On 25 June 2010, the Australian Securities and Investments Commission (ASIC) released new disclosure requirements for unlisted debentures and unsecured notes. The requirements are set out in an updated version of Regulatory Guide 69, Debentures and unsecured notes: Improving disclosure for retail investors (RG69) and Regulatory Guide 156, Advertising of debentures and unsecured notes (RG156).

The changes were made by ASIC following industry consultation in response to Consultation Paper 123 debentures: strengthening the disclosure benchmarks, on which McCullough Robertson made submissions.

Who does RG69 and RG156 apply to?

Principally, RG69 applies to issuers of debt securities, referred to in RG69 as ‘notes’ which includes, debentures which have been secured by a charge in favour of a trustee over tangible property of the issuer and other debt securities referred to as unsecured notes. RG69 does not apply to notes that are listed or intended to be listed on a financial market or are convertible into listed securities at the discretion of the investor. RG69 requires issuers of unlisted notes to report against eight benchmarks on an ‘if not, why not’ basis.

RG69 also provides guidance to the following persons involved in the issue of unlisted notes:

• trustees
• auditors, and
• valuers.

RG156 prescribes certain advertising standards which must be complied with by issuers of notes as well as publishers and members of the media who play a role in promoting notes.

Why have the changes been made?

Over the past two years, ASIC has commenced a number of high profile proceedings against persons involved in issuing unlisted notes, including the Westpoint and Fincorp cases, which both involved the issuing of unlisted notes in order to fund property development projects. In these cases, ASIC brought proceedings against:

• the issuer of the notes
• directors of the issuer
• the trustee of the notes
• the auditor of the issuer, and
• financial advisers who recommended that their clients invest in the notes.

RG69 states that the purpose of developing the benchmarks is to assist investors understand the risks, assess the rewards being offered and decide whether investing in unlisted notes is suitable for them.

When do the changes take effect?

The changes made to RG69 apply to any new disclosure document issued on or after 1 September 2010.

What changes have been made?

Set out below is a summary of the changes which have been made to RG69 and RG156.

Equity ratio

All issuers will be required to disclose their equity ratio for the current and the prior year which must be calculated as follows:

ASIC has abandoned its initial proposal that all related party loans be deducted in the calculation of the equity ratio.

Liquidity

RG69 requires all issuers of unlisted notes to:

• have cashflow estimates for the next three months, and
• ensure that at all times they have cash or cash equivalents sufficient to meet their projected cashflow needs over the next three months.

When reporting against the liquidity benchmark, all issuers must disclose:

• material assumptions underlying their cashflow estimates
• how their rollover or retention rate assumptions relate to historical rates, and
• their policy on balancing the maturity of their cash or cash assets against maturity dates of their liabilities.

Issuers must disclose whether they have cash on hand or cash equivalents sufficient to meet their projected cashflow needs if:

• the percentage of note funds to be rolled over during the next three months were 20% less than the percentage that was rolled over in the past three months, or
• for note funds that are held on an ‘at call’ basis - the amount of note funds retained during the next three months were 20% less than the amount that was retained during the past three months.

Issuers are only required to disclose whether they comply with these benchmarks. If they do not comply, then they must explain why. However, it is clearly intended by ASIC that issuers will adopt reasonable assumptions (perhaps historically based) and will monitor their assumptions against ‘actuals’. Stress testing assumptions are advocated by ASIC to have regard for impacting circumstances. By implication, any adverse liquidity position encountered or expected would need disclosure. It does not appear that the actual cashflow projections need to be disclosed in a prospectus.

Credit ratings

The most controversial change proposed to RG69 was the proposal that issuers obtain a credit rating from a recognised credit agency.

With effect from 1 January 2010, ASIC withdrew class order relief which previously exempted credit rating agencies from the need to obtain an Australian financial services licence in order to issue credit ratings in relation to securities offered to retail and wholesale clients. In response, the major credit rating agencies such as Standard & Poor’s, Moody’s, A.M. Best and Fitch exited the retail credit rating market and now only provide credit ratings in relation to securities offered to wholesale clients.

In recognition of this, ASIC has abandoned its proposal that all issuers of unlisted notes obtain a credit rating.

Rollovers

All issuers will be required to disclose their approach to rollovers, including:

• what process is followed at the end of the investment term, and
• how they inform those rolling over or making further investments of any current prospectus and continuous disclosure requirements.

Expectedly, circumstances where ‘automatic’ rollovers occur will be explained in the prospectus as well as ‘automatic’ notification to investors where a rollover has occurred. Use of a website where the prospectus can be accessed is another desired feature contemplated by this benchmark.

Debt maturity

Issuers need to disclose:

• their analysis of the maturity profile of interest bearing liabilities (including notes on issue) by term and value; and
• the interest rates, or average interest rates, applicable to their debts.

Compliance could be addressed by a ‘liability calendar’ which progressively shows payment obligations based on dates. By implication, ASIC expects this would be historically based for past issuers. Clearly the intention is to assist investors in aligning information disclosed in compliance with the liquidity benchmark with disclosure on debt maturity periods. However, the comparison will not be easy (unless extra information is included) because the timeframe for liquidity disclosure (three months) does not necessarily extend to the full maturity period of liabilities under the debt maturity benchmark.

The remaining benchmarks of Loan Portfolio, Related Party Transactions, Valuation and Lending Principles have not been subject to material changes but are mentioned (with changes) for the sake of completeness.

