CHAIR—Welcome. Mr Battellino, would you like to make an opening statement?

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Mr Battellino—Thank you very much, Senator Ronaldson. I thank the committee for giving the Reserve Bank the opportunity to appear here today to talk about private equity. As you know, the Reserve Bank published an article on private equity in the March 2007 edition of—

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CHAIR—Could I interrupt briefly. You distributed a document to senators this morning. Would you like to seek leave to table that document?

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Mr Battellino—Certainly. As I say, we published that article, and this document, which I distributed this morning, in some ways summarises and updates that article. So I submit that as part of the evidence here today. I will be talking to some of the charts, if that is acceptable.

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CHAIR—You have leave to table that document. Please proceed.

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Mr Battellino—As I was saying, we have prepared this set of charts which summarises that earlier work. That work took into account information that the Reserve Bank had collected on private equity. It also took into account discussions that had taken place at the Council of Financial Regulators.

Senator JOYCE—Those pesky shareholders: they are always a problem! I want to concentrate my questions on three issues: transparency, vulnerability and interest rates. I should start with the first. If you believe that private equity firms are going to the market in search of funds—and take into account that they are getting it from the US mortgage market or wherever—and that to combat this the companies themselves are going back into the market and buying more funds, should this not mean that there is a greater demand for debt and so intrinsically we are forcing up interest rates by the advent of private equity funds?

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Mr Battellino—When we talk about interest rates, I think we need to distinguish two different things. There is the risk-free rate. Let us go back to the very short-term interest rates, which is what the central bank set. They are determined by economic activity and inflation. As we move further out the security spectrum, more factors come into account in what determines the level of interest rates. The main benchmark is typically the interest rates at which governments can borrow, the so-called ‘risk-free rate’. In recent years that has been very low, mainly because governments have not been doing a lot of borrowing and the demand for debt in global markets has been very strong, driven mainly by excess savings coming out of Asia. At the same time, we have seen spreads on corporate debt. So corporate bonds are usually traded at a yield higher, obviously, than that at which the government can borrow. Those spreads over time have come down because economic conditions have been very good, default rates have been very low, investors have been searching for yield, so they have been prepared to take on debt at lower and lower yields because they are trying to maintain their rate of return.

In recent times, I think it is the case that as the demand to issue debt increases, it puts upward pressure on those spreads. So we do not see any change in the risk-free rate at which governments can borrow, but the spread at which corporations can borrow starts to rise and we have seen that. In the last month or two, we have seen spreads on corporate bonds rise by up to 100 basis points, so one percentage point.

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Senator JOYCE—It is really not that complicated. People just use the rule of 72 and take off their interest rate, and if they can basically hold the debt, in due course they will own the company by the yield of the company. I am a simple old accountant from St George. I can work that out, so I imagine they can work it out too. Inevitably, if it is going to die naturally, it is going to die naturally by reason of interest rates going up to knock that possibility out.

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Mr Battellino—Yes. There is limited at-risk appetite. Investors are prepared to devote a certain amount of their portfolios to higher risk investments but not all. We have seen in the last month or so that investors are saying: ‘We bought a lot of these securities last year. We’ve got enough.’ So now, when issuers go to the market, they are finding some resistance.

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CHAIR—Just so I am clear on this, what you are saying is that in relation to official interest rates, there is not going to be any negative impact from private equity transactions but there will be some risk pricing in relation to the amount that the corporate sector will be required to pay to borrow in the future. Is that what you are telling this committee?

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Mr Battellino—That is right.

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Senator JOYCE—Onto the next issue. I credit you for your report in March. It was a very good report and very concise. My query is: are we going to get that continual feedback on what is happening, or was that just a one-off? It was a very important document. What will your reporting structure be into the future? How will you deliver information back to our nation about how this process is going forward?

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Mr Battellino—The bank’s approach is to monitor all developments in capital markets, as well as the economy, globally and domestically. We have a big team of economists and analysts there and we are keeping track of all the things that are happening. When we see something unusual happening—as we saw late last year in relation to private equity—we start looking a bit more deeply. The article that we published early this year was the outcome of the analysis that we did. This was something unusual happening, so we thought that we would write something about it. We did a similar thing on CDOs, collateralised debt obligations. That was another unusual development. The bank’s policy is to write and talk to the community about unusual things and important things that are happening. While ever private equity remains a big issue, we will continue to monitor and write about it. There are various vehicles for doing that. We produce a financial stability review every six months. As I said, while ever this remains a topical issue, we will be commenting about it in the review.

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Senator JOYCE—So does that means that we are going to get regular reports?

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Mr Battellino—While ever it remains a topical issue. Are we going to have regular reviews on private equity for the next 10 years? Maybe not, because if this does what it did in the early 1990s and dies away to nothing, we can summarise what is happening in the space of a paragraph rather than a 20-page document.

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Senator JOYCE—So, while it remains at the level that it is, we are going to get regular reviews?

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Mr Battellino—Yes. And while ever anything topical is happening in that area. It could be that activity falls away but credit concerns arise. There will be issues around.

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Senator JOYCE—How are we going to get that information without some kind of code conduct around how these people deliver the information? Obviously, as you said, in essence, once a person goes to a private equity firm they have inherently pulled down the shutters on transparency. Therefore, how are you going to get access to that information about what they are doing?

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CHAIR—I do not think that those were Mr Battellino’s comments; I think that they were your spin on them, Senator Joyce.