Inquiry overview
1.1
On 6 February 2020, the Treasurer, the Hon Josh Frydenberg MP, referred the Inquiry into the Development of the Australian Corporate Bond Market
(the inquiry) to the Standing Committee on Tax and Revenue (the Committee).
1.2
The Terms of Reference for the inquiry are set out in the front pages of this report.
1.3
On 10 February 2020, the Committee announced the inquiry and called for written submissions from relevant individuals and organisations. The Committee received 18 submissions. Submissions are listed at Appendix A.
1.4
The Committee subsequently held two public hearings in Canberra on 6 and 13 November 2020. Submissions and transcripts for all public hearings can be found on the Committee’s webpage.
1.5
The Committee acknowledges the thoughtful and comprehensive contributions of witnesses. All evidence brought to the attention of the Committee, both written and verbal, has been given careful consideration.
Report outline
1.6
During the inquiry the Committee sought to understand the underlying causes of what has been described as an ‘underdeveloped’ corporate bond market in Australia, and considered whether there are any taxation or regulatory impediments that prevent the development of a more active market.
1.7
This report consists of four chapters:
Chapter one presents an overview of debt financing, the corporate bond market in Australia, and the regulatory framework and reforms relating to corporate bonds.
Chapter two analyses some of the key benefits of the corporate bond market, and the barriers to its development. It also explores ways to facilitate uptake of retail corporate debt in Australia to create a more dynamic retail corporate bond market.
Chapter three explores possible reforms to the Corporations Act 2001 (Cth) (Corporations Act) to alleviate the regulatory burden and facilitate the uptake of corporate bonds. The chapter also provides an overview of the regulatory setting in New Zealand, which some submitters saw as a potential model for Australia.
Chapter four discusses the tax treatment of corporate bonds compared to other forms of debt financing, both for issuers and investors. The chapter also draws a comparative analysis of tax arrangements in other jurisdictions and considers how they might be adapted to an Australian context.
Inquiry background
Financing solutions for businesses
1.8
Historically, bank loans have been the preferred solution for businesses to fund their growth, productivity and innovation. However, the economic turmoil brought about by the global financial crisis (GFC) exposed the absence of an alternative funding method to that of domestic bank loans.
1.9
The issuance of shares is another source of funding for a business although the attendant dilution of its ownership and decision-making powers can produce reluctance to pursue this funding avenue.
1.10
As a result, several economies, including Australia, have an increased interest in developing other funding solutions. As pointed out to the Committee by Gilbert + Tobin, ‘[a] corporate bond market often becomes an attractive source of funding during or after a financial crisis, simply because banks limit their lending.’ This has also given rise to the ‘spare tire’ theory, where the corporate bond market is seen as a risk mitigation strategy to lessen the impact of crises on the economy.
1.11
In the post-GFC period, initiatives to diversify funding sources intensified, mainly driven by the financial sector, including banks, investment funds, insurers, and other institutional investors. For investors, the GFC also heightened the need for increased investment asset diversification.
1.12
FIIG Securities Limited told the Committee that the GFC ‘illustrated that Australia needs to have prudent asset allocation, particularly against the background of an ageing population that has limited capacity to withstand a market correction.’
What are corporate bonds?
1.13
Corporate bonds are a type of debt security, issued by entities to finance their business operations. Through the purchase of a bond, an investor is lending money to an issuing entity for a fixed period of time in exchange for an instrument (the bond). In addition to paying the principal (face value) at a future-specified date (maturity), the bond promises periodic interest payments (coupons). In this way, bond holders are seen to be creditors and, unlike equity, bonds do not dilute company ownership.
1.14
In general, corporate bonds are considered more risky than Australian Government Bonds (AGBs; issued by the Australian Government) as return on investment depends on the solvency of the business. However, to compensate for this, corporate bonds offer higher coupon payments than AGBs. Further, they are seen as a safer investment than shares due to a lower market volatility, as corporate bonds offer a regular stream of fixed income.
1.15
Corporate bonds can be bought on the wholesale or ‘Over-The-Counter’ (OTC) market; directly from the issuer through a public offer; or in the retail market, such as on the Australian Securities Exchange (ASX).
The corporate bond market in Australia
1.16
In Australia corporate bonds are typically issued into the wholesale corporate bond market (for purchase by wholesale investors such as hedge funds, banks, or unions), and are done so without regard to the retail disclosure requirements of the Corporations Act. After 12 months, wholesale bonds can then be sold in the retail market on the ASX.
1.17
Historically, more than 95 per cent of Australian bonds, in value terms, are issued into the domestic market to wholesale investors. Wholesale investors include Australian Prudential Regulation Authority-funds and other individuals who qualify as ‘sophisticated investors’ who are ‘presumed to be getting their own advice’ and have met a certain threshold as prescribed by the legislation. For example, they must have net assets of at least $2.5 million, or invest where the purchase price of the product or single security is at least $500,000.
1.18
Comparatively, only a limited number of corporate bonds are directly available for purchase by retail investors through the ASX. The sale of corporate bonds in the retail market requires appropriate disclosure documents (e.g. a prospectus) to be prepared and lodged with the Australian Securities and Investments Commission (ASIC), an independent Australian Government body that regulates the financial system, and provided to retail investors in accordance with the Corporations Act.
1.19
The Australian corporate bond market is also characterised by a concentration of financial, rather than non-financial issuers. Corporate bonds represent only 10 per cent of non-financial organisations’ total funding, compared to 40 per cent on average in Organisation for Economic Cooperation and Development (OECD) countries. However, in the past decade or so there has been an increase in unrated and lower to medium grade corporate bonds, which provide a higher yield than ‘safer’ bonds, such as AGB or investment grade bonds.
1.20
The Inspector-General of Taxation and Taxation Ombudsman described another feature of the Australian corporate bond market. It indicated that less than half of the market was held by Australian investors and less than one per cent of all corporate bonds held in Australia were owned by private investors, compared to 20 per cent in the United States of America.
1.21
According to Deloitte Access Economics, in September 2017 the total bond market was valued at over $2.3 trillion in outstanding bonds.
1.22
At the end of the 2019-20 financial year, the value of bonds issued by Australian corporate entities domestically and offshore totalled
$1.7 trillion. Of this total, the value of bonds issued domestically by Australian corporate entities was $1.1 trillion.
1.23
The Association of Superannuation Funds of Australia Ltd (ASFA) estimated that superannuation funds held a total of around $60 billion of Australian corporate bonds, and highlighted the key roles superannuation funds will play in coming decades in corporate bond market growth. ASFA anticipates that:
As the population ages, the proportion of system assets in the retirement phase will increase. Since post-retirement products typically have higher allocations to fixed income investments compared to investments in the accumulation stage, this should amplify demand for fixed income investments in general.
Regulatory framework and reforms
1.24
Australia’s corporate bond market is shaped by regulation and processes set out in the Corporations Act. This legislation is largely administered by ASIC. The Corporations Act specifies regulations including, but not limited to, disclosure requirements, selling restrictions, and licensing requirements for market operators and participants.
1.25
In addition to the Corporations Act, the Income Tax Assessment Act 1936 (Cth) (Income Tax Act) and the New Business Tax System (Imputation) Act 2002 (Cth) are relevant to the tax treatment of income derived from corporate bonds. In particular, the Income Tax Act specifies tax regulations in relation to capital gains and interest earned by foreign investors of Australian corporate bonds.
1.26
Over the last decade, the Australian Government has amended the regulatory regime for corporate debt to facilitate a deeper and more active retail corporate bond market. However, the Australian market has remained undynamic despite these reforms.