The corporate bond market
A deeper and more liquid corporate bond market would provide diversification benefits to both issuers and investors.
Over recent years, bond issuance by Australian corporates has increased steadily, with 80 per cent of issuance in offshore markets (Chart 3.11). On average, around 30 bonds are issued in the domestic market per year, with a slightly higher number of offshore issues, which are generally larger.97 Traditionally, private non-financial corporations have made relatively little use of the domestic market. In recent years, domestic issuance has been dominated by the major banks.98
Australia has an established domestic bond market, although a range of regulatory and tax factors have limited its development.
Chart 3.11: Australian corporate bonds outstanding
(by market of issuance, market value)
In the international context, Australia’s pattern of corporate debt financing is fairly typical. The proportion of debt funding for Australian corporates that is intermediated by banks is broadly consistent with that of other advanced economies with the exception of the United States, which has an unusually large corporate bond market.99 Corporates in Australia and other advanced economies tend to issue bonds in Europe and the United States.
In Australia, it is more common for corporate bonds to be issued into the wholesale market and traded over the counter. Despite this, a small number of public offers of listed corporate bonds are made to investors each year. Unlike in the United States, there is limited public transparency in the over-the-counter corporate bond market in Australia.100 Since the corporate bond market in Australia is largely over-the-counter and lacks transparency, retail investors are effectively precluded from investing directly in these bonds.
For lower-rated or unrated corporates, raising funds through bond issuance can be challenging, particularly for tenors longer than seven years. That said, market conditions for both lower-rated and longer-dated issuers have improved recently, with more Australian dollar BBB-rated issuance and at longer tenors in 2013 than in previous years.101, 102
In recent years, the Government has taken a number of steps to stimulate the corporate bond market:
- The Australian Office of Financial Management has extended the length of the yield curves for CGS to 20 years.
- The RBA has begun publishing pricing data for non-financial corporate bonds.103
- The Government has made exchange-traded Commonwealth Government Bonds available for trading on the ASX since May 2013, to provide a visible pricing benchmark for corporate bonds and to encourage retail investors to consider diversifying their asset portfolio to fixed income products.104
In addition, legislation currently before Parliament aims to simplify the prospectus requirements for retail ‘vanilla’ bonds and reduce the liability of company directors issuing these simple bonds to retail investors.105
Alternative funding sources for corporates
Australian corporates generally have good access to alternative funding sources. Bank and syndicated loans are usually offered at interest rates similar to those available in the bond market (Chart 3.12). Loans can involve lower fixed costs, and funds can be accessed in a more flexible way. However, the tenor of funding available from banks may not be as long as bonds, and covenants in loan contracts can make bond funding more attractive. In some jurisdictions, syndicated loan participations are tradable and therefore available to other investors. This is rare in Australia.
Chart 3.12: Interest rates on corporate debt
Offshore debt markets are often more attractive to Australian corporate issuers. These markets, particularly in the United States, often provide funding for Australian corporates at a lower cost, for longer tenors, in larger sizes and to lower-rated issuers than the domestic market. In some countries, the double taxation of dividends has tended to encourage debt funding over equity, which has directly contributed to the size of bond markets offshore.
Domestic demand for corporate bonds
Australian investors’ appetite for fixed income securities is arguably lower than in some other advanced economies.107 The tax system treats fixed income securities unfavourably compared to other savings vehicles (see Chart 3.2 in the Household saving section in this chapter). In addition, the dominance of defined contribution superannuation and the relatively low proportion of superannuation assets currently in the retirement phase explain why superannuation funds are more heavily invested in equities than in corporate bonds. The domestic corporate bond market is relatively illiquid compared to markets for other assets, and the lack of issuers limits investors’ ability to diversify credit risk in their portfolios.
Some potential wholesale investors in corporate bonds are only able to invest in rated securities under their investment mandates. Investors use credit ratings as a proxy for, or to provide comfort in the absence of, their own independent credit assessment. However, some issuers find the cost of obtaining a credit rating from major rating agencies to be prohibitive. A factor affecting public offerings is that some ratings agencies will not consent to ratings being used within a prospectus, due to liability concerns and a requirement to participate in mandatory dispute resolution mechanisms.108
Issuers also face impediments in making public offers of listed corporate bonds, particularly to retail investors. Submissions raise issues with the application of the prospectus requirements for public offerings and the scope of exemptions from the prospectus regime for offerings to sophisticated individuals. Submissions also raise issues of cost and the liability regime associated with prospectuses. In particular, listed companies query why they cannot rely on a prospectus exemption similar to that for issuing further equity, which is based on compliance with the continuous disclosure regime, when they issue listed debt. To some degree, the reforms currently before Parliament deal with these issues.109
Policy options for consultation
Some trends could contribute to the natural deepening of the ‘vanilla’ corporate bond market. In particular, as the superannuation system matures and the population ages, demand for fixed income products is likely to increase.
