26 January, 2013

 

Legal News & Analysis – Asia Pacific – Australia – Capital Markets

 

WHAT YOU NEED TO KNOW

 

• The Government has released draft legislation in relation to retail corporate bonds. The proposed reforms include
  • a two-part disclosure regime for offers of "simple corporate bonds"; and
  • amendments to the prospectus civil liability provisions for directors in respect of offers of simple corporate bonds.

 

Background

 

On 11 January 2013, the Government released an exposure draft of the Corporations Amendment (Simple Corporate Bonds and Other Measures) Bill 2013 ("Bill"). The Bill follows on from:

 

 

• ASIC's 2010 rarely used Class Order [CO 10/321] ("Class Order") which allowed listed entities to offer "vanilla bonds" under a simplified two part prospectus with similar content requirements to a transaction-specific prospectus; and
• a discussion paper and consultation process conducted by the Treasury

 

The Government is seeking submissions on the Bill by 15 February 2013.

 

The proposed reforms are part of a broader regulatory focus of the Government aimed at developing a liquid corporate bond market in Australia. The initial discussion paper issued by the Treasury identified a number of reasons for the reluctance of Australian companies to raise debt through the issue of retail bonds. These included an onerous disclosure regime, better pricing in more liquid institutional markets, higher investor demand for shares over bonds, beneficial tax treatment of franked dividends compared to interest payments and the inability to disclose credit ratings of retail bonds.

 

While the reforms seek to alleviate some of the elements of the disclosure regime considered burdensome, some financial market participants have commented that commercial factors, more so than legal issues, are the main impediments to establishing a liquid corporate bond market in Australia.

 

What are "simple corporate bonds"?

 

In keeping it "simple", the regime is intended to apply to plain vanilla debt securities whose terms are considered "simple". In order to qualify as a "simple corporate bond", the bond must:

 

• be a debenture (as defined in the Corporations Act 2001 ("Corporations Act");
• be quoted on a prescribed financial market (ie on the ASX);
• be denominated in AUD;
• not be issued at a price exceeding A$1,000 (a condition not required for "vanilla bonds" under the Class Order);
• be offered on the basis that they will not be issued unless at least A$50 million is raised under the offer (a condition that is currently a transitional requirement scheduled to expire on 12 May 2013 under the Class Order);
• have a fixed term not exceeding 10 years;
• carry a fixed interest rate or floating rate of interest comprised of a reference rate plus a fixed margin which cannot be decreased (ie the fixed rate or fixed margin cannot be reduced); and have periodic interest payments which cannot be deferred or capitalised.

 

An issuer's ability to redeem (call) the bonds early must also apply only in limited circumstances (eg due to a change in control of the issuer, due to a change in law the effect of which results in a reduction of tax benefits available to the issuer or pursuant to a 10% clean-up call). Except as noted above, these requirements essentially reflect those for "vanilla bonds" in the Class Order.

 

In addition, the holders of the bonds must have a higher priority than unsecured creditors of the issuer should the issuer be wound up. One point to note is that to give effect to this, the bonds would need to be secured. A requirement of this kind would clearly reduce the usefulness of the regime for many, if not all, corporate issuers. For example, it may cut across restrictions on granting further security under an issuer's existing corporate financing arrangements. It would also be out-of-step with both the established Australian wholesale bond market and the developing Australian retail bond market where bonds are typically unsecured.

 

The exposure draft of the Explanatory Memorandum to the Bill notes that this requirement is intended to ensure that the regime does not apply to subordinated debt securities. If this is the intention, the requirement should be amended to instead provide that the holders of the bonds cannot be subordinated to unsecured creditors of the issuer – consistent with the equivalent eligibility requirement for "vanilla bonds" in the Class Order.

 

Two-part prospectus for simple corporate bonds

 

The Bill introduces a mandatory, two-part prospectus for the issue of simple corporate bonds aimed at simplifying the disclosure obligations. To be eligible to take advantage of the new two-part prospectus the issuer, or the issuer's parent, must have continuously quoted securities (ie be listed on ASX for at least 3 months before the offer and not be subject to certain exemptions, modifications or relief in relation to periodic and continuous disclosure) and the trading in those securities must not have been suspended for more than a total of 5 days in the 12 months before the offer. Further, the most recent audited financial statements must be in accordance with the Corporations Act and the auditor's report must not note any defects or irregularities or contain an emphasis of matter related to the issuer being a going concern.

