Wed Jul 24

ANZ is embroiled in allegations it manipulated government bond sales – what exactly does that mean?

Written by: Mark Humphery-Jenner, Associate Professor of Finance, UNSW Sydney

Background of Australian notes, soft-focus.

ANZ is being investigated by the Australian Securities and Investments Commission (ASIC) amid serious allegations ^[1] the bank manipulated markets when it facilitated a A$14 billion sale of government bonds in April last year.

ASIC has now publicly stated ^[2] it suspects ANZ broke the law. Speaking to the Australian Financial Review on Tuesday, ASIC chairman Joe Longo said:

It’s a matter for the CEO of ANZ how he wants to characterise it, but it’s on the public record that it is an investigation, which means by definition we suspect a contravention of the law.

Earlier this month, ANZ launched its own internal probe ^[3] into alleged misconduct within its markets division. ANZ says it is treating the allegations “with the utmost seriousness” and has engaged external legal counsel to assist with its investigations.

ANZ has also been accused of inflating the value ^[4] of its bond trading by billions of dollars to win “lucrative” government mandates that accrue to firms trading big quantities.

Bond markets? Government mandates? You’d be forgiven for feeling a bit lost.

On its face, the alleged wrongdoing might seem quite esoteric and technical. But the Australian Financial Review has suggested ^[5] the matter could end up becoming “the biggest scandal” in ANZ’s 182-year history.

To be clear, these are allegations amid an ongoing investigation by Australia’s corporate regulator. But it’s important to understand exactly what the bank has been accused of here, and how what happens in the bond market has the potential to affect us all.

It’s all about government borrowing

To understand the allegations against ANZ, you need a good grasp of a slightly dry-sounding and fairly routine transaction.

The Australian government often borrows money. It does this by selling so-called “bonds ^[6]” to investors.

Bond sales allow the government to borrow money. Robyn Mackenzie/Shutterstock ^[7]

An investor buys a bond – which used to be a piece of paper but is now electronic – and in return receives (usually fixed) interest payments called “coupons”, one each month or year.

At the expiry of the bond, be it after three years, ten years, 20 years or more, the investor gets her or his money back.

You don’t need to understand everything about the way bonds work. You just need to know that bonds are traded in an open market – investors can sell them to other investors, and their price can fluctuate.

The investors’ returns come from a combination of both (a) receiving those coupons, and (b) the difference between what they pay for the bond and the final principal amount they receive at maturity.

If general interest rates climb above the coupon rate on the bond, the price of the bond will fall. This is because the bond simply would not pay enough relative to what they demand for an investment with that level of risk.

Conversely, if general interest rates fall, the bond price is likely to climb.

Banks are appointed to manage bond issues

New government bonds are issued by an arm of the Commonwealth Treasury, known as the Australian Office of Financial Management (AOFM). For big bond sales, AOFM typically appoints a bank – or banks – to manage the process and engage with investors.

In April 2023, the government contracted ANZ to help manage a large A$14 billion bond sale. This gave ANZ access to confidential information, including details about when the offering would occur.

As part of the role, ANZ was to buy bonds from investors who wished to exchange them for the new bonds. The price of those bonds would depend on the return investors require on government bonds. Recall that if a bond is paying a return that is too low relative to what is required, its price falls. Thus, if the required return increases, the price ANZ has to pay decreases.

You might have heard the adage: buy low and sell high. Well, ANZ allegedly sought to do just that.

It’s alleged ^[8] ANZ sought to raise bond yields by trading in what is called the “futures market”, which is essentially a market that allows traders to bet on future interest rate moves.

Those bets also influence the reference rate that is used to set the price of new bonds. This is because the government looks to the futures rate to assess what return the market requires on its debt and to set the coupon rate on the bonds it issues.

If that futures rate climbs, then so too does the coupon rate on the government’s new bond issues. This increases the government’s total interest bill.

ASIC Chairman Joe Longo. Lukas Koch/AAP ^[9]

ANZ is alleged ^[10] to have manipulated futures yields higher, enabling it to buy bonds from investors at a low price.

ANZ allegedly then reversed its futures trades, letting general interest rates fall and the price of the bonds it held climb, giving it a profit.

If the allegations are true, then ANZ would have engaged in both market manipulation and insider trading. This would be illegal.

The Australian Financial Review says trading data points to unusual price movements ^[11] on and around April 19 last year.

Market ten-year bond yields either side of April 19 issue being priced

10 Year Bond Yields (from the SFE Continuous price feed on Factset)

From SFE Continuous price feed on Factset. Graph data inspired by AFR reporting. Factset

The data appears to show bond prices falling (yields rising) up until the bond was issued on April 19, then climbing as yields fell.

But it’s important to note this graph says nothing about causation. Prices might have fallen for reasons completely unrelated to ANZ.

Overstated success

ANZ has also been accused ^[12] of overstating its trading success to the government, to secure lucrative bond management opportunities.

The government selects managers based on their experience and activity in trading government bonds. It is alleged ANZ misrepresented how much trading it did.

According to the Australian Financial Review ^[13], ANZ told the government it had “facilitated” $137.6 billion in bond trades to the year ended June 2023, when it had really only facilitated $83.2 billion – a discrepancy of $54.4 billion.

It might feel far removed from everyday life, but what happens in the bond market has the potential to affect us all.

If found to be true, ANZ’s alleged manipulation could reportedly have cost taxpayers as much as A$80 million ^[14].

That figure reflects how much extra interest the government might be having to pay if it issued bonds with a higher interest rate than it needed to.