Focus: Retail corporate bonds: A resurrection?
13 May 2010
In brief: The Australian Securities and Investments Commission has announced a range of regulatory reforms designed to re-invigorate the retail corporate bond market in Australia and to increase the ease and efficiency with which ASX-listed issuers are able to issue corporate bonds to retail investors. Partners Robert Pick (view CV) and Tom Story (view CV) outline the changes and consider their likely impact.
- Key features of the reform
- Who can rely on the vanilla bonds prospectus relief?
- What is a 'vanilla' bond?
- What needs to be disclosed in a vanilla bonds prospectus?
- Using a two-part prospectus
- Convertible bond disclosure relief
- What are the practical impacts of the reforms?
How does it affect you?
- The Australian Securities and Investments Commission (ASIC) has introduced reforms which aim to make it easier for listed issuers to make offers of bonds to retail investors.
- To take advantage of the relief introduced by these reforms, issuers will need to offer 'vanilla' bonds which have no complex features under a 'vanilla bonds prospectus' that satisfies a reduced, and more standardised, disclosure test.
- Issuers will also be able to use a two-part prospectus when they wish to offer multiple tranches of bonds.
- ASIC has also streamlined the process for issuing convertible notes to institutional investors by introducing the ability for issuers to use one 'cleansing notice' at the time of issuing such notes to institutions.
On 11 May 2010, ASIC announced a range of regulatory reforms that are designed to promote the issue of corporate bonds to retail investors. The reforms are a result of the consultation process undertaken by ASIC in response to Consultation Paper CP126: Facilitating Debt Raisings (released in December 2009). The aim of the reforms is to generate an increase in the number of corporate bond issues that are currently extended to retail investors.
The key features of the reforms are as follows:
- permitting certain offers of 'vanilla' bonds to be made under a simplified prospectus with a similar level of content to a transaction-specific prospectus; and
- allowing vanilla bonds to be offered under a two-part prospectus, comprising a base prospectus (which could be used for several different offers) and a second part prospectus (which relates to the terms of a particular offer).
In order to rely on the relief provided by these reforms, both the issuer of vanilla bonds and the terms of the offer of the vanilla bonds will need to satisfy certain prescribed criteria (discussed below).
In addition to the retail bond reforms, ASIC has also provided disclosure relief for offers of convertible notes to institutional investors that should reduce the unnecessary regulatory burden that currently applies to these offers.
Only certain classes of issuers are able to rely on the vanilla bonds prospectus relief. In summary, to be entitled to rely on the relief:
- the issuer must be entitled to use a transaction-specific prospectus under s713 of the Corporations Act 2001 (Cth) for the offer of an existing class of its securities (eg, it has ordinary shares that are continuously quoted securities (on a market such as ASX));
- trading in the issuer's continuously quoted securities must not have been suspended for more than five days during the shorter of the following:
- the period during which that class of securities was quoted; or
- the period of 12 months before the day on which the offer of vanilla bonds is made;
- the auditor's report on the most recent annual financial report, and any subsequent half-year financial report, of the issuer is unmodified; and
- the issuer must not be the subject of a determination that would prohibit the issuer relying on the reduced disclosure regimes permitted by the Corporations Act in relation to placements (ss 708A and 1012DA) and rights issues (ss 708AA and 1012DAA), or the use of a transaction specific prospectus/PDS (ss 713(6) and 1013FA(3)).
Effectively, this limits the class of issuers that are able to rely on the vanilla bonds prospectus relief to existing listed issuers with a good history of continuous disclosure compliance. The relief does not extend to issuers that are listed on a foreign market, nor to issuers that are subsidiaries of a listed parent that would otherwise satisfy the above criteria (although ASIC has stated that it may be prepared to consider case-by-case relief to permit wholly-owned subsidiaries of a listed parent to rely on the vanilla bonds prospectus relief).
