Is the ghost of Bill Shorten's failed attack on tax credits resurfacing? – Nicholas Chaplin

After the 2019 federal election, which ended in a surprise victory for the coalition, then-defeated Labor leader Bill Shorten admitted: “I misread the franking credits.”

The tax credit policy, which was intended to end annual tax rebates of up to $6 billion for retired shareholders who are not subject to income tax, led to a drop in the polls of as much as 15 percent in favor of Labor in areas where those over 60 made up more than 15 percent of the population.

The rest is political history.

With the federal election approaching, we have yet another seemingly routine announcement from the financial regulator APRA regarding the possible phasing out of Additional Tier 1 (AT1) instruments (also known as bank hybrids) from the capital markets.

Bank hybrids generally offer a fair share of tax credits as part of their regular distributions, making them particularly attractive to self-managed super funds (SMSFs) as the SMSF receives a tax refund for the difference between its 15% tax rate and the 30% corporation tax rate paid by the hybrid issuer.

APRA has announced that (subject to a two-month consultation period) it intends to begin transitioning to a “simpler capital framework” from 1 January 2027, replacing all currently issued AT1 bonds with subordinated bonds (unfranked) and a small proportion of equity by 2032. While on the surface APRA's concerns relate to its role as a regulator, closer analysis suggests possible political undertones influenced by past controversies surrounding franking credits.

APRA had already consulted the market a year ago after expressing interest in adjusting the structure and/or quantity of AT1 bonds issued by Australian banks. It was clear that APRA's main concerns were that following the collapse of Credit Suisse in Switzerland in March 2023, AT1 bonds were not being used soon enough to support struggling banks and that Australia's unique situation of a large proportion of hybrid bonds being owned by retail investors meant that the government could potentially step in to bail out retail investors at exactly the wrong time when AT1 bonds were supposed to be saving them.

APRA's job is to regulate banks and protect Australian savers, but it appears to be acting haphazardly here. Australia's banking sector is one of the safest in the world. Four of the world's seven largest banks with AA credit ratings are based in Australia. The “big 4” banks have historically maintained good credit ratings due to the stability of the Australian banking system, conservative lending practices and a robust regulatory environment. APRA has a very good record of regulating.

In addition, Australia's four big banks are mortgage lenders, not investment banks, unlike most of the global banks that have run into trouble over the past 15 years, including Credit Suisse. The simpler business model of Australian banks makes it much less likely that they will experience a liquidity shortfall.

Yet APRA wants to discourage retail investors from holding hybrid bonds, even though it and ASIC are happy for someone to hold the lowest capital ratio of the banks. “That's OK. Everyone understands capital,” is the general response.

It is remarkably easy to exclude retail investors from the hybrid market. As a regulator, all you do is require banks to issue their hybrids for OTC trading only. I.e. no ASX listing. This would immediately exclude any retail investor as the wholesale market requires a minimum investment and trading amount of $500,000. Problem solved. If retail investors exit the product, AT1 can still provide important capital support for bank depositors.

If the solution to one of APRA's core problems is so simple, and if abolishing AT1 will significantly weaken the banking sector – the opposite of APRA's mandate – why does APRA want to do it?

Could it be that franking credits are the real issue here? If Labour could not advance its aims of restricting franking credit rebates in 2019 because it grabbed headlines, then a quieter but more successful solution might be to do so, at least in part, but secretly, via a prudent regulation proposal.

While this would only end the use of franking credits for bank hybrids and not for all securities, hybrids represent a market of over $40 billion in which franking credits are used significantly. It is estimated that this move would save the government at least $800 million annually.

While APRA's mandate is to protect the interests of depositors and ensure the stability of the financial system, the proposed changes to AT1 instruments raise questions about the underlying motives – potentially driven by a desire to indirectly manipulate the distribution of franking credits without making direct legislative changes. It is critical that policymakers, industry representatives and the public thoroughly examine these proposals to ensure that regulatory measures under the guise of simplification do not inadvertently damage financial stability or retirement incomes.

It seems that these issues require a more transparent discussion about the motives and impacts of changes in financial regulation.