Over the past year we have seen many investors move beyond Term Deposits (TD’s) to Floating Rate Notes (FRN’s) as margins on TD’s have continued to contract. Amicus believes this trend is likely to continue as the regulatory pressure on ADI’s is to secure longer term stable funding to better match their longer term lending (which is often 30 year residential mortgages) in their asset base. This trend obviously favours the issuance of longer dated FRN’s over shorter dated TD’s by all ADI’s.
For investors buying an FRN for the first time, they must make a choice as to how they will “hold” their investment. Unlike TD’s, which are a bilateral contract between the ADI and an investor, FRN’s are securities which are transferable between investors without the borrower’s (ADI’s) consent. Ownership of the FRN at any time is recorded in a registry system called Austraclear and all trading of the FRN’s occur through the Austraclear system, with only members of Austraclear able to hold and trade FRN’s with other members of Austraclear.
It is unlikely a first time FRN investor is already a member of Austraclear and therefore they have two choices; either join Austraclear themselves or have an existing member of Austraclear hold the FRN’s on their behalf. Further, those new investors that choose to join Austraclear probably just want to hold and trade their own securities and do not want the expense and compliance requirements of being a full member of Austraclear which is generally something applicable only to banks, brokers and large fund managers who are trading frequently in the system as part of their regular business.
The two practical options for new investors are either Austraclear Proxy or Safe Custody. Under Austraclear proxy, the investor joins Austraclear and appoints a proxy to execute trades for them in the Austraclear system. Currently, Amicus understands only ETOS and Laminar Capital offer proxy services. These two organisations run very different business models and there are pros and cons of each so we invite investors to call us to discuss which is the better organisation for them if they decide to go the proxy route.
The alternative is Safe Custody. Typically, the bank or broker selling the bond to the investor will offer the investor this service to hold the bond on the investor’s behalf. ANZ, CBA and NAB have offered this service for many years with more recently FIIG and Curve also entering the market. Under the safe custody option, the bank or broker (who is a full member of Austraclear) holds the bonds in a sub account of their own Austraclear account on behalf of the investor. The bank or broker incurs a small cost from Austraclear for holding these bonds, but all teh aforementioned organisations are willing to absorb this cost in order to sell FRN’s to the investor with the exception of ANZ that has a general policy of charging for its safe custody services[1]. However, no bank or broker wishes to provide free safe custody for another’s bonds and incur costs for doing so effectively facilitating their competitors trades. Hence in practice many investors end up with FRN’s held in safe custody with all of the different banks and brokers from whom they buy FRN’s and consolidation of their holdings with one bank or broker has proven difficult.
Westpac has recently stopped providing safe custody services. The other banks and brokers who remain in the market are offering different terms both explicit and implicit for investors who held FRN’s with Westpac for moving their securities across to their own safe custody accounts and also for those investors who intend to buy FRN’s from Westpac on an ongoing basis. Please feel free to call Amicus if you would like to discuss this issue in more detail.
The pros and cons of Austraclear proxy vs safe custody are many and varied, but in summary, Austraclear Proxy will cost around $6,000 in the first year and $3,000 in subsequent years all up for those buying and holding a few FRN’s; whereas Safe Custody is often “free” but can be cumbersome for those holding multiple FRN’s and can be an impediment for those wanting to trade with the multiple banks and brokers at the best price (e.g. if a bank or broker is offering an FRN at the best price, but cannot provide safe custody, then the investor must either trade with a bank or broker who offers the same bond at an inferior price, but can provide the safe custody service or trade on the goodwill of another bank to help one of its competitors facilitate a trade with one of its clients).
Interestingly the issue of relative security of the holdings under the two methods comes up regularly in conversation and while this is definitely an important issue, Amicus notes the safe custody method has survived the collapse of Lehman Brothers Australia when no investor’s holdings were imperilled. Similarly, Austraclear proxy survived the collapse of Oakvale Capital (as proxy services provider) with the same result of no issues arising regarding the safety or security of client holdings.
Amicus welcomes inquiries from any investor wishing to discuss the pros and cons of each method and the mechanics involved. This is a service we provide as a matter of course to our own retained clients.
[1] This is a general policy, but we have anecdotal evidence there appears to be a sliding scale of fees down to zero depending on how much business the investor does with ANZ
