ASIC RG 69 — ASIC Regulatory Guide – RG 69 Debentures and notes: Improving disclosure for retail investors

Page 1 REGULATORY GUIDE 69 Debentures and notes: Improving disclosure for retail investors February 2012 About this guide This guide is for issuers and others involved with the issue of mortgage debentures, debentures, secured notes, and unsecured notes or unsecured deposit notes. It sets out our guidelines for disclosure to retail investors to help them understand and assess unlisted debentures and notes, while maintaining the flexibility of the public fundraising process. It also provides guidance on how debentures and notes may be described. Note: See also Regulatory Guide 156 Advertising of debentures and notes to retail investors (RG 156). Page 2 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 2 About ASIC regulatory documents In administering legislation ASIC issues the following types of regulatory documents. Consultation papers: seek feedback from stakeholders on matters ASIC is considering, such as proposed relief or proposed regulatory guidance. Regulatory guides: give guidance to regulated entities by:  explaining when and how ASIC will exercise specific powers under legislation (primarily the Corporations Act)  explaining how ASIC interprets the law  describing the principles underlying ASIC’s approach  giving practical guidance (e.g. describing the steps of a process such as applying for a licence or giving practical examples of how regulated entities may decide to meet their obligations). Information sheets: provide concise guidance on a specific process or compliance issue or an overview of detailed guidance. Reports: describe ASIC compliance or relief activity or the results of a research project. Document history This version was issued in February 2012 and is based on legislation and regulations as at that date. In July 2022 we updated references to Class Order [CO 12/1482] When debentures can be called secured notes to ASIC Corporations (Describing Debentures—Secured Notes) Instrument 2022/61 because [CO 12/1482] was reviewed as part of the sunsetting of legislative instruments under the Legislative Instruments Act 2003; updated references to Regulatory Guide 99 Quotation of securities offered by prospectus (s1031) to Regulatory Guide 254 Offering securities under a disclosure document, as in March 2016 we consolidated seven regulatory guides relating to disclosure documents into Regulatory Guide 254; removed outdated references to a no- action position that preceded [CO 12/1482]; and removed outdated references to updates to the investor guide Investing in unlisted debentures and unsecured notes?. Previous versions:  Superseded Regulatory Guide 69, issued October 2007, reissued August 2008 and June 2010 Disclaimer This guide does not constitute legal advice. We encourage you to seek your own professional advice to find out how the Corporations Act and other applicable laws apply to you, as it is your responsibility to determine your obligations. Examples in this guide are purely for illustration; they are not exhaustive and are not intended to impose or imply particular rules or requirements. Page 3 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 3 Contents A Overview ........................................................................................... 4 Who this guide applies to................................................................... 4 Improving disclosure to retail investors ............................................. 5 Benchmarks for unlisted notes .......................................................... 6 Other participants involved with unlisted notes ................................. 7 Underlying principles ......................................................................... 7 B The unlisted note sector ................................................................. 9 Business models and activities .......................................................... 9 Risks to investors ............................................................................. 10 C Benchmarks for unlisted notes .................................................... 13 Benchmark 1: Equity ratio................................................................ 13 Benchmark 2: Liquidity .................................................................... 14 Benchmark 3: Rollovers ................................................................... 16 Benchmark 4: Debt maturity ............................................................ 16 Benchmark 5: Loan portfolio ............................................................ 17 Benchmark 6: Related party transactions ........................................ 19 Benchmark 7: Valuations ................................................................. 20 Benchmark 8: Lending principles—Loan-to-valuation ratios ........... 21 D Form and method of disclosure ................................................... 23 Disclosure obligations ...................................................................... 23 Disclosure against the benchmarks: ‘If not, why not’ ...................... 24 Disclosure in a prospectus............................................................... 25 Ongoing disclosure .......................................................................... 27 E Trustees of issues ......................................................................... 31 The trustee’s role ............................................................................. 31 Monitoring disclosure against the benchmarks ............................... 31 Underlying principles ....................................................................... 32 F Auditors and valuers ..................................................................... 34 Auditors ............................................................................................ 34 Valuers ............................................................................................. 35 G Naming of debentures ................................................................... 36 The categories of debentures .......................................................... 36 Conditions to the use of the term ‘secured note’ ............................. 38 The concept of ‘sufficiency of property’ ........................................... 40 Branding of products ........................................................................ 41 Key terms ............................................................................................... 43 Related information ............................................................................... 