The Interim Report echoes a now familiar message supporting measures to encourage the development of a deeper and more liquid retail bond market in Australia.
The paths available to the FSI are many and varied when it comes to the corporate bond market:
- it could back the Corporations Amendment (Simple Corporate Bonds and Other Measures) Bill 2014 (Cth) (“Simple Corporate Bonds Bill”) that represents a cautious balance between reform and regulatory control, tailoring the prospectus regime to a simpler form of offering;
- it could demand bolder reform that significantly changes disclosure and liability rules for simple corporate bonds; or
- it could decide that regulatory reform will not make a big difference, and that we need to look to other market drivers to develop the corporate bond market.
One thing seems clear from the Interim Report – the FSI does not seem likely to conclude that developing Australia’s domestic bond market is not necessary.
Testing a bold reform proposal
The FSI is seeking input on more fundamental regulatory reforms than those recommended in the Johnson Report and which led to the Simple Corporate Bonds Bill (currently awaiting consideration by the Senate after being passed by the lower house on 16 July 2014).
This broader reform proposal could see:
- listed issuers able to issue "vanilla" bonds without a prospectus - this is a great idea, but not a new one - more about this shortly; and
- unlisted issuers able to issue small parcels of bonds within "small offering " exemptions, with adjustments to make them more useful. While this is only an incremental improvement over the current exemption regime, in this part of the market we suspect any progress is welcome.
The ability for listed companies to issue corporate bonds without a prospectus is a great idea. It is not the first time it has been aired - industry voices called loudly for just this sort of reform during the consultation process that led to the Simple Corporate Bonds Bill. Although our friends in New Zealand are passing a set of similar – in fact broader – reforms, this step was stoutly resisted in Australia, as being just a bridge too far.
Perhaps it is now an idea whose time has come?
The quid pro quo for continuous disclosure?
Listed companies in Australia are subject to comprehensive disclosure obligations - both continuous disclosure and periodic disclosure. These are vigorously policed - even small delays in getting a disclosure released to market can result in companies having to spend time and money explaining themselves to ASIC, with the added prospect of a fine even where a delay is not actually proved to be a breach.
This rigorous regime has lots benefits – it supports a well-informed, efficient market, and it promotes equality of access to information. For issuers – it can feel onerous, and it doesn’t come cheap – but it can provide some efficiencies. It allows for streamlined disclosure for rights issues and secondary prospectuses. But those benefits have been limited – issuers do not get to use make full of the benefits that continuous and periodic disclosure could provide.
It seems to us that utilising it to get rid of red tape for simple corporate bonds issuance is an obvious example of how these benefits could be extended to those who bear the costs of the disclosure regime.
How important is it to take this step?
Don’t get us wrong – we are big supporters of the reforms in the Simple Corporate Bonds Bill. It is a tremendous step forward, and it should encourage some change.
However, its effectiveness will be hampered in a few important respects:
- Still using a prospectus - the Simple Corporate Bonds Bill still involves a simplified prospectus (albeit in 2 parts). We think we will be able to improve the processes for preparing and finalising those documents, but it will still need board attention, formal consents, ASIC lodgements and fees. That is not needed for a wholesale offer, which does not need a prospectus.
- Still a liability regime that directly affects directors - the consent requirements for a prospectus mean directors still have to be personally involved in the diligence process, adding time, process and cost. There is a different liability regime for wholesale offers that focusses on the company.
- Still different to wholesale offers and equity - because of those two factors it will still be more of a process and a different risk profile for directors to issue simple bonds to retail, than it would be to issue them to wholesale or to conduct a low-doc rights issue of equity. Wholesale debt offers can be done swiftly within normal board delegations, with management carrying out the diligence and drafting processes.
For listed entities to use the Simple Corporate Bonds reforms they will have to accept those differences, but there are not a lot of incentives for them to do that.
