2.1
The global financial crisis, and more recently the economic impact of the COVID-19 pandemic have prompted consideration of the availability and reliability of the various forms of debt financing used to provide alternative and complementary funding sources for Australian businesses.
2.2
This chapter considers the benefits of developing a more dynamic corporate bond market in Australia to bring about the diversification of funding sources and investment profiles. The chapter also explores some of the barriers and impediments that restrict the growth of a robust corporate bond market, especially for retail investors and issuers.
Benefits
2.3
The majority of submissions to this inquiry outlined the benefits associated with growing Australia’s corporate bond market for individual investors, companies, and the Australian economy more broadly. The need to grow the corporate bond market was seen as particularly important in the current context of Australia’s ageing population and economic recovery efforts in the wake of COVID-19.
Risk mitigation through investment diversification
2.4
In its submission, the Australian Financial Markets Association (AFMA) articulated the benefits of a vibrant corporate bond market that can provide ‘a secure, flexible and reliable source of finance.’ AFMA highlighted how corporate bonds can provide an alternative to bank loans and equity (shares) and minimise the risks of funding shortages through the diversification of investments.
2.5
The Association of Superannuation Funds of Australia Ltd (ASFA) asserted the importance of having alternative sources of funding available, in particular for small and medium enterprises (SMEs) as they face major obstacles in relation to the cost of debt issuance and impediments to market access.
2.6
In their submission, Associate Professor Rand Low (Dr Low) and Professor Terry Marsh (Dr Marsh) state that they ‘strongly believe that a well-developed Australian Corporate Bond market can be useful for Australian investors in better structuring their investment portfolios and retirement incomes’. Drs Low and Marsh go on to emphasise the benefits of supporting innovation and productivity for the Australian economy:
A strong, functioning Australian corporate bond market means that Australian investors can structure portfolios to generate a stable, and steady income in retirement … It also means that we share the task of unlocking the intellectual and economic potential of one of the youngest, well-educated, western democracies in the world with international investors. We have personally met so many young, and bright Aussie professionals and entrepreneurs who have left our shores for the United States due to the depth and breadth of the United States capital markets to fund their ideas.
2.7
The Property Council of Australia (PCA) commented on the need for businesses to have ‘greater access to diverse and competitively priced funding’ and reduce the reliance on ‘offshore bond markets for greater diversity and longer tenor debt’, including to ‘help securitise Australia’s banking sector.’
2.8
Diversification of investment assets is a key driver for investors.
MSC Trustees, citing a report from Deloitte Access Economics (DAE), described how investors may use stable, income-generating financial instruments, such as corporate bonds, to diversify their investment portfolio and balance risks and returns:
Corporate bonds play an important role in a well-diversified portfolio by offering a higher – but still stable – rate of return compared to other fixed income securities such as deposits and government bonds, albeit with a higher level of credit risk compared to these other investments (Stewart and Valtwies, 2015). In this context, corporate bonds can fill a niche between low-return and low-risk fixed income investments, and high-return but riskier shares, offering a mid-point in risk and return for investors seeking further diversification (ASIC 2015).
2.9
Similarly, the Inspector-General of Taxation and Taxation Ombudsman (IGTO) outlined that the benefits for investors of corporate bonds include:
access to a reliable income stream from regular coupons paid by corporate bonds;
a good overall return given their risk profile; and
diversification of an investor’s investment portfolio, with corporate bonds offering a mid-point between other lower-return and lower-risk fixed income investments and high-return but riskier shares.
2.10
It is apparent from DAE’s research that the more stable revenue generated by fixed income securities rather than volatile shares has also proved more attractive to older investors. For those under 55 years of age, corporate bonds represent 3.4 per cent of investment portfolios and 22 per cent for investors who are 55 years and over. In the context of an ageing population, DAE stated that there was a potential for growth in the corporate bond market.
2.11
Dr Low and Dr Marsh described the benefits of boosting Australia’s corporate bond market for investors nearing retirement:
Equity holdings alone are too risky as a retirement strategy for an ageing population due to their volatility over relevant decision horizons. The ASX is highly concentrated in Financials (24.6%), Materials and Metals (18.7%), and Healthcare (13.8%). As a result the Australian economy is highly cyclical. … A strong, functioning Australian corporate bond market means that Australian investors can structure portfolios to generate a stable, and steady income in retirement.
