bond market for SMEs. There are also regulatory settings which prohibit the disclosure of credit ratings in disclosure documents for retail bond issuance, unless the rating agency holds a retail authorisation.
The Committee recommends that the Australian Government takes further steps to streamline and regularise disclosure requirements for the issuing of simple corporate bonds. This should ensure there is no duplication of requirements for listed entities that are already subject to continuous disclosure requirements.
Several of the submissions noted that issuers would benefit from the removal of the two-part prospectus requirements for SCB issuance and its replacement (for ASX-listed companies) with wholesale style disclosure documentation and a cleansing notice or (for unlisted companies) a single prospectus for the inaugural simple bond issuance, followed by continuous disclosure and financial reporting obligations (consistent with listed entities). Follow on issuance would use wholesale style disclosures complemented by a cleansing notice.
The Committee recommends that the Australian Government amends relevant regulations to allow for the early redemption of simple corporate bonds to enable issuers to refinance bonds prior to their maturity date.
Several submissions recommended the removal of the current requirements for SCBs to have a fixed term with limited redemption rights. The main challenge with these restrictions is that issuers typically refinance by issuing new bonds into the market, making them vulnerable to market conditions at the time of issuance. Issuers therefore require the flexibility to restructure their bonds in advance of a refinance by either redeeming the bonds early or extending their maturity date. This enables issuers to optimise market conditions at the time of the refinance. The restrictions on redemptions under the SCB regime reduces this flexibility, increasing the refinance risk for bonds to levels that may be unpalatable for risk-averse issuers.
The Committee recommends that the Australian Securities and Investment Commission (ASIC) review its approach to financial ratios to maintain investor confidence in a standardised approach, while introducing more flexibility for bond issuers.
Submissions commented on ASIC’s standardised approach to financial ratios, which several submissions described as a ‘one size fits all approach’. Currently, issuers must include certain prescribed financial ratios in the offer-specific prospectus for an SCB. As each issuer has a different capital structure and its cash flow liquidity depends on various factors, one financial ratio applicable to an issuer in one industry may not be relevant to another issuer operating in a different industry.
The Committee recommends that the Australian Government reviews Chapter 2L of the Corporations Act 2001 (Cth) and other regulatory obligations applicable to trustees with the aim of increasing the availability of trustees for the retail bond market.
Chapter 2L of the Corporations Act requires an issuer of retail bonds to appoint an entity to act as trustee for the holders of the bonds, subject to the requirements of Chapter 2L. Numerous submissions noted that Chapter 2L imposes duties on trustees over and above trustee duties imposed by the common law. Trustees are traditionally unwilling to assume broader duties, due to the additional costs and risks that this involves, which they are not paid to assume.
The Committee recommends that the Australian Government review the regulatory reforms implemented in New Zealand’s corporate bond market to further develop, broaden, deepen and make more liquid Australia’s corporate bond market.
Numerous submissions pointed to whether reforms made to New Zealand’s corporate bond market could have application to the corporate bond market in Australia. Despite the relative size of New Zealand’s corporate bond market, it is ‘deeper and more liquid’ than Australia’s. This is largely a result of relatively recent reforms, such as the introduction of a streamlined disclosure regime.
The Committee recommends the Australian Government investigates the impact of increasing tax incentives to support the development of the corporate bond market to create alternative sources of funding and increase opportunities for investors to diversify their investment portfolios.
The submissions reflected differing views on the role tax could play in the development of the corporate bond market. Some submissions believed different taxation methods were unlikely to have a significant impact on the corporate bond market’s size and shape. In contrast, several submissions saw the differential tax treatment between debt and equity as a reason for the underdevelopment of Australia’s corporate bond market.
The Committee recommends that the Australian Government further engages with mature and sophisticated international capital markets to determine how Australia could adjust its taxation system to further enhance domestic and international investment through the growth of the corporate bond market.
The Report noted that the corporate bond issuance in Australia is much lower than in the United States of America, New Zealand and Europe. Some submissions stated that this was, in part, because these markets have sophisticated taxation systems which do not favour a particular asset class over the other.
The Committee recommends that the Australian Government investigate options to remove barriers inhibiting the investment of superannuation in the Australian corporate bond market.
A few submissions highlighted that Australia’s superannuation industry has the potential to be a larger source of domestic capital.
A few submissions highlighted that Australia’s superannuation industry has the potential to be a larger source of domestic capital.
The way forward for Australia's corporate bond market
As the Morrison Government returns from COP26, it will be mindful of the huge lift in investment that will be required for Australia to meet its Paris Agreement commitments. Banks cannot fund this alone, and more than ever, companies will need to look to Australia’s corporate bond market as an alternative source of funds to banks and equity. A deep and liquid corporate bond market is therefore a critical part of the Government’s response to the economic challenges posed by climate change. Any delays in implementing the Committee’s recommendations could come at a cost to the Government’s ability to step up to meet these challenges. And, as various leaders at COP26 made clear in their speeches and announcements, the time for all nations to respond to these economic challenges is now.