45 Page 4 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 4 A Overview Key points This guide applies to issuers of unlisted ‘mortgage debentures’, ‘debentures’, ‘secured notes’, and ‘unsecured notes’ or ‘unsecured deposit notes’: see RG 69.1–RG 69.3. The risk features of notes and their appeal to ordinary retail investors require an improved approach to disclosure: see RG 69.4–RG 69.6. ASIC has developed eight benchmarks that can help investors understand the risks, assess the rewards being offered and decide whether these investments are suitable for them: see RG 69.7–RG 69.8. An issuer of unlisted notes should address the benchmarks in its disclosures on an ‘if not, why not’ basis, and ensure that their advertising is consistent with these disclosures: see RG 69.9–RG 69.10. Those parties involved with issuers (e.g. trustees, auditors and valuers) should use the benchmarks and the ‘if not, why not’ explanations in carrying out their responsibilities: see RG 69.11. This guide also provides guidance to all issuers of notes (whether listed or unlisted) on how these products may be described consistently with s283BH of the Corporations Act 2001 (Corporations Act): see RG 69.2. Who this guide applies to RG 69.1 This guide applies to issuers of unlisted ‘mortgage debentures’, ‘debentures’, ‘secured notes’, and ‘unsecured notes’ or ‘unsecured deposit notes’. These products are interchangeably referred to as ‘notes’ in this guide. Note: See s283BH of the Corporations Act, ASIC Corporations (Describing Debentures—Secured Notes) Instrument 2022/61 and Section G of this guide for information on how these products may be described. RG 69.2 We expect issuers of unlisted notes to follow the guidance and expectations in this guide. We expect issuers of listed notes to follow the guidance on the naming of notes set out in Section G. RG 69.3 Apart from Section G, this guide does not apply to: (a) issuers of notes that were not required to follow the guidance when RG 69 was first introduced in October 2007; (b) initial public offerings under a prospectus that states that the offered notes are to be quoted on a financial market. This guide will apply, however, if that prospectus is varied by a supplementary or replacement Page 5 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 5 prospectus indicating withdrawal of the intention to quote the notes on a financial market. For further information, see Regulatory Guide 254 Offering securities under a disclosure document (RG 254) and s723(3) of the Corporations Act; or (c) any notes that are convertible into listed securities at the discretion of the investors. Improving disclosure to retail investors RG 69.4 Notes held by retail investors are used as a source of finance for a range of business models and activities. With notes, the investor provides loan funds to the issuer, and in return the person borrowing the funds (the issuer) issues a note with a promise to pay a rate of interest (usually fixed) for a defined term, and then repay the loan. RG 69.5 Some features and risks common to notes and their issuers can create risks for investors. This is particularly the case for notes that are not quoted on a public market (‘unlisted’ notes): see Section B. A lack of clear benchmarks can also make it hard for investors to adequately understand, assess and compare these securities. RG 69.6 We have identified four guiding principles for improved disclosure by issuers of unlisted notes, which are designed to provide for better risk assessment by retail investors: see Table 1. These principles are the foundation for our approach in this guide. Table 1: Guiding principles for improved disclosure on unlisted notes What the principle is Related information Principle 1: Benchmarks can help retail investors assess the risk and risk−reward prospects of notes. See Section C of this guide. Principle 2: Issuers of unlisted notes should disclose against the benchmarks on an ‘if not, why not’ basis, and ensure that their advertising is consistent with these disclosures. See Section D of this guide and Regulatory Guide 156 Advertising of debentures and notes to retail investors (RG 156). Principle 3: Those parties involved with issuers (e.g. trustees, auditors and valuers) should use the benchmarks and the ‘if not, why not’ explanations in carrying out their responsibilities. See Sections E–F of this guide. Principle 4: Additional education will assist investors and potential investors in the unlisted note sector, including by helping them understand and use the benchmarks and the ‘if not, why not’ responses in their investment decision making. See our investor guide, Investing in unlisted debentures and unsecured notes? Page 6 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 6 Benchmarks for unlisted notes RG 69.7 We have developed eight benchmarks that apply to unlisted notes: see Table 2 and Section C. Some benchmarks apply to all issuers; others apply only to certain issuers. We expect issuers to disclose against the benchmarks (as applicable) on an ‘if not, why not’ basis: see RG 69.9–RG 69.10. We also expect any advertising to support the use of these benchmarks: see RG 156. RG 69.8 Failing to meet one or more of these benchmarks does not mean that a particular note is necessarily a poor investmenthowever, additional disclosure to investors will be needed to address that benchmark on an ‘if not, why not’ basis so that investors can assess its impact on their investment decision. Table 2: Benchmarks for unlisted notes General benchmarks for all issuers of unlisted notes 1 Equity ratio Benchmarks 1 and 2 address the issuer’s financial structure and ability to meet loan obligations on time. 2 Liquidity 3 Rollovers Benchmark 3 addresses the transparency of the issuer’s approach to ‘rollovers’ of investments. 4 Debt maturity Benchmark 4 addresses the debt maturity profile of the issuer and associated interest rates. Additional benchmarks for lenders 5 Loan portfolio Benchmark 5 addresses the issuer’s lending practices. 6 Related party transactions Benchmark 6 addresses a specific area of lending risk. Additional benchmarks for property-related notes 7 Valuations Benchmark 7 addresses the issuer’s property-related practices. 8 Lending principles Loan-to-valuation ratios Benchmark 8 addresses the issuer’s property-related practices. Disclosure against the benchmarks: ‘If not, why not’ RG 69.9 Issuers of unlisted notes should disclose against the benchmarks on an ‘if not, why not’ basis: see Section D. This means stating that the issuer and product either: (a) meet the benchmark; or (b) do not meet the benchmark and explaining how and why the issuer deals with the business factors or issues underlying the benchmark in another way. RG 69.10 Disclosure against the benchmarks should be: (a) addressed up-front in the prospectus; Page 7 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 7 (b) updated in ongoing disclosure as material changes occurfor example: (i) in a replacement prospectus, supplementary prospectus or continuous disclosure notice; and (ii) at least twice a year, in quarterly reports to trustees; and (c) supported in, and not undermined by, advertising material. Other participants involved with unlisted notes RG 69.11 We expect other parties involved with issues of unlisted notes to support the guiding principles in Table 1: see Sections E–F. This includes trustees, auditors and valuers. Underlying principles RG 69.12 The disclosure framework in the Corporations Act requires issuers of financial products who seek retail investors to: (a) disclose up-front to these