What Type of Debentures Are Available in Australia - Essay Example

1. A.Define a debenture as defined in section 9 of the Corporations Act A debenture of a body corporate means a legal obligation that requires the body corporate to repay money lent to it by investors. The corporate may use security interest over property that it owns so as to secure the repayment of the loan. However, a debenture cannot be defined in the following actions: Where a body corporate repays a loan lent or money deposited with it if the individual who lent or deposited the money did it in the ordinary course of business or the body corporate received the money in the ordinary course of its business that does not involve providing of finances or borrowing of money. Secondly, in the case where an Australian financial institution repays money lent or deposited with it in the course of its banking business. In addition, payment of money under a bill of exchange, a cheque or an order for money payment by the body corporate does not equate to a debenture as well. Lastly it’s in the case where body corporate repays money that is prescribed by regulations or to a body corporate that is related (Rajapakse, 2006). b. Provide a plain English explanation that you would give to a fellow student A debenture is a long term loan which a body corporate takes so as to finance its capital and agrees to repay it at a future date. The debenture holders receive payment in form of interest at a fixed rate per annum that is deducted from the company’s profit, until the debenture matures. The debenture agreement lays out the terms of the loan. Such terms include, the amount to be borrowed, the repayment period, the interest charged among others. Where a company is unable to repay the interest, the debenture holders can recover their money by selling the company’s properties since debentures are secured using charges on the company’s property. However, it is important to note that, debenture holders do not have voting rights in the company. They only make decisions that affect the loan they have issued to the company. c. Give examples of what type of debentures are available in Australia Debentures are categorized depending on how the money loaned is used or by the level of risk associated with it. High yield debentures are the debentures whore rate of return is 1-3% higher than the market rates for similar products (ASIC 2005). Unrated debentures are those whose performance cannot be put in comparison with other debenture related products. Unlisted debentures are the debentures that are not quoted or sold in a secondary market. Mortgage financing debentures are the loans that are issued to acquire or improve property. Capital mortgages are the funds that a corporate acquires so as to finance its capital or working capital needs. Membership debentures are those that are issued in order to facilitate groups, clubs or franchise memberships. Financial debentures are issued to enable the borrower undertake personal and commercial purposes for instance acquiring working vehicles or leasing of a building. 2. Discuss what type of financial product a debenture is in Australia A financial product is a financial facility at enables an individual manage a financial risk, make a financial investments or settle a non-cash payment. They are issued by investors who in return earn income in form of interest. They are categorized according to their volatility, return, risk or their underlying class. They include debt, equity claims and currency. A debenture is a debt financial product issued by body corporate to raise capital. This is because; the debenture holders are creditors to the company and are to be paid a defined principle amount and interest over a specified future period. The debenture funds are mostly loaned out to third parties and invested in mortgages financing, debt capital funding among others. There are benefits attached to a company having financed its capital using debentures. Some of them include, the tax benefit, where the interest paid to the investors is a tax deductible item in the profit and loss account (Gizycki 2000). The debenture holders do not have voting rights except in case of decision making that’s in relation with the debentures. This ensures that dilution of control is minimized in the managerial levels. Debentures are beneficial to the investors since the rate of return is fixed and stable. In times of liquidation they are given higher priority compared to the ordinary share holders. They may either be unsecured notes, listed or unlisted in the Australia security exchange. Unsecured debentures have a fixed interest rate. However, the time of recovering the capital and receiving returns is uncertain. When they have been quoted and are being traded in the secondary market, they are listed debentures while those that have not been quoted in the market are unlisted. The investor therefore deals with the issuing company directly. 3. The role played by trustees and gatekeepers for debenture issuers These are individuals who the debenture issuing company entrusts with the role of securing a debenture issue in a trust deed agreement. The trustees ensure that the company being issued with the debenture has met the stock exchanges listing agreement and the company’s act provisions. They monitor the debenture issuer’s financial position in order to protect the investors’ interests. This is achieved by evaluating whether; the debenture issuer has sufficient resources so as to meet the obligations. In addition, they on a regular basis assess the issuer’s performance, viability and financial position and ensure that the information issued through the prospectus is up-to-date and correct. By conducting these analyses, the trustee is in a position of ascertaining whether the issuer has any financial difficulties. They are to issue the debenture holders with the issuer of debentures periodic reports .in the report, they incorporate the extent of issuers non-performing loans and indicate whether they are being recovered in timely manner. Report should also indicate any accrued interest payable to the debenture holders. It is the trustee’s duty to ensure that the property that has been charged to the debt is adequate and available always in order to discharge the principle and interest payable. They also notify the holders of any impairments that take place on the property and Where the debentures are convertible, the trustees ensure that they have been converted according to the trust deed and where such terms have been breached; they immediately inform the board and thereafter take appropriate measure to ensure that the interests of the debenture holders are protected (Trustee Corporations Association of Australia 2007). The gatekeepers ensure that the Australia’s financial markets are transparent and fair supported by investors sand consumers who are informed and confident. However their main role is to ensure that market integrity is maintained with professional ethics and the law. They include accountants, lawyers, valuers, asset managers among others. Auditors have an obligation to the issuers of the debenture of reporting any issue that comes to their attention after they have conducted an audit. It is their duty as well of questioning policies that have been drafted as provisions and reviewing their credibility. Moreover, they seek for any valuations that have been updated. 