PORTFOLIO POINT: The ASX is hoping to establish a retail bond market for Commonwealth government securities, and that could open the door to a retail corporate bond market.
If all goes according to plan, retail investors could soon be trading Australian government bonds via the Australian Securities Exchange.
Last month the ASX released its submission to the Australian Securities and Investments Commission’s consultation on retail trading in Commonwealth government securities.
Yes, the process of moving towards listing Commonwealth government bonds is still ongoing, despite being announced by Treasurer Wayne Swan as a part of his Competitive and Sustainable Banking System package in December 2010.
While the ASX submission did not receive much media attention when released, the structure proposed for the listing of CGS on the ASX looks like a winner. It also could be easily adapted to take corporate bonds out of the wholesale market and make them available to retail investors too.
The ASX is proposing to use “depository interests”, the structure and operation of which appears to draw heavily on the American Depository Receipts (ADRs) used to trade the shares of foreign companies that are not listed in the US, on US stock exchanges.
Without getting bogged down in the regulatory requirements governing the creation and trading of ADRs, the idea is that the shares of a foreign company will be purchased in bulk and effectively securitised through the issuance of ADRs. The ADRs represent interests in the underlying foreign company shares and are listed and traded on a US stock exchange.
Thus, the nature of the underlying shares does not change and the foreign company does not have to seek a US listing.
The ASX is proposing to list depository interests in Commonwealth government bonds to enable retail investors to buy and trade CGS that are now only available in the wholesale market. This will allow retail access to CGS without creating a new class of CGS, and the bonds will not be removed from Austraclear, the central securities depository CSD of debt securities in Australia.
By creating depository interests in CGS, the ASX will effectively link the wholesale and retail markets and create a retail price for a wholesale bond. And, because the depository interest represents an interest in the underlying CGS, the retail price should never move too far from the price in the wholesale market.
With the listed product being available to both wholesale and retail investors, any significant price divergence that may emerge will be quickly arbitraged away.
To effect this plan and ensure a liquid secondary retail market for the depository interests, the ASX is planning to contract three market makers to provide continuous two-way pricing. In return, the market makers will get exclusive rights to source the CGS for the depository interests.
The ASX says this exclusivity will be removed once the market reaches maturity, in other words, when a minimum daily turnover of $250 million is regularly being achieved.
If depository interests can be developed for CGS, then there is no reason why the process cannot be extended to corporate bonds.
This would give retail investors access to the same corporate bonds that are now available to institutional investors and give them a reasonable chance of constructing a diversified and safe corporate bond portfolio. With around 500 individual bond issues quoted on wholesale rate sheets, this is potentially a far superior option on a risk adjusted basis than being limited to hybrid issuance as retail investors are now.
The ASX’s proposal should go a long way in ensuring the development of a deep and liquid corporate bond market that will offer a competitive alternative to banks and equity markets for medium- to long-term funding for corporate Australia. It will allow Australian companies to diversify their funding risks and will reduce Australia’s reliance on international debt markets.
What is being proposed by the ASX sounds very similar to what has been successfully implemented by the London Stock Exchange.
Coming out of the GFC, the UK government was keen for retail investors to have a safer and more stable alternative to shares. This led to the opening of a new retail bond market on the London Stock Exchange in February 2010.
The new market was supported by dedicated market makers, prepared to continuously quote two-way prices for an initial, 49 Gilts (UK government bonds) and just 10 corporate bonds.
The initiative has been so successful that at the beginning of this year there were 100 corporate bonds being traded alongside the Gilts, and more market makers have signed-up to the system.
Philip Bayley is a former director of Standard & Poor’s and now works as an independent consultant to debt capital market participants. He also writes on matters concerning debt capital markets and banking for various publications and is associated with Australia Ratings.