Why Australia’s proposed corporate bond boost won't work

Author: Ashley Lee | Published: 7 Feb 2013
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Proposed amendments to Australia's Corporations Act are intended to encourage the issuance of retail corporate bonds. But market participants have branded them too restrictive. Here’s why.

While Australia boasts a vibrant equity-linked market, its corporates have traditionally relied on bank loans or tapped debt capital markets abroad. According to a September 2012 report by the Reserve Bank of Australia, the stock of non-financial corporate bonds outstanding offshore is more than double the non-financial stock of bonds outstanding onshore.

The terms set out in the Corporations Amendment (Simple Corporate Bonds and Other Measures) Bill 2013 aim to kick off retail corporate bond offerings.

But stringent limitations within the amendments may make it difficult for the programme to succeed.

Directors’ liability

Most media coverage relating to the Amendments to the Corporations Act has focused on directors’ liability for a defective prospectus. Local lawyers agree that it is the most important aspect in this proposed legislation.

Herbert Smith Freehills’ Patrick Lowden said that directors will now be exempt from  per se  liability for defects. This has been a significant disincentive for public companies to issue bonds – especially top public companies able to readily borrow elsewhere.

“Bond issues are harder to sell to the board when the board must take that risk,” he said.

However Lowden added that while directors may not be automatically liable for a defective prospectus, the issuer and underwriters would remain liable.

“Directors may still be liable if they failed to take reasonable care to ensure the prospectus is not misleading, which falls short of the bar set for civil liability at the moment,” he said. “The scope of the carve out in favour of the directors is broad, and it’s fair to wonder whether it’s consistent with the broader prospectus regime.”

Secured debt

However, a larger issue is that the proposed new prospectus regime requires companies to rank retail corporate bonds above unsecured loans.

Lowden explained that the new prospectus regime is only available to debentures that rank ahead of the unsecured creditors of the issuer.

“If that remains, that will rule out a lot of the top prospective issues that the government might like to see because those companies would typically borrow on an unsecured basis; we wouldn’t expect them to start issuing secured bonds as that would require them to restructure existing borrowing agreements,” he said.

Gilbert + Tobin’s Janine Ryan agreed that the stipulation that the notes take priority over unsecured creditors is difficult, as it suggests the notes must be secured in some way. She said that the intention may be that the bonds should not be subordinated to other unsecured creditors, but currently the draft legislation requires some form of security.

Two-part prospectus

Moreover the proposed legislation requires a specific prospectus regime. It stipulates that there is a “base prospectus” valid for three years that will include general company information. It does not need to be updated.

The offer-specific prospectus will be required for each tranche of notes, and must have an expiry date no more than 13 months after the document is filed with the Australia Securities and Investments Commission (Asic).

Therefore the types of notes that can actually be issued under this amendment to the Corporations Act is limited to vanilla bonds with fairly specific terms, Ryan said.

“I think it’s a little odd that they’re mandating the two-part prospectus, rather than giving issuers the option to having a base prospectus with specific supplements,” Lowden commented. “It seems a bit prescriptive in the requirement to use that path, especially if a company has a one-off issue in mind.”

Future of the bond market

However this may be the first step in a series of rules for the corporate bond market. David Lynch, executive chairman of the Australian Financial Markets Association, said that there’s general agreement that it will take a range of initiatives in respect of both the demand and supply sides to develop a highly liquid corporate bond market in Australia.

“The government measures are seen as a necessary and welcome step in the process, but there is, for example, a significant role for investor education in relation to the nature of bonds and also their role in a diversified portfolio,” Lynch added.

In particular, a development Lowden is hoping for is a relaxation of restrictions that apply to the use of ratings.

“It will be disappointing if the government does nothing to facilitate the use of ratings in the face of a current content rule that requires all experts named or referred to in the prospectus to consent to their being named” he added.

Asic relies on this section to stop any credit ratings from appearing in a prospectus because the credit agency ratings would need to consent, Lowden explained. They effectively cannot do that because Asic would then view them as providing financial advice, for which they would need a retail financial services license – which they don’t have – which is a significant impediment.

But the corporate bond market in Australia might develop anyway as funding costs rise elsewhere. Lynch added that he expects a number of changes to regulations on the global front to influence the evolution of the domestic bond market.

“Companies may have to be less reliant on bank funding as the Basel III reforms are implemented,” he said. “Moreover, Australian companies issue far more bonds overseas than locally and the Australian dollar cost of this funding may rise as a consequence of the various global reforms.

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