investors all they need to know to make prudent decisions in their own interest; and (b) provide ongoing disclosure to help retail investors monitor whether their expectations are being met. Note: For notes, the framework provides an additional safeguard by requiring that there be a trustee for note holders: see Section E. RG 69.13 In recent years, there have been a number of market failures in the note sector, including unlisted notes. If the funds invested in failed unlisted notes were raised in professional markets or provided by professional investors, their commercial failure would be of less concern to ASIC or the broader community. In an open economy, such as that in Australia, business failure is accepted as an inevitable result of a competitive environment. RG 69.14 What is of concern is the combination of the risk features of these types of investments (see Section B) and their appeal to ordinary retail investors. RG 69.15 The regulatory framework places special emphasis on the needs of retail investors, and makes disclosure the key tool for them. Disclosure is not designed to stop retail investors from taking investment risks, but to help them understand the risks involved in any particular investment or type of investment. This enables them to make an informed decision about whether the potential reward (the return on their investment) matches the level of risk involved, and whether they are prepared to take on that risk. Page 8 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 8 RG 69.16 This assessment is particularly important and difficult if investors need to consider not only underperformance risk (the risk that an investment will not produce returns as high as expected), but also the risk of significant or total loss of the original investment funds. For notes, typically the return is fixed because the issuer promises to pay interest on the loan at a fixed rate. Therefore, the issuer’s ability to repay the funds lent (credit risk) is usually the most critical risk. RG 69.17 We believe that our approach balances: (a) the need to improve disclosure to allow investors to make informed decisions; and (b) the desirability of not unduly interfering with this market as a market for raising capital. Note: The need to strike an appropriate balance between protecting investors’ interests and allowing markets to operate freely is part of ASIC’s mandate under the Australian Securities and Investments Commission Act 2001 (ASIC Act). RG 69.18 Our approach cannot prevent investments failing, nor ensure that they perform to investors’ expectations. However, better disclosure can help investors make better risk–reward decisions. RG 69.19 Our approach should not result in longer disclosures. Recent experience shows that investors need better quality and relevant disclosure, presented in a way best suited to investor understanding. Page 9 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 9 B The unlisted note sector Key points Notes held by retail investors are used as a source of finance for a range of business models and activities: see RG 69.20–RG 69.21. Some features of unlisted notes and their issuers can create risks for investors, and a lack of clear benchmarks can make it hard for investors to adequately understand and assess these products: see RG 69.22–RG 69.30. Business models and activities RG 69.20 Capital markets provide funds to enable companies in the real economy to innovate and take commercial risks without certainty of return. RG 69.21 Notes held by retail investors are used as a source of finance for a range of business models and activities, and have been part of capital markets for a long time. Uses of capital raised in this way include: (a) debt capital funding—money raised and applied as working capital or transaction-specific funding to further the issuer or group’s business operations; (b) finance—lending for personal and general commercial purposes; (c) integrated property—funding of property transactions and development within a group or with related parties where that amount of funds applied is greater than 10% of the total assets of the note issuer; (d) mortgage financing—secured mortgage lending for residential and commercial property ownership and improvement, with security over real property; (e) structured real estate investments—participation in ownership of commercial and residential real estate as part of a wider ownership structure; and (f) memberships—notes issued to facilitate membership of clubs, groups or franchise operations. Page 10 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 10 Risks to investors RG 69.22 In recent years, there have been a number of market failures in the note sector, including unlisted notes. A large number of investors have faced potential losses of significant amounts of money. RG 69.23 We have analysed the common features of those failures. This analysis has identified the key features and risks common to those failed entities: see Table 3. These features are not present in every issue of notes to retail investors. The investment risks described will vary from issuer to issuer and from business model to business model. However, disclosure about these features and risks, including to what extent they are present in a given offering, is desirable for a broad range of notes. Table 3: Common risk features of unlisted notes Risk feature Description What this means Minimal equity capital The note issuer frequently has little equity capital relative to the loan funding it relies on to operate its business (loan funds include both funds borrowed from a lending institution and funds contributed by note holders). The owners of the entity that issues the notes have little capital at risk compared to note holders and other lenders. This arguably means they have less incentive to ensure the prudent management of the business, and also that their interests and those of note holders are not well aligned. If an investment runs into difficulties, there is no source of funds to tide the investment over, other than by raising further investment funds. Liquidity The liquidity of the issuer is key to its ability to meet its obligations to pay interest and principal to note holders on time. Liquidity is often at risk because of a mismatch between the timing of the issuer’s obligations to repay note holders, and the timing of cash flows from the underlying businesses or assets to which funds have been on- lent. Liquidity is frequently heavily dependent on continuing inflows from new investors, or ‘rollovers’ by existing investors. This problem is exacerbated if inadequate disclosure in a prospectus leads to ASIC halting further fundraising by issuing a stop order. The issuer can then no longer rely on an inflow of funds from new investors. This may worsen its liquidity and in extreme cases threaten its solvency. Loan assessment and diversification The criteria issuers use to decide what loans to make are extremely variable and prone to risk, especially in the following key areas:  loan-to-valuation ratios are often much higher than for traditional lending; and  the loans issuers make