ISSUES THAT MATTER - ANZ...CONTENTS Welcome to Volume 2 of ANZ FIG’s Issues that Matter publication The focus for this edition is Funds and Insurance, which is ANZ’s fastest growing

ISSUES THATMATTER

FINANCIAL INSTITUTIONS GROUPFUNDS & INSURANCE

ISSUE 2

CONTENTS Welcome to Volume 2 of ANZ FIG’s Issues that Matter publication

The focus for this edition is Funds and Insurance, which is ANZ’s fastest growing Institutional industry segment and a core focus for the FIG team.

It is a tumultuous time for our investor clients. Volatility is back with a vengeance and markets have been rattled by the China slowdown and transfixed by the timing of the first interest rate increase by the U.S. Federal Reserve. Financial Institutions continue to be impacted by regulatory changes, creating challenges and opportunities for banks, insurers and funds globally.

I am pleased to share a range of topical articles triggered by our discussions with Funds and Insurance clients over the last six months as they evaluate capital, liquidity, and risk management solutions that remain relevant through the cycle.

I sincerely hope you enjoy the read and welcome your feedback.

GILES BORTEN Global Head, Funds & Insurance E: [email protected]

Thank you for reading

It seems that bouts of illiquidity are becoming more common in the market. Our first two articles discuss how such events have increased scrutiny on liquidity management, and changed the demand dynamics for long term repos and capital call facilities.

We’ve then turned our attention to opportunities for foreign investors and funds investing into or through Australia, detailing some of the major projects in Australia’s infrastructure pipeline. For those offshore investors looking to use Australian fund managers or intermediaries, our article on the recent taxation changes, dubbed ‘IMR 3’ is a must-read.

Our final two articles take a look at China’s new solvency regime for insurers, with one article focusing on the new-look C-ROSS bonds relative to Basel III bank bonds, and another article evaluating the impending collateralisation requirements for reinsurers writing Chinese business.

If you would like any more detail on any of these articles or the underlying reports, please reach out directly.

CARLI RENZI Industry Insights, Global Financials E: [email protected]

FUNDS & INSURANCE IS THE FASTEST GROWING INDUSTRY SEGMENT IN ANZ’S INSTITUTIONAL & INTERNATIONAL BANKING BUSINESS AND CORE TO ANZ’S FINANCIAL INSTITUTIONS GROUP (FIG) STRATEGY.

30 OCTOBER 2015

FOREWORD

A NZ F I NA N CIA L I NS T I T U T I O NS N E W SL E T T ER 2 /2015 2

3

5

8

11

14

17

Balancing liability driven investment

with crisis liquidity

Rise of capital call facilities for Asian funds

Investment in infrastructure – pension

funds and sovereign wealth funds

IMR 3 tax update – Australia open

for business

China’s C-ROSS compliant regulatory

capital bonds

Multinational insurers – China SBLCs

A N Z F I N A N C I A L I N S T I T U T I O N S N E W S L E T T E R 2 / 2015 3

BALANCING LIABILITY DRIVEN INVESTMENT WITH CRISIS LIQUIDITY

BACKGROUND Liquidity assumptions are being tested

It used to be the case that markets were deemed either liquid or illiquid, however the flash crash in US Treasuries on October 15, 2014 raised some questions about even the world’s ‘most liquid market’. Indeed, with eight intraday moves exceeding five standard deviations since 2012 – and none in the ten preceding years – many financial institutions would agree that occasional bouts of enormous illiquidity are more commonplace.1 These changes in market dynamics are driven in part by the regulatory changes on banks and broker dealers’ ability or willingness to make markets and warehouse risk in times of stress.2

Liability driven investment and solvency considerations may conflict

Long term investment is an intuitive approach for insurers with long term liabilities, such as life insurers. However, these long-term assets often require restructuring or hedging via derivatives to better match policyholder liabilities and reduce risk capital. For example, an insurer participating in a floating rate loan syndication will typically need a matching interest rate swap (IRS) to manage the risk back to fixed rate and lock in the spread.

Long-term derivatives, such as IRS come with substantial counterparty credit risk which is mitigated via collateralisation. An over the counter (OTC) IRS will be subject to the specific terms of the collateral swap annex (CSA) with the counterparty bank, which may allow for a broad range of collateral.

However, increasingly regulators are implementing mandatory clearing of OTC derivatives, with Central Counterparties (CCPs) requiring some variation margin in cash. That means insurers with their liquid assets in term tradeable securities will need access to the repo market.

1 Risk.net “Liquidity events becoming more common, buy-siders claim” (08 Sep 2015)

2 Treasury Market Practices Group’s Minutes (26 Feb 2015)

Figure 1 – Estimated future cost of collateral

*Excludes potential collateral and netting across asset classes. Sources: Oliver Wyman Analysis, BCBS, IOSC

2012 2013 2015 2018 2020

0.4

0.6

1.1

1.80.6

USD (trn)

1

2

3

0

Bilateral Trades Centrally Cleared Trades

1.9

0.2

0.2 0.4 0.8 0.9 0.9

0.2

0.30.9 1.0

Range ofExpected Outcomes

Incremental collateral need versus 2012 USD (trn)

- +0.25 +0.75 +1.4 +1.5

Collateral as percentage of unencumbered assets (dealers only)

4 5 8 11 12


Rising interest rates will intensify collateral needs – Is the repo market always accessible?

The long-dated, fixed-rate receiver positions of insurance companies will change out-of-the-money in a rising interest rate environment, requiring billions in cash variation margin to CCPs. A key risk is that pre-emptive collateral / cash hoarding may turn previously liquid securities into illiquid assets.

When quantitatively modelling liquidity risks, it’s this pre-emptive hoarding and intensification of collateral needs that has many insurers reconsidering the adequacy of Global Master Repurchase Agreements (GMRAs) with their usual broker dealers. Regulators as well as advanced insurers are increasingly asking what would happen under adverse scenarios if the repo access became more limited, with concerns manifested in the 2014 Insurance Risk collateral management survey (Figures 2 and 3).

