KN Mutuals Wholesale Financing Seminar – Sydney
13 February 2019
Presented by Michael Bath – Head of Global Markets and Business Strategy, AOFM
Good afternoon everyone. I’d like to start my remarks by acknowledging the custodianship of the Gadigal people of the Eora Nation of the land on which we meet and to pay my respects to their elders, past, present and emerging.
I’d also like to take the opportunity to thank the organisers of this event, Kanganews, our hosts King and Wood Mallesons, and their co-sponsors Laminar Capital, Perpetual and S&P Global Ratings. In particular I’d like to congratulate Laminar Capital for recently celebrating its 10th birthday. When I think back to what we at the AOFM were doing 10 years ago, which included restarting the Government bond market after an extended hiatus and bedding down an intervention in the RMBS market that some in this audience will recall, it strikes me that there are probably few better ways to build a resilient business than to start it in such a crucible. I suspect it didn’t feel that way at the time, though.
Today I will provide an update of the work being done within government on the Australian Business Securitisation Fund, announced by the Treasurer in mid-November. The overarching objective of the Fund is to provide SMEs with improved access to finance, on more competitive terms.
The AOFM has been working with the Treasury, the agency that has had primary carriage for advising the Government on the Fund and related policy matters, during the Fund’s consultation and design phase. The Government released an exposure draft of the legislation it will use to establish the Fund, along with a draft investment mandate, on the 21st of December. The consultation on the draft legislation closed in mid-January and submissions have been considered. I’d like to thank the organisations and individuals who took the time to make a submission. The Bill was introduced to parliament this morning and while I won’t comment on the Bill’s journey from here, I will note that, regardless of the timing of its passage through parliament, the earliest the legislation provides for investment by the Fund is in July this year.
Treasury has led a wide ranging consultation process that has seen engagement not only with SME lenders operating in a variety of segments in the market, but with their financiers, including banks, other warehouse providers, and investors big and small, along with ratings agencies and other service providers to the industry. AOFM’s focus during this process has been to ensure that the model is workable and to assist Treasury to identify options and to help with the consideration of the implications of the various options. Discussing often-competing perspectives with market participants has also assisted the AOFM with its own deliberations with regards to how the Fund can be used to incentivise them to become aligned in developing the markets that finance SME lending in the long term. This process is ongoing, although we’ve moved from a ‘proof of concept’ stage to a stage in which more detailed investment objectives are able to be identified and developed.
It’s worth noting at this point that a key difference between the task at hand and the AOFM’s intervention in the RMBS market was that ten years ago we were simply ‘plugging a gap’ in the market – a market that had temporarily seized but which could be expected to recover as investors returned and the secondary market overhang dissipated. Indeed the steer I gave my colleagues at the time was that we wanted to avoid leaving a lasting legacy unless absolutely necessary, describing our approach as that of an ‘eco-tourist…taking only photographs and leaving only footprints’. This time, as they say in the classics, is different; the securitisation market for SME loans could best be described as ‘under construction.’
In making its deliberations regarding the best way to pursue government policy in this market, the AOFM interprets its mandate as investing in a manner that contributes to the development of the securitisation market so that securitisation can ultimately finance small business lending sustainably and without indefinite government support. The last part of my last sentence is important and highlights the need to develop an exit strategy early in the process.
In short, we see engaging with new investors as key to that exit strategy. It follows then that a priority has been, and will continue to be, to identify barriers to entry for new investors with a view to addressing these, while keeping existing investors engaged with the market. In other words, crowding out non-government investment activity would not be viewed as an indicator of success.
One important perspective we are seeking is that of the international investment community. To this end it gives me great pleasure to announce today that the AOFM has secured the secondment of Mr Neil Calder, Head of Credit Investment at the European Bank for Reconstruction and Development for three weeks next month. Mr Calder is very familiar with the Australian securitisation market and has been a close follower of other countries’ experiences with developing financing for SME lending via capital markets, including securitisation markets. He will be joining us next month for around three weeks to share his knowledge, both with the AOFM and with market participants.
For those of you who have had the chance to examine it, you will have noticed that the draft investment mandate is broad and the target rate of return is designed to balance financial return to Government with the desired policy outcome of supporting the market. The purpose of this is to provide the AOFM with flexibility, rather than to distort the market by injecting subsidy haphazardly.
As I mentioned, an important consideration is to ensure that existing investors remain engaged. Our experience with the RMBS intervention informs our view that we will need to operate in a manner that neither crowds them out nor allows them to extract excess returns at the expense of the intended recipient of any subsidy.
I note that the potential for subsidy to undermine rather than enhance the market’s development was raised by a number of submissions made during the consultation process on the Fund’s draft legislation. It will be important for the AOFM to reflect on these concerns in formulating its investment strategy.
For example, we may form the view that it makes sense to invest in a particular warehouse at certain points in the capital structure and that the fair market price would be a certain margin over a floating rate benchmark like BBSW. However we might be prepared to invest at a lower margin, having identified that in the long run the market infrastructure needs to adjust in a certain way that would remove barriers to entry for new investors and we might be prepared to contribute to the cost of making these adjustments via investing with a degree of subsidy. I make these comments not as a prediction of our behaviour but in order to highlight how our thinking on the task might unfold.
It is likely that the Government will expect to see a positive impact of the intervention, in the form of lower borrowing costs for SMEs. We see the primary driver of savings to be the increased scale that will be sponsored by additional capital being lent into this sector. Over what timeframe this may be achieved is a question that will need to remain open until the programme is in place.
It is fair to say that the AOFM will be seeking to closely monitor the impact of its investment decisions including the impact of any subsidy imparted via its investment activity. Treasury will also be monitoring the impact of the Fund’s investment activities.
I just mentioned the importance of achieving scale in driving cost savings. I would imagine that achieving the benefits of scale is a challenge faced by many in this room. Following my address I plan to join the audience in the hope that I can learn from the ideas discussed throughout this afternoon’s seminar.
In closing, the AOFM has learned a great deal about the current state of SME finance and has benefited from being a part of consultations that will inform its intervention in what is a complex, heterogeneous market. The AOFM is determined to ensure that any intervention that changes the market does so for the better and is mindful of the risks involved in investing in this space, both to the public balance sheet and to the existing market infrastructure.
Before taking some questions I’d like to take the opportunity to thank my colleagues in Treasury and the AOFM for their efforts on this project to date.
Last updated: 14 February 2019