Evolution of the Australian dollar bond market
The AUD bond market is not just one market. It’s, at last count – at least six markets with their own features, documentation and target investors.
Some investors can straddle a number of the formats while others are more constrained due to other factors like restricted mandates or regulatory drivers.
The main AUD bond formats are:
- AUD Onshore Wholesale: This comprises our domestic and Kangaroo borrowers, with bonds usually settled through Austraclear initially and subsequently bridged to Clearstream/Euroclear. Documentation is generally under Australian law however recently we have seen some offshore law creeping in.
- AUD Onshore Retail: These bonds are usually ASX listed and settled through CHESS, with subordinated bank hybrid deals dominating volumes. This is a well-established market with a very different execution process and targeted non-institutional investor base.
- AUD EMTN (Reg S): These bonds are usually documented under a European jurisdiction (predominantly under UK law) with the programme also listing in Europe. AUD Eurobonds started to proliferate once the AUD became a ‘floating’ currency in 1983, however, appetite has expanded beyond the original European retail arena with the emergence of Asian investors who buy AUD structured notes and vanilla private placements in this format. AUD EMTN subordinated (Tier 2) public deals have started to proliferate in recent years with issuers favouring this format over the Kangaroo which is more costly and takes longer to establish. The EMTN transactions are usually more modestly sized, often starting with just A$100 million as an initial volume target.
- AUD SEC Registered Global: As the name suggests, these bonds can be sold in most of the large markets including the US. The format has grown dramatically in recent years, partly as a result of increased regulation of the global systemically important banks (G-SIBs). This market is discussed in more detail below.
- AUD Local market bonds like Uridashi and Formosa bonds use the EMTN format as a base. Uridashi notes overlay a Japanese ‘shelf’ to enable distribution to Japanese retail investors. Technically, they are notes issued outside of Japan and are sold in secondary trade (one day or more later) to Japanese retail investors. Formosa bonds are issued by non-Taiwanese borrowers and are listed on the Taipei Exchange, thereby effectively becoming a ‘domestic’ issuer. This allows Taiwanese life companies to participate as investors without breaching holding restrictions on offshore names.
- AUD denominated US Private Placement (USPP) deals: These bonds are occasionally added to a USD USPP if it does not suit an issuer to either receive US funding, or if they do not wish to swap USD note proceeds to AUD. Some USPP investors can accommodate this.
What’s so special about the AUD global?
How has this market muscled in on the action over the last few years?
The format has always been around for non-USD deals. However due to higher legal costs and more viable alternatives the Global format had only been occasionally used. Five years ago, there was a flurry of AUD and NZD fixed rate US-bank names tapping this market and aiming directly at large US based funds. The deals received some demand from Asia, however as the target comprised US onshore investors, the deals were launched and priced in New York time. There was close to no participation from Australian accounts.
Then nothing much happened for three years. As rates dropped globally, AUD yields followed, as a result, fixed rate bonds in AUD became less popular for financials. Just one AUD Global was printed by a US bank in each of the years 2013, 2014 and 2015.
However, a turning point seems to have occurred with the Citigroup trade in July 2015. Firstly, it wasn’t driven by the attractiveness of a fixed rate issue. Rather, the focus was a floating rate note (FRN). The FRN tranche was ultimately four times larger than the fixed tranche. Secondly, the deal was launched and priced in the Asia-Pacific time zone rather than the US. In this case, the target for this trade was the pool of stickier AUD funds and commercial banks based in Asia rather than the US based funds previously targeted by the market. Demand onshore in Australia was considered to be a bonus, attracting a very healthy 37% from a small number of Australian buyers.
But why was the Global format chosen in the first place?
The real driver links to one of our key identified trends around financial system change, that is, a trend of increased regulation. The proposed introduction of the total loss-absorbing capacity (TLAC) rules has removed the Kangaroo option for US based G-SIBs.
The Australian law governed Kangaroo bond does not have the US home market jurisdiction required to achieve the bail-in status required under TLAC. The proposed TLAC regulation has been constructed on the premise that US home market jurisdiction of the issuance will make it easier to enforce the bail-in laws. One way US bank issuers can issue AUD and have home jurisdiction on their transactions is to use their existing SEC Global programme instead of using the Kangaroo.
Since that Citigroup trade, we have witnessed four bank deals in 2016 raising circa A$2.95 billion. Citigroup returned to the AUD Global market twice in 2016, raising A$1.30 billion in 5 and 10 year maturities. Wells Fargo (A$1.65 billion across three tranches) and Bank of America (A$750 million across two tranches) also printed very successful deals in 2016. Wells Fargo successfully returned again to the AUD Global market this year. What is pleasing is that the Australian domestic participation continued to broaden as the format became more familiar to investors.
The ongoing use of the format has increased familiarity of it with Australian based investors. Over the past 12 months, the Ford Motor Company has used US Global documentation to print two AUD deals rather than setting up a Kangaroo alternative. The format was used in Q1 2017 by Sumitomo Mitsui Financial Group (SMFG) on their inaugural deal in the currency. SMFG was the first Japanese HoldCo issuer in AUD and the first non-US domiciled issuer to use the format in AUD. The Australian participation rate on the A$1 billion deal was a little over than 30% which is a clear endorsement of the format by Australian based investors.
Other Issuers have chosen another path. Goldman Sachs re-wrote their documentation so now they can choose either NSW law or New York law on their AUD (and NZD) onshore MTN. The NY law option was selected recently for the Goldmans AUD 7-year transaction (NAB Joint-Bookrunner). That deal settled through the Australian system and has an Australian Issuing and Paying Agent.
Whilst we don’t expect the Global format will replace the broader appeal of the Kangaroo for offshore issuers, we believe this format is now a proven option for issuers who either cannot use the Kangaroo format and for those who prefer the simplicity of using one Global programme.
NAB has been fortunate to be involved as a Bookrunner on almost every US bank AUD Global in recent years and was a Bookrunner on the SMFG A$ deal.
Article adapted from Capital Financing 2016 Year in Review