may be highly concentrated to particular types of assets, commercial activities, locations or borrowers. In many cases, the note issuer’s loan book exposure is not diversified. Lack of diversification means there is greater risk that an adverse event affecting one borrower or one type of loan will simultaneously affect the majority of borrowers, and therefore put the overall portfolio at risk. Page 11 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 11 Risk feature Description What this means Inconsistency in valuations The valuations lenders rely on are carried out on a variety of bases, with differing assumptions and instructions. This makes it difficult to assess reliably the risk exposure associated with a loan, and difficult to monitor loan-to-valuation ratios on a continuing basis. Related party lending Funds raised through notes are often on-lent to companies or businesses associated with the note issuer. There is an increased risk that lending decisions will not be made on arm’s-length commercial terms, and that the note issuer who makes the loans will not monitor performance by the borrower as rigorously as it would in an arm’s-length transaction. Misleading advertising Advertising used to promote some notes helps create unrealistic expectations about the relative safety of the notes. Even if the prospectus disclosure highlights risk in an appropriate way, advertising that conveys messages not in line with the regulated disclosure document can undermine the effect of that disclosure. RG 69.24 Unlisted notes pose particular challenges because retail investors who hold these types of securities do not have the benefit of price discovery mechanisms and market forces to: (a) help them work out the value of their securities on an ongoing basis; (b) monitor and publicise the ongoing performance of the issuer (through a licensed market’s continuous disclosure regime); and (c) provide them with a reliable way to exit their investment efficiently. RG 69.25 Being unlisted means there is no liquid secondary market on which an investor can sell an investment that is no longer required, or in which the investor has lost confidence. Some note issuers offer early exit mechanisms, but these are likely to be unavailable if the issuer is in financial difficulty. RG 69.26 Being unlisted also means that there is no market supervisor to: (a) initially assess and, if appropriate, admit the issuer’s securities to trading; and (b) supervise the issuer’s ongoing compliance with any listing rulesin particular, a continuous disclosure regime. RG 69.27 The absence of a market listing exacerbates the risk that key new information about the performance of the issuer may not be communicated to existing investors. This is of particular concern given that the Corporations Act does not require that existing investors receive a prospectus before rolling over their investment or making a further investment in the issuer’s notes: see s708(14) and RG 69.45. RG 69.28 Typically, there are few external benchmarks retail investors can use to assess and understand the risk of the investment, and the value of the notes they may subscribe for. In particular: (a) retail investors cannot obtain and rely on research prepared by market professionals (such as analysts) or the coverage the financial media provides for many listed securities; Page 12 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 12 (b) few retail adviser groups conduct detailed research on individual note products; and (c) retail investors do not have a way of assessing the market value of their investment, and of monitoring the ongoing performance of the issuer, as reliably as they would have if these products were listed and traded on a regulated financial market (and were therefore subject to the relevant supervision and continuous disclosure regime). RG 69.29 Risks are most significant where funds are on-lent for the development of property assets. Reasons include that there is often no cash flow to meet obligations until after a development has been completed and can be sold. In these circumstances, there is likely to be greater uncertainty about whether properties can be completed and sold for anticipated values; and if further loan investments are needed to complete development projects, the overall viability of the venture may be doubtful because interest costs for the project will increase. RG 69.30 Nonetheless, the features described in Table 3 are present, or potentially present, to varying extents in many forms of note investments. For example: (a) the underlying business models of property development issuers share some features with other note issuers who on-lend funds to third parties; (b) many types of note issuers have low levels of equity capital; and (c) many types of note issuers have some degree of mismatch between the maturities of their assets and liabilities, making them vulnerable to liquidity problems in adverse market conditions. Page 13 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 13 C Benchmarks for unlisted notes Key points All issuers of unlisted notes should address general benchmarks on: • equity ratio (see RG 69.31–RG 69.34); • liquidity (see RG 69.35–RG 69.42); • rollovers (see RG 69.43–RG 69.46); and • debt maturity (see RG 69.47–RG 69.49). Issuers of unlisted notes who lend money should address additional benchmarks on: • loan portfolio (see RG 69.50–RG 69.59); and • related party transactions (see RG 69.60–RG 69.63). Issuers of unlisted notes involving property should address additional benchmarks on: • valuations (see RG 69.64–RG 69.69); and • lending principles—loan-to-valuation ratios (see RG 69.70–RG 69.75). Benchmark 1: Equity ratio RG 69.31 An issuer should use the following equity ratio benchmarks: (a) where more than a minor part of the issuer’s activities is property development or lending funds directly or indirectly for property development—the issuer should maintain a minimum equity ratio of 20%; (b) in all other cases—the issuer should maintain a minimum equity ratio of 8%; (c) the issuer’s equity ratio should be calculated as follows: total equity ; and total liabilities + total equity (d) the issuer should disclose its comparative equity ratio from the prior year. Note 1: ‘Equity’ and ‘liabilities’ have the meanings given under the Australian accounting standards. Note 2: The comparative equity ratio should be from a date approximately 12 months prior to the current equity ratio. Page 14 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 14 Explanation RG 69.32 Paid-up capital or equity is the money invested by the owners of the issuer (plus any profits retained by the issuer). It provides a ‘buffer’ to the issuer in the event of financial difficulties, and it also provides the issuer’s owners with an incentive to operate prudently and responsibly (sometimes referred to as ‘hurt money’ or ‘skin in the game’): see ‘Minimal equity capital’ in Table 3. RG 69.33 Insufficient capitalisation appears to be a contributing factor in each of the failures of unlisted note issuers in recent years. Where involved in property development, the issuer