Figure 2 – Use of the repo market as a tool in collateral optimisation

Figure 3 – Comfortably hold enough assets of the requisite quality to meet posting obligations

Pricing of repo markets is another concern as Basel III’s leverage ratio requirement on banks kicks in from 2018. For many Asia Pacific banks, the leverage ratio at 3% is unlikely to be a binding constraint in the near term. However, for many of the US and European based broker dealers that are deemed ‘global systemically important banks’, the leverage ratio could be 6-8% forcing a repricing for repos of 50–100bps.3

Term repo with the right bank counterparty can provide both liquidity and long-end exposure

Buying longer-dated assets and repo’ing them out gives insurers the best of both liquidity and exposure to the long-end. However, consideration must be made to how liquidity may be rationed by banks if there is a wide-scale liquidity problem and increasingly, insurers are evaluating which banks can support their liquidity needs in times of crises.

GLOBAL MARKETS Noel Carlin Head of Collateral Optimisation & Repo Trading E: [email protected]

FINANCIAL INSTITUTIONS GROUP Elodie NormanHead, Funds & Insurance, Hong KongE: [email protected]

3 Risk.net “Tighter spreads prompt insurers to rethink liquidity premium” (14-Sep-15)

“During a crisis, cash tends to accumulate in the accounts of the highest rated banks as investors seek safety. Lower rated banks may be more selective providing cash or seek larger haircuts on illiquid assets.” — Noel Carlin, ANZ Head of Collateralisation and Repo Trading.

Most insurance companies have GMRAs with their usual brokers, but in the event of financial turmoil, it may not be these banks that will have the cash.

SHARING OUR INDUSTRY INSIGHTS WITH CLIENTS

While insurers within the Asia Pacific region are generally considered flush with liquidity, there is growing pressure to optimise collateral management. Recent signs of deterioration in market depth and resiliency across sovereign markets in Asia Pacific has also driven a growing number of regulators to enforce or encourage insurers to quantitatively model liquidity risk, and consider the collateral requirements they would face in a variety of market shocks.

Whether insurers run models on market shocks or incorporate liquidity risks into their general risk management framework, the availability and cost of repo market access in crises are key considerations. Key bank beneficiaries of a flight to quality will have the greatest propensity to make cash available to relationship clients in times of stress.

ANZ Financial Institutions Group and Global Markets have been fielding questions from a number of insurers about global bank regulation and the implications of a shift to central clearing. Term repo forms one part of ANZ Global Markets’ suite of solutions for funds and insurers covering liquidity, capital and risk management as well as yield enhancement investment options.

2012

2014

45.0%

16.6%

2012 - - 2013 0.95 0.5 2015 1.7 0.98 2018 2.4 1.5 2020 2.6 1.75 2012

20142013

41%

15%

25%

For further detail or any questions, please [email protected] or call your ANZ relationship banker directly.


RISE OF CAPITAL CALL FACILITIES FOR ASIAN FUNDS

BACKGROUND What is Funds Finance?

Typically there are three types of leverage used by Funds: Structural Leverage; Portfolio Leverage; and Financial Leverage, which includes undrawn lines of liquidity. ANZ’s specialist Funds & Insurance team can support clients across all three levels, connecting with in-house specialists across Leveraged Finance, Project Finance, Property Finance, Loan Syndications, Corporate Advisory and Global Markets.

The rise of capital call facilities in Asia, speaks to Financial Leverage, which remains the most nascent of leverage categories across Asia Pacific. Capital Call facilities are typically revolving credit facilities secured by the unfunded capital commitments of investors in a fund.

The traditional capital call facility in Asia

Initially, capital call facilities were offered as relationship deals for Real Estate funds. Key Asian fund sponsors began diversifying away from traditional equity stocks and bonds in 2008, looking to Real Estate as an alternative asset class to drive returns. Capital call facilities provided the Fund’s general partners (GPs) with bridging finance during the

period when the fund was drawing down from its investors. For example, some investors can require up to 30 business days’ notice to provide funds to GPs, however banks can provide monies to the fund within 1-2 days business days. This liquidity materially increases the GP’s flexibility in the execution of its business strategy.

Evolution of Funds Finance in Asia

ANZ has increasingly fielded requests for Funds Finance through Asia and Australia. While the traditional capital call facility remains the most common discussion point, we are increasingly structuring financing solutions for a broader range of specialty funds and sponsors, including Infrastructure, Private Debt, and other specialty Private Equity Funds.

“ANZ’s Global Funds & Insurance team have structured a broad range of financing solutions for Funds in the US, Europe and our home markets in Australia and Asia. The Funds market in Asia is maturing fast and we are now working with a number of Asian-based Funds to support their intra-Asian and global investment strategies.” — Mark Harding, Director, Funds.

Figure 4 – Evolving funds finance spectrum

Traditional/ Bridging Capital Call Facility

Liquidity Lines

Unconventional Capital Call Development Facility

Secured hedging mechanics

Umbrella Facility

After-Care Facility

Hybrid Facility

Separate Account Facility

Equity Commitment Financing

Core Leverage Facility

Uncommitted Facilities

Unsecured Corporate Fund Facility

SECURED BY LP/INVESTOR COMMITMENTS NAV-BASED FINANCING UNSECURED FINANCING


This evolution of financing facilities used by Asian funds is reflective of several factors:

• Asian investors are increasingly comfortable investing outside of their home countries and are therefore more exposed to the sophisticated funds finance markets of North America and Europe via GPs.

• The liquidity wave, driven by unconventional monetary policies, record new debt issuance and financial regulatory reform, has contributed to historically low yields on assets. As a result, GPs are taking longer to find suitable assets and need to act more quickly, in the face of competition, when opportunities present.

• In the wake of the Global Financial Crisis, as regulators and policy makers shift focus to shadow banking, fund families are improving their governance, oversight and ‘toolkits’, to improve fund performance and reduce liquidity risks.

• As banks increasingly require collateralisation for derivative exposures to meet new regulatory standards, funds that invest in illiquid assets are looking for alternatives to carrying a low yielding liquidity portfolio for collateralisation purposes.

