Fixed Income

It is really encouraging seeing the Government announce a review of the corporate bond market, led by Jason Falinski, who I am pretty confident can quickly come to grips with the issues. 

There is certainly ample opportunity to improve the depth, diversity and liquidity of the market. The Aussie non-government bond market is massive. We estimate that there are almost $1 trillion worth of Australian corporate and financial bonds issued locally and offshore, including foreign corporate issuers into the Aussie market (ie, so-called Kangaroos). 

But as one stockbroker recently said to me, it is much harder for him to sell over-the-counter Telstra senior bonds to mums and dads than it is to offer them far riskier Telstra shares. This in turn generates portfolio biases---for over a decade I have shown that both individual and institutional investors are carrying way too much equities risk for their stated return targets (mean-variance optimisations imply they should be diversifying into much more fixed-income). 

There is also excellent secondary liquidity in the OTC bond market, although this is nigh on impossible for mums and dads to access: in January alone, which is normally a seasonally illiquid month, we bought and sold about $2.2 billion worth of corporate/financial bonds, including $1.6 billion of secondary transactions and $600 million of primary investments. 

There are several obvious policy solutions that we have previously proposed that the Falinski review could consider:

  • Divisibility: The typical minimum investment size for most unlisted bonds is $500,000, which is unusually large globally and more or less destroys any retail market participation. Some blame the ASX-owned clearinghouse, Austraclear, while others blame risk-averse issuers wanting to restrict their securities to wholesale investors. We need to urgently address this issue and reduce the minimum investment size to $10,000 or less, which will revolutionise the ability of mums and dads to access the sector and in turn amplify the demand for domestic issuance, enhancing overall liquidity.
  • Disclosure: Almost all local bond market transactions are settled through Austraclear. Yet for some reason, Austraclear publishes no information on the price and volume of trading in the market. The academic research literature on market microstructures shows that there is a strong positive correlation between a market's transparency and its liquidity. For years we have called on Austraclear to publish daily value of trading statistics for all bonds and a volume-weighted average price to provide participants more confidence around secondary liquidity. Austraclear could then sell additional data for those willing to pay for it. While Austraclear is expected to make some positive moves on this front, they not yet done so.
  • Distribution: It is not clear why ASX listed companies that are subject to continuous disclosure obligations have to issue long-form prospectuses when trying to raise capital via relatively vanilla debt securities, which makes the entire process slow and cumbersome. There is an argument that they should be able to do so via a short-form prospectus or terms sheet, which would reduce issuance costs while increasing speed to market.   

There is a lot of low-hanging fruit here for the Falinski review, which I have no doubt Jason, who is very pragmatic, will pick. You can read his op-ed in the AFR today on the subject here.

Michael Whelan

Good write-up Chris. If they can do up to $30k on SPPs for listed shares (riskier, down the curve), the $500k for unlisted bonds is absurd. Anything to make the paperwork shorter and briefer must be done - but when you have lawyers involved, well, they're always the winners.

Sam Binder

While I think this is a useful initiative, I am cautious of the depth in the Australian debt market for vanilla/easily understood/sound quality debt issuers. As an example, the 4th ever 'simple' corporate bond issued under that program was the recent (ish) Axsesstoday instrument. This was anything but simple if analysed correctly, and resulted in the speedy incineration of a reasonable chunk of principal. While this might be seen as a fringe case, it is a useful example of what can happen in an advisor led market for debt hungry issuers. How do you protect against this?

Christopher Joye

agree, agree, agree

Christopher Joye

yeah good question Sam

Michael Whelan

Sam - from memory the AXT issue was at 490bps over so risk would have been self-evident, one would hope. We need to accept we'll have a few defaults and car crashes along the way, otherwise the market will never develop.

Sam Binder

To Michael Whelan - while margin can compensate if the probability of default is appropriately identified, I think there is a strong argument in the case of AXT's SCB that all the risks were not identified. The fact that both the listed debt and equity went into suspension only a few months after the issue, and never came back out is one indicator. The subsequent restatement of accounts provides some further hints.