The relief only applies to offers of 'vanilla' bonds. To qualify as a 'vanilla' bond, a bond must:
- be denominated in Australian dollars;
- have a fixed term of no more than 10 years, and only redeemable before the end of that fixed term:
- at the option of the holder (subject to such additional conditions as the terms of issue may prescribe); or
- at the option of the issuer (subject to such additional conditions as the terms of issue may prescribe) where:
- there is an adverse tax event (ie, a change in law or regulation which means that interest ceases to be deductible for tax purposes or gives rise to a withholding and associated gross-up obligation); or
- there is a change in control of the issuer or less than 10 per cent of the bonds remain on issue (provided all bonds are then redeemed);
- have a fixed rate of return, or a floating rate of return that comprises a variable reference rate plus a fixed margin;
- provide for interest to be paid periodically on the dates specified in the prospectus the terms of issue may not permit interest to be deferred;
- not be subordinated it must rank at least equally with amounts owing to unsecured creditors of the issuer;
- not be convertible into any other securities; and
- be issued to all investors at the same price under the vanilla bonds prospectus.
In addition, to qualify as a vanilla bond, the minimum size of the relevant bond issue must be at least $50 million (although this minimum size requirement will only apply until 11 May 2012, unless renewed by ASIC).
These requirements give rise to a number of structural limitations for bond design if issuers want to rely on the vanilla bonds prospectus relief:
- The requirement that the bonds not be subordinated is likely to limit the ability of APRA-regulated entities (historically keen users of bonds) to rely on the vanilla bonds prospectus relief, as to qualify for appropriate regulatory capital treatment such bonds generally need to be subordinated.
- The requirements do not permit for any interest deferral a feature of recent retail bond issues by ALE Property Group, AMP and Heritage Building Society.
- The requirements regarding the term of the bonds, the interest rate and the circumstances in which they may be redeemed early will limit the ability of issuers to have a staged redemption profile of an interest rate 'step-up' within the life of the bond.
Where both an issuer and the terms of the bonds satisfy the criteria outlined above, the vanilla bonds prospectus relief permits the issue to make an offer of 'vanilla' bonds under a simplified prospectus with a similar level of content to a transaction-specific prospectus. ASIC has prescribed a list of matters that a vanilla bonds prospectus must contain1. The key matters that must be disclosed in a vanilla bonds prospectus include:
- certain 'key financial metrics' for the issuer namely, the issuer's gearing ratio (total liabilities divided by total equity), interest cover (EBITDA divided by net interest expense) and working capital ratio (current assets divided by current liabilities) and details of whether the issuer has materially breached any loan covenants or debt obligations in the two years prior to the date of the prospectus. In addition, the issuer will need to provide annual and half-yearly updates to the market on these key financial metrics;
- prescribed details regarding the features of the bonds, the risks associated with an investment in the bonds and where investors can get additional information regarding the issuer; and
- a catch-all requirement, similar in effect to the transaction-specific prospectus test in s713(5) of the Corporations Act, that it include any information about the offer of the bonds that:
- has been excluded from a continuous disclosure notice in accordance with the listing rules of the relevant market operator to whom that notice is required to be given (eg, information withheld under the continuous disclosure exception in ASX Listing Rule 3.1A); and
- is information that investors and their professional advisers would reasonably require to make an informed assessment of:
- the assets and liabilities, financial position and performance, profits and losses, and prospects of the issue; and
- the rights and liabilities attaching to the vanilla bonds.
The vanilla bonds prospectus relief should enable some efficiencies in the documentation process for an offer of retail bonds as a result of the reduced content requirements, and should allow issuers to prepare such a prospectus faster and with reduced costs compared to a full prospectus. As a result, issuers should be more likely to extend offers of corporate bonds to retail investors. However, it needs to be recognised that the history of Australian market practice regarding the use of transaction-specific prospectuses for rights issues suggests that issuers may still view the legal and compliance burden of a vanilla bonds prospectus as significant.2 The preparation of a vanilla bonds prospectus will still require the issuer and its advisers to undertake a detailed due diligence, verification and prospectus drafting process. Whether this more prescriptive form of a vanilla bonds prospectus will overcome perceptions of this burden will be interesting to observe.
Under the reforms, issuers will also be able to offer vanilla bonds under a two-part prospectus, comprising a base prospectus (which could be used for several different offers) and a second part prospectus (which relates to the terms of a particular offer). Together, the base prospectus and the second part prospectus need to satisfy the content requirements for a vanilla bonds prospectus (described above).
