The year in review
The Commonwealth government and regulators have continued their review of the framework for regulation of the financial sector, and for the laws governing access to, and the operation and supervision of, Australia's capital markets. This process commenced in 2010 in response to the global financial crisis. In particular, the Commonwealth government remains committed to the initiatives developed through the G20, the Financial Stability Board, the International Monetary Fund and other multilateral institutions to support financial stability and to foster stronger economic growth. Some of the more important recent developments are outlined below.
The federal election in May 2022 resulted in a new government being formed by the Australian Labor Party. That has not so far led to significant change in the direction of regulation relevant to debt capital markets.i Developments affecting debt and equity offeringsProduct intervention powers and design and distribution obligations
The Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019 gives ASIC a product intervention power exercisable where a risk of significant consumer detriment exists, and introduces design and distribution obligations in relation to financial products, including debentures, where there is retail product distribution. The design and distribution obligations commenced on 5 October 2021.
The design and distribution obligations apply to (among other things) debentures issued by ADIs, even where no prospectus is required, and even where the issue is of a simple corporate bond.83 Under Regulation 7.8A.06 of the Corporations Regulations, debentures issued by ADIs and life insurance companies are financial products that require target market determinations even though such issues are otherwise exempt from the requirements to issue a prospectus.
The design and distribution obligations apply in addition to the disclosure obligations and the product intervention power may be exercised notwithstanding that a product has otherwise been offered in compliance with disclosure and other applicable laws.
The design and distribution obligations require a product issuer to prepare and make available a target market determination (TMD) before the product is distributed to any retail investor. DDO does not impact the wholesale markets. DDO relates to the primary offer of securities in the retail markets, and obliges issuers to determine target markets of the securities. Issuers and distributors must then take reasonable steps to ensure that the distribution of the securities is consistent with that target market. However, DDO does not oblige issuers and distributors to limit trading in the secondary (listed) market.
One consequence of the legislation has been to offer complex securities, such as hybrids only through channels where it is reasonably believed a retail investor has received the benefit of personal advice from a qualified adviser. The practice of offering such securities to existing holders or ordinary shareholders of the issuer, based solely upon that holding, has ceased.
ASIC has issued regulatory guidance in relation to the product design and distribution obligations84 and product intervention power.85
ASIC has used its product intervention power to ban the provision of certain financial products but thus far has not in relation to capital market products.86
In July 2022, ASIC issued its first DDO stop orders to prevent the offer of certain managed investment scheme interests or shares to retail investors.87 ASIC placed interim stop orders as it found deficiencies in TMDs for those financial products; the products either did not have TMDs or the TMDs failed to appropriately identify the consumers market for the product. There has as yet been no stop order affecting a debt capital market instrument.Technology and market infrastructure
In August 2018, the World Bank mandated the Commonwealth Bank of Australia (CBA) to be the sole arranger of the world's first blockchain bond, termed 'bond-i' (blockchain operated new debt instrument). In May 2019, the World Bank and CBA successfully enabled secondary market trading of this bond-i recorded on blockchain.88 The bond will be created, allocated, transferred and managed through its life cycle using distributed ledger technology.89 In August 2019, the World Bank issued a second tranche of the blockchain bond via bond-i. There have been an increasing number of blockchain bond issuances internationally; however, there have not been any further issuances in Australia.
Like many other countries, the RBA is currently considering whether to issue central bank digital currency (CBDC) as a new digital form of money.90 CBDC could be used for retail use (like cash, it would essentially be universally accessible) or for wholesale use (like settlement accounts, it would only be accessible to a limited range of participants).91 In a speech in November 2021, the RBA suggested that for financial assets such as bonds, it is more likely that market participants would prefer to use a stable form of currency to settle payments, such as CBDCs. CBDCs could also assist with settlements of securities transactions if the currency and the securities are both tokenised on the same blockchain.92Social impact bonds
In recent years, state governments have initiated the development of the social impact bond (SIB) as an innovative approach to financing social service programmes. SIBs are designed to raise private capital for intensive support and preventative programmes, which are suitable for funding by state governments on an outcomes basis. Australia's first SIB was the Newpin Social Benefit Bond, initiated by the New South Wales government in collaboration with UnitingCare Burnside and SVA, which opened to investment in April 2013. There are around eight SIB initiatives that have been implemented by state governments and are open. Many more are underway for implementation in Australia.93
In June 2020, the Commonwealth's National Housing Finance and Investment Corporation, jointly with ANZ, UBS and Westpac, led a social bond issue of A$562 million, representing the largest social bond issue by an Australian issuer.94Climate change impacts and sustainability
Efforts to tackle emissions and climate change are increasing in response to investor demand, pressure from regulators on financial institutions and government policy to reform the energy market.95 In accordance with this development, APRA is playing an increasingly active role in the management of climate-related risks affecting the institutions it supervises.