Some submissions suggest policy options to improve access for retail investors to the corporate bond market. Potential policy options include:
- Allowing listed issuers (already subject to continuous disclosure requirements for at least 12 months in respect of their listed equity) to issue listed ‘vanilla’ bonds directly to retail investors without the need for a prospectus110
- Reviewing the size and scale of corporate ‘vanilla’ bond offerings that can be made without a prospectus where the offering is limited to 20 people in 12 months up to a value of $2 million111
- Reviewing the size and scale of corporate ‘vanilla’ bond offerings that can be made without a prospectus where the offering is less than $10 million and an offer information statement is offered to investors112
The Inquiry would value views on the costs, benefits and trade-offs of the following policy options or other alternatives:
- No change to current arrangements.
- Allow listed issuers (already subject to continuous disclosure requirements) to issue ‘vanilla’ bonds directly to retail investors without the need for a prospectus.
- Review the size and scale of corporate ‘vanilla’ bond offerings that can be made without a prospectus where the offering is limited to 20 people in 12 months up to a value of $2 million, or for offers of up to $10 million with an offer information statement.
The Inquiry seeks further information on the following areas:
- As a greater share of the population enters retirement, would the demand for fixed income products increase in the absence of regulation or other incentives?
- Would the development of annuity-style retirement income investment products encourage the growth of fixed income markets?
- Could enhanced transparency of transactions improve liquidity in the over-the-counter Australian corporate bond market, including its attractiveness to retail investors? What commercial or regulatory impediments are there to the potential development of improved transparency in the over-the-counter corporate bond market?
- Could alternative credit ratings schemes develop in Australia and would this help improve the appetite for bonds, particularly those of growing medium-sized enterprises? Could alternative standards of creditworthiness develop in Australia? What are the barriers to such developments, and what policy adjustments would assist such developments?
97 Lowe, P (Deputy Governor, Reserve Bank of Australia) 2014, Opportunities and Challenges for Market-based Financing, speech to the ASIC Annual Forum 2014, 25 March, Sydney.
98 From mid-2007 to the end of 2011, the major banks accounted for around 60 per cent of issuance since mid-2007. Black S, Kirkwood J, Rai A and Williams T 2012, A History of Australian Corporate Bonds, Reserve Bank of Australia, Research Discussion Paper 2012-09, Sydney.
99 Reasons for the exceptionally large US corporate bond market include the fragmented banking system, a long history of credit ratings agencies, the size of the funds management industry, an investor base familiar with fixed income assets, the most liquid government debt market and the status of the US dollar as the world’s reserve currency.
100 In the US, the Trade Reporting and Compliance Engine (TRACE) is a vehicle that facilitates mandatory reporting of over-the-counter secondary market transactions in certain kinds of US corporate bonds. TRACE was developed by the Financial Industry Regulatory Authority, a self-regulatory organisation of financial market participants. TRACE became operational on 1 July 2002.
101 Debelle, G (Assistant Governor, Financial Markets, Reserve Bank of Australia) 2014, The Australian Bond Market, speech to the Economic Society of Australia, 15 April, Canberra.
102 Lowe, P (Deputy Governor, Reserve Bank of Australia) 2014, Opportunities and Challenges for Market-based Financing, speech to the ASIC Annual Forum 2014, 25 March, Sydney.
103 See Reserve Bank of Australia (RBA) 2014, Statistical Tables, Aggregate Measures of Australian Corporate Bond Spreads and Yields (F3), RBA, Sydney.
104 Revised Explanatory Memorandum, Commonwealth Government Securities Legislation Amendment (Retail Trading) Bill 2012.
105 The Corporations Amendment (Simple Corporate Bonds and Other Measures) Bill 2014 was introduced into the winter sitting of Parliament, but is yet to be passed. ‘Vanilla bonds’ are defined in the Bill as having certain features including a face value of less than $1,000, a maturity of less than 15 years, and being issued by a listed entity or wholly owned subsidiary of one.
106 Reserve Bank of Australia (RBA) 2014, Statistical Tables, Aggregate Measures of Australian Corporate Bond Spreads and Yields (F3) and Interest Rates, Indicator Lending Rates (F5), RBA, Sydney.
107 Particularly for pension funds. Organisation for Economic Cooperation and Development (OECD) 2013, Pension Markets in Focus, OECD, France.
108 A ratings agency that provides ratings to retail investors through a prospectus is required to obtain an Australian Financial Services Licence as the rating amounts to general financial advice. As a licensee, the ratings agency would need to be a member of an external dispute resolution scheme.
109 The Corporations Amendment (Simple Corporate Bonds and Other Measures) Bill 2014.
110 Consistent with Corporations Act, s708AA right issue relief.
111 Corporations Act, s708: “where the offer is a personal offer, and offers or invitations have been made to fewer than 20 persons in the previous 12 months, and the new offer will not result in more than $2 million being raised in that 12 months”. The value ($2 million) has remained unchanged since its introduction in 2001.
112 Corporations Act, s709(4).The change from $5 million to $10 million was in 2007.