The two-part prospectus relief is consistent with the approach adopted in certain foreign markets and should enable issuers to issue various tranches of bonds using the same base prospectus (setting out information applicable to any offer of bonds by that issuer) with tranche-specific information set out in the second part prospectus.
ASIC has also provided disclosure relief for offers of convertible notes to institutional investors which should reduce the unnecessary regulatory burden that currently applies to these offers.
Without this relief, a prospectus or product disclosure statement would generally be required for an on-sale of the underlying shares to retail investors within 12 months of the conversion unless the issuer:
- provided a 'cleansing notice' (under s708A or 1012DA) on each conversion; or
- prepared a prospectus or PDS for the initial offer of the convertible notes.
Under the relief provided by ASIC, to avoid these on-sale issues, an issuer of convertible notes can provide a cleansing notice containing prospectus-like disclosure at the time the convertible notes are issued3.
In addition to providing a cleansing notice at the time the convertible notes are issued, issuers will also need to provide annual disclosure during the term of the convertible notes regarding:
- how many notes can still be converted, the number of underlying securities they will convert into, the price (if any) to be paid on conversion and the circumstances in which conversion may occur;
- the issuer's remaining liability to make payments under the notes;
- the average conversion price (if any) paid for any notes converted during the previous 12 months and the number of underlying securities issued on conversion; and
- any other matters relating to the notes that holders of the issuer's enhanced disclosure securities (eg, listed securities, such as ordinary shares) would reasonably require to make an informed assessment of the issuer's financial position and its prospects for future financial years.
The introduction of the cleansing statement approach is a welcome development that should increase the efficiency of the process associated with the offer of convertible notes to institutional investors, as it removes the unnecessary regulatory burden associated with the issue of a prospectus or multiple cleansing notices that are otherwise required. The additional annual reporting requirements are unlikely to materially increase an issuer's disclosure obligations as, to a large degree, the matters prescribed for annual disclosure are largely covered by the issuer's current annual reporting obligations under the Corporations Act and the Accounting Standards.
These reforms are a welcome development to the process of 'levelling the playing field' between retail and wholesale debt investors, while retaining necessary retail investor protections, in order to facilitate the re-emergence of an Australian retail corporate bond market.
That said, it remains to be seen whether the reforms go far enough to encourage a significant number of issuers to enter the retail corporate bond market. As noted above, although the reforms will standardise the approach to disclosure in relation to retail bonds, the reforms still require the preparation of a formal prospectus that will require the issuer and its advisers to undertake a detailed due diligence, verification and prospectus drafting process.
In addition, the limited nature of what constitutes a 'vanilla' bond is such that the relief will only be useful to those issuers who are in a position to issue bonds that meet those criteria. Those issuers who want to issue bonds with features that are outside the 'vanilla' bond definition albeit features that are commonly used in connection with bonds and should be easily understood by retail investors and their professional advisers will not be able to take advantage of the relief.
- The full list of prescribed disclosures is contained in Appendix 1 to ASIC Regulatory Guide 213: Facilitating Debt Raising and the new section 713A inserted by ASIC Class Order 10/321
- Legislative reforms through the introduction of s708AA of the Corporations Act were required in order to address the disadvantage suffered by retail investors as a result of the fact that issuers could avoid the costs of preparing a prospectus by raising equity capital under an institutional placement as opposed to a rights issue.
- The content requirements for such a cleansing notice, and the eligibility criteria for issuers entitled to use such a cleansing notice when issuing convertible notes, is contained in Part E of ASIC Regulatory Guide 213: Facilitating Debt Raising and the new s708A(12C) to (12F) inserted by ASIC Class Order 10/322.
- Robert PickPartner,
Ph: +61 3 9613 8721
- Tom StoryPartner,
Ph: +61 2 9230 4812
- Stuart McCullochPartner,
Ph: +61 2 9230 4420
- James DarcyPartner,
Ph: +61 3 9613 8516
- Tim LesterPartner, Sector Leader, Japan,
Ph: +61 8 9488 3841
- Andrew PascoePartner,
Ph: +61 8 9488 3741
- Andrew KnoxPartner,
Ph: +61 7 3334 3356