Retail bond obstacles are not insurmountable
Given these three hurdles, market reaction last week to ASIC's announcement was pretty flat. However, it is the last hurdle that actually holds the keys to why a retail corporate bond market could in fact be successful.
There is an assumption that the retail market is always going to be a smaller market than the wholesale market - the poor cousin, in effect.
It needs to be said however, that there is more money invested in self managed superannuation funds than there is invested in all the corporate bonds outstanding in the wholesale market -A$384 billion and A$307 billion, at the end of December 2009, respectively
If allowance is made for the fact that foreign investors play an active role in the wholesale market, then it can be concluded that Australian institutional investors do not invest much money in corporate bonds at all (and this is the nub of the problem with the market, but more on that below).
Moreover, much of the money invested in SMSFs continues to be held in cash. Corporate bonds would make a very good alternative investment and SMSFs are still the fastest growing sector of superannuation.
Many CFOs and corporate treasurers are dismissive of the wholesale market because experience has told them that demand for their 'A' or 'BBB' rated bonds runs hot and cold. Similarly, demand for bonds with longer terms to maturity, say five years and beyond, waxes and wanes.
While it may be easier, and possibly cheaper, to issue into the domestic wholesale market, many potential issuers would rather go offshore or pursue other alternative sources of debt funding that offer greater certainty of the outcome.
Australian institutional investors are constrained by investment mandates that limit exposure to lower-rated investment grade corporate bonds and, typically, do not allow investment in non-investment grade or unrated corporate bonds at all. Many also, seemingly rigidly, adhere to the UBS Composite Bond Index, which with its relatively short duration, results in limited appetite for longer-dated bonds.
Retail investors are not restricted by investment mandates or the need to hug an index.
Unrated companies like David Jones, Myer and Harvey Norman, just to pick some examples, should be able to readily issue bonds to retail investors. Name recognition would ensure demand and the absence of credit rating would have no impact, in this respect.
Retail investors should also be quite willing to buy longer-dated bonds out to ten years, as permitted by ASIC under short form issuance. A retail investor may have no intention of holding the bond to maturity but the higher coupon required for longer-term issuance will be attractive; and when the investor needs cash, the bond can be easily sold, by virtue of being listed.
The benefit of listed bonds could work to the similar advantage of issuers. While a company may desire the stability and certainty offered by longer-term funding, there is always the opposing concern over whether the long-term debt will always be required i.e. can it be profitably deployed over the full term of the borrowing?
It will be easier to issue ten-year listed bonds knowing that any cash surpluses that may arise from time to time can be used to buy, on-market, the company's bonds. The bonds can be held for as long as the funds invested are surplus to the company's requirements and then can be sold again.
Once developed, listed bond markets also tend to be cheaper for issuers than wholesale, over the counter, markets because of the greater transparency and liquidity that they provide. This means investors do not need to be compensated for these concerns and the yields offered on bonds can be lower.
New Zealand provides our closest example of that. Issuers there generally prefer to issue listed bonds, rather than just issue into the wholesale market. The listed market is generally considered cheaper and the wholesale market is being used more for private placements and by those issuers that cannot issue listed bonds.
Many of New Zealand's institutional investors are now saying that they prefer to buy listed bonds because of the greater liquidity that retail investors bring to the market. New Zealand provides us with the example of why our retail market may indeed one day surpass the wholesale corporate bond market.