In 2021, it introduced CPG 229 to establish best practice standards for governance, risk management, scenario analysis and disclosure of climate change financial risks,96 and has recently produced an information paper considering a requirement for banks to undertake climate vulnerability assessments.97 APRA intends to also release a Prudential Practice Guide for SPS 530 which will aim to provide guidance on how a prudent RSE licensee can reflect ESG considerations in investment planning.98 It is expected that these forces will encourage further green and sustainability linked bond issuance.
As of December 2020, the Australian market for investments that achieve social or environmental goals as well as financial returns was estimated to be around A$29 billion, a 46 per cent increase from 2019's A$19.9 billion.99 Green, social, climate and sustainability bonds made up 88 per cent of the impact investment in Australia in 2020, and social impact bonds accounted for A$66 million.100 The issuance of green, social and sustainable bonds has continued to grow in 2021 and 2022, as these instruments have become an established part of the Australian debt capital market.101 Examples of sustainability-linked bonds issued in Australia in the past year include issues by Wesfarmers,102 Woolworths,103 Optus104 and Ampol.105 Prudentially regulated entities have issued hybrid capital in a green format on the basis of the use of proceeds, but as yet not with a coupon linked to sustainability targets.106
There has also been an increased momentum for environmental, sustainable and governance (ESG) derivatives in the past year, with NAB issuing its first Australian ESG-linked derivative in October 2021. The derivative operates such that its value is derived from both the financial market and the counterparty's ESG performance.107 ANZ launched a sustainability-linked derivative in August 2021 in Australia as well as several other countries.108Australian corporate bond market inquiry
Despite amendments to the regulatory regime for corporate debt over the past decade to facilitate a deeper and more active retail bond market in Australia, the market remains small compared to those in similar countries.109 In October 2021, the Standing Committee on Tax and Revenue delivered a report, 'Development of the Australian Corporate Bond Market: A Way Forward' considering the development of the Australian retail corporate bond market.
The Report makes 12 recommendations aimed at promoting a deeper, more liquid retail bond market in Australia. These recommendations include general measures, such as raising awareness of the benefits of corporate bonds and reviewing the regulatory reforms implemented in New Zealand, together with specific reforms of the regulatory and taxation regime for the issuance and treatment of corporate bonds. The recommended reforms include:
- lowering the minimum investment parcel for corporate bonds from A$500,000 to A$1,000;
- streamlining the disclosure requirements and allowing for greater flexibility in the structure of simple corporate bonds;
- increasing tax incentives for corporate bond holders relative to other asset classes (for example, the availability of franking credits on dividend income but not for most corporate bonds);
- reforming Chapter 2L of the Corporations Act to increase the availability of trustees for retail bond issuers; and
- ASIC reviewing its approach to financial ratios to introduce more flexibility for issuers.
The Commonwealth government has committed to taking action on all 76 recommendations of the Royal Commission into alleged misconduct by Australia's banks and other financial services entities.110
Australian regulators, including ASIC, APRA and ACCC, have signalled greater assertiveness and willingness to pursue enforcement action against misconduct in the financial sector post the findings arising out of the Royal Commission.
Since the Royal Commission's final report was released, the Australian government has implemented at least 34 of these commitments, and work is still underway to implement further recommendations. Recently, the Financial Regulator Assessment Authority, which assesses the effectiveness and capability of APRA and ASIC every two years, was established as a result of the Royal Commission's recommendations.111Financial institution governance
The Treasury Laws Amendment (Banking Executive Accountability and Related Measures) Act 2018 (BEAR) provides APRA with powers to impose penalties on ADI groups, their directors and senior executives for breaching accountability obligations.112 The BEAR regime is being extended to all APRA regulated entities.113Basel III reforms and other prudential initiatives
In November 2021, APRA finalised its new bank capital framework, embedding Australian ADIs with 'unquestionably strong' levels of capital and completing the alignment of Australian capital standards with the internationally agreed Basel III requirements.114 The updated prudential standards will come into effect from 1 January 2023.
Under the new framework, capital instruments can no longer be issued through SPVs. Another significant change is the introduction of the concept of a non-significant financial institution (non-SFIs) into the prudential standards.115 Non-SFIs are subject to simplified requirements for determining and reporting credit, securitisation and operational risk-based capital ratios, and are exempt from requirements to maintain a minimum leverage ratio. Other APRA initiatives are in the areas of risk-weightings116, risk management,117 liquidity (APS 210),118 securitisation (APS120),119 operational risk (APS 115 and proposed CPS230)120 and margining requirements for derivatives.121
In December 2021, APRA introduced its capital adequacy framework for ADIs to help facilitate orderly resolution in the event of failure.122 Prudential standards CPS 900 (Resolution planning) and CPS 190 (Contingency planning) are designed to protect beneficiaries, minimise disruption to the financial system and provide continuity of functions critical to the economy.123 These standards will apply from 1 January 2024 for banks and insurers, and 1 January 2026 for the superannuation industry.