is more vulnerable to adverse market movements and at higher risk of financial distress. Therefore, this benchmark has a higher minimum capital requirement where more than a minor part (e.g. 10%) of the issuer’s activities (e.g. as a proportion of notes on issue) is related to property development. If this capital is not present, investors should be informed (on an ‘if not, why not’ basis) so they can make their own assessment of the risks involved. RG 69.34 The disclosure of a comparative equity ratio from the prior year will help investors identify any change in the issuer’s equity capital over the past year. Benchmark 2: Liquidity RG 69.35 An issuer should: (a) have cash flow estimates for the next three months; and (b) ensure that at all times it has cash or cash equivalents sufficient to meet its projected cash needs over the next three months. RG 69.36 In reporting against this benchmark, an issuer should disclose: (a) material assumptions underlying its cash flow estimates (e.g. cash, estimate rollover or retention rates); (b) how its rollover or retention rate assumptions relate to historical rates; and (c) its policy on balancing the maturity of its assets and the maturity of its liabilities. For example, where an issuer has a policy of ensuring that its assets and liabilities have similar maturity profiles, it should state this in its prospectus and report against this in its ongoing disclosures. RG 69.37 An issuer should also disclose whether it would have cash on hand or cash equivalents sufficient to meet its projected cash needs if: (a) 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 Page 15 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 15 (b) 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. Note: In estimating cash flows, an issuer can take into account a reasonable estimate of ‘rollovers’ based on previous experience, but not new fundraising. An issuer should consider possible redemptions as well (if its policy or practice is to allow redemptions). An issuer can also take into account reasonable estimations of cash inflows generated by operations (e.g. payments of interest, repayments of debt) in preparing its cash flow projection. Explanation RG 69.38 Liquidity is the proportion of cash or cash equivalents in a company’s assets. It is a powerful indicator of the short-term financial health of a company. For note issuers it is relative liquidity (i.e. short-term assets relative to short-term liabilities) that we are particularly concerned with. RG 69.39 Experience and expert advice we have received show adequate liquidity is a key feature in the ability of note issuers to meet their obligations to investors. Insufficient liquid assets appear to be a contributing factor in recent failures. Historically, lack of liquid assets has been a contributing factor in the failure of otherwise well-capitalised institutions. RG 69.40 We envisage an issuer would need to review its forecast cash flows on an ongoing basis to determine whether it continues to meet this benchmark. We would expect an issuer to take into account its historical experience on redemptions and rollovers in estimating its cash flows. We also expect an issuer to disclose material assumptions underlying its cash flows (e.g. historical rollover rate) when disclosing against this benchmark. RG 69.41 By ‘cash’ or ‘cash equivalents’ we mean cash or cash equivalents as defined in Australian Accounting Standard AASB 107 Cash flow statements. Generally, this includes highly liquid assets that can be reliably realised for cash within a very short period of time and undrawn amounts under certain bank overdraft facilities. RG 69.42 We expect an issuer to periodically ‘stress test’ its liquidity assumptions. For example, we would expect an issuer to consider: (a) its current prospectus and the possibility of an ASIC stop order disrupting its cash flows; (b) the possibility of an overdraft or other credit facility on which the issuer is relying being withdrawn; and (c) the possibility of a significant reduction in the rate of investor rollovers. We would expect an issuer to take into account the results of its stress testing in its liquidity planning. In some cases, this may mean it needs to increase its cash position: see RG 69.35. Page 16 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 16 Benchmark 3: Rollovers RG 69.43 An issuer should clearly disclose its approach to rollovers, including: (a) what process is followed at the end of the investment term; and (b) how it informs those rolling over or making further investments of any current prospectus and continuous disclosure announcements. Explanation RG 69.44 Some note issuers rely on investors keeping their funds in the investment beyond the end of the initial period. In some cases, the terms of the issue allow this to occur automatically unless the investor makes a positive decision to withdraw their funds. In other cases, it is the investor who makes a positive decision to have their funds reinvested. It is important that investors fully understand the issuer’s approach to rollovers through clear disclosure in the prospectus. Note: Issuers should consider the fairness of the contractual terms applying to rollovers in accordance with Subdiv BA of the ASIC Act. RG 69.45 Section 708(14) of the Corporations Act provides for an exception from the requirement to provide investors with a prospectus for rollovers and offers to existing investors. We consider that it is potentially misleading not to provide investors with updated information when they are considering whether to roll over their investment or make a further investment in notes. RG 69.46 The commercial circumstances of the issuer may have changed since the initial investment. To ensure investors are fully informed about the circumstances of the rollover, it is important for them to have the benefit of current disclosure (in either a prospectus or disclosure notice) to help them decide whether to continue with their investment. To avoid possible breaches of the Corporations Act, an issuer should contact investors before each rollover and make the current disclosure document and any relevant ongoing disclosure available to them (e.g. direct them to a website where they can obtain the documents): see RG 69.93–RG 69.101. Benchmark 4: Debt maturity RG 69.47 An issuer should disclose: (a) an analysis of the maturity profile of interest-bearing liabilities (including notes on issue) by term and value; and (b) the interest rates, or average interest rates, applicable to its debts. Note: For updating information, see Section D. Page 17 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 17 Explanation RG 69.48 Disclosure of debt maturities will assist investors in understanding how the business is funded in terms of the nature, timing and cost of the issuer’s debt obligations. RG 69.49 The disclosure of information about the profile of note terms and loan terms (see Benchmark 5) and key assumptions underpinning the issuer’s cash flow projections (see Benchmark 2) are generally matters required to be disclosed by s710(1). In our view, it is information