Nearly all Floating Rate Notes (FRNs) and other corporate bonds traded between institutional investors in Australia are held within the Austraclear system. This is a registry which records the legal holder of the securities and allows trading of the FRNs to occur in a secure manner.
Unfortunately, the costs and compliance requirements of being a Full Member of Austraclear and thus being able to trade and hold securities in the system is prohibitive and out of reach for small investors. To allow wider access to the system, Austraclear allows some of its Full Members to act as “Proxies” managing the Austraclear accounts of its Associate Members. Full Members can also hold bonds for their clients who are not members of Austraclear themselves in safe custody in sub-accounts. Both are viable options for smaller institutional investors.
In practice, there are only two Full Members of Austraclear that offer the proxy service widely to smaller investors being ETOS and Laminar Capital (the Major Banks offer the service, but not to clients they wish to trade with because it does not meet their internal compliance policies as under the Austraclear system they would be entering both sides of any trade which essentially circumvents the major controls within the system). The approximate cost to a small institutional investor of appointing an Austraclear Proxy is around $7,000 for the first year and $4,000 in subsequent years as a combined total of proxy fees and fees paid directly to Austraclear for Associate Membership. As an alternative, NAB, CBA and most of the brokers will hold bonds for their customers for free in safe custody in sub accounts (ANZ usually charges and this is not a service offered by Westpac). Safe custody is therefore clearly a far more cost effective method than holding the bonds directly in Austraclear especially for investors who hold less than ten different bonds across which to defray the Austraclear costs. Both methods seem to be equally secure but with essentially the same small risk but in different formats[1].
However, behind the scenes these banks and brokers are incurring fees from Austraclear for holding their customers’ bonds, but they are willing to do this because of the fees they make selling the bonds to the customer (usually at new issue) and potentially afterwards if the customer ever wants to trade the bonds. As these banks and brokers are absorbing these costs themselves, there are certain “custom and practice” rules to be observed when asking a bank or broker to hold bonds in safe custody. The bank or broker will generally take umbrage if the customer abuses their generosity of providing a “free service”. For example, simply selling the bonds to a third party without giving the bank or broker the opportunity to bid on those bonds or expecting one bank or broker to hold bonds purchased from another bank or broker in safe custody is generally not looked upon favourably.
Amicus is widely skilled in these nuances of dealing with banks and brokers due to its Director having worked as a bond trader at different banks and brokers in the Australian market prior to the forming of Amicus. Amicus is also deeply experienced at helping its clients manage their safe custody arrangements with banks and brokers as well as negotiating with them to have safe custody “for free” for Amicus clients.
[1] The primary risk with safe custody is that although the customer is the beneficial holder it is the bank whose name is recorded in the Austraclear register and therefore the bank can theoretically trade the bond on the client’s behalf but without their consent although this would be fraud. The risk with Austraclear proxy is the customer has delegating authority to a third party (their proxy) to operate its Austraclear account so again that third party could trade the bonds on the client’s behalf but without their consent although again this would be fraud. It is for this reason that many customers feel more comfortable holding their bonds in safe custody with a Major Bank as the Major Bank has the capacity to make them whole should fraud be committed by a rogue employee of the safe custody holder or Austraclear proxy rather than having to make a claim against the broker’s PI Insurance.