Loan portfolio

RG69 requires issuers who on lend funds or indirectly on lend funds through a related party to disclose certain information in relation to the composition of their loan portfolio.

Changes to RG69 include the requirement to disclose the following information in relation to loan portfolios:

• interest rates or average interest rates applicable to assets
• an analysis of the number of loans, value of loans, value of principal and interest of loans that are more than 30 days in arrears and renegotiated loans, and
• by number, value and percentage, what loans are subject to legal proceedings, which has been defined in RG69 as ‘a proceeding in a Court to recover a payment due under loan, or taking possession of property under a mortgage or taking any other action to enforce a mortgage.’

Related Party Transactions

Disclosure requirements under this benchmark affects only those issuers who make related party loans. These issuers have to disclose:

• how many loans have been made to related parties
• the value of those loans
• the value of those loans as a percentage of total assets
• the assessment and approval process followed when loans are made, varied or extended, and
• the related party lending policy adopted by the issuer (covering matters such as interest rates, security and loan to valuation ratios).

Valuations

ASIC abandoned its proposal to require issuers of unlisted notes to disclose the ‘forced sale’ value of a property secured against more than 5% of the total property assets. The proposal to require development properties to be revalued at least every 12 months has been included in the changes to RG69, however an exception will apply if funds are advanced to the borrower in stages in order to cover project completion costs.

Lending principles

Where an issuer directly or indirectly on lends money in relation to property related activities, RG69 requires it to maintain the following loan to value ratios:

• where the loan relates to property development - 70% on the basis of the latest ‘complying valuation’, and
• in all other cases - 80% on the basis of the latest ‘complying valuation’.

ASIC has abandoned its proposal that all property development loans must be valued in accordance with the first point above. ASIC has clarified that an issuer may rely upon a valuation that complies with either the first point above or a value ascribed to a property (for example capital improved value) in a municipal rates valuation.

Disclosure of benchmarks in prospectus

Changes to RG69 provide that reporting against the benchmark disclosure must be clear, concise and effective and prominently disclosed.

When a product can be called a debenture

From 1 July 2011, ASIC will no longer permit a product to be called a debenture if the issuer’s obligation to repay money to investors is not secured by a charge over tangible property. ASIC considers tangible property to be property that has ‘an actual physical existence, for example, goods and land’. Tangible property is distinguishable from intangible property such as debt.

Advertising standards

ASIC has also made some consequential amendments to RG156. These changes include the following requirements for advertising unlisted notes:

• any advertisement for notes that are offered to retail investors should contain prominent disclosure that investors risk losing some or all of their principal investment
• products must not be compared favourably to a bank deposit and advertisements should not suggest that there is little or no risk of the investor losing the principal or not being paid interest
• terms such as ‘secured’, ‘guaranteed’, ‘safe’ and ‘deposit’ should be avoided in advertisements
• advertisements for notes should not state or imply that investments are suitable for a particular class of investors (for example, ‘this product is suitable for a conservator investor’ or ‘this product is suitable for self managed super funds’)
• statements in note advertisements should be consistent with all corresponding disclosure in the prospectus, and
• issuers of notes should be aware that statements made over the telephone or in any correspondence in respect to notes will be subject to the misleading and deceptive conduct prohibitions.

What are ASIC’s expectations of trustees, auditors and valuers?

Trustees

ASIC expects that the trustee’s role of exercising reasonable diligence will embrace monitoring the issuer’s ability to repay debt securities. Impliedly, this, in ASIC’s view:

• would entail the trustee making a judgment on the reasonableness of assumptions used for benchmark disclosure and monitoring actual outcomes, such as actual cashflow received in a period, against the issuer’s expectations in the assumptions, and
• making enquiries if benchmark information disclosed materially deteriorated from the actual position.

Overall, ASIC expects trustees to monitor the issuer’s financial position and performance using benchmark information, quarterly, half yearly and yearly reports on the issuer and to, at least quarterly, formally review the issuer’s financial position and performance.

Auditors

ASIC expects that the issuer’s scope of engagement of an auditor will require audit coverage on the benchmark disclosure (which by implication would centre on achievement or non achievement) having regard to the issuer’s quarterly reports to the trustee, continuous disclosure notices and relevant disclosure documents.

Valuers

ASIC expects that valuers will be appropriately registered and that their valuation reports will warrant:

• compliance with all relevant industry standards and codes, and
• that their valuation has been independently prepared and that the valuer is not aware of any conflict of interest that a reasonable person would conclude is capable of affecting the valuation.

How should you comply?

Issuers of unlisted notes are not required to comply with each of the benchmarks contained in RG69. However, if an issuer does not comply, it must disclose to investors that it does not comply with the benchmark and explain why it does not comply and how it addresses the benchmark in another way.

Updated benchmark disclosure should be contained in continuous disclosure notices, quarterly reports and prospectuses issued on or after 1 September 2010. Issuers with a prospectus in circulation as at 1 September 2010 should consider addressing the benchmarks by way of a supplementary or replacement prospectus.

McCullough Robertson represents a number of unlisted note issuers including general business issuers and businesses involved in on lending activities and property development. Accordingly, we can assist you in ensuring that you are complying with the new requirements of RG69 and RG156.

Further information

For further assistance or enquiries please contact:

Sean Robertson on 07 3233 8860
Tony Stumm on 07 3233 8885
Diana Lohrisch on 07 3233 8845
Tim Wiedman on 07 3233 8716
Brendan Leighton on 07 3233 8985.