• Increased financing costs from banks for infrastructure and real-estate assets arising from post-GFC banking regulation can make funds finance a cheaper alternative to asset or company level finance to enhance investment returns.

Changing Demand Dynamics in Asia

The private equity industry in Asia continues to develop as the long term macro trends of urbanisation, industrialisation and the rising middle income class attract investor attention. Real Estate is losing ground to Venture Capital and Buyout Private Equity, additionally Infrastructure is increasingly being separated from Real Estate as its own asset class.

Total fundraising for Asia-focused funds has dropped off since peaks in 2011, largely due to the significant reduction in funds targeting China (Figure 5). This decrease has largely been driven by the general macro-economic Chinese slowdown and concerns regarding the real estate sector in China. It has also coincided with increased fundraising restrictions for Private Equity Funds, including the obligation to register with the Asset Management Association of China when raising mainland-based vehicles.

However, while Asian-focused investments have declined year to date 2015, as Figure 5 demonstrates, Asia remains a very relevant source of fundraising for global private equity funds. As such, many funds are setting up regional headquarters in Singapore and Hong Kong, taking advantage of their world class regulatory, legal and tax framework as well as proximity to Asia Pacific investors and investment opportunities.

While much of Asia Pacific investors’ allocation is directed intra-regionally, increasingly the investment mandates are expanding to reduce concentration risks and access the world’s highest yielding investments.

“With respect to real estate investments, Asian Sponsors have recently increased their geographical allocation to Europe and US (relative to Asia-Pacific) because stabilised property yields there are still more attractive than in Asia at the moment. However, Asian Sponsors have not stopped investing in real estate in Asia-Pacific as evidenced by CIC’s (China Investment Corporation) ¥140bn purchase of Meguro Gajoen Complex in Tokyo and Investa’s A$2.45bn real estate portfolio in Australia early this year” — Li Min Lam, Asian Head of Property Funds.

Figure 5 – Annual Asia-Focused Private Equity Fundraising 2008-2015 YTD Aggregate Capital Raised USD (bn)

86

55 20

7

21

23

20

37

6

34

20

11

43

2

20

30

734

51

6560

3

21

21

11

54

1

16

20

13

55

6

20

Other Asia-Focused Funds China-Focused Funds ASEAN-Focused Funds India-Focused Funds

2008 2009 2010 2011 2012 2013 2014 2015H1

Source: Preqin

ASEAN’s relevance is increasing, with Singapore fast becoming a hub for Funds

CHINA FOCUSED FUNDRAISING DROPPED TO A FIVE YEAR LOW IN 2014 OF $20BN THROUGH 49 FUND CLOSURES


SHARING OUR INDUSTRY INTELLIGENCE WITH CLIENTS

ANZ’s Global Funds & Insurance team work with both fund sponsors and the funds themselves to structure debt facilities that meet their evolving needs. For capital call facilities, the quality of the investors and understanding of their credit characteristics is key to the size of the facility. Involving a bank that works with investors in their home domicile of Asia Pacific, and has significant experience in the more broadly syndicated US and European markets, increases the pool of eligible investors upon which the borrowing base is calculated.

Financial leverage opportunities form one part of ANZ’s suite of value-add solutions for funds and should be considered in the context of our ongoing client dialogue covering Investor Sales, Risk Management, Yield Enhancement, Asset and Company Level Financing as well as Corporate Advisory.

FINANCIAL INSTITUTIONS GROUP Li Min Lam Commercial Property Funds, Asia E: [email protected]

FINANCIAL INSTITUTIONS GROUP Mark HardingDirector, FundsE: [email protected]

Figure 6 – Annual Private Equity Fundraising by location 2008-2015 YTD

Source: Preqin

Asia Paci�c Rest of World

2008 2009 2010 2011 2012 2013 2014 Q1-Q22015

USD (bn)

400

500

300

200

100

600

0

93

3856 71 67 58

75

20

595

281

241278

333

483469

222


ASIA PACIFIC WAS A STRONG CONTRIBUTOR IN 2014,

HOWEVER 1H2015 HAS HAD A SLOWER START ACROSS ALL

GEOGRAPHIES


INVESTMENT IN INFRASTRUCTURE – PENSION FUNDS AND SOVEREIGN WEALTH FUNDS

BACKGROUND Evolution of infrastructure as an asset class

Infrastructure is emerging as a strong asset class in its own right, increasingly separate to Real Estate or Private Equity allocations, and rapidly building up in the portfolios of investors and fund managers.

A year ago, unlisted infrastructure assets under management stood at an all-time high of USD293bn – 17 times higher than a decade ago and representing an ~85% increase since December 2010. Of this, “dry powder” represents ~34%, partly reflecting low deal flow which is lengthening the period to find suitable investment opportunities.4 Currently 62% of investors remain below their target infrastructure allocation.5

This heightened demand for infrastructure exposures reflects the great alignment of this asset class to multigenerational investors.

“Infrastructure, as an asset class, is well suited to public pension funds and sovereign wealth funds, many of whom blend investment choices with Government initiatives around development. These investors have an ability to deploy large volumes of capital at a time. In contrast to insurance companies, they have no long-term liabilities or unexpected redemptions to manage. They can also be more patient, unencumbered by regulatory restrictions on investment choices.” — Rennie Siow, Head of Funds and Insurance, Singapore.

Australia as an investment destination for Pension Funds and Sovereign Wealth Funds (SWFs)

Deal sizes since 2010 have substantially increased for developed markets, but particularly Australia, with average deal size now at ~USD761m, a 158% increase on 2010 and among the largest average deal sizes globally.

