Debentures
Better disclosure for retail investors in unlisted unrated debentures, Media release 08-82
Investing in debentures? - Independent guide for investors (PDF file)
Understanding investors in the unlisted, unrated debenture (UUD) market - ASIC Report 126
Warnings about fixed interest products
What is a ‘debenture’?
A debenture is one way for a business to raise money from investors. In return for your money, the business (or ‘issuer’ of the debenture) promises to:
- pay you interest and
- pay back the money you lend them (or your ‘capital’) on a future date.
By investing in a debenture, you are lending your money to a business, with all the risks that this involves. The issuer might use your money to finance a wide range of business activities. They might also lend your money to another business (known as ‘on-lending’).
Do you know exactly what the issuer of the debenture is going to do with your money?
Could you explain the underlying business model to a friend or colleague?
Debentures are ‘fixed interest’ investments. This means that the interest rate on the money you lend is set in advance. However, interest payments on your money and return of your capital are not certain. A debenture is not the same as a term deposit.
What is an ‘unlisted’ debenture?
An unlisted debenture is not listed on a public market, such as the Australian Stock Exchange (the ASX).
There are differences between listed and unlisted debentures that can make it harder for investors to easily know what’s going on with their investment. These differences include:
- the issuer of an unlisted debenture is not subject to stockmarket requirements to make information affecting the price or value of the investment publicly available
- unlisted debentures are not listed on a stockmarket where you can see the price of the investment (and whether it is going up or down) or sell it if you want to
- it can be harder to get out of the investment early
- unlisted debentures are not subject to the ongoing supervision of a market supervisor, such as the ASX.
What is an ‘unrated’ debenture?
An unrated debenture does not have a credit rating from a rating agency recognised by ASIC. The Investing in debentures? independent guide for investors (PDF file) has more information on credit ratings.
Why is the prospectus important?
The prospectus will tell you how the investment works and you should read it in full. However, if you read nothing else, read the sections that:
- explain the key features and risks of the investment
- give you information about certain indicators (or ‘benchmarks’) which can help you assess the risks of unlisted debentures.
You should find this information in the first few pages of the prospectus.
The prospectus should tell you everything you need to know about the issuer, what they will do with your money, and the terms of the investment. A prospectus must be lodged with ASIC before it can be used to raise money from investors. However, this does not mean that ASIC has checked or endorsed the underlying investment in any way.
Consider the risks
The return offered on an investment is not the only way to assess how risky it is.
ASIC’s benchmarks can help you assess the risks
ASIC has developed 8 benchmarks that apply to unlisted debentures to help you assess the risks.
Benchmarks are designed to help you:
- understand the risks and
- decide whether to invest your money.
Issuers must tell you in their prospectus how they meet each benchmark. If they don’t meet a particular benchmark, they must explain why not, allowing you to make up your mind whether you’re comfortable with the explanation.
The Investing in debentures? guide has more detail on each benchmark, and how you can use them to assess the risks in unlisted debentures.
Benchmark 1: Equity capital means money the issuer has invested in the business.
The issuer must have a certain minimum equity capital. 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 their own money is at risk.
Benchmark 2: Liquidity means the issuer’s ability to meet short-term cash needs.
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, they might be unable to meet their short-term obligations (e.g. to run the business properly, pay you interest, or pay your money back at the end of the term).
Benchmark 3: Rollovers
Some investments are automatically rolled over at the end of the investment term. This may mean that your money is re-invested for a similar term unless you withdraw it. To meet this benchmark, the issuer must clearly state in the prospectus what happens at the end of the investment term.
Benchmark 4: Credit rating
To meet this benchmark, the issuer must make sure the investment has a credit rating from a credit rating agency recognised by ASIC. The prospectus should explain what the rating says about the risk of investors not getting their money back. If the investment does not have a credit rating, the issuer must say this in the prospectus and give the reasons for this.
A credit rating can help you assess the issuer’s ability to pay you interest on your investment and pay your money back at the end of the term. An unrated investment is not necessarily high risk, but it does mean that you will have to use other means to evaluate the issuer’s ability to repay your interest and capital.
The Investing in debentures? guide has more information on credit ratings.
Benchmark 5: Loan diversity (for issuers who lend your money to someone else)
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 your money) at risk.
Benchmark 6: Related parties (for issuers who lend your money to someone else)
A ‘related party transaction’ is a transaction (e.g. a loan) involving parties that have a close relationship with the issuer.