4. Discuss the failure of Banksia Securities Ltd and the action being taken by ASIC as a result Incorporated in 1968, Banksia securities limited commenced its operations shortly after. Through the issuing of debentures to local retail investors, it was able to raise funds that were loaned to third parties for the purpose of investing in property. Some of the funds were issued through a contributory mortgage scheme. However, Banksias securities went into liquidation and an immediate receivership, owing about 15000 investors $660 million. The company’s major asset was the interest in the loans that it had advanced. While a number of factors contributed to the failure of the company, the following are the main reasons. Drastic reduction in the value of property followed by difficult market conditions lead to the increase in the loans that were defaulted. In addition, there was a shortage in funds in time of debenture repayments since the loans that had been issued covered long periods. The company had issued third parties with funds who had their underlying security properties in area where a decline in their market values. Upon receivership, the following are the actions that ASIC has undertaken; the key employees and officers were interviewed and the daily operations of the company stabilized. It also assisted external administration in addressing any ongoing misconduct by the company officers. This involved reviewing the corporate structure and the closing of ten branches so as to rationalize business. The company’s books and records were reviewed for the financial position to be ascertained. This assisted ASIC in identifying the transactions that required investigation. The directors were issued with requests of delivering any records or books that were not in the company’s possession. It is the duty of ASIC to prosecute such directors who fail in assisting insolvency practitioners in conducting their task. In addition, the ASIC liaise with government stakeholders in matters relating to the receivership and establish the basis upon which claims will be dealt. in order to determine the approximate claims and strategize on ways of maximizing debenture holders returns, it conducted a review of the loan portfolio of about 1000 loans issued to individuals and liaised with borrowers and real estate agents so as to ascertain the loans status and impairment levels. 5. Discuss the ASIC reforms being proposed for the debenture sector Australian Securities Investments Commission (ASIC) is a new service that registers business nationally in Australia, this is for the sake of registering businesses in one register. Since the service is a replacement of an earlier state and territory services, the business names that existed in previous service are automatically transferred to the new register. The move to reform the law was as a result of the collapse of the high profile sectors such as Banksia Securities Ltd. In its reform the ASIC consults on the fixed minimum funds and the liquidity requirements. The debenture issuers must have a minimum capital ratio of 8% of their total risk weighted assets, this is for the issuers who accept the retail investments and who is on lend. ASIC should have the flexible power in raising or lowering the 8% capital ratio depending on the case basis, and this is due to the fact that issuers are not subject to close prudential supervision (ASIC 2013). The debentures issuers should maintain the minimum of 9% of their liabilities in high value liquid assets. It is important for the issuers having sufficient liquidity for meeting the short term obligations to investors. Secondly, it consults on the proposals of strengthening the revelation of debenture issuers to investors. The issuers should be prevented from raising further funds in case of breaching the capital or liquidity ratio. Thirdly, the reform clarifies the authority and duties of debenture trustees, this is important since they are given the responsibilities of monitoring the financial position of the debenture issuer. They are required to express their views in writing regarding the ongoing viability and the debentures issuer’s financial position; this applies to all types of debentures investments concerning retail clients. Trustees are also given authority to get information from an issuer on as required basis (ASIC 2013). On the other hand the debentures are required to appoint their auditor to directly report to the trustee twice per year and are answerable to any reasonable questions asked by the trustee. This is applicable to all types of debentures investments concerning retail clients. The provided report should be audited annually and reviewed report half yearly; the auditor should report to trustee directly the issues that are most likely to be detrimental to debenture proprietors or applicable to the exercise of the trustee’s authority. Finally, the reform proposes on the disclosure to investors rolling over their investment. The debenture issuers that agree to retail investments and then on led are required to present prospectus disclosure while obtainable retail investors make advance debenture investments or turn over. A participant is required to disclose to its clients the differences between contracts clearance and contract settlement by LCH and the Australian based CS facility. There should also be, at minimum, a requirement on participants to obtain written confirmation from the client showing that they have received and understood the bargain. The disclosure should entail a prominent clarification of detail of how rights and remedies differ (Zajkowski 2012). 6. ASIC areas of focus and proposal 1. Revenue recognition All the revenue that is recognized upfront such as revenue in form of rights to future income should be classifies either as non-financial or financial asset and should be accounted for in view of that (PWC 2013). The auditors and directors need to ensure that the revenue is correctly recognized as per AASB 118 Revenue. 2. Expense deferral It is important that expense should be deferred only where there is an asset and a probability that there will be arise in the future economic benefits from these assets. In addition, all expenses need to be correctly allocated to loss or profit or any other comprehensive income. 