The White Paper identifies a number of objectives, underpinned by a raft of proposed measures, which aims to strengthen the position of the Australian financial system in the Asian region by 2025.
Goals for the Australian financial system
The White Paper identifies the following objectives for the Australian financial system in the outlook towards 2025:
- maintaining a strong and liquid fiscal position;
- preserving Australia’s triple-A sovereign credit rating;
- developing a deep and liquid corporate bond market, with new opportunities to access Asian capital pools;
- reducing net Government debt; and
- establishing direct trading between the Australian Dollar and the RMB.
These are all messages that are consistent with the Government’s statements over the last couple of years, so there are no surprises in the White Paper for the capital markets.
To achieve these objectives, the White Paper proposes a range of measures, including:
- building further on the strength, stability and competitiveness of Australia’s financial systems by implementing the Basel III capital and liquidity standards;
- streamlining market disclosure obligations and reducing transaction costs in the retail corporate bond market;
- allowing Commonwealth Government Securities (CGS) to be traded on a securities exchange;
- increasing superannuation balances and ensuring reasonably priced credit; and
- ensuring that the funds management industry is efficient and well regulated.
Many of these measures have previously been raised for discussion in earlier policy statements of the Government, Treasury and the relevant regulators. However, it is good news to see that they remain firmly on the Government’s agenda and some warrant further comment.
The implementation of the Basel III standards is already well underway, new capital standards will apply to those banks that are Authorised Deposit-taking Institutions, general insurers and life insurers from January 2013. Final liquidity rules are still to come.
The impact of these new standards on APRA-regulated entities and their consequences for investors and customers are not known and will only become known over time. However, the success of those rules in achieving real risk transfer from the prudentially regulated sector requires, among other things, a functioning capital market peopled by investors who are prepared to take those risks. A successful Basel III needs, among other things, a liquid market, where bonds issued by non-financial institutions can be traded between the regulated institutions and end investors.
Corporate and Government bonds
It is helpful therefore that the White Paper also indicates that the long awaited reforms to the disclosure and liability regime for corporate bonds are back on the Government’s priority list. We see this as a key initiative to help promote a corporate bond market.
A healthy retail bond market is systemically useful. Retail capital market distribution of sound credit can spread risk more broadly and emphatically. Retail investors need more diverse and stable sources of income. The retail market offers diversity of funding to good domestic corporates and should be more loyal when foreign markets are disturbed. But the growth of a retail market is chafed by the frictional costs (and liabilities) of the offering process.
For a retail bond market to be a viable alternative to the wholesale market it has to be relatively easy to conduct the offer, especially where that wholesale market is largely unregulated, as is the case in Australia. Pricing and execution certainty are also important factors – but a little bit of “build it and they will come” won’t hurt.
The listing of CGS on a recognised exchange will also be an important step in kick-starting an Australian retail bond market and promoting education of retail investors. But why stop at CGS? A refresh of the listing principles for a broader array of financial products would increase transparency in our capital markets as well as broadening the offering available to retail investors.
Will these initiatives, by themselves, create a corporate bond market? No, but they will help open the door to investment. The question then is which investors will walk through that door.
Retirees and their funds
The obvious domestic pool of investment for a corporate bond market is retirement funds. A growing, ageing, retired population, with some savings but eager for income and wary of the gyrations of equity markets could be attracted to a robust, liquid bond market. The individuals, however, may lack the confidence, knowledge or control of their funds to come in the volumes necessary.
Superannuation funds are critical players but they need encouragement to break from their traditional bias towards equities. On the contrary, by encouraging a focus on short term liquidity, recent reforms may only be fostering that bias.
The Government should implement the recommendations of the Henry Report on Australia’s tax system to relax prescriptive rules to allow for the development of products that allow people to manage better their retirement income. This should increase demand for pension and annuity products.
Superannuation funds and life companies would need fixed income products to support the pension and annuity products. Investing more into fixed income assets would have the added benefit of reducing the allocations by Australian superannuation funds on equities which is high by comparison to other countries.
The other, greater, pool of investment lies in Asia, amid its burgeoning middle classes with their strong propensity to save. Australia, despite its balanced government budgets, remains a hungry consumer of foreign capital.
As the wealth of Asia grows, the proportion of that capital sourced from Asia can only grow. At present most of that foreign capital is channelled into the country through the wholesale borrowing operations of our major banks. We can continue to rely on that intermediated path to the pool of Asian savings. We can lessen the systemic risk it creates by making it easier for Asian banks to set up business here and write loans which are funded ultimately by their domestic savings pools. Or, more radically, we could recognise that direct capital market funding, disintermediated from banking systems, can play an important role in our financial markets, both as a competitive source of funds and as means of reducing the systemic risk of our major financial institutions.
Achieving that end in our region is an enormous task: it needs regional securities exchanges, clearing systems, harmonised or at least mutually recognised securities laws across the region, and reforms such as the extension of double taxation agreements and relaxation of IWT requirements. But if we believe in prospering from “The Asian Century” and developing an open, stable, financial system, it is a task that has to be tackled.
Impact on your business
We encourage our clients to engage with Government, industry and business associations to bring on the proposed reforms to promote retail bond offerings and listed CGS, and to stimulate debate around the development of truly regional capital markets.