that investors and their professional advisers would reasonably require to make an informed assessment of the offer. Benchmark 5: Loan portfolio RG 69.50 An issuer who directly on-lends funds, or indirectly on-lend funds through a related party, should disclose the current nature of its (or the related party’s) loan portfolio, including: (a) how many loans they have and the value of those loans; (b) an analysis of the maturity profile of interest-bearing assets (including loan portfolio) by term and value; (c) the interest rates, or average interest rates, applicable to the assets; (d) by number and value, the loans they have by class of activity and geographic region; (e) an analysis (number of loans, value of loans, value of principal and/or interest) of those loans more than 30 days past due and renegotiated loans; Note 1: If the issuer monitors arrears on a monthly basis, then an analysis of receivables a month past due can substitute for an analysis of 30 days past due. Note 2: See the Key terms for definitions of ‘past due’ and ‘renegotiated loans’. (f) by number and value, what proportion of the total loan money is lent on a ‘secured’ basis and what is the nature of the security; (g) by number and value, what proportion of the total loan money they have lent to their largest borrower and their 10 largest borrowers; and (h) by number, value and percentage, what loans are subject to legal proceedings. Note 1: For reasons of privacy or commercial confidence, it may not be appropriate to actually name the largest borrowers. The total loan money lent to the 10 largest borrowers can be disclosed as an aggregate amount. Note 2: The term ‘related party’ should be interpreted broadly: see the Key terms. See the Key terms also for a definition of ‘legal proceeding’. RG 69.51 Disclosure should also cover the issuer’s policy on these issues. For example, where the issuer has a policy of not lending more than (say) 5% of Page 18 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 18 its total loan funds to any one borrower, this should be stated in the disclosure document. RG 69.52 Disclosure should also contain clear explanations about the issuer’s approach to taking security in relation to its lending (e.g. what types of security it takes and in what circumstances). Explanation RG 69.53 This benchmark and Benchmark 6 (related party transactions) apply to note issuers who on-lend funds raised through the notes. This includes issuers who lend the funds to related parties only. RG 69.54 Many issuers of unlisted notes on-lend the funds lent to them by note holders. The primary assets of the issuer are the loans it makes to others. The quality of these loans is a key element in the financial position and performance of the issuer. RG 69.55 The quality of the issuer’s loans is important at an overall loan portfolio level, as well as the individual loan level. A key way lenders manage the quality of an overall loan portfolio is to ensure that it is diversified. Portfolio diversity has a number of elements, including: (a) the number of loans and the value of those loans; (b) how many loans are related to a particular class of activity (e.g. residential property, commercial property, leasing, development); (c) geographic concentration (e.g. are the borrowers concentrated in one geographic region?); and (d) whether the lender has major exposures to a small number of borrowers (e.g. what proportion of funds are lent to the largest borrower, and to the 10 largest borrowers?). RG 69.56 The more diversified a loan portfolio is, the lower the risk that an adverse event affecting one borrower or one type of loan will simultaneously affect the majority of borrowers, and therefore put the overall portfolio at risk. RG 69.57 It is important that an issuer discloses in its prospectus its approach to loan portfolio diversification. At the prospectus stage, an issuer may not be able to set out exactly how funds will be lent, but it should be able to generally explain how funds have been lent so far. Most issuers will have a firm policy of how and when they will lend funds. This should be disclosed as clearly and concretely as possible to help trustees and investors monitor the financial position and performance of the issuer over time. RG 69.58 It is important that investors understand what proportion of loans is secured, by number and by value. However, this needs to be explained carefully, including by reference to the nature and scale of the security (e.g. its Page 19 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 19 ranking, the value of the assets supporting the security and the financial position of any guarantor). Note: If any security rights (e.g. mortgages) held by the issuer have been assigned or transferred to third parties, this needs to be disclosed as well. RG 69.59 It is also important for investors to know what proportion of loans are in default and what the issuer’s approach is to such loans. The issuer may be relying heavily on repayment of the loans it has made for it to repay note money. Investors (as the holders of the notes) therefore have a strong interest in knowing the proportion of loans in arrears and what the issuer is doing to address this. Benchmark 6: Related party transactions RG 69.60 An issuer who on-lends funds should disclose its approach to related party transactions, including: (a) how many loans it has made to related parties; (b) the value of those loans; (c) the value of the loans as a percentage of total assets; and (d) the assessment and approval process it follows with related party loans when loans are advanced, varied or extended (e.g. are they subject to the approval of the trustee?). RG 69.61 The issuer should also disclose any policy it has regarding related party lending (including matters such as interest rates, security and loan-to- valuation ratios). Note: The term ‘related party’ should be interpreted broadly: see the Key terms. Explanation RG 69.62 Related party loans are less likely to be monitored as robustly as third-party loans, and this can affect valuations, loan-to-valuation ratios and credit assessment processes. Related party loans appear to be a contributing factor in some recent failures. RG 69.63 It is important that an issuer discloses in its prospectus its approach to related party lending. At the prospectus stage, an issuer may not be able to set out exactly how funds will be lent, but it should be able to generally explain how funds have been lent so far. As discussed under Benchmark 5, we expect that most issuers will have a firm policy of how and when they will lend funds and this should be disclosed to investors. Page 20 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 20 Benchmark 7: Valuations RG 69.64 Where the issuer is involved in or (directly or indirectly) lends money for property-related activities, it should take the following approach to obtaining and relying on valuations: (a) properties (i.e. real estate) should be valued on an ‘as is’ and, for development property, on an ‘as if complete’ basis; Note: See the Key terms for definitions of ‘as is’ and ‘as if complete’ valuations. (b) development properties should be re-valued at least every 12 months unless the funds are retained by the issuer and only released in stages to cover project completion costs; Note: For advancing funds in stages for loans relating to property development, see RG 69.71 and RG 69.75. (c) an issuer should have a clear policy on how often it obtains valuations, including how recent a valuation has to be when it makes a new loan; (d) an issuer should establish a panel of valuers and ensure that no single valuer conducts more than one-third of the total number of valuations obtained; and (e) the appointment of valuers should be with the trustee’s consent. RG 69.65 An issuer should also include information about the valuation of a particular property in its prospectus where: (a) the property accounts for 5% or more of the total value of property assets of the issuer; (b) the property accounts for 5% or more of the total value of property assets of a related party through which the issuer has indirectly on-lent money; (c) a loan secured against the property accounts for 5% or more of the total value of the issuer’s loan book; or (d) a loan secured against the property accounts for 5% or more of the total value of the loan book of a related party through which the issuer has indirectly on-lent money. Note 1: We would also expect an issuer to include the ‘cost’ of such a property in the prospectus for comparison purposes. Note 2: The information about the valuation of a particular property should help the potential investor assess the quality and reliability of the valuation (e.g. the identity of the valuer, the valuation method and the key assumptions). Explanation RG 69.66 This benchmark only applies to an issuer who is (directly or indirectly) involved in or on-lend funds for property-related activities. It includes an issuer who, for example: Page 21 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 21 (a) is in the business of property development or lends funds to property developers; (b) uses funds as part of an ‘integrated property’ business; or (c) is involved in mortgage financing. Note: ‘Integrated property’ is defined in Consultation Paper 89 Unlisted, unrated debentures: Improving disclosure for retail investors (CP 89). See also RG 69.21(c). RG 69.67 Robust and objective valuations are needed to ensure the issuer’s financial position is correctly stated in the prospectus and ongoing disclosure. Valuations affect the key ratios of the issuer—such as the adequate capital, liquidity and loan-to-valuation policies. RG 69.68 It is therefore important for investor confidence that independent experts perform the valuations, and that the process is transparent. We expect that an issuer’s policy should aim to ensure that the valuer is independent from the issuer and its associates. In particular, an issuer should aim to ensure that valuers do not have any conflict of interest that a reasonable person, with full knowledge of all relevant facts and circumstances, would conclude is capable of affecting the valuation. Note: See Section F for further discussion of valuers and the valuation process. RG 69.69 It is in the interests of an issuer that the valuations it obtains and uses are robust and accurate. An issuer is responsible for the accuracy of the financial statements and other documents that rely on these valuations. Therefore, we expect that an issuer will only use professional valuers who are registered or licensed in the relevant state or territory, and who are a member of an appropriate professional body and subscribe to that body’s standards and code of conduct. We also expect that an issuer will be careful to ensure that its written instructions to valuers are comprehensive and contain reasonable assumptions. Benchmark 8: Lending principles—Loan-to-valuation ratios RG 69.70 Where an issuer (directly or indirectly) on-lends money in relation to property-related activities, it should maintain the following loan-to-valuation ratios: (a) where the loan relates to property development—70% on the basis of the latest complying valuation; and (b) in all other cases—80% on the basis of the latest complying valuation. Note 1: For the purposes of calculating the loan-to-valuation ratio, the issuer’s loan amount should be added to any prior ranking security and divided by the value of the property security. Note 2: See the Key terms for the definition of ‘complying valuation’. Page 22 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 22 RG 69.71 Where the loan relates to property development by a second person (even if related to the issuer), the issuer should ensure that funds raised by the issue of notes are only provided to the developer in stages, based on external evidence of the progress of the development. Explanation RG 69.72 This benchmark only applies to an issuer who (directly or indirectly) on- lends funds for property-related activities. It includes an issuer who, for example: (a) lends funds to property developers; or (b) is involved in mortgage financing. RG 69.73 An issuer’s approach to loan-to-valuation ratios is one indicator of how conservative or aggressive its lending practices are. Less conservative lenders are willing to lend funds equal to a higher proportion of a property’s value (sometimes up to or exceeding 100% of its value). Such ratios mean that the lender is more vulnerable to the risk that a change in market conditions (such as a downturn in the property market) will lead to it being unable to fully recover the money it has lent to borrowers. It also increases the risk that the security (if any) it has obtained from borrowers will not be sufficient to cover the loan. RG 69.74 We have separated loans relating to property development from other property-related loans (e.g. residential mortgages). By property development, we mean loans whose main or primary purpose is for real estate developments (e.g. home units, retail, commercial, sub-divisions and industrial development). RG 69.75 Where funds are on-lent for property development activities, a loan-to- valuation ratio may be agreed up-front, but it is generally not appropriate to advance all of the funds to the developer up-front. Rather, we expect an issuer to put systems and controls in place to ensure funds are only provided to the developer where there is satisfactory progress of the development (based on reliable external evidence of that progress). We also expect that the issuer’s policy on how and when funds are provided to developers will be stated in its prospectus. Page 23 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 23 D Form and method of disclosure Key points An issuer of unlisted notes has an obligation to provide disclosure at the time of offering notes, while the offer remains open and while the notes remain on issue: see RG 69.76–RG 69.77. In meeting these disclosure obligations to investors, an issuer should disclose against the benchmarks in Section C on an ‘if not, why not’ basis: see RG 69.78–RG 69.81. Disclosure against the benchmarks should be: • addressed up-front in the prospectus (see RG 69.86–RG 69.90); • updated