High time for corporate bond action

Malfunctioning of Europe's markets makes the case for a proper retail corporate bond market even more compelling today than when Wayne Swan first announced it.

The most significant aspect of Wayne Swan’s announcement of the release of a discussion paper on reforms aimed at developing a proper retail corporate bond market today was actually announced a year ago.

Last December, among a rather motley collection of banking ‘reforms', Swan announced the federal government would facilitate the trading of Commonwealth government securities on a securities exchange. He did it again today.

It is unclear why a year has passed and nothing has happened to realise the potential of last year’s promise but there is little doubt that while making it easier and quicker for companies to issue bonds to retail investors, the most important prerequisite for a functioning retail bond market is the ability to buy and sell Commonwealth government securities on an exchange.

The ASX, which does, of course, have a vested interest in expanding the range of securities traded on its platforms, has been making the case to Treasury and the government for creating a retail market for listed CGS for more than two years.

Giving retail investors access to CGS and the ability to freely trade them would capitalise on the dramatically increased appetite of retail investors and DIY funds for fixed interest securities post-crisis but more importantly create a foundation and benchmark pricing framework for a broader and deeper bond market.

The absence of a corporate bond market in this country is the glaring deficiency in what is otherwise an exceptionally sophisticated financial system. Most other major jurisdictions have developed the secondary markets for trading corporate debt that facilitate corporate debt issuance.

There is an appetite for securitised debt, as the demand for recent bond issues by Commonwealth Bank, Bendigo Bank, Woolworths, Origin Energy and Australian Foundation Investment Company have illustrated. That interest could be leveraged into the creation of a proper corporate bond market if the government both makes it easier and more efficient for companies to issue debt into the market and provides the transparent risk-free benchmark against which they can be priced.

There is a need for a deep and liquid domestic corporate bond market and some of the potential flow-on effects from creating one would undoubtedly appeal to Swan.

The most obvious early issuers into an efficient retail bond market would be the major banks, which are now acutely aware that the US and European markets from which they have traditionally raised term funding can’t be relied on and therefore represent a significant source of vulnerability. A domestic bond market of consequence would help diversify their funding sources and reduce their reliance on those volatile offshore markets.

Similarly, it would create an alternate source of funding for other Australian corporates that now raise funding in the US, UK and Europe or in a somewhat limited domestic wholesale market.

Given the problems in those markets, particularly in Europe – where sovereign and bank issuers will probably need to raise trillions of euros of funding next year from markets that are malfunctioning today – a domestic market for corporate debt becomes even more compelling.

It would also be timely. There has been considerable discussion since the financial crisis emerged in 2008, not only about the dramatic increase in the appetite of retail investors for low-risk fixed interest investments, mainly bank deposits, but of the over-exposure of superannuation funds to equities and other relatively high-risk investment classes.

A developed corporate bond market might help release some of the funds locked up in equities within the superannuation system for domestic lending, lowering the level of latent risk in the super system and helping fill the structural gap within the broader financial system.

There is something of the order of $50 billion of Australian corporate debt maturing next year that will have to be refinanced along with any new borrowings, with a big chunk of the refinancing task related to the A-REIT sector which the banks are now wary of lending to. The continuing withdrawal of the foreign banks from this market, and the careful management of balance sheet growth by the majors, creates the potential for a credit shock.

From Swan’s perspective, encouraging the development of a truly deep market for corporate debt would not only help reduce the refinancing risk in the system for banks and companies and reduce, to some degree, the exposure of the economy to offshore debt markets but would also create a significant source of competition to the major banks for deposits and lending. That ought to be appealing to him.

In terms of the disclosure requirements for corporate bond issues to retail investors, it shouldn’t be that hard to simplify the requirements for listed companies, which already operate within a continuous disclosure environment, while ensuring the investors are made aware of the particular features and risks of the debt securities being issued.

If the disclosure requirements for equities can be streamlined then it ought to be possible to have an even simpler and more efficient regime for listed debt, particularly vanilla issues.

If we are still talking about this issue next December, the failure to attempt to create a market that has been talked about for decades may not just represent a missed opportunity to capitalise on the risk aversion and strong appetite of retail investors for high-quality yields but a failure to create some insurance against the risk posed to the stability of the domestic system by the disturbing developments in debt markets offshore.

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