The 1990’s have seen the Australian financial markets evolve and expand in ways that capitalised on the deregulatory reforms and technological advances of the 1980s to bring increased internationalisation and intensified competition.
Australia entered the 1990s with a larger, more vigorous and effective financial system than had been feasible in the pre-deregulation days of rigid controls that inhibited efficient allocation of funds.
During the early 90s financial markets grew in maturity with a focus on regulation and documentation of dealing, risk-management and control systems, behavioural standards and practices, servicing the customer, improving efficiencies and cutting costs.
Markets radically changed and developed during this period and along with technological developments and globalisation of local markets the diversified full service financial organisation offering the facilities of banking, investment, corporate and financial advisory, insurance, fund management and stockbroking evolved.
The maturing of the markets in the 1990s can be mapped by a number of significant events and trends.
- Considerable merger activity leading to providers of full financial services.
- Intensified competition in financial markets, leading to a contraction in margins and cost cutting.
- Return to high levels of profitability for financial service providers, emphasis placed on control of risks and return on capital.
- Increasingly strict prudential framework is now in place. A shift to coordinated supervision has occurred with the establishment of the Australian Prudential Regulation Authority (APRA) in 1998.
- Globalisation of financial markets. (Australian markets are now plugged into world markets 24 hours a day).
- RBA adopted a more open approach to monetary policy management, establishing an inflation target and a publicly announced cash-rate target. Having the central bank announce its target cash rate tended to reduce volatility in short-term interest rates.
- Higher profile for fund managers as they manage a rapidly growing pool of funds. Legislative changes to superannuation and the focus on the need to save for retirement by the retail investor have underpinned this increase.
- A contraction in government (commonwealth and state) borrowings and a series of privatisations led to a decline in the volume of securities they issued. As investors sought alternatives, vigorous growth was fuelled in corporate bonds, CPI-linked infrastructure bonds and mortgage/asset backed securities.
Australian fixed income markets have come along way over the last decade and today extend far beyond domestic horizons. Significant international investor interest, predominantly from Japan, Europe and the US has been a feature in $A securities since the early 90s.
The fixed interest market is not driven solely by domestic factors; the long end of the bond market in particular is vulnerable to overseas influences because Australian bonds compete with all others for a place in the portfolios of international investors. Australian bonds account for between 1 and 2 percent of the benchmark indices of major overseas investment banks.
The market in fixed income securities almost exclusively involves institutional and wholesale investors but there has been a growing participation from retail investors over the last few years as specialist retail brokers have entered the marketplace to capture this growing business.
In Australia the regulatory developments throughout the 90s has been rapid with the focus today on an integrated approach to prudential supervision and regulation.
In the early 90s as part of a move to ensure all financial institutions were adequately capitalised and supervised the Australian Financial Institutions Commission (AFIC) was established to lift standards of prudential supervision of building societies and credit unions.
In 1996 the federal government commissioned an inquiry into the financial system due to the relentless momentum of change and technological advances in electronic communications that continue to revolutionise how business is conducted.
An outcome of the findings of the committee of inquiry (Wallis committee) was further regulatory change, focusing on a balance of statutory and self regulation. Key reforms proposed and accepted by the federal government have seen the following three regulatory agencies established (the first two of these bodies are new agencies:
- Australian Prudential Regulation Authority: Has assumed responsibility for the prudential supervision of all banks, insurance companies and superannuation funds. It is intended to extend supervision to financial service companies including credit unions, building societies and friendly societies in the near future.
- Australian Corporations and Financial Services Commission: Primary functions of ensuring financial market integrity and consumer protection. In particular it has responsibility for ensuring retail investors who participate in the financial markets are treated fairly.
- Reserve Bank of Australia: Regulatory functions now involve two principal areas of responsibility. The first is the management of monetary policy and the second is maintenance of financial stability, including monitoring the payments system.
Within the financial markets, the growing emphasis on self-regulation has had clear expression in the growth of the Australian Financial Markets Association (AFMA). AFMA is the representative body of the over-the-counter financial markets whose work in devising a market code of conduct, standards of behaviour, strong framework of self discipline and dealer accreditation exam has done much to lift the profile of the financial markets.
Today and into the future, regulation of Australia’s financial markets can expected to be based on a co-regulatory approach aimed at facilitating the orderly and open operation of the market rather than formal prudential regulation.
The debt securities market is no different to any market where a buyer meets a seller and together they negotiate a price to exchange for a commodity and vice versa.
In the debt securities market, participants are dealing with money where the buyer of money (the borrower) negotiates with a seller of money (the investor) about the price (interest rate) at which the investor will lend money to the borrower. Generally, the borrower will offer some security to the investor to reduce risk. This security may be a guarantee from a bank or a charge over assets of the borrower.