3. Asset value The directors need to careful consider the asset values and the underlying assumptions appropriately. This specifically applies in the present economic conditions; if a business has considerable assets that are held in the emerging economies; or a business is impacted by Mineral Resources Rent Tax and carbon tax. Essentially, sensitivity analysis and key assumptions need to disclose in order to enable the user to make his or he own assumptions on the carrying values (PWC 2013). 4. Off balance sheet arrangements The directors need to carefully review all the handling of off balance sheet arrangements, joint venture arrangement and investment in associates so as to guarantee that special rationale entities are correctly consolidated where they have been introduced for the benefit of the entity (PWC 2013). 5. Going concern Clear and adequate disclosure need to be made concerning any material ambiguity in entity’s ability to persist as a going concern, that is, the directors should adequately discloses details of an uncertainty and they should give reasons why they consider the entity as a going concern. 6. Non-IFRS financials information disclosures The directors need to seek a continuation in the review of non-IFRS financials information disclosures that is included in market announcements, financial reports, media releases and media and investor presentations with the Australian Securities and Investments Commission’s (ASIC) regulatory guide as seen in RG 230 7. Non-current and current classification All the directors should make certain that the non-current and current liabilities and assets are correctly classified. 8. Accounting and estimates policy judgments A disclosure need to be made about important judgments in using source of estimation and accounting policies uncertainty that have a great jeopardy of material adjustment to liabilities and assets (PWC 2013). . 9. Financial instruments All entities should disclose all the methods and important assumptions that are used to fair the value financial instruments that essentially not quoted on any active market. Directors need to focus on the financial instrument disclosure for the end of year financial report (PWC 2013). . 10. Standards of new accounting Entities need to disclose the result of the new accounting standards and all interpretations that have been directly or indirectly been issued but have not been applied to the entity. Qualitative and quantitative disclosure should also be included to the new accounting standards (PWC 2013). 7. Provide a web link to an Australian debenture issuer and describe the product issued and how it might be affected by the reforms proposed by ASIC Anga securities issued a fixed term debenture that commenced on the 1st of February 2013 charging no entry nor will exit Fees. The Company is paying the investors interests at a fixed rate of 7% per annum. http://www.angassecurities.com/investments/fixed-interest/ .Funds from the issue will be invested in mortgage loans and other investments that will be permitted by the board. Lending will only be applied to third parties who have passed the credit criteria prudently. This is to ensure that risks are minimized and returns maximized. Angas assets and mortgages will be charged securities for the fixed interest investments. Investing in a fixed interest debenture has the following advantages. The investor can assess the returns to received over a certain period of time. This curbs uncertainty and it created a consistent and reliable stream of income to the investor. The time at which capital can be recovered is well defined and hence is able to know when to access capital in case it was required in other investments. In addition the investor needs no specific financial expertise in making the investment, since the issuer is responsible for the placing of the funds in viable projects. Following the collapsing of high-profile companies in the debenture sector for instance Banksia, the ASIC brought to task a number of proposals. This is in order to regulate and strengthen the debenture sector in the country. The proposals include the debenture issuer maintaining the liquidity requirements and a compulsory minimum capital base. They are required to have a minimum capital ratio of 8% of their total risk-weighted assets. However this ratio can be reviewed depending on the profit levels of the firm and the prevailing conditions in the market. In order to meet their liquidity obligations, Anga securities will be required to maintain a 9% holding of their short term debts in liquid assets that are of high quality. Where Anga securities breach any of these conditions, they will be stopped from conducting the issue. This is to ensure that, the investor’s risks are minimized and that they will only invest in companies that assure them of constant returns. The issuers are also required to disclose proper and adequate information that is required by the investors for their decision making. Lastly the ASIC has proposed reforms on having the duties of auditors and the trustees clarified. This will enable them to carry out their supervisory duties successfully and effectively. This means that Anga securities are required to issue the trustees will all the relevant information concerning the company that the investors may need. They are required to issue out both the interim and final audit reports so that the company’s financial position and its viability can be communicated to the investors. In case of any issues raised the trustees should get a full report on the same from Angas auditors. Since the funds obtained from investors will be lent to third parties, Anga securities will be required to provide the trustees with the third parties business prospectus and clarify how that other party will invest the funds. References Gizycki, M, Lowe, P 2000, Reserve Bank of Australia, Proceedings of a Conference, table 2, p. 192. ASIC, 2013. Zajkowski, M, A 2012, Proposed Amendments to ASIC Market Integrity Rules, Sydney: Sydey Nsw. PWC 2013, March 2013 ASIC’s key areas of focus for June 2013 reporters http://www.pwc.com.au/assurance/ifrs/assets/guidance-accounts/ASIC-Watch-List-Mar13.pdf ASIC 2005, February 2005.High yield debentures, Report 38 http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/Debenture_Campaign_Report.pdf/$file/Debenture_Campaign_Report.pdf Trustee Corporations Associations of Australia, 2007, unlisted, unrated debentures – improving disclosure for retail investors. http://www.asic.gov.au/asic/pdflib.nsf/lookupbyfilename/consultation_paper_89_submission_trusteecorporationsassoci%e2%80%a6.pdf/$file/consultation_paper_89_submission_trusteecorporationsassoci%e2%80%a6.pdf Rajapakse, P, J 2006, Issuance of Residential Mortgage: backed securities in Australia-legal and regulatory aspect, volume 29(3). Read More