Figure 7 – Average Size of Infrastructure Deals by Country, 2010–2015 YTD6

4 Preqin “Record Infrastructure Assets under Management” (April, 2015)

5 Preqin H1 2015 Infrastructure Outlook

6 As at 3 August 2015

Average Deal Size USD (m)800

600

400

200

0

2010 2011 2012 2013 2014 2015 YTD

US Canada UK Australia

Source: Preqin Infrastructure Online


Figure 8 – Major Public Infrastructure Projects > AUD 2bn

COMPANY PROJECTCOST (AUD) STATE INDUSTRY START END

Under construction / committed

NBN Co National Broadband Network (NBN) ^ 31.5bn AUST Telecoms 2012 2021

NSW Roads and Maritime Services WestConnex ^ 15.5bn NSW Roads 2014 2023

NSW State Rail Authority North West Rail Link 8.3bn NSW Rail 2014 2019

NSW Roads and Maritime Services/ Transurban, QIC & Intoll

NorthConnex 3.0bn NSW Road 2015 2019

Proposed

VIC Dept. of Transport Melbourne Metro 11.0bn VIC Rail 2018 2025

NSW State Rail Authority Sydney Rapid Transit 10.4bn NSW Rail 2018 2024

Victorian Government 50 Level Crossing Removals 6.0bn VIC Rail/Road 2016 2023

QLD Dept. of Transport and Main Roads Brisbane Bus & Train (BaT) x 5.0bn QLD Rail/Road 2017 2021

NSW Roads and Maritime Services Western Harbour Tunnel 4.5bn NSW Road 2019 2023

Western Sydney Airport Alliance/ Australian Federal Government

Badgerys Creek Airport 2.5bn NSW Airport 2016 2024

Transport NSW CBD and South East Light Rail 2.2bn NSW Rail 2015 2019

WA Dept. of Transport Airport Rail Link 2.2bn WA Rail 2016 2019

VIC Dept. of Transport Cranbourne-Pakenham Rail Corridor

2.0bn VIC Rail 2016 2020

Victorian Government Western Distributor NEW 5.0bn VIC Roads 2015 2017

Updates since February: The Western Distributor project in Melbourne (AUD5bn) looks likely to go ahead, while the BaT project (AUD5bn) is now very unlikely to go ahead. Spending on both WestConnex in NSW and the NBN has increased by AUD4bn and AUD1.5bn respectively since the Australia Major Project Update was published.

Sources: ANZ Research (October, 2015); ANZ Australia Major Project Update (February 2015) citing company reports, Deloitte Access Exonomics, Infrastructure NSW, State government budget papers and ANZ Research.

Strong appetite for the favourable characteristics of brownfield sites among Pension Funds and SWFs has worked favourably in terms of Australian privatisation of state-owned infrastructure, with recent major bids from the Abu Dhabi Investment Authority, Kuwait Investment Authority, China Investment Corporation and Korea Investment Corporation.8

This is a far more diversified investor base as compared to a decade ago, when it was limited predominantly to Australian and Canadian pension funds, and the strong demand over the recent three years has driven up prices. Some recent profit-taking is evident from the early players, including Singapore’s GIC, although much of this is skewed to Australian Real Estate assets.

Australia Major Project Update

Earlier this year, ANZ Research released the Australia Major Project Update which highlighted the unprecedented investment and development of Australian major resource projects over the past decade and some of the challenges to resources investment over the near to mid-term. One of the major observation of the report was the strong infra-structure demand from both domestic and foreign investors.

Since this report was released, Australia has had a change in Prime Minister although no announcements have been made on infrastructure and many of the decisions are driven by state governments.

“The themes presented in the Australia Major Project Update remain relevant today, although our expectations of public infrastructure spending have increased by ~AUD2bn in each of 2017, 2018, and 2019.” — Felicity Emmett, Head of Australian Economics (October, 2015).

7 Preqin “The Australian Infrastructure Market” (September, 2015)

8 Institutional Investor’s Sovereign Wealth Centre “Down Under SWFs Compete for Hard Assets Amid Rising Prices” (April, 2015)

40% AND 57% OF DEALS IN 2014 AND 2015 YTD RESPECTIVELY WERE COMPLETED FOR AUD1BN OR MORE. COMPARATIVELY, THE

PROPORTION OF DEALS OCCURRING FOR AUD1BN OR MORE IN THE PRECEDING FOUR YEARS WAS AN AVERAGE OF 20%7



ANZ Funds & Insurance team, together with our in-house industry specialists within the Utilities & Infrastructure team, continue to support our Pension Funds and SWF clients allocating their capital to Australia Pacific infrastructure projects. This industry expertise is augmented by ANZ’s strong product capabilities across Project Finance, Corporate Advisory, DCM and Loan Syndications.

The opportunities for this asset class are vast, but investors must remain mindful of uncertainty regarding the timing and the scale of the impending financing task, have a sufficiently broad and flexible investment mandate and an ability to self-manage liquidity over a long-term investment horizon. For some investors, shifting to a less passive investment opportunity will require local insights from their banking partner and/or contracting, partnering or co-investing with experienced and reputable local investment managers.

GLOBAL LOANS & ADVISORY Paul Orton Global Head of Project & Export Finance E: [email protected]

FINANCIAL INSTITUTIONS GROUP Rennie SiowHead of Funds & Insurance, SingaporeE: [email protected]



IMR 3 TAX UPDATE – AUSTRALIA OPEN FOR BUSINESS

9 The Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015; The revised explanatory memorandum of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015; publicly available research

10 The Johnson Report (2009);

Figure 9 – Expanded measures of IMR 3

EXPANDED MEASURES SPECIFIC DETAILS

Tax concessions to eligible foreign investors/ funds investing directly or indirectly through an Australian fund manager

• Direct concession: confirms that gains/losses on Australian portfolio assets are not taxable for foreign investors/funds when investing directly

• Indirect concession: designed to remove tax uncertainty for foreign investors/funds that invest in Australian or foreign assets through an independent Australian fund manager

Broader set of foreign investors/ funds that are eligible for concessions

• A designated class of ‘widely held entities’ (e.g. life insurers, pension funds, sovereign wealth funds) and a simplified legislative test

Broader range of Australian portfolio assets, except for real property

• Gains on Australian portfolio assets are no longer taxable in Australia even if Australian-sourced – this includes derivative arrangements (i.e. gains from disposal of portfolio equity interests, bonds and FX under forward contracts) for direct and indirect concessions and sub-underwriting arrangements for indirect concessions

• However, income items (i.e. interest and dividends) will still be subject to Australian withholding taxBroader range of foreign assets; greater clarity for US investors/funds

