A Guide to Exchange-Traded Australian Government Bonds
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Australian Government Bonds (AGBs), also known as Commonwealth Government Securities (CGS) or Treasury Bonds (TBs), are debt securities issued by the Commonwealth of Australia. These securities pay fixed coupon interest payments every six months (or quarterly for inflation-linked bonds) until maturity.
Institutional investors have historically held these securities for a number of reasons such as liquidity, duration positioning, and income, but it is important for individual investors to understand their use before implementing them as part of their investment strategy.
The physical AGBs are not traded on the ASX and are typically traded "over the counter" in large parcels, putting them beyond the reach of many retail investors. But legislation passed in November 2012 means the rights to these physical bonds can be traded on the ASX as a CHESS Depositary Interest. These depositary interests are known as exchange-traded treasury bonds (eTBs) and exchange-traded treasury-indexed bonds (eTIBs).
These securities have the appeal and convenience of being electronically traded and settled through the Australian Securities Exchange (ASX) in small or large parcels. Exchange-traded AGBs offer a convenient and readily accessible way for investors to buy Australian Government Bonds.
CHESS Depositary Interests (CDIs) - How They Work
The owner of an eTB (or eTIB) will hold an Australian Government Bond in the form of a CHESS Depository Interest (CDI). This means the holder obtains all the economic benefits (including payments) of the underlying bond but without legal title, which remains with the nominee (explained below).
The mechanism for ownership is somewhat confusing, but in reality both the physical treasury bond and the exchange-traded treasury bond work in exactly the same manner except that the market makers (intermediaries CommSec, JPMorgan and UBS) must ensure they maintain sufficient liquidity in both products within a few basis points of each other. The market makers have agreed to provide two-way liquidity of at least A$5 million with a bid-offer spread which is for retail participants very competitive.
One exchange-traded AGB provides beneficial ownership of A$100 face value of the TB or TIB over which it has been issued. Owning an exchange-traded AGB gives the holder the right to receive interest and principal payments due on the underlying AGB.
The Depositary Nominee
CHESS Depositary Nominees Pty Ltd is the entity appointed by the Australian Government under the ASX Settlement Operating Rules to hold any economic benefits respective to the specific exchange-traded Treasury bond. This company is a 100%-owned subsidiary of the ASX and will hold the securities for the benefit of the holder of an exchange-traded treasury bond.
The Legal Owner (Austraclear)
Austraclear is the ASX wholesale securities depositary, which holds legal title to all AGBs.
The Issuer (The Australian Government)
The Australian Government is the issuer of the underlying AGB and makes interest and principal payments due on the underlying bond. Under payment instructions from Austraclear and the Depositary Nominee, interest and principal payments due on the underlying AGBs are paid from the Australian Government to the holders of the exchange-traded AGBs.
Potential Conversion to Physical Bonds
Investors should be aware that the Government at its sole discretion may convert the exchange-traded government bonds into physical government bonds. If this were to occur, then investors would continue to receive the same Coupon Interest Payment and maturity amounts they were entitled to, but would not be able to sell their investment on the ASX.
For example, the Government could decide to do this if its agreement with the ASX for trading bonds was terminated.
Australian Office of Financial Management (AOFM)
The AOFM is a specialist agency of the Treasury responsible for the management of all forms of Australian Government debt, including exchange-traded treasury bonds. Its primary role is debt management activities including the issue of debt securities such as Treasury Bonds, Treasury-Indexed Bonds and Notes. But it also undertakes financial risk management and compliance activities on behalf of the Government including managing funding risk, market risk, credit risk and operational risk.
Types of Commonwealth Government Securities
The Australian Government currently issues debt securities to the public in the form of Treasury Bonds, Treasury-Indexed Bonds and Treasury Notes.
- Treasury Bonds are medium to long-term debt securities that carry an annual rate of interest fixed over the life of the security, payable six-monthly. There are currently 17 bond issues on offer, and 13 of these lines have more than A$10 billion outstanding. Treasury Bonds are only issued in A$ as prescribed in Section 3A of the Commonwealth Inscribed Stock Act 1911.
- Treasury-Indexed Bonds are medium to long-term securities for which the capital value of the security is adjusted for movements in the Consumer Price Index (CPI). Interest is paid quarterly, at a fixed rate, on the adjusted capital value. At maturity, investors receive the adjusted capital value of the security, being the value adjusted for movement in the CPI over the life of the bond.
- Treasury Notes are short-term debt securities issued to assist with the Australian Government's within-year financing task. Treasury notes are not included as part of the exchange-traded government bond initiative.
In the past, the Australian Government has issued a range of other types of debt securities such as Australian Saving Bonds and Treasury Adjustable Rate Bonds. All debt securities issued by the Australian Government both now and in the past are collectively known as Commonwealth Government Securities.
Why Do We Need Exchange-Traded Treasury Bonds?
There are a number of reasons why we need exchange-traded treasury bonds.
- Their issue is part of a broad government initiative to develop a deep and liquid corporate bond market and promote Australia as a leading financial services hub. A vibrant corporate bond market provides a competitive medium to long-term funding source as an alternative to banks and equity markets, allowing issuers to reduce their financing costs and spread their funding risks.
- It will reduce Australia's reliance on offshore funding. The development of an exchange-traded CGS and corporate bond market will assist in mobilising domestic savings for investment in infrastructure and corporate expansion, and so reduce Australia's reliance on offshore markets for funding requirements. Retail CGS may also lead to increased foreign investment in Australia as it adds a further low-risk asset class.
- Exchange-traded treasury bonds will provide retail investors with a more visible pricing benchmark for investments they may wish to make in corporate bonds.
- It will encourage retail investors to diversify their savings through investments in fixed-income products like government and corporate bonds, thereby reducing the risk of retail investor wealth being heavily affected by sharp movements in equity and property prices.
- Treasury bonds provide higher-certainty income streams, which are attractive to self-managed superannuation funds in the pension stage.
Types of Exchange-Traded Treasury Bonds
There are two different types of exchange-traded AGBs:
Exchange-Traded Treasury Bonds (eTBs) are medium to long-term debt securities that carry an annual rate of interest fixed over the life of the security, payable every six months.
Exchange-Traded Treasury-Indexed Bonds (eTIBs) are medium to long-term debt securities for which the face value of the security is adjusted for movements in the Consumer Price Index (CPI). Interest is paid quarterly, at a fixed rate, on the adjusted face value. At maturity, investors receive the adjusted face value of the security - the value adjusted for movement in the CPI over the life of the bond (this final value is also known as the "nominal value").
The minimum investment holding of any Exchange-Traded TB will be one unit, which is equivalent to A$100 Face Value of the Treasury Bond over which the exchange-traded TB has been issued.
The minimum investment holding of any Exchange-Traded TIB will be one unit, which is equivalent to A$100 Face Value adjusted for movements in the CPI of the Treasury-Indexed Bond over which the exchange-traded TIB has been issued.
For more security detail please see Appendix 1.