Getting direct exposure to the top international stocks can be onerous and costly for Australian investors. flow speaks to Chi-X Australia’s Vic Jokovic about how innovations in the Australian trading and market framework will allow investors to broaden their horizons
According to the United Nation’s World Happiness Report 2018, Australia is the tenth happiest place on earth 1. The rankings are based on a number of factors including GDP, social support and freedom.
However, when it comes to Australia’s investment landscape, the joy is somewhat diminished as investors are increasingly looking towards international stocks. There are a number of reasons for this.
Skewed sector mix
This point is underlined by Figure 2. The cumulative growth of the MSCI ex Australia companies is more than three times that of the companies represented under the ASX 200 since the post-crisis trough. Global shares are performing better, and Australian investors are principally looking at the big US technology companies (see Figure 3).
The significant and growing Australian pension or superannuation pool is another reason for this investor base seeking greater diversification. Now the fourth largest in the world (behind the US, Britain and Japan) at A$2.7trn, this pool is growing rapidly and is expected to reach A$9.6trn by 2035 given the mandatory requirement for individuals to pay into a super fund. However, at present, while 31% of the country’s investible pool is held in offshore assets, only 1% is invested in direct international equities 2.
While Australian investors are seeking more international investment, there is a staggeringly high bias to domestic equities in Australia versus other countries, despite Australia representing just 2.8% of the global equity world (MSCI World Index). This over-concentration presents risk and limits an Australian investor’s ability to truly diversify their investment portfolio.
A finite investable universe at home and a superannuation pool that is bursting at the seams is leading these investors to try to find homes outside of Australia to diversify their holdings.
However, they are finding it difficult to access international shares. Direct ownership, particularly of US stocks, has been fraught with challenges. In order to gain meaningful exposure to global growth stories and the new economy, both retail and institutional investors usually need a US-based account and associated services. While many Australian listed companies, exchange traded funds (ETFs) and listed investment companies are delivering underlying offshore assets and exposure in an Australian listed stock, to date no-one has been able to provide direct beneficial ownership of US corporate names.
Alternative exchange approach
After obtaining an Australian financial market operator license in 2011, pioneering stock exchange Chi-X sought to grow in this market with alternative solutions for investors in partnership with other companies. Its name, explains the website 3, is derived from the Greek letter Chi, written X, “symbolising the crossing of the two sides of a trade.” With about 20% of the Australian financial markets daily volumes trading on the securities and derivatives exchange, Chi-X wanted to help more investors gain exposure to the top overseas companies.
Chi-X partnered with Deutsche Bank to work on a solution that would provide direct beneficial ownership of US corporates. Vic Jokovic, a former Deutsche banker who ran a number of businesses including equity derivatives, equity sales and institutional coverage, and latterly headed up the bank’s global markets business in Australia, joined Chi-X Australia as CEO in January 2018 to lead the charge. “As one of the early brokers to execute trades on Chi-X and a banking, FX, rates credit and equities house for close to 30 years, Deutsche Bank was a natural fit for the exchange provider who was thinking about new products for the Australian market,” Jokovic explains.
US market access
The US market was also an obvious place to focus on. “Australian investors are increasingly becoming self-directed and want access to household names like Apple and Facebook,” comments Jokovic. International share ETFs have grown from 16.7% to over 43% of the Australian ETF market over the last five years and 35% of daily ETF volumes are currently traded in Australia occur on Chi-X.
Chi-X could also leverage Deutsche Bank’s experience as the first bank to issue transferable custody receipts (TCRs) over US shares in Argentina, Mexico and Chile, beginning in the late 1990s. This allowed TCR investors in these markets to invest in the underlying shares of US companies on their home market’s stock exchange.
Together, Deutsche Bank and Chi-X identified a number of pain points for Australian investors and brokers, who faced a clunky process, with significant operational issues, to obtain direct access to US companies. “There are extensive forms and long set-up times for accounts, with some brokers telling us it can take eight to 12 weeks to set up a new account to access shares globally,” recounts Jokovic.
The two companies developed a solution using transferable custody receipts that would simplify the process of buying US names locally in the Australian market on Chi-X from 10am to 4pm local hours, as opposed to overnight. The partnership would see Chi-X responsible for the new market framework, including trading and the new TraCRs web site, while Deutsche Bank would issue and service the transferable receipts, leveraging its deep experience as a global depositary bank.
Essentially these transferable custody receipts, or TraCRs (see box-out), reflect the beneficial interest in a US share, with settlement happening during the same cycle as normal Australian shares. Investors will also have the ability to convert their TraCRs into the underlying US share as long as they have a US-based account.
