Monday 26 August 2013 by FIIG Securities FIIG Securities Legacy

ASIC – Hybrid Securities Report August 2013

ASIC is concerned with the “extensive issuance” of ASX listed hybrids from November 11 to June 2013 ($18bn), so has reviewed the sector, producing this report which includes:

  1. What are hybrids, who they are marketed to and challenges for ASIC in its oversight
  2. Issues for investors
  3. Improving prospectus disclosure
  4. Review of selling methods

This article summarises part a. and b. of the ASIC report and highlights parts of the new “Australian Guide to Fixed Income” where additional information can be found. 

Key points

1.     ASIC will continue to “provide warnings” while they remain concerned about investors being attracted to yield without fully understanding the risks involved”.

Examples of warnings include:

  • “Hybrid securities are complex products. Even experienced investors will struggle to understand the risks in trading them. If you don’t fully understand how they work you should not invest”. ASIC’s SmartMoney website (Note this quote is reproduced in the Guide page 131)
  • “We think retail investors too often see the household name and they see something as secure and reliable without looking at the underlying product and the risks associated with it”. ASIC Commissioner Peter Kell
  • “Investors need to understand the conditions of these offers, such as the terms and conditions that allow the issuer to exit the deal or suspend interest payments, and long term maturity dates of several decades. We want to ensure consumers are fully informed before they invest”. ASIC Chairman Greg Medcraft

2.     Particular risks include:

  • Long investment terms
  • The ability to defer interest payments and how long they can remain unpaid
  • The subordination of the security and the implications if the issuer fails
  • That market prices for hybrids can be volatile and experience low liquidity and selling on market may incur a capital loss
  • Potential conversion into ordinary shares

3.     Hybrids have been structured to achieve one or more of the following:

  • Particular treatment for accounting and tax purposes
  • Recognition of ‘equity content’ or ‘equity credit’ under ratings methodologies used by credit rating agencies
  • Qualification as a particular form of ‘regulatory capital’ (Basel III - which requires banks to increase the amount of regulatory capital that they hold) under prudential standards set by APRA

(Note S&P revised the equity credit status on Origin Energy, Tabcorp and AGL hybrids from 100% to 50% equity content and as one commentator remarked “turned the instruments from cheap equity into expensive debt”).

4.   Approximately 75,000 investors invest in listed hybrid securities, a much smaller number than shares (roughly 34% of the adult population). Two thirds of these are SMSFs who appear attracted by the high yield and the brand or reputation of the issuer, with less than half from an Investment Trends survey saying their financial advisor played a role in their most recent investment in these securities.

5.     ASIC urges investors to ask whether the promised returns adequately compensate for the investment risks

6.    Hybrid securities are different to traditional fixed income securities, “these products may not be suitable for everyone, especially if an investor needs steady returns or capital security” ASIC Commissioner Greg Tanzer

7.    ASIC highlights examples of “failed” hybrids

  • Australand ASSETS, Multiplex SITES and Nufarm step-up securities have passed their call dates and remain on issue. Interest continues to be paid but there’s no incentive for the companies to redeem, thus the securities’ price now reflects their perpetual nature and below the original $100 face value
  • Elders Hybrids and Paperlinx SPS are in financial distress and interest payments have not been made for some time. Prices of these securities have recently dropped to below $20 and below $10 respectively

8.   There has been little institutional investment in hybrid securities which is often attributed to hybrid securities falling outside of traditional fixed income mandates. Another possible reason is that institutional investors consider the risks are not adequately priced , although there was no evidence from APRA to support the claim.

To help FIIG clients better understand Hybrids, we published a new chapter on them in edition 2 of The Australian Guide to Fixed Income (Pg 125). A section called “Key structural features”, explains the terms as well as investors considerations (Pg 133 & 134 of the Guide)

The Guide has two case studies (pg 138 & 139) on Crown – an example of an equity credit security and on Goodman – an example of a step up security where the investor was not given the option of repayment and instead offered a coercive exchange.