• Covers investments in all foreign assets through an Australian intermediary, not just portfolio assets• Expands the benefit of IMR 1 by providing further clarity regarding the tax concessions

for qualifying US investors/funds

BACKGROUND Policy reform to further develop Australia as a funds management centre

In late May 2015, the Australian Federal Government introduced into parliament a bill for the third element of the IMR tax reforms, which was subsequently passed in June. Informally known as ‘Investor Manager Regime 3’ (IMR 3), this Bill will take effect for the 2015/16 and later income tax years, although taxpayers can retrospectively apply it to the 2011/12-2014/15 income tax years.9

Tax uncertainty was a significant issue historically

In 2009, the Johnson Report provided recommendations with the aim of boosting Australia’s competiveness as a regional financial services centre.10 The Investment Manager Regime (IMR) is part of a package of proposals aimed at removing Australian tax uncertainties and impediments that arise for foreign investors and funds when they invest in:

• Australian assets through an Australian intermediary; or

• foreign assets through an Australian intermediary.

These uncertainties presented significant competitive disadvantages for Australian fund managers in sourcing and managing money on behalf of foreign investors and funds.


As a AAA-rated country with relatively stable economic and regulatory environments, Australia continues to be an attractive destination for foreign investment flows. Policy reforms are also in development to improve the country’s position as a funds management centre for global and regional Asia Pacific investment flows. The recently introduced third element of the Investment Manager Regime should be welcomed by foreign investors and funds investing into or through Australia using domestic fund managers or intermediaries.

However, IMR 3 is not the complete solution, and it will need to be further built upon in the context of both strategic (i.e. what other policy changes will help?) and operational considerations (i.e. what is needed on a day-to-day basis to capture the opportunity?).

IMR 3 provides greater tax certainty for foreign investors and funds

By way of historical context, IMR 1 (2012) was intended to address the US FIN 48 requirement which required eligible US investors/funds to disclose uncertain tax liabilities arising from transactions. IMR 2 (2012) was intended to address the tax uncertainty that arises when an Australian intermediary manages foreign assets on behalf of widely held foreign entities (conduit income).

IMR 3 supersedes the existing IMR 1 and 2 reforms, broadening and simplifying the tax regime for foreign investments into and through Australia.


11 Australian Bureau of Statistics – ABS: 5655.0 – Managed Funds, Australia, March-2015

IMR 1 and 2 enacted in September 2012

Mar 10

Jun 10

Sep 10 10

Dec Mar 11

Jun 11

Sep 11

Dec 11 12

Mar 12 Jun Sep

12 Dec 12

Mar 13

Jun 13

Sep 13 13

Dec Mar 14

Jun 14

Sep 14 14

Dec Mar 15

12%

10%

8%

6%

4%

2%

–

(2%)

(4%)

(6%)

However, complimentary reforms are required – other macro or policy issues being discussed for further developing Australia as a funds management centre include the following:

• Collective investment vehicle structure: the Australian funds management industry uses a relatively unique unit trust structure. In comparison to other parts of the world, the structure is less well understood and hence could hinder the ability of Australian fund managers to source foreign fund inflows from overseas

• Withholding tax: Australia has a higher withholding tax rate for investment portfolio income (30% for dividends, 10% for interest, 30% for royalties) in comparison to Hong Kong (0% for dividends and interest, ~4.95% for royalties) and Singapore (10-15%). As such, while Australian tax treatment of portfolio gains and losses are on par with other financial centres, greater tax on the income component presents another potential competitive impediment for Australian fund managers

• What aspects of recent Free Trade Agreements are complementary to IMR 3? (i.e. Japan, Korea, Taiwan, China)

Apart from strategic, longer-term considerations, industry participants will have to consider operational needs to capitalise on the opportunities arising from IMR 3:

• Cross-border payment and liquidity requirements (e.g. investors/funds from different countries, timing mis-match vis-à-vis asset sales and redemptions, cash management)

• FX spot and hedging requirements

• Business origination and distribution channels to target offshore funds/investors, including offshore regulatory requirements.

GLOBAL MARKETS Dominique Blanchard Global Head of Investor Sales E: [email protected]

FINANCIAL INSTITUTIONS GROUP Phil CarmontHead of Funds & Insurance, AustraliaE: [email protected]

Next steps and considerations

With IMR 3 now in place, it should be a catalyst for much stronger offshore investment flows both into and through Australia going forward.

Figure 10 – Quarterly growth rates of overseas sourced funds managed by Australian investment managers11



CHINA’S C-ROSS COMPLIANT REGULATORY CAPITAL BONDS

BACKGROUND China Life’s perpetual note marked a new precedent for financial institution regulatory capital bonds

China Life’s June 2015 USD1.28bn issuance of perpetual bonds marked the first Chinese insurance regulatory capital issued under new C-ROSS12 standards. US, European and Australian insurance groups have long utilised hybrid capital and/or subordinated debt instruments as part of their regulatory capital management strategies. However, Asian insurers have been relatively better capitalised making bond issuance less urgent. As these insurers internationalise and compete with the global peer groups, regulatory capital instrument issuance may feature more.

“Investors have ingested billions of dollars in Asian bank capital since 2013. Asian insurance credit is more scarce and C-ROSS bonds could provide a chance to diversify portfolios” says Kang Jae Kim, Global Head, Financial Institutions DCM.

