Fixed income market researcher BondAdviser has questioned whether the restrictions on the distribution of hybrid securities, prompted by the new Design and Distribution Obligation, will actually provide any consumer benefit.
Instead, BondAdviser argues in its latest Monthly Review, the new obligations will create a “regulatory arbitrage” for institutions.
ANZ announced last month that it will restrict the distribution of an upcoming issue of capital notes, as it adjusts the marketing and sale of its hybrid securities to take account of requirements under the DDO.
The bank said that with the implementation of DDO in October last year, future capital note offers will be limited to wholesale investors and investors receiving personal advice.
Future offers “are unlikely to include a securityholder offer under which existing ANZ securityholders can apply to ANZ directly for those notes”.
In December, Westpac responded to the regulatory development by establishing a funding program that will allow it to issue capital notes into the wholesale market.
Under DDO, financial services companies are required to identify the target market for any product that requires a disclosure document and must design the product for that market. They have to select appropriate distribution channels and periodically review those arrangements to ensure they continue to be appropriate.
The scheme is aimed at reducing the harm of mis-selling by requiring issuers to design products for which an appropriate target market can be identified.
Issuers are required to consider the likelihood of a product being appropriate for the retail clients in the target market: that is, whether it is likely to be consistent with the likely objectives, financial situation and needs of retail clients.
Relevant factors in this consideration include a product’s complexity, risk profile and fees, as well as investors’ likely understanding of product features, their capacity to meet their obligations or bear losses.
ASIC has had concerns about hybrids for years, seeing them as complex products that are not well understood by the majority of retail investors who buy them.
BondAdviser said: “Hybrids have become an accepted portfolio allocation amongst advisers/retail investors. If other issuers choose to go down this [wholesale distribution] path it would reduce listed AT1 supply for retail investors, so retail investors that are locked out of the primary market could end up paying more by having to buy these securities in the secondary market.”
DDO obligations do not apply to sales of financial products on secondary markets.
“This would be a perverse outcome for retail investors considering ASIC’s DDO regime was designed to protect retail investors.
“Given the lack of alternative yield present in the system for retail investors, we do not think the regulation will change retail investor behaviour in terms of allocations. Instead, the regulation now means the investors who were supposed to be protected will instead now just have to pay more to retain the same exposure.”
BondAdviser said there are seven hybrid issues due to be called this year, worth a total of around $10 billion.