Such guarantees by the Commonwealth and State Governments to repay loans of their borrowing authorities have made the debt securities saleable, thus greatly enhancing their attractiveness to investors.
In Australia there are two distinct segments of the debt market:
- Short-term money market
- Fixed interest market
These markets are linked together because the same group of people use both segments that form the Australian bond and money markets. Our bond and money markets are part of our financial market, or sector, whereby savings are channelled into investments via financial intermediaries or financial advisors.
Instruments traded in the financial markets are priced according to their rate of interest and term to maturity. Changes in either the interest rate or term to maturity will have a significant effect on the market value (price) of money market and fixed interest securities.
Debt instruments are priced in different ways depending on whether they are long-term or short-term instruments. Typical money market securities, such as Treasury notes, bills of exchange and promissory notes, are valued on a simple interest basis, whereas bonds with a term to maturity of six months or longer are valued using compound interest.
As the name suggests, this is the market for short-term money. Transactions for money occur on the basis of overnight through to one year.
Money makers can be identified by the following characteristics
- They are wholesale markets, ie. the market participants borrow or lend large sums of money. Trades are large and the people who make them are almost always dealing for the account of a substantial institution.
- Deposits are accepted for short-term periods and the financial instruments traded are also short term (usually less than 12 months).
- The markets are closely related to, and integrated with, other sectors of the financial system, particularly banking.
- Interest rates in these markets are extremely sensitive to changing monetary conditions and frequently lead other interest rates such as mortgage rates charges by banks to retail customers, overdraft (prime) rate charges to corporates, etc.
- The value of the turnover in deposits and financial instruments (ie. products traded) is high.
What instruments are traded?
Money market securities are often called instruments. The instruments traded include:
- Treasury notes (TN’s)
- Promissory notes (PN’s)
- Bank-accepted bills of exchange (BAB’s)
- Certificates of deposit (CDs and NCDs)
- Floating rate notes (FRN’s)
A cash transaction is the most simple form of transaction to take place in short-term money market. Cash is transacted on the basis overnight (11am call) or another determined fixed period.
Treasury Notes (TNs)
Treasury notes are short-term securities issued by the Commonwealth Government through the Reserve Bank of Australia (RBA). New issues have maturity periods of 5, 13 and 26 weeks and the minimum subscription is $100,000. They are issued by periodic (weekly) tenders and smooth fluctuations in liquidity requirements in the financial system.
Promissory Notes (PNs)
Promissory notes may be issued by Government and Semi-government authorities. Promissory notes are also issued by large corporations, eg. BHP Finance Ltd, Pacific Dunlop Ltd, etc. They are unsecured and hence they tend to be restricted to ‘top-name’ borrowers who have a sufficiently high credit rating established by either Moody’s or Standard and Poor’s Australia.
Bank-Accepted Bills of Exchange
For practical money-market purposes, a bill of exchange is a negotiable instrument, maturing within six months and sold at a discount to face value.
A bank’s name appears as the Acceptor of the bill which means the bank is liable to pay the amount of money due on the bill’s maturity to the Holder of the bill.
Hence, the market views these bills as first class bank credit. They therefore trade at the finest rates (lowest yields) in the market due to the perceived security associated with banks.
Bank-accepted bills are the most traded security in the short-term money market, with approximately $50billion (August 1999) of outstanding debt and daily turnover of in excess of $1,000billion.
Negotiable Certificates of Deposit (NCD)
Negotiable certificates of deposit are issued by banks for varying periods of time. They trade in the market place at yields similar to bank-accepted bills.
Floating Rate Notes (FRNs)
Many borrowers wish to have longer-term borrowing commitments but pay only short-term interest rates. This is why many borrowers are issuing Floating Rates Notes (FRNs). The borrower has longer-term committed funds at a floating (bank-bill based) rate while the investor achieves a return of bank bill plus an agreed margin. The interest rate on the FRNs is generally reset every 90 to 180 days at the prevailing rate. The term of FRN varies form one to five years from the date it is first drawn down.
How are Money Market Instruments Priced?
Short-term money market instruments, also known as discount or non-coupon securities, are issued at a discount to their face value on the assumption that the buyer will receive the face value when the securities mature.
The yield on a security refers to the rate of interest expressed as a percentage per annum on the amount outlaid when the instrument is bought. For example, a trader buying a note with a face value of $100,000 and a term of 90 days at a yield of 5.00 per cent would outlay $98,782.14. When the note matures the holder (who may or may not be the original buyer) would receive its face value, $100,000, so that the interest earned would be the $100,000 less the outlay of $98,782.14 = $1,217.86.