Brian Studdert, Head of Depositary Receipt services, Deutsche Bank expects TraCRs to bring “the benefit of global diversification to Australian investors, by providing a simple and convenient way of investing in leading US companies such as Microsoft and General Electric during the Australian trading day.”
“With Australian investors increasingly seeking international diversification in their portfolios, we have partnered with key market participants and have developed an innovative market infrastructure to bring an efficient solution for these investors”
Jose Sicilia, Head of Trust and Agency Services, Deutsche Bank
Meeting regulatory expectations
Size of Australian superannuation fund pool
(Fourth largest in the world)
Chi-X satisfied ASIC’s request by building a website that would serve as a single source of all material information on US companies, as well as provide price information on both the TraCRs and their underlying US shares. In addition, this website would contain US company disclosure notices filed with the US Securities and Exchange Commission (SEC), and company-specific news feeds. “Together with Chi-X, we went above and beyond. This one-stop shop on the TraCRs website directs investors to a wealth of company news and US SEC filings, along with TraCR corporate actions notifications,” commented Jeff Margolick.
Chi-X and Deutsche Bank worked closely with ASIC, and the Australian Tax Office to ensure TraCRs could launch. The product took more than two years to develop, as it needed to fit within the existing Australian market ecosystem while at the same time requiring certain changes to be made to existing regulation.
How TraCRs work
ASIC classifies TraCRs as Australian equity market products. By holding a TraCR, an investor gets the beneficial interest in a US share, which is ultimately held by a US custodian bank. This means that TraCR investors gain exposure to the financial performance of that share, including the right to receive dividends in Australian dollars, and to exercise voting rights.
TraCRs are purchased and sold through an investor’s local broker in Australian dollars during local trading hours, which can be more cost-effective than investing directly into shares in the US. Clearing and settlement takes place in Australia’s Clearing House Electronic Subregister System (CHESS), and investors can see their holdings right alongside their other Australian domestic securities investments.
Challenges of Direct Overseas Investment
Direct share investment in the US has historically proven challenging for Australians. Investors require US accounts capable of holding the shares, and given the time zone difference, may have trades executed at unknown prices during the Australian night time. Additionally, direct investment has meant higher brokerage fees than for domestic trades, and foreign exchange conversion costs. In some cases, investors also bear US custody costs.
TraCRs solve these challenges, as they trade on the Chi-X exchange during local market hours in Australian dollars. Market makers will help provide quotes with the expectation that natural liquidity will form on both sides over time. TraCR investors will also benefit from wholesale foreign exchange rates via Deutsche Bank’s foreign exchange platform. Since TraCRs are held domestically, there is no US account requirement, nor associated US custody costs. Simply put, investors can trade TraCRs in the same way as they would invest in listed shares of Australian companies.
With the new solution, the process is simplified because the local broker who receives the order will simply send the order through and execute it on Chi-X.
Sheridan Thompson, Head of Strategic Development at Commonwealth Securities, an online stockbroker that invests in overseas companies, says, “We have been supportive since first hearing about the product over two years ago because of the potential benefit for our customers. The product launch is a concrete example of the benefit of competition in the Australian market and a tribute to the perseverance of the issuer, Deutsche Bank, and Chi-X in meeting regulatory scrutiny of a new-to-Australia product.”
Thompson described the process of investing in overseas listed companies as “difficult and expensive for our customers”. To invest, the customers are required to open a separate account, move money to a foreign currency account, place orders to trade overnight and most submit a US W8-BEN tax form. He adds, “Brokerage rates, including our own, are typically higher on international accounts than on domestic accounts. Partly because of these barriers, our customers’ investments are not as well diversified geographically as they could be, despite the relative maturity of the Australian market.”
With a TraCR they will not need to open a new account, will not need to convert funds to a foreign currency, and will be able to trade in real time with live prices at the domestic brokerage rate rather than a higher rate. This, says Thompson, “is a much better customer experience”. He hopes that more of them will take advantage of the opportunity to diversify their investments as a result.
Given the size of the Australian market, Jokovic expects there will be a lot of interest and support, from retail clients through to the larger self-managed superannuation accounts and institutional fund managers that either find it difficult to invest in US names or don’t have a mandate that allows them to do so.
He expects to roll out TraCRs over Apple shares in the first tranche and TraCRs for four globally-recognised US corporates in the second tranche, and an additional five in the third tranche. Further tranches will follow based on demand from investors.
“From there, based on the success of those, we’ll look at Asian TraCRs next and then move on to European names. Beyond that we’ll look at other products if it makes sense and we’re certainly keen to partner with Deutsche Bank,” concludes Jokovic.
2See https://bit.ly/2MueWTu at ato.gov.au
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