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 your money is at greater risk if the:
- issuer has a high number of loans to related parties, and
- assessment and approval process for these loans is not independent.
Benchmark 7: Valuations (for property-related activities*)
Knowing exactly how much the issuer’s underlying assets are worth (i.e. accurate valuations) can help you assess their financial position.
If the issuer does not include information about valuations in the prospectus, it will be more difficult for you 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: Loan-to-valuation ratio (LVR) (for property-related activities*)
This benchmark applies to issuers who on-lend money in relation to property-related activities. The LVR tells you how much of the value of an asset is covered by loan money. The LVR is a key risk factor when assessing whether to lend money to someone.
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 losing your money could be higher.
(*For example, property-related activities might include property development or mortgage financing.)
Remember: Benchmarks are not a guarantee that an investment will perform well. Even if this investment meets all the benchmarks, you could still lose some or all of your money if things go wrong. The benchmarks are simply designed to help you understand the risks and make a decision about whether to invest your money.
ASIC does not endorse specific investments.
Think about your own situation and needs
Does the investment meet your goals?
Whenever you invest your money, it is important to have a financial goal in mind, and a strategy for meeting that goal. For example, your goal may be looking for a secure income for your retirement. Think about getting professional advice from a licensed financial adviser to help you develop a suitable investment strategy according to the level of risk you’re comfortable with. Then measure all investments against that strategy.
Do you want total safety for your money?
Certain financial products (such as term deposits) offered by financial institutions like banks, building societies or credit unions are specially regulated to make sure that, under all reasonable circumstances, they can meet their financial promises.
If you can’t afford to lose any of your capital, consider investing in those types of products. Most issuers of debentures are not subject to that kind of regulation.
Be careful about words like ‘safe’ and ‘guaranteed’ in advertisements. They might imply that the investment is secure, when in reality it is not.
Have you spread your investments to manage risk?
Most people have heard the saying, ‘Don’t put all your eggs in one basket’. When it comes to investing your money, a good way of managing risk is to spread your money between different investment types, such as cash, fixed interest, property and shares. The spread will depend on your financial goals and how much risk you’re comfortable with. These different investment types are known as ‘asset classes’.
Spreading your investments to manage risk is called ‘diversification’
Just investing in debentures is not diversification.
By spreading your money both across different asset classes and between different investments within the same asset class, you reduce the risk of losing everything. By putting only a proportion of your total funds into any one type of investment, you won’t lose everything if one investment produces poor results or fails completely.
What returns are you being offered?
‘High returns means high risk’ is a familiar rule of thumb. However, as with all rules, there are exceptions to look out for.
Some investments, that appear to offer relatively modest returns, can be extremely risky. That’s why it’s important to consider more than just the returns when deciding whether to invest in something.
When comparing rates of return, make sure you compare ‘apples’ with ‘apples’ (i.e. similar investments).
Can you get your money back early?
What happens if you need to get your money out before the end of the loan term? Is this an option and are there penalties for doing so?
If you need flexibility, think about investing in other financial products that allow you access to your money without heavy fees or penalties.
Do you know how risky the investment is?
Debentures are riskier than term deposits offered by banks, building societies and credit unions.
Ask yourself, is the return you are being offered high enough to compensate you for the risk you are taking by putting your money in this investment?
Can you accept the risks?
The main risk with this type of investment is that the issuer might be unable to pay you interest when it is due, or pay back your money at the end of the term.
If you don’t understand the risks in this investment or you’re not comfortable taking any risks with your money, look at other financial products instead. Get professional financial advice if you’re unsure about an investment decision.
Do you know what you are investing in?
Check what the issuer plans to do with your money. This information should be clearly set out in the prospectus, but don’t hesitate to ask questions until you really understand.
Knowing what your money will be used for can help you assess the risks and decide whether you are comfortable with this investment.
Is the investment related to property development?
If your money will be used for property development, consider these extra risks:
- Will the property development be completed on time and on budget?
- How is the property valued?
- How will the issuer meet cash flow needs before the property development is completed and sold?
The prospectus should help you to answer these questions.
People like to think that investing in property is ‘safe as houses’. In reality, it involves the same risk as any other investment – the risk of losing as well as gaining money.
Take your time and think things over before you invest
Get professional financial advice if you are unsure about what to do.
More on cash and fixed interest investments
FIDO Website: Printed 07/25/2008