2.12
Similarly, the PCA emphasised the limited investment choices available in Australia, particularly for individual investors and stated that our growing retirement population will make it important to have a ‘substantive and robust retail bond market’:
As Australia’s working population moves into retirement the requirement to draw down from savings should change the way in which money is invested, from its current form of equity (which is a growth asset) to more fixed income products (which are generally viewed as defensive assets) that provides lower risk and more stable returns.
2.13
In its submission, the AFMA shed light on how superannuation fund managers increasingly seek to ‘source fixed income alternatives and provide a greater range of investment opportunities beyond government debt and equities.’
Greater resilience in volatile times
2.14
Gilbert + Tobin stressed how corporate bonds can ‘be attractive in volatile equity market conditions, avoiding shareholder dilution while at the same time offering potentially longer-term funding than the banks are prepared to offer.’ It added in its submission:
When interest rates are at record lows, investors are looking for yield and retail corporate bonds usually offer more attractive interest rates … than term deposit rates and government bonds.
2.15
Dr Shumi Akhtar highlighted the need to build economic resilience in a context of uncertainty and volatility through investment diversification:
Equity or real-estate or alternative investments are much riskier than investment in government bond [sic] or corporate bonds, due to the sheer size and creditworthiness of the corporations. Given the current headwinds facing our economy from the COVID-crisis combined with the Chinese Cold War, it has never been more important that we redesign our tax system for retail and institutional investors to promote Australia as an internationally competitive debt market.
2.16
PCA echoed Dr Akhtar’s comments stating:
We have seen during the COVID-19 pandemic that those markets that have deep retail debt markets were able to respond to the economic shockwaves by continuing to issue bonds while Australia’s wholesale bond market froze for corporate issuers.
2.17
Gilbert + Tobin commented that in times of crisis the corporate bond market could increase the lending capacity for Australian businesses by enabling them to access an enhanced pool of investors. ASFA highlighted how superannuation funds’ investments in corporate bonds could contribute to the post-COVID economic recovery and mitigate the impact of future crises.
2.18
FIIG Securities Limited (FIIG Securities) made the point that:
A distorted exposure to particular asset classes means that there is greater reliance on the Federal Government for protections when it comes to retirement savings… when a market correction occurs. A stronger participation rate in Fixed Income Investment in Australia would mitigate that and future proof the economy for misaligned investment allocations across the various asset classes.
Barriers
2.19
Despite the benefits of corporate bond investments, there is almost a complete absence of corporate debt accessible to retail investors. Several submitters identified a bias towards other forms of investment, such as equity (shares) and real estate, which is reflected in the regulations and, in their view, act as an impediment to the growth of the corporate bond market. For example, FIIG Securities stated that:
a retail investor has unbridled (actually encouraged, if anything) and incentivised access to the equity of an ASX-listed or an unlisted entity in the secondary market but cannot purchase a bond issued by the same issuer which is a lower risk investment.
2.20
According to the IGTO and Gilbert + Tobin, taxation only has a marginal impact on the growth of the corporate bond market, and as Gilbert + Tobin put it ‘the most significant impediments to the further development of the Australian corporate bond market relate to a range of non-tax matters.’
Opacity of the market
2.21
In July 2014, the Treasury Financial System Inquiry Interim Report concluded that ‘a deeper and more liquid corporate bond market would provide diversification benefits to both issuers and investors.’ It also found that ‘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.’
2.22
The Committee received strong evidence suggesting that the opacity of the market continues to limit the uptake of corporate bonds. King & Wood Mallesons (KWM) commented on the need for investors to have access to ‘timely disclosure of information to enable them to make an informed decision.’
2.23
National Australia Bank Ltd (NAB) stated that ‘greater disclosure and transparency of information would ultimately generate more interest in fixed income and greater availability of product.’ This included greater retail investor access to credit rating reports.
2.24
Mr Philip Harvey from KWM also highlighted that currently, ‘credit ratings can’t be disclosed to retail investors.’ This is in contrast to the wholesale market, where ‘most investors will require a credit rating to be obtained for those investment-grade issuers who are accessing that market.’
2.25
KWM put forward that ‘issuers of simple corporate bonds (and retail bonds more generally) should be required to disclose [ratings] information to investors to assist them in deciding whether to make an investment.’