in ongoing disclosure (see RG 69.91–RG 69.101) as material changes occur—for example: – in a replacement prospectus, supplementary prospectus or continuous disclosure notice; and – at least twice a year, in quarterly reports to trustees; and • supported in advertising material (see RG 156). Disclosure obligations RG 69.76 An issuer of unlisted notes has an obligation to provide disclosure at the time of offering notes, while the offer remains open and while the notes remain on issue. We have issued the following general guidance about these disclosure obligations: (a) Regulatory Guide 228 Prospectuses: Effective disclosure for retail investors (RG 228) provides guidance to persons offering securities about how to prepare prospectuses that satisfy the content requirements in s710. It also provides guidance on how to word and present prospectuses in a ‘clear, concise and effective’ manner under the Corporations Act. (b) Regulatory Guide 198 Unlisted disclosing entities: Continuous disclosure obligations (RG 198) provides guidance for unlisted disclosing entities about how to comply with their continuous disclosure obligations. RG 69.77 An issuer of unlisted notes should have regard to this general guidance as well as comply with the specific disclosure guidance set out in this section. Page 24 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 24 Disclosure against the benchmarks: ‘If not, why not’ RG 69.78 An issuer should disclose whether it meets the benchmarks in Section C, and if not, why not. ‘Why not’ means explaining how it deals with the business factor or the issue underlying the benchmark (including the alternative systems and controls the issuer has in place to deal with the issue underlying the benchmark). Note: Where a benchmark contains multiple requirements, if an issuer cannot meet all the requirements under a benchmark, it should state that it does not meet the benchmark and clearly explain why it failed to meet the particular requirements. RG 69.79 An issuer’s disclosures for Benchmarks 1, 2, 5, 6, 7 and 8 should also explain the importance of each of these benchmarks to its business. We are not prescribing ‘boilerplate’ or standardised wordinghowever, we expect an issuer to closely base its disclosure on the material in Table 4, which is adapted from our investor guide, Investing in unlisted debentures and unsecured notes? Table 4: Explanation of benchmarks Benchmark Explanation Benchmark 1—Equity ratio If the issuer has less equity capital invested in the business, there might be no safety margin to tide things over if the business runs into financial difficulties. It could also mean that the issuer has less incentive to operate the business prudently and responsibly because less of its own money is at risk. Benchmark 2—Liquidity Liquidity is an important measure of the short-term financial health of an issuer or business. If the issuer has insufficient cash or liquid assets, it might be unable to meet its short-term obligations (e.g. to run the business properly, pay interest, or pay investors their money back at the end of the term). Benchmark 5—Loan portfolio Is the issuer’s loan portfolio heavily concentrated into a small number of loans, or loans to a small number of borrowers? If so, there is a higher risk that a single negative event affecting one loan will put the overall portfolio (and investors’ money) at risk. Benchmark 6—Related party transactions The risk with related party transactions is that they might not be made with the same rigour and independence as transactions made on an arm’s-length commercial basis. There is a greater risk of the loans defaulting and, therefore, investors’ money is at greater risk if:  the issuer has a high number of loans to related parties; and  the assessment and approval process for these loans is not independent. Benchmark 7—Valuation If the issuer does not include information about valuations in the prospectus, it will be more difficult for investors to assess how risky the investment is. Keeping valuations up-to-date and shared among a panel means they are more likely to be accurate and independent. Benchmark 8—Lending principles A high loan-to-valuation ratio means that the investment is more vulnerable to changing market conditions, such as a downturn in the property market. Therefore, the risk of investors losing their money could be higher. Page 25 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 25 RG 69.80 Disclosure against the benchmarks is not intended to lead to longer and more complex disclosure documents. Rather, we expect that this disclosure will help issuers produce disclosure documents that are more focused on the issues that matter to investors and are more clear, concise and effective. RG 69.81 This approach is based on our view that the inherent risks for investors in unlisted notes mean that information about these risks is: (a) information that investors and their professional advisers reasonably require to make an informed investment decision (s710(1)); (b) not something investors may reasonably be expected to know without explicit disclosure in a prospectus (s710(2)); (c) needed to ensure a note issuer’s quarterly reports to the trustee and to ASIC comply with the content requirements for those reports (s283BF(4)); and (d) relevant to consideration of whether the issuer is required to issue a supplementary or replacement prospectus (s719) or has obligations under the continuous disclosure provisions (s675). Note: We have produced an investor guide, Investing in unlisted debentures and unsecured notes?, to help investors understand and use the benchmarks and to promote informed decision making. We encourage an issuer to make the guide available to investorsfor example, when distributing its prospectus. Copies of the investor guide are available at www.moneysmart.gov.au. Disclosure in a prospectus RG 69.82 A prospectus for unlisted notes should contain a clear and prominent disclosure of the key features of the product and its risks. It should address the benchmarks in Section C on an ‘if not, why not’ basis. This means that it should state that the issuer and product either: (a) meet the benchmark (including how they meet the benchmark, where appropriate); or (b) do not meet the benchmark and explain how and why the issuer deals with the business factor or the issue underlying the benchmark in another way. RG 69.83 In addition, we consider that a prospectus should state that the issuer will continue to meet the benchmarks and, if not, why not. In circumstances where a benchmark is not met, the extent of and reasons should be disclosed. In some circumstances, not meeting a benchmark is a risk that should be disclosed prominently. RG 69.84 An investment overview should be included to help retail investors make an informed decision by highlighting key information. The investment overview should: (a) be the first substantive section of the prospectus; Page 26 REGULATORY GUIDE 69: Debentures and notes: Improving disclosure for retail investors © Australian Securities and Investments Commission February 2012 Page 26 (b) highlight and provide