Home / Analysis / How advisers can navigate APRA’s likely hybrid phase-out

While APRA's proposed hybrid phase out is designed to improve the resilience of the financial system, it will inevitably impact investors and the strategic plans that some advisers have laid out. Navigating the transition will require forethought.

To enhance financial system stability, APRA has proposed phasing out Additional Tier 1 (AT1) capital instruments, better known as hybrids, by 2032. These complex hybrid securities, which combine features of both debt and equity, are designed to absorb losses in financial crisis situations but have raised concerns for regulators due to their complexity.

The proposal aimed to enhance financial system stability capital instruments for banks inadvertently impacts clients utilising hybrids as part of their investment strategy. The consultation period is open until 8 November 2025, and the changes are not expected until 2025, proactive engagement with this potential shift is not merely prudent, but essential for advisers.

Deconstructing APRA’s rationale

APRA’s concern stems from the inherent complexity of hybrid securities. Unlike simpler instruments like Tier 2 capital and common equity, hybrids occupy a nuanced space in a company’s capital structure.

This complexity, APRA argues, has the potential to amplify instability during financial crises, as evidenced by the recent collapse of Credit Suisse, and the high-profile failures of banks in the US and EU, where AT1 complexities contributed to market volatility. In Australia, compared to other jurisdictions, the hybrid market is considered to have higher grade ATI’s which are also listed and traded on the ASX.

While the Australian banking system is considered robust, APRA’s stance reflects a more simplified approach to risk mitigation. The regulator is particularly concerned about the high proportion of AT1 instruments held by retail investors, who may lack the sophistication to fully grasp the intricacies and risks associated with these securities during a financial crisis.

This raises the question: is APRA’s move a justified pre-emptive measure or an overreaction to an idiosyncratic event in a vastly different financial ecosystem?

APRA’s Discussion Paper: A more effective capital framework for a crisis released on 10 September 2024 shows the expected impact in this table.

Impact to retail clients

While APRA has stated the expected impact to investors from the proposal is an orderly adjustment, with no immediate impact on existing ATI for investors, since the release of the consultation paper there has been some volatility in hybrid markets.

APRA acknowledges that while the proposed changes aim to improve the overall resilience of the financial system, they will inevitably impact retail investors. Specifically, access to new AT1 issuances will cease, forcing investors to seek alternative products to fulfill similar roles in their portfolios.

While APRA recognises the attractiveness of AT1 instruments to certain investors, it emphasises the prudential nature of these securities and their primary function in supporting regulatory outcomes. The regulator believes the proposed changes are necessary to enhance the effectiveness of bank capital during a crisis, even if it results in a material shift in asset allocation for some individuals.

However, APRA tempers this impact by highlighting that AT1s represent a relatively small proportion of overall household assets. This suggests that while adjustments will be necessary, the overall impact on the broader investment landscape may be less pronounced.

ASIC’s cautious stance

ASIC has consistently cautioned retail investors about the complexity and risks of hybrid securities, emphasising the potential for capital loss and the need for careful consideration of their terms and conditions.

They have expressed concern that retail investors may be drawn to hybrids based on the reputation of the issuer without fully understanding the inherent risks, including the possibility of suspended interest payments, deferred redemption, and the complexities associated with the hybrid structure. ASIC recommends seeking independent financial advice. These warnings underscore the importance of informed decision-making and the need for advisers to prioritise their clients’ best interests when recommending or facilitating investments in hybrid securities.

Advisers navigating the transition

1. Client engagement: Prepare now
   • Identifying clients holding hybrid securities is merely the first step. A deep dive into individual portfolios is necessary to assess the extent and nature of their AT1 exposure.
   • What role are hybrids fulfilling in the client’s portfolio and what assets can achieve the same results.
2. Informed decision-making: Balancing prudence and opportunity
   • Engage in discussions with clients, exploring the full spectrum of potential outcomes and their implications. Consider:
     • Scenario planning: Full implementation of APRA’s proposal, a modified version, or no change at all.
     • Risk assessment: Risk appetite, time horizons, and financial goals.
   • Document discussions and advice recommendations including the rationale behind your recommendations.
3. Leverage industry associations: Adviser voices
   • APRA intends to have round table discussions with industry associations and key stakeholders.
   • Work with your associations to inform them of the impact to your retail client and ensure your adviser voice is heard.

APRA’s proposal to phase out hybrid securities presents both challenges and opportunities for financial advisers. While the potential impact on retail investors is undeniable, proactive engagement, thorough client communication, and a strategic approach to portfolio management can mitigate risks and ensure clients’ financial goals remain on track.

Advisers should leverage their expertise to guide clients through this evolving landscape, advocating for their best interests and contributing to a balanced regulatory outcome.

By staying informed, engaging with industry associations, and adapting investment strategies, advisers can demonstrate their value and reinforce trust with their clients during this period of transition.

Furthermore, advisers should remain cognisant of ASIC’s longstanding concerns about the complexity and risks of hybrid securities for retail investors, ensuring that all advice aligns with the regulator’s guidance on investor protection and informed decision-making.