2.26
Acacia Partners noted that Australia’s over-the-counter (OTC) corporate bond market was ‘fundamentally opaque, with limited price transparency available to investors,’ and claimed that there was a ‘risk that the carrying value of bonds may not reflect market pricing, particularly in periods of heightened volatility.’ To increase transparency, Acacia Partners recommended that Austraclear, a central securities depository for the wholesale debt market, ‘publish daily average price and volume figures for securities cleared through its platform.’
2.27
Dr Low highlighted transparency as being an important part of fostering a healthy corporate bond market and stated:
We need to make sure that bond market prices and executions are visible for all market participants. We need to have regulation that ensures that record-keeping of all these transactions is in a centralised, publicly accessible database. We also need to make sure that we reduce the information asymmetry between issuers and investors and that corporates provide timely, debt-specific information to the market. Because the information that's provided on equities versus debt is very, very different for investors.
Lack of investor awareness and understanding
2.28
According to DAE, the lack of readily available information about corporate bonds has had an impact on investors’ confidence in them, and in the growth of the market. DAE noted that 18 per cent of retail investors without corporate bonds in their investment portfolio received financial advice not to invest in corporate bonds, and a third of investors were unaware of corporate bonds as an asset class.
2.29
In addition, KPMG Australia observed the negative public opinion about corporate bonds, which the media have painted as ‘unattractive to retail consumers.’
2.30
ASFA remarked that ‘there is a lack of understanding about the role and features of fixed income securities and corporate bonds in particular.’ Quoting the DAE research, ASFA reported that:
Almost 70 per cent high net worth individuals without corporate bond holdings did not have sufficient understanding of corporate bonds to feel comfortable making an investment in corporate bonds. The same research found that only around 16 per cent of HNWIs [high-net worth individuals] own corporate bonds.
2.31
ASFA added that ‘issuers of unrated bonds have targeted HNWIs [high-net worth individuals] as potential investors’ but highlighted that the lack of awareness about corporate bonds acted as an impediment for those types of bonds that are likely to be issued by smaller organisations.
2.32
The IGTO suggested that ‘the Committee may wish to explore whether additional [Australian Taxation Office] guidance on aspects of corporate bond investments is warranted and would additional guidance provide more certainty and clarity for investors.’
2.33
The PCA expressed similar sentiments, stating that there was a ‘lack of coverage’ of corporate bonds on the Australian Securities and Investments Commission’s (ASIC) website. The PCA recommended that ASIC and other market participants should work to raise awareness about ‘the role corporate bonds can play in a diversified portfolio, particularly as a defensive asset providing lower risk and more stable returns,’ adding that:
Without this awareness, investors are unlikely to investigate further on the potential risks and returns of this investment product, and how this compares to other investment options.
2.34
Dr Low and Dr Marsh recommended the rollout of ‘more executive courses or professional development courses on fixed-income investments so that advisors can provide the appropriate fiduciary insights for their clients.’ They also suggested developing an ‘Invest in Australia’ campaign, akin to the ‘Australian Made’ campaign, with the Australian Government committing funding towards increasing investors’ confidence and awareness and to encourage Australian investors and pensioners to invest a portion of their savings in Australian businesses.
2.35
Finally, in regard to increasing investor awareness, Dr Low and
Dr Marsh recommended providing ‘funding for universities to create a web-based analytics platform for Australian corporate bonds.’ They state that this would allow SMEs to have:
a baseline understanding of what their expected bond ratings are, and the market expectations in terms of the tenor and coupon of the bonds to be sold for the capital raising. Second, investors who are looking to have an understanding of whether they are obtaining a fair return for the risk in the bonds they are buying have an unbiased credit rating that is free from conflicts of interest.
Market access and equity
2.36
Several submitters discussed barriers that limit access to the corporate bond market, especially for retail investors. The IGTO explained that the minimum parcel size is $500,000 and advised that this restricts access to wholesale and sophisticated investors (HNWIs). HWNIs typically have extensive experience in financial markets and large financial capacities with net assets of at least $2.5 million.
2.37
The IGTO advised the Committee that the large parcel size requirement results in the low uptake of retail corporate bonds as most bonds are traded in the professional, OTC market. This means that the instruments are exchanged without a central marketplace, such as the ASX, but directly between the seller and the buyer. As OTC trade is not disclosed publicly before the transaction, this causes a lack of transparency and a situation where other investors do not have access to OTC prices until the exchange has occurred.