Figure 11 – Financial Institution Subordinated and Hybrid capital instrument issuance13 (in USD bn)

12 The China Insurance Regulatory Commission (CIRC) finalised its China Risk Oriented Solvency System (C-ROSS) in February 2015

13 Sample comprise subordinated debt and deeply subordinated debt issues (i) by Banks and Insurance companies; (ii) in both onshore and offshore markets; (iii) for issuers with home country Australia, China, Hong Kong, Japan, Philippines, Singapore, Thailand, Taiwan and Europe. 2015 YTD reflects Bloomberg data as at August 31, 2015

2013

2015 YTD2014

104.1145.7

261.2

InsuranceBanks

75%

25%

86%

14%

89%

11%

Core T1 = Min. 70% of Total Core

Core T2 = Max. 30% of Total Core

Supp T1 = Max. 100% of Total Core

Supp T2 = Max. 25% of Total Core

Supp Capital

(Max. 100% of Total Core)

Rank

Most subordinated /

permanent

Total Core Capital

Expected / minimum requirements

PERMANENCE COUPONS/DISTRIBUTIONS

ST2 < 5 yrs Mandatory

ST1 ≥ 5 yrs Optional deferrable (cumulative)

CT2 ≥ 10 yrs with loss absorption language; Perpetual without loss absorption language

Optional deferrable, if dated, subject to solvency tests (cumulative)

CT1 Perpetual Fully discretionary

Note: Only precedent instrument as at September 2015 is China Life’s CT2 perpetual notes.

C-ROSS outlines structural terms for new capital instruments for Chinese insurers

C-ROSS introduces an expanded range of eligible capital instruments, comprising core & supplementary capital, each featuring unique structural requirements. Core capital and supplementary capital are each broken down into two categories, Tier 1 and Tier 2. Both tiers of core capital are subordinated to the two tiers of supplementary capital in a hierarchy demonstrated in Figure 12.

Figure 12 – C-ROSS regulatory capital hierarchy

Core capital represents the primary source of loss absorption for the insurer and a minimum of 70% of core capital must be in the form of Tier 1 (“CT1”), comprising ordinary equity. Up to 30% of core capital can be Tier 2 (“CT2”) instruments. These CT2 instruments must have a minimum tenor of 10 years, with call options no earlier than five years. If structured as a dated instrument, CT2 bonds must feature loss absorption language, however the CIRC is yet to define a trigger event and no precedents exist to date for this structure. CT2 bonds are not required to contain loss absorbing language if structured as perpetual bonds, like the China Life CT2s.


Figure 13 – Key Feature Comparison C-ROSS vs. Basel III regulatory capital instruments

C-ROSS BASEL III

Tiers of Capital 4 Tiers of Capital: Core Tier 1, Core Tier 2, Supplementary Tier 1, Supplementary Tier 2.

3 Tiers of Capital: Common Equity Tier 1, Additional Tier 1 (“AT1”), Tier 2 (“T2”).

Regulatory Capital Bonds Can qualify as CT2, ST1 or ST2. Can qualify as AT1 or T2.

Loss Absorption Loss absorption language required for dated CT2 bonds.

Loss absorption language required on all AT1 and T2 securities.

Triggers CIRC has not defined what the trigger event would be. No precedents exist as trigger is only required for dated CT2 bonds.

Both AT1 and T2 instruments require loss absorption triggers at the point of non-viability. Liability-accounted AT1 instruments (in some jurisdictions, all AT1 instruments) also require a CET1 loss absorption trigger.

Ratings Agency ‘Equity Credit’

There is no global regulatory framework prescribing a common structure for insurers. Therefore C-ROSS compliant regulatory capital instruments also need to meet the minimum rating agency requirements for corporate hybrids to gain equity credit.

AT1 instruments that qualify under Basel III rules will typically receive equity credit without additional structural adjustments. T2 instruments do not typically qualify for equity credit.

Coupon Deferral Optional (cumulative, deferrable) for CT2 and ST1. ST2 allows for mandatory coupons. Dated CT2 instruments also subject to solvency test for distributions.

Fully discretionary, non-cumulative for AT1 and subject to dividend tests. T2 allows for mandatory coupons.

Permanence CT2 instruments must be at least 10yrs minimum tenor with a minimum non-call period of 5yrs. ST1 instruments must be at least 5yrs minimum tenor and ST2 instruments can be less than 5yrs tenor.

AT1 notes must be perpetual in nature with minimum non-call period of 5yrs. T2 notes can be 5yrs minimum tenor, but regulatory capital benefit will reduce by 20% per annum in the last 5yrs to final maturity.

Incentives to redeem No incentives to redeem are permitted on core capital, however it is not explicitly stated for supplementary capital.

No incentives to redeem permitted, such as step-ups coinciding with call dates. No call dates coinciding with mandatory conversion (minimum 2yr gap). Indirect incentive to redeem T2 instruments prior to their regulatory capital amortisation in last 5 years (therefore call date is typically 5 years prior to final maturity).

Supplementary capital does not require loss absorption language and is capped at 100% of total core capital. Of this, at least 75% must be in the form of Tier 1 (“ST1”) instruments which closely resemble traditional dated subordinated debt instruments although coupon deferral is optional. The remaining supplementary capital up to 25% can be in the form of Tier 2 (“ST2”), which can be shorter dated and have mandatory coupons. To date, there has been no precedent for supplementary capital issuance offshore.

Similar but different to Basel III bonds

China Life’s CT2 bond shared similarities with Basel III bank Additional Tier 1 securities, however there are several key differences between the requirements under C-ROSS vs. Basel III illustrated in Figure 13.



While bank capital instrument criteria has become more harmonised globally through the Basel III framework, the insurance capital instrument criteria remains highly customised to the domicile of the insurer. This limits the ability of ratings agencies and investors to easily categorise and compare different country insurance capital instruments by tier of capital. Indeed, for many insurers, it is the minimum criteria for ‘equity credit’ from ratings agencies that drives a more loss-absorbing structure than the country’s prudential supervisor.

ANZ Financial Institutions DCM team has worked with a number of Asia Pacific insurers on capital instrument issuance that both complies with local regulatory requirements and achieves the targeted equity credit from rating agencies.

In Australia, this has even included a structure for a bank and insurance conglomerate that is fully harmonised with Basel III, LAGIC and rating agency criteria. Greater investor education requirements are assured as many more jurisdictions follow Australia’s LAGIC and China’s C-ROSS lead, including Solvency II in Europe and RBC 2 in Singapore. ANZ looks forward to working more closely with both issuers and investors as this nascent suite of bond structures develops.