 

The Bill leaves the disclosure requirements for the two-part prospectus to the regulations – which have not yet been released. However, the detailed disclosure requirements for a two-part prospectus for "vanilla bonds" under the Class Order may give some hint as to what may be forthcoming. We suspect the devil will be in the detail, as the level of information required in each document will be crucial to the attractiveness to issuers of the two-part prospectus structure. The Explanatory Memorandum does however indicate that the intention is that the two-part prospectus consists of:

 

• Base prospectus: The base prospectus will have general information about the issuer and the offer which should be unlikely to change significantly over the 3 year life of the document. In addition to being lodged with ASIC, the base prospectus must also be available on the issuer's website for its 3 year life.
• Offer-specific prospectus: The issuer will also need to release an offer-specific prospectus for each tranche of simple corporate bonds which outlines the key details of the offer. The offer-specific prospectus must also update the base prospectus and include any matters material to an investment in the simple corporate bonds which have not already been released to the market under the issuer's continuous disclosure obligations.

 

Given the static nature of the information that will qualify for inclusion in a base prospectus, we expect that the information included will be limited to basic details about the issuer and the terms and conditions of the bonds. What is not clear from the Bill is how the two-part prospectus structure and, in particular, the offer-specific prospectus interacts with the continuous disclosure regime. For example, it is unclear whether information disclosed to the market between the first issue of the base prospectus and the subsequent offer-specific prospectus needs to be repeated in the offer-specific prospectus.

 

While the two-part process is aimed at "streamlining" the disclosure regime, we query the extent of the benefits of this process in practice. The two-part prospectus structure facilitated by the Class Order has had little success – only one issuer has used the structure since it was introduced in

 

2010. However, unlike the class order relief for "vanilla bonds", the new two-part prospectus will be compulsory for the issue of simple corporate bonds after a 2 year transitional period.

 

Amendments to the prospectus liability regime

 

Under the current prospectus disclosure laws, a person who suffers damage as a result of a defective prospectus is given a right to recover the loss or damage from the issuer and also from the directors individually, any proposed directors who have consented to be named in the prospectus and the underwriters, even where those persons were not involved in the particular defect. However, there is no right to recover against such a person if they can establish they made reasonable enquiries and, after doing so, believed on reasonable grounds that the prospectus was not defective (the "due diligence" defence) or placed reasonable reliance on information provided by other people (the "reasonable reliance" defence).

 

This prospectus liability regime is seen as creating a regulatory bias for issuers to structure fundraising activities in order to avoid the obligation to prepare a prospectus ,for example, by making the offer solely to wholesale investors or by doing a "low-doc" rights issue or share purchase plan. The Bill seeks to address this issue by removing the strict liability for directors and persons named in the two-part prospectus as a proposed director. However, a director may still have liability if they are "involved" in a contravention.

 

Changes to some general offences provisions

 

The Bill also proposes a change to the general offences provisions in sections 1308 and 1309 of the Corporations Act (in addition to the prospectus liability provisions). Under those provisions, a person can face criminal liability if they fail to take "reasonable steps" to ensure that documents or information which they make or authorise the making of do not contain a statement that is false or misleading in a material particular or omit information without which the statement is misleading in a material respect. The Bill proposes to amend the general offences provisions to introduce a "due diligence" and a "reasonable reliance" type defence (similar in form to those currently included in the prospectus liability regime). The effect of this in the context of prospectuses will be that if a person is able to establish a "due diligence" defence or a "reasonable reliance" defence in respect of a defective prospectus, that person will also have a defence to prosecution under sections 1308 and 1309 of the Corporations Act.

 

Conclusion

 

While the Government's attempt to develop a liquid corporate bond market in Australia is to be encouraged, it remains to be seen whether the proposed reforms will have the desired effect. It may be the case that the legislation goes some way to further liquidity in the retail corporate bond market in Australia. However, further reforms and appropriate market conditions are likely to be needed in order to encourage more retail investor participation.

 

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