Taking simple bond issuances by listed entities outside the prospectus regime would achieve something of real importance - it would (almost) level the regulatory playing field between simple retail bonds and simple wholesale debt issuance. There will still be differences – eg listing costs, and there is always a bit more scope for liability that comes with listing and retail involvement.
However, it would not be such a big deal for a company to add a retail tranche to a wholesale issuance or to quote wholesale debt on the ASX. It would not have to dramatically transform the offer documents (or have two sets of documents); it could use its current diligence processes; and it would have a similar liability framework.
It would not involve finding special space in the board calendar for a normal treasury function.
This is not about avoiding disclosure or liability – it is about efficiency. It does not mean there would be no disclosure – just the same disclosure for wholesale and retail. It does not mean that there would be no-one on the hook for the disclosure – just the same liability regime that applies in a wholesale or continuous disclosure context.
Efficiencies would come from the minimal adaptations to issuance procedures and a reduction of advisory costs.
That sounds worthwhile to us.
Presumably, regulators would call for a “cleansing notice" to be issued, confirming that the market is fully informed. We suggest that industry should push for that sort of notice to address only things relevant to a debt issue, to avoid reintroducing some of the shortcomings of the existing regime.
Investor protection remains a priority
The efficiencies of simplified disclosure must of course be weighed against investor protection.
However, just as the FSI queried the effectiveness of disclosure of financial products to consumers, we query whether the prospectus framework materially improves the information available to investors when deciding whether to purchase a “vanilla” bond. Investor protection is supported by accessibility of information (eg online resources), and content guidance – but none of that means that it has to be in a prospectus.
It will be interesting to see the path that the FSI chooses when faced with the question of if and how, to reform Australia’s disclosure regime for corporate bonds.
It is of course possible, that the FSI forms the view that current depth and liquidity of Australia’s corporate bond is not the result of market or regulatory inefficiencies, but instead reflects an appropriate equilibrium given the availability and pricing of intermediated finance and the current demand for fixed interest securities. We think there’s room to do better.
While we are on the subject of content …
Another important issue – that the Interim Report avoids - is that credit ratings can only be disclosed to wholesale investors, but not retail investors.
Wholesale investors demand that information, and retail investors should too. Compare the Australian position to that in New Zealand, where it is mandatory to disclose credit ratings and ratings agency consent is not required.
It is time to end the stand-off on this issue in Australia. It is not serving the interests of retail investors and the big picture - allowing investors to make informed decisions - is being lost. There has to be a way forward that doesn’t just mean that retail investors miss out on information that the experienced bond market investors think is key.
Should this debate be extended to simple equity?
The next big question - only briefly touched on in the Interim Report - is whether this disclosure reform should be extended to equity as well?
The report suggests that there could be some tweaks to the small offering exemptions - not a bad idea, but not a big idea either.
The bigger idea would be to extend the logic for simplified disclosure simple debt to simple equity. Why should a listed company have to produce a prospectus or conduct a rights issue, just to issue more ordinary shares? Given that any investor can buy ordinary shares on the market, why treat a fresh issuance by a listed company differently?
A simple cleansing notice should be enough for any secondary issue of listed ordinary shares, rather than just institutional placements.
Rights issues can be done with a cleansing notice, but these still involve all sorts of costs and constraints. The primary purpose of these constraints is stakeholder engagement, and giving investors the opportunity to avoid dilution and these are important considerations for the board when choosing an equity issuance strategy. However, the purpose of the prospectus rules is not the management of dilution - that is the province of the listing rules, and it is protected well enough there.
Simultaneously reforming simple bond and simple equity disclosure regimes would give the Australian corporate sector a broader array of funding options, while reducing the potential for regulation to distort companies’ choice between debt and equity finance to fund investment.
A great start, but could we take it to the next level?
We applaud the comments in the Interim Report, but think it is time to rationalise the disclosure regime for issues of both simple debt and simple equity, allowing listed companies to realise some of the benefits from our continuous and periodic disclosure regimes.
It's not a new debate, but clearly the debate is not over.