DEBT CAPITAL MARKETS Kang Jae Kim Global Head, Financial Institutions DCM E: [email protected]

FINANCIAL INSTITUTIONS GROUP Bridget QiHead of FIG, ChinaE: [email protected]


MULTINATIONAL INSURERS – CHINA SBLCsBACKGROUND Increasing credit risk charges for insurance ceded offshore

The China Insurance Regulatory Commission (CIRC) finalised its China Risk Oriented Solvency System (C-ROSS) in February 2015. C-ROSS is a dynamic risk based capital regime which applies credit risk charges to counterparties, including reinsurers, based on a sliding scale driven by the counterparty’s solvency level or credit rating. In addition, C-ROSS introduces higher credit risk charges on reinsurance exposures (exposures include receivables and reserves) ceded by primary insurers to overseas reinsurers. These higher charges can be avoided by holding collateral against the reinsurance exposures, including eligible Standby Letters of Credit (SBLCs) or Financial Guarantees from onshore banks.

As expected, most onshore Chinese insurers have indicated that they want foreign reinsurers to provide the required collateral. ANZ’s Global Funds & Insurance team along with Transaction Banking Product specialists have been working with the CIRC to understand the key regulatory features for SBLCs on behalf of foreign reinsurers to meet Chinese onshore insurers’ collateralisation requirements.

Global context of SBLCs in the insurance sector

The CIRC are not the first regulator to recognise SBLCs as a cash-fungible trade product to meet onshore collateralisation or capital requirements. Indeed, ANZ has worked with reinsurers across many jurisdictions

where similar rules apply as shown in Figure 14.

• The Australian Prudential Regulatory Authority (APRA) prescribes punitive capital charges for general insurers on reinsurance assets due from non-APRA authorised reinsurers. However, explicit, unconditional and irrevocable guarantees or SBLCs issued by an APRA authorised bank can be used to support the reinsurer’s performance on the reinsurance contract(s) and reduce the capital charges.

• The Office of the Commissioner of Insurance (OCI) in Hong Kong permits qualifying SBLCs or other commitments from a bank, in favour of the insurance authority, as a substitute for maintaining assets in Hong Kong for General Insurers.

• The National Association of Insurance Commissioners (NAIC) in the United States requires that insurance liabilities ceded to an insurer that is not licenced within that state, be supported with cash, securities qualifying as ‘admitted assets’, or SBLCs issued by qualifying banks.

• Funds at Lloyd’s (FAL) in the United Kingdom permit SBLCs and Financial Guarantees issued by a bank as ‘Approved Assets’ to support members’ underwriting commitments.

• The European Commission (EC) has permitted qualifying SBLCs from banks to qualify as insurers’ Tier 2 capital.

SBLCs in the context of China’s C-ROSS insurance rules

The collateralisation of reinsurance exposures will be an additional cost of operating an insurance company in China, and will impact foreign reinsurers writing Chinese business.

Figure 14 – Global use of Regulatory SBLCs to meet onshore collateralisation requirementsA number of geographies allow ANZ issued SBLCs or Financial Guarantees to meet onshore collateralisation or regulatory capital requirements for insurers.

APRA

HK OCI

CIRC

NAIC

FAL

EC


Figure 15 – Indicative capital requirements per USD100 of reinsurance exposures by counterparty type (USD)14

As shown in Figure 15, collateral can provide an ~85% lower capital requirement for primary insurers ceding to overseas counterparties, while for reinsurance exposures ceded by reinsurers to overseas counterparties, collateral reduces the capital set aside by ~40%. As such, collateralised reinsurance exposures will be more compelling for ceding parties from a capital requirements perspective.

“The global insurance industry continues to evolve as the regulators seeks to add protections within their local countries. Many of our multinational insurance clients use SBLCs extensively to meet the expanding regulatory requirements for onshore collateral in multiple jurisdictions. C-ROSS provides clarity that SBLCs, from a qualifying bank, are an alternative to onshore reserve deposits and I expect take-up to be strong for foreign reinsurers working with onshore Chinese insurance companies as the industry grows along with the economy”, says Joshua Landau, Head of Funds & Insurance, Europe, America and Middle East.

While details of the specific terms and conditions of such SBLCs are still under consultation, ANZ expects the first qualifying C-ROSS SBLCs to be issued in 2016, with terms likely to adopt international best practice:

• The Chinese legal framework already recognises both Financial Guarantees and SBLCs and ANZ expects that bank support of the reinsurer’s performance on the contract(s) could take either form.

• Clean, unconditional and irrevocable such that the instrument fully reflects the same characteristics as onshore cash collateral if held by the insurer.

• Permanence, reflected in a suitable tenor likely to be greater than 12 months initial term. ANZ notes that in North America, one year is market standard, however other jurisdictions, such as Australia, require a minimum two-year initial term.

• Evergreen such that the instrument automatically renews subject to a minimum notice period.

- The exact period for notice remains to be set, and ANZ notes that market standards range from 30 days to 12 months, or even longer in the case of FAL.

- Needs to allow sufficient time for applicants to find replacements, taking into account the average time required for application and approval of such instruments from issuing banks and the CIRC.

• Claims collection must typically be in the local country where the SBLCs are lodged to ensure timely payments.

14 ANZ Analysis, based on CIRC regulation #8

15 Domestic counterparties with solvency ≥100%

16 Lower end is for affiliated overseas counterparties, while higher end is for unrelated counterparties

17 Range indicative of overseas counterparty’s rating

18 Swiss Re Sigma 2014. YoY growth rates – inflation adjusted growth rates of premium volumes from 2013–2014.

85%lower

40%lower

40%lower

Ceded by primary insurers to domestic counterparties15 Ceded by reinsurers to overseas

counterparties rated ≥ AA- 17Ceded by reinsurers to overseas counterparties rated ≥ BBB- 17Ceded by primary insurers to overseas counterparties16

No Collateral Collateral No Collateral Collateral No Collateral Collateral

0.5 - 4.9

52.9 - 58.8

7.8 - 8.7

0.6 - 5.6 0.4 - 3.4

8.3 - 14.4

5.0 - 8.6


ANZ’s insurance specialists across Transaction Banking and the Financial Institutions Group have a long history of providing SBLCs to suit the regulatory nuances of each country’s insurance rules. SBLCs are an important tool for insurers, which encourage the global spread of risk and improve the free flow and fungibility of capital across jurisdictions.