2.38
ASFA advised that access barriers were the primary impediment for households’ limited investments in corporate bonds. NAB also identified the tradable parcel size as a barrier to retail investors. In addition, NAB advised:
Borrowers face legal and other operational costs of approximately $100,000 for a wholesale investor targeted transaction in the local bond market. For investment grade rated borrowers this transaction typically delivers strong volume and diversity of investors. By comparison, legal and process costs for issuance of simple corporate bonds usually exceed $500,000 with little or no incremental benefit in funding cost. Unless there is a need for significantly more volume, beyond the capacity of the wholesale markets, borrowers are unlikely to invest these additional amounts.
2.39
FIIG Securities commented that the Corporations Act (along with the
Banking Act 1959 (Cth)) impedes market access for retail corporate bond investors. They explained:
When you consider that equities are readily available in minimum purchase commitments of $1.00 or less and hybrid securities at $100.00 or less, it doesn’t follow that retail clients have no access to more secure investments in the capital structure of the same entity.
2.40
As at June 2017, DAE reported that investors, non-professional individual investors, and self-managed superannuation funds (SMSFs) represented only about 1 per cent of ownership of outstanding Australian corporate bonds each.
2.41
ASFA drew the Committee’s attention to the absence of ‘close substitutes (for fixed income securities) for retail investors’ and argued that:
The ability of SMSFs to invest in bank deposits – that are subject to a government guarantee for the first $250,000 of deposits – acts to reduce incentives to invest in fixed income securities and corporate bonds and would continue to do so even if retail access to corporate bonds improved.
2.42
Similarly, AFMA suggested that the government guarantee available for retail bank deposits may once have made them more attractive to investors, but that this has changed in recent times:
Under the Financial Claims Scheme, retail bank deposits are guaranteed by the Federal Government for deposits up to $250 000 per account holder per Approved Deposit‐Taking Institution. Accordingly … there is a relative attractiveness for bank deposits covered by the Financial Claims Scheme relative to corporate bonds, which are unsecured, albeit ranking higher than equity in the event of insolvency. As such, in order to attract retail investors, the bond yields need to be significantly larger. This issue was exacerbated in the last few years, particularly as the cost of retail deposits for banks increased; however recently the returns on retail deposits has fallen, making corporate bonds increasingly attractive on a risk‐adjusted basis.
2.43
More recently, fixed income investment service providers have facilitated the purchase of corporate bonds by smaller investors. They have allowed for a larger pool of investors by buying the large parcel OTC and then reselling smaller parcels to retail investors.
Concentrated offering
2.44
In Australia, corporate bonds are less represented than other class assets, with only 30 bonds issued annually on average. The issuance of corporate bonds is also concentrated in few industries, where banks and other financial institutions largely dominate the issuance of corporate bonds.
2.45
ASFA indicated in its submission that ‘bonds issued by Australian non-financial corporations account for around 6 per cent,’ and that the issuance of corporate bonds issued by non-financial institutions is further concentrated in well-established large corporations or the resource sector. ASFA advised that most non-financial organisations and SMEs in particular remain largely unrepresented in the market, and that:
Only a small proportion of corporate bonds on issue can be directly purchased by retail investors. There is a small number of listed bonds available for retail investors on the ASX.
2.46
In addition, corporate bonds are almost exclusively traded on the wholesale market with more than 95 per cent of domestically-issued corporate bonds, in value terms, issued to wholesale investors. After 12 months, wholesale bonds can then be sold to individual investors in the retail market on the ASX. The IGTO noted that comparatively, only a limited number of corporate bonds were directly available for purchase by retail investors through the ASX.
Flaws in the credit rating system
2.47
AFMA explained that there was an incongruity, from a policy perspective, where retail investors who ‘may be more in need in utilising the services of rating agencies in order to assess the creditworthiness of the issuer’ are somehow excluded:
Under the Corporations Act, all credit ratings agencies must hold an AFS [Australian Financial Services] licence authorising the agency to provide financial product advice by issuing a credit rating. Disclosure of a rating in a PDS [Product Disclosure Statement] or a continuous disclosure statement requires a retail authorisation. To the extent that the credit rating agency chooses only to hold the wholesale authorisation, such as due to increased costs or potential liability, then the result is that the ratings issues by such agencies in respect of corporate bonds can only be available to wholesale and not retail investors.
