First State Super is responding to a shake-up in international banking reforms by putting its capital to work in new ways. Something fixed-income experts tip more super funds to do in the years ahead.
The next wave of global banking reforms – notably Basel IV, plus changes to Dodd-Frank, and Glass-Steagall – is set to reshape bank balance sheets once again, with flow-on effects in fixed-income markets that will create opportunities for non-traditional lenders.
Aberdeen Asset Management head of fixed-income Nick Bishop says new rules like Basel IV will make it even harder for banks worldwide to maintain liquidity. This means major Australian banks will increasingly be looking to buy (highly rated) instruments from other institutions. These non-traditional lenders to the banks include the world’s largest pension funds, sovereign wealth funds and endowments, and local super funds.
This will reshape risks across the capital structure of institutional lenders.
One trend witnessed by National Australia Bank head of hybrid and capital structured origination, Nicholas Chaplin, is greater syndication and more involvement from institutions in the loan process.
“Better liquidity would be a great thing, as corporate Australia is light years behind overseas counterparts,” Chaplin says. “For example, Australia’s over-the-counter bond market does not pass muster with European regulators.”
Moving down the risk spectrum
First State Super head of implementation, Michael Clavin, admits that not being deemed to have high-quality liquid assets causes issues with lending.
“Illiquidity of markets in general is why we got the treasury team to look at where we can take illiquidity risk and get paid for it.”
What’s also playing out, Chaplin adds, is the unintended consequences of other institutional investors filling the lending void left by banks.
“But underwhelming returns, compared with expectations, further encourage people to [take on less risk],” he says.
He says some positives from this new regulatory landscape include expanded access to credit, more investment opportunities outside of banks – which should enhance investors’ returns through credit and illiquidity premia – plus, portfolio diversification through access to corporations not present in the bond market.
But he says the downsides include a lack of the sophisticated risk modelling and systems seen in traditional banking, which could lead to mispriced lending.
“Lack of standards could lead to defaults and delinquencies, with less capital put aside for when things go wrong,” Chaplin explains.
First State Super innovates
As an asset owner, First State Super quickly recognised that, because a new regulatory environment made it harder for banks to use their balance sheets, it presented good opportunities for the fund. These included private loans in Europe and the US that have replaced large allocations to First State Super’s traditional fixed-income portfolios.
“We started to look at what regulatory changes mean for banks locally in the short-term and cash space,” Clavin says. “We’re also working with the treasuries of banks to understand what these rules mean for their funding, and bringing solutions to the table that are mutually beneficial.”
In the context of ongoing regulation, professor Kevin Davis from the Australian Centre for Financial Studies wouldn’t be surprised if Basel IV fell apart as the global cohesion around it disappears.
“When you look at what’s happened with Basel III and IV, they’re moving away from risk-sensitivity and less complexity from the big-bank advanced approach,” Davis says. The question, he explains, is why do we need to level the playing field worldwide if the internal ratings-based approach is being applied only in domestic markets?
In Australia, he expects regulatory developments, plus the Australian Prudential Regulation Authority’s recent guidance, to improve the position of smaller banks and authorised deposit-taking institutions relative to big banks.
“What’s particularly interesting for fixed-income managers is the regrowth of bank securitisation for risk transfer and funding purposes, and institutional participation in syndicated lending,” Davis says. “There are lots of opportunities for fixed-income managers to push funds, through platforms, into credit areas that haven’t been seen as important.”
This article is based on a panel at the 2017 Investment Magazine Fixed Income, Cash and Currency Forum, held in Healesville, VIC, on July 25-26. The session was chaired by Australian Financial Review contributing editor Christopher Joye and was titled, ‘The effect of regulation on fixed-income markets’.