Alongside the release of this framework, APRA also finalised the loss-absorbing capacity requirements to support resolution planning for ADIs.124 From 1 January 2027, all domestic systemically important banks (D-SIBs) will be required to hold as total capital an additional 4.5 per cent of risk weighted assets. These requirements are spurring continued Tier 2 Issuance by D-SIBs.
APRA is in the process of harmonising and strengthening the capital framework for private health insurers.125 It is hoped that in time this harmonisation will spur hybrid capital issuance by private health insurers, including mutual entities.AONIA reference rate
The alternative reference rate for Australia is the Interbank Overnight Cash Rate (the Cash Rate), which is administered by the RBA. The RBA sets an operational target rate and, as the banks use the market for unsecured overnight interbank loans to manage their liquidity, the Cash Rate results from the average rate of those transactions, which is expected to meet the RBA's operational target rate.126 On 10 August 2020, the Australian Financial Markets Association, a member-driven industry body that represents participants in Australia's financial markets and providers of wholesale banking services, clarified the definition of the Australian Overnight Index Average Rate (AONIA) to be the published screen rate for the RBA Cash Rate.127 Accordingly, the term 'AONIA' is another way to refer to the Cash Rate and is now coming into more common usage in the Australian market.128
AONIA has been used as a reference rate for some debt capital market transactions. In June 2019, the South Australian Government Financing Authority issued a one-year floating rate note using AONIA as the reference rate. In December 2019, CBA led Australia's first AONIA-linked securitisation of residential mortgage-backed securities.129 In June 2020, the South Australian Government Financing Authority issued a three-year floating rate note using AONIA as a reference rate.130
The RBA will require all floating rate notes and marketed asset-backed securities to contain fallback provisions for use as collateral in the RBA's domestic market operations from 1 December 2022.131 The RBA has indicated that AONIA is an acceptable fallback reference. As this requirement commences, AONIA-linked securities may become more appealing for issuers and investors. This is expected to lead to the inclusion of AONIA as a reference rate in programme documentation, at least as a fallback.Collective corporate investment vehicle
From 1 July 2022, a new type of company, a corporate collective investment vehicle (CCIV), may be registered in Australia.132 The CCIV framework was introduced by the Corporate Collective Investment Vehicle Framework and Other Measures Act 2022 with the aim of introducing a new type of corporate entity that is suited for funds management. A CCIV is a company limited by shares which must have at least one sub-fund and its sub-funds must be registered.
It is currently unclear what impact the introduction of CCIVs will have on debt capital markets.Impact of the covid-19 pandemic on Australian debt capital markets
The covid-19 pandemic has had a significant impact in Australia and on Australia's capital markets, as well as on the ability of individuals, businesses and governments to operate in Australia. In 2020 and 2021 the pandemic led to:
- a reduction in the level of new issuances in capital markets, by both domestic and foreign issuers, in Australia;
- an initial increase in spreads, leading to the withdrawal of certain retail issues, followed by spreads beginning to contract, probably because of a lack of supply;
- an increase in liability management transactions as issuers deleverage;
- a significant increase in government debt, at both the Commonwealth and state levels, as these governments introduced numerous measures aimed at counteracting the effects of the covid-19 pandemic and supporting the Australian economy during the resulting financial crisis. The need to finance Government policies enacted during the pandemic resulted in gross issuance of Commonwealth treasury bonds totalling over A$85 billion in the three months before 30 June 2020.133 This exceeds the volumes issued in each of the two prior financial years.134 In the 12 months to 30 June 2021, the continued need for funding resulted in gross issuances of Commonwealth treasury bonds growing to a record $212 billion whilst gross issuance of treasury notes experienced a sixfold increase from the 2019 financial year to A$95 billion;135
- the postponement of regulatory reform and changes in regulatory focus;136
- the recommendation by APRA to banks to reduce dividends to ordinary shareholders;137 and
- the introduction of term funding for banks by the Reserve Bank under the Term Funding Facility (TFF).138
On the other hand, the volume of ABS issuances by non-lenders remained high through 2021 as there was strong demand for these assets and low interest rates.139
However, the immediate effects of the covid-19 pandemic are now subsiding. There have been significantly increased bond and hybrid issuances in 2022, especially by the banks with the end of the TFF. Interest rates are rising as monetary policy adapts to deal with inflationary pressures associated with supply chain disruption, and there have been some increases in credit spreads. The key regulators have resumed their policy initiatives.140