ASIC’s “crackdown” on hybrids – more noise?

Co-founder of the Switzer Report
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I always get a little worried when ASIC announces yet another “crackdown” (yes, their words). Two ready possibilities come to mind – either ASIC is late in taking action about some investor scam where the horse has already bolted, or they have got it horribly wrong again. To be fair to ASIC, the ASIC of 2013 has lifted its game considerably and recent innovations, such as the Money Smart website, are to be applauded.

On Tuesday, ASIC announced a “crackdown” in the hybrid securities market. It issued ‘Report 365’, which details its thinking about the market and the actions it proposes to take.

The hybrid market

According to ASIC, more than $18 billion has been raised by companies between November 2011 and June 2013 through the issue of ASX-listed hybrid securities. These securities combine both ‘equity-like’ and ‘debt-like’ characteristics (see Table 1 at end).

Investment in hybrid securities is, according to ASIC, narrowly focussed among a group of 75,000 retail investors. They claim that there is almost no participation by institutional investors, and of the retail investors, two thirds are SMSFs.

What are ASIC’s concerns?

ASIC has three primary concerns with the issue of hybrid securities:

  • Misleading conduct in the sale of hybrids. This includes inappropriate labelling of hybrids and unwarranted comparison of hybrids to different, less risky products e.g. covered bonds or senior debt;
  • Spruiking of the potential higher returns of hybrids, and the brand name or reputation of the issuer, without balancing that with the risks of the product, and
  • The complexity of the issues, meaning that some investors don’t know what they are getting in to.

What is ASIC proposing?

The regulator says that it has already worked with issuers and their lawyers to improve disclosure in prospectuses (for example, by requiring an ‘Investment Overview’ and ‘About the Security’ sections at the start), and has also been active in issuing warnings through the media. In addition, it now proposes to:

  • Develop tools that will allow investors to “check their understanding” of hybrid securities;
  • Investigate any reports of problematic behaviour by brokers and other distributors;
  • Review advertising and promotional material;
  • Consider naming conventions for hybrid securities to ensure that they are accurate; and
  • Continue to work with issuers and their lawyers to further improve prospectuses.

Of these actions, standardising naming and labelling conventions for hybrid securities and simplifying prospectuses are steps in the right direction. Naming and labelling is an issue, with ASIC noting that recent issues of hybrid securities by the major banks that qualify as ‘Additional Tier 1’ capital have been variously described as “Capital Notes” and “Convertible Preference Shares”. ASIC would like to see them described as “Capital Notes”.

A “crackdown”? Hardly.

What else could ASIC do?

I start from the perspective that there aren’t many serious problems with the hybrid securities market, so any talk about a “crackdown” is unwarranted and noise – there are far more important things for the regulator to put their resources to work on. However, if improvements can be readily made to better inform investors (both in the primary and secondary markets), that can’t be a bad thing.

To add to ASIC’s list, here are my suggestions.

  1. Require all issuers to prominently display a copy of the prospectus on their website until the issue matures and is repaid. Access to the prospectus is the only way that an investor in the secondary market can check the terms and conditions.
  2. Look at ASX announcements – make it easier for investors to identify an “announcement” about their issue from the (sometimes) hundreds of announcements coming out from the major banks. On some broker websites, announcements about hybrid securities (eg. from non-listed ASX companies) don’t get picked up.
  3. Require the ASX to get its act together and freely publish and communicate distribution/dividend dates, and the relevant payment amount. You only have to look at the way many hybrid securities trade on the day they go ex distribution, to see that some retail investors are being seriously legged over. The level of transparency here is disgraceful.
  4. Forget all the “mumbo/jumbo” about risk disclosure – pages and pages of risk disclosure in the prospectus means that it is too much to comprehend. Investors don’t generally have the time or interest in reading all this guff. For the “security” risk (as opposed to the specific issuer risk), agree on some common words that can be used by all issuers. For market and general economic risks, keep this to an absolute minimum.
  5. The ‘Capital Note’ type issues are made more complex in that the maximum number of ordinary shares that an investor would receive on conversion is not known until after the issue has concluded. No one remembers what the issue price of the ordinary shares was at the time of issue – so work with APRA and set these numbers up front. That way, the prospectus could actually demonstrate the tests for conversion.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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