China’s insurance market experienced 15.2% growth in total premium volume in 2014, comparing favourably to growth rates of 0.6%, 3.5% and 6.5% in North America, Europe and Asia respectively.18 While C-ROSS will add costs to international insurance dealings, ANZ expects foreign insurers to continue to invest in this dynamic and underpenetrated market.


TRANSACTION BANKING Lisa Vasic Global Head of Financial Institution Sales E: [email protected]

FINANCIAL INSTITUTIONS GROUP Joshua LandauHead of Funds & Insurance, EMEAE: [email protected]


ANZ CONTACTS

ANZ GLOBAL FUNDS & INSURANCE TEAMGLOBAL HEAD, FUNDS & INSURANCE Giles BORTENT: +61 2 8037 1051E: [email protected]

AUSTRALASIA

Australia Philip CARMONTT: +61 2 8037 0702E: [email protected]

Pacific Islands Peter DAVIS T: +61 2 8037 0704 E: [email protected]

New ZealandReuben TUCKERT: +64 9 252 3438E: [email protected]

MIDDLE EAST AND INDIA

Middle EastRanjit ROYT: +971 4 4172802E: [email protected]

India Aarti MITTAL T: +91 22 3362 0038 E: [email protected]

EUROPE AND AMERICASAmericasJoshua LANDAUT: +1 212 801 9882E: [email protected]

EuropePatrick SHIELDST: +44 20 3229 2169E: [email protected]

SOUTH EAST ASIAIndonesiaEka SUKADA T: +62 21 575 3443 E. [email protected]

Singapore, Brunei, Greater Mekong Rennie SIOWT: +65 6681 2039E: [email protected]

Philippines Jesus Plaridel Jr. SANTIAGO T: +632 841 7782 E: [email protected]

Thailand Surapon PLOYPAIRAOH T: +662 168 8777/8 E: [email protected]

Malaysia Karen CHONG T: +603 2078 1588 E: [email protected]

VietnamThanh Thuy NGOT: +84 4 3938 6901E: [email protected]

NORTH ASIAChina, Macau Bridget QI T: +86 10 6599 8192 E: [email protected]

South Korea Jeffrey HA T: +82 2 3700 3125 E: [email protected]

Hong Kong Elodie NORMAN T: +852 3918 2818E: [email protected]

TaiwanKatherine CHINT: +886 2 8722 3040E: [email protected]

Japan Kazuya KURANO T: +81 3 6212 7736 E: [email protected]


ANZ CONTACTS

SOLUTIONS, FINANCIAL INSTITUTIONSCLIENT INSIGHTS & SOLUTIONS (CIS) Sumeet WADHERAGlobal Head of Solution DesignT: +65 6681 2341E: [email protected]

Kevin WONGDirector, Solution Design, AustraliaT: +61 2 8937 7320 E: [email protected] Robert TSANGDirector, Solution Design, AsiaT: +852 3918 2122E: [email protected]

Mark LINDONHead of CIS, New ZealandT: +64 9 252 6185 E: [email protected]

Carli RENZIDirector, Industry Insights, Global FinancialsT: +65 6708 1575E: [email protected] Tafadzwa SHAAMANOAssociate, Insights & Research T: +61 3 8655 6684E: [email protected]

Prakash PRABHUAssociate, Global FinancialsT: +91 80 3952 7187E: [email protected] Prateek AGRAWALAnalyst, Global Financials T: +91 80 3952 4989E: [email protected] Vaibhav GARGAnalyst, Global Financials T: +91 80 3952 7134E: [email protected]

DEBT CAPITAL MARKETSKang Jae KIMGlobal Head, Financial Institutions DCMT: +852 3918 7864E: [email protected]

Bhavik PANDYADirector, DCM AsiaT: +852 3918 7854E: [email protected]

Anthony CHOAssociate, DCM AsiaT: +852 3918 7856E: [email protected]

GLOBAL LOANS & ADVISORYChristina TONKINMD, Global Loans & AdvisoryT: +61 2 89377691E: [email protected]

Sean JOSEPHHead of Global Loans & AdvisoryT: +65 6681 2228E: [email protected]

Paul ORTONGlobal Head, Project & Export FinanceT: +61 3 8655 6625E: [email protected]

TRANSACTION BANKINGLisa VASICGlobal Head, Fin. Institutions SalesT: +61 2 8937 8007E: [email protected]

Deepan DAGURHead of Fin. Institutions Sales,South East Asia & PacificT: +65 6681 2883E: [email protected]

GLOBAL MARKETSDominique BLANCHARDGlobal Head, Investor SalesT: +852 3918 7711E: [email protected]

Troy BOWLERGlobal Head, Rates Investor SalesT: +65 6681 8864E: [email protected]

Timothy MOLONEYGlobal Head, FX Investor SalesT: +61 2 8037 0587E: [email protected]

Subhramit DASGlobal Head, StructuringT: 65 6681 8859E: [email protected]

Noel CARLINHead of Collateral Optimisation & Repo TradingT: +65 6681 8919E: [email protected]

LOAN SYNDICATIONSJohn CORRINGlobal Head of Loan SyndicationsT: +852 3918 7830E: [email protected]

Carl ROBERTSHead of Loan Syndications, South AsiaT: +65 8428 7592E: [email protected]


ANZ GENERAL DISCLAIMER

SPECIAL THANKSTroy Bowler, Global Head of Rates; Felicity Emmett, Co-Head of Australian Economics; Colin Ng, Head of Insurance, North East Asia; Rennie Siow, Head of Funds & Insurance, Singapore; Head of FIG, Malaysia; Robert Tsang, Director, Asia Financials; Kevin Wong, Director Australia Financials; CIS Global Financials Analytics team; ANZ Research

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Documents

ISSUES THAT MATTER - ANZ...CONTENTS Welcome to Volume 2 of ANZ FIG’s Issues that Matter publication The focus for this edition is Funds and Insurance, which is ANZ’s fastest growing