The Australian Securities & Investments Commission has warned consumers and financial advisers to be aware of the potential risks of hybrid securities before they invest.
Citing the volatility in equity markets, the regulator claims many investors are looking for alternative investments, including debt and fixed interest securities.
However, it warned that some of these alternatives need close scrutiny before the decision to invest is made.
“Retail investors may be attracted by the interest rates offered by household name companies and trusted brands, but hybrid securities should not be confused with government bonds or ‘vanilla’ corporate debt,” says ASIC Chairman Greg Medcraft.
“In some cases investors are taking on equity-like risks but only receiving bond-like returns.”
ASIC advises consumers and retail investors who are thinking about investing in a corporate hybrid security to compare offers, read and understand prospectuses, and pay particular attention to the risks.
“Investors need to understand the conditions of these offers, such as terms and conditions that allow the issuer to exit the deal or suspend interest payments, and long-term maturity dates of several decades,” said Medcraft.
“We want to ensure consumers are fully informed before they invest.”
Most hybrid securities are likely to be sold or recommended to consumers by brokers or financial advisers and the ASIC pronouncement is likely to put extra pressure on intermediaries to fully explain complex investment products to investors.
Specifically, the regulator wants gatekeepers to get into the detail of how the interest rate compares with other investments on a ‘risk adjusted’ basis and whether other less complex, less risky or short-term investments can provide a similar or better return.
“While trading the security on a secondary market such as the ASX may offer investors a way to exit the investment (assuming the market is liquid and there is demand for the securities), some hybrids have investment terms lasting several decades,” said ASIC in a statement.
“For example, with a 60-year term, a 40 year old investing today would need to live to 100 to see their investment mature.
“Furthermore, the risk of a company defaulting on its obligations, or eventually running into financial difficulties, increases over the long-term. Investors in some hybrid securities take on these unpredictable long-term business risks.”
In a recent presentation, “Bad Practice – the complaints that come to ASIC and our expectations for how you fix & prevent them”, delivered at the Financial Planning Association Conference, ASIC’s Delia Rickard told delegates that trust was the key underpinning of a healthy industry.
Advice involving complex products is currently a key focus for the regulator.
According to Rickard, recurring problems include: misallocation of assets relative to the client’s time horizon or psychological risk profile; loss of valuable features when switching products; inappropriate leverage such as excessive margin lending; strategies that ignore cash flow; and the use of complex or sophisticated products that the client doesn’t understand and which don’t match the client’s needs.
“Where we see practical and effective risk management systems in place that identify and analyse problems and prevent recurrences then our regulatory response will be much more consultative and light touch,” she said.
“We understand that mistakes happen but when we then see you identify the root cause and fix that problem it gives us comfort that the licensee can manage the issue itself.
“Where we have no such comfort the consequences for the licensee can be significant with resulting reputational damage for the licensee and, unfortunately, a further dent in confidence for the sector more broadly.”
