The shift in focus from financial advisers to research consultants continues apace, both here and abroad, as asset managers follow the great money management migration.
The Bill comes after a report from the Council of Financial Regulators warned that the financial system’s reliance on financial market infrastructure had “significantly increased” following the 2008 global financial crisis and subsequent reforms.
Is APRA’s hybrid war about protecting banks, retail investors… or itself?
Consternation is growing over the prudential regulator’s off-beat ‘solution’ to concerns about the effectiveness of bank hybrids during times of crisis, with stakeholders saying the move to phase them out will only serve to push investors towards alternative investments.
After a year spent fretting the design of hybrid bonds after the Credit Suisse collapse, APRA last week proposed getting rid of them altogether by 2032.
On the rare occasion that a bank begins to spiral and needs liquid capital, APRA said, hybrids are ineffective because they’re too complex, legally vulnerable and don’t ameliorate the risk of contagion. “These risks are heightened in the Australian context due to the unusually high proportion of AT1 held by retail investors,” it said.
Instead, APRA wants banks to rely on Tier 2 capital, or subordinated bonds, which are more senior in the capital stack and typically owned by institutional investors.
ASIC has also long been concerned about hybrids, warning consumers back as far as 2012 that despite coming from “trusted brands” like CBA and Westpac, “some hybrid securities and notes are highly risky investments”.
APRA believes that imposing losses on such a broad swathe of retail investors in the event of a crisis could lead to the kind of run that saw a clutch of regional banks in the US fold in early 2023, which peaked with the failure of Credit Suisse.
Holes in the story
Yet many believe Australia’s 2021 Design and Distribution Obligations were put in place specifically to prevent such a series of events, by making sure people understand the type of products they’re buying.
“The impact of the [DDO] regime should allay APRA’s concerns that there are a large number of retail clients holding hybrid securities that pose a challenge to the operations of hybrids in Australian markets,” the Stockbrokers and Investment Advisers Association stated, echoing a similar line from the Australian Banking Association.
Investment research giant Lonsec questioned the veracity of data behind APRA’s reasoning. Much of the 53 per cent of hybrid ownership APRA classifies as “retail” (because its value is under $500,000) is held in managed accounts, Lonsec said, “which has professional wealth manager oversight at an aggregate level across many clients”.
“Ownership of AT1 hybrids through a managed account structure is significantly different to an individual investor independently buying hybrids, and the difference merits consideration in APRA’s efforts to mitigate risk to retail investors,” the researcher added.
Out of the blue
What makes the proposal even more incongruous is that of the 12 published submissions to APRA’s consultation, not one of the investors, consultants, research teams, associations or universities advocated for a hybrid phase-out in their response.
They had little reason to do so, as APRA said the idea of replacing hybrids with “other existing, more reliable” forms of capital would require “significant structural change”, and “careful consideration and transition” in its discussion paper. The other potential options – to monitor the situation or improve the design of hybrids – came across as more feasible and likely to be pursued.
According to Yarra Capital Management co-head of fixed income Roy Keenan, APRA’s primary concern is that if something does go drastically wrong in the domestic banking system, the authority would need to oversee a mass conversion of hybrids into what would be distressed equity – a potentially costly and messy exercise.
“The release of APRA’s latest paper shows that they were not jumping at shadows, but they are shaking in their boots at the thought of converting AT1 (Hybrids) into ordinary equity,” Keenan said in a recent note.
APRA’s proposal won’t lead to a more effective capital framework, he argued. “All they have done is simplify the process to make their response easier.”
Coolabah Capital’s Chris Joye made a similar point, noting that APRA is simply “worried about reputational and management risks… when it is supposed to be protecting deposit takers”.
Inferior outlook
APRA’s hyper-conservative stance on hybrids is a “sad day” for retail investors, Keenan believes, despite likely coming as a boon for investment product providers.
“APRA’s decision is positive for the funds that we manage,” he said, noting the large proportion of retail investors that will be shuffled out of them in coming years. “At some point these investors will rotate into investment grade funds, ETFs, equities or private credit.”
One of the biggest watches in the fallout from the proposal, Keenan added, will be whether APRA changes the structure of Tier 2 capital, which it wants banks to use more as a lever to raise capital and potentially absorb losses. “Remember, existing Tier 2 securities are only convertible to equity when a bank is non-viable and does not help resolve any issues if a bank gets into trouble.”
More broadly, he believes, APRA’s move is one that will inhibit the banks’ collective flexibility and erode faith in what is a relatively robust banking system.
“APRA has tried to fix something that wasn’t broken, and we are now left with a capital structure that in my opinion is inferior to what we have today,” he said.