2.48
ASFA recommended that ‘the licensing regime for credit ratings agencies be reviewed, insofar as the regime reduces accessibility of ratings to retail investors. ASFA provided some insight into capital raising for SMEs and explained how a credit rating could act as a significant barrier to entry for SMEs:
Historically, corporates required a credit rating to issue in the Australian market. This is a lengthy and costly process, and for smaller companies, the costs may outweigh any benefits. However, a nascent market for unrated corporate debt is slowly developing.
2.49
Similarly, Dr Low and Dr Marsh saw credit rating fees as an access barrier, which they described as ‘punitive’ for SMEs. Acacia Partners advised that while they were ‘satisfied with the current regulatory settings in respect to credit ratings,’ they acknowledged that ‘the cost of traditional ratings agency services may be too high’ for smaller public companies.
2.50
Gilbert + Tobin noted the potential conflict of interest between rating agencies and the credit rating fees paid by bond issuers. NAB provided some insight on the impact of the lack of rating agencies in Australia on the corporate bond market and stated:
The lack of domestic rating agencies or research firms to provide ratings in the context of the Australian economy creates barriers for broader corporate issuance. While it is within an agency’s rights to set its own rating criteria, “scale” and other matrix tests that global wholesale rating agencies use tend to penalise Australian companies solely operating in the smaller Australian market. For example, companies that are smaller in scale (revenues for instance) but maintain a strong market position in Australia do not compare well to global peers operating in other larger markets, often resulting in sub investment grade rating outcomes that make issuance in the Australian market difficult and relatively expensive. As a result, borrowers often elect to remain un-rated and approach credit providers such as banks and private funds that are familiar with the company... This redirection therefore restricts supply of rated wholesale corporate issuance that could be fractionalised and distributed to wholesale and smaller retail investors.
Committee Comments
2.51
Corporate bonds offer investors an opportunity to diversify their investment profiles and assist in maintaining stability in investment returns. Developing Australia’s corporate bond market can also ensure that Australia is not over exposed to any single class of investment product. Ensuring that investors, including retirees, have a wide range of options is particularly important as Australia’s population continues to age, and the economy looks towards recovery from the economic impact of COVID-19.
2.52
The Committee believes that educating businesses on the benefits of diversifying funding sources would result in increasing the number of retail corporate bonds issued, including unrated corporate bonds, which would augment the interest and attention of financial advisers and investors.
2.53
The Committee acknowledges the multiple benefits of corporate bonds in relation to enabling Australian businesses, especially small and medium enterprises, to access capital and diversify their funding sources. The Committee also values the role corporate bonds can play in offering investors opportunities to diversify their investment profiles and maintain stability in investment returns.
2.54
The Committee agrees with the many submitters who have argued that developing Australia’s corporate bond market can also contribute to ensuring that Australia is not overly exposed to any single class of investment product and increasing its resilience to economic shocks.
2.55
It is vital that investors are provided with accurate information about the risks and returns of corporate bonds, to ensure they can make informed investment decisions. The Committee considers that further steps could be taken to ensure that this information is being provided by financial advisors and government agencies.
2.56
The Committee heard that the lack of awareness and understanding about the corporate bond market acted as a barrier that precludes the growth of a strong and vibrant corporate bond market, especially for retail investors. The Committee agrees that a more transparent approach with better access to information would allow investors, advisers and businesses to trade corporate bonds more confidently.
2.57
The Committee agrees that the minimum parcel size of corporate bonds causes an access barrier for retail investors and hinders the development of the corporate bond market. The Committee acknowledges that this limits Australian businesses’ opportunity for growth, productivity, innovation and job creation.
2.58
The Committee notes the access barriers resulting from credit rating agencies’ fees that were brought to its attention and agreed that these barriers should be minimised and removed where possible.
2.59
The Committee notes the potential for superannuation funds and savings to contribute to the post-crisis recovery effort and the propensity of older Australians shifting their investments towards safer debt securities in the context of an ageing population. As such, the Committee agrees that there is a need to facilitate uptake of corporate bonds for retirees and superannuation funds.
2.60
The Committee recommends that the Australian Government ensures that investors have access to timely and useful information about corporate bonds to make informed decisions, and increase the transparency around corporate bonds trading, including non-rated bonds, to improve access to a wider range of investors.
2.61
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.
2.62
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.
2.63
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.