Two holdings can sit inside the same line of a portfolio summary, both described as fixed income, and share very little beyond the basic fact that money has been lent to a company. One is a corporate bond. The other is a secured note.
The difference between them is not a matter of packaging. They are issued under different processes, they draw repayment from different places, they are exited in different ways, and in Australia they sit under different parts of the same legislation.
The word doing most of the work in that comparison is “secured”. It is commonly read as a description of how likely an investor is to be repaid. In law it describes something narrower: what an investor can claim against, and where they stand relative to other creditors, if the borrower does not pay.
That distinction is the subject of this article.
The common ground
Both instruments are debt. In each case the investor is a lender rather than an owner. The borrower undertakes to pay interest at an agreed rate and to repay the principal at a stated date. Neither confers a share in profits, and neither confers voting rights. In a wind-up, debt claims are dealt with before any return to shareholders.
Both also carry credit risk, being the risk that the borrower does not meet its obligations, and both are exposed in some form to movements in interest rates. ASIC’s Moneysmart material identifies those two exposures as the standard risks attaching to bonds, and notes that a change in rates can reduce a bond’s market value.
That is roughly where the similarity stops.
The corporate bond as the reference point
A corporate bond is a company borrowing from investors to fund its business. Each bond is issued with a face value, and an investor who holds it to maturity receives that face value back. An investor who sells earlier receives market value instead, which can be below face value, and which moves with interest rates, the credit standing of the issuer, liquidity, and the time remaining to maturity.
Coupons can be structured in several ways. A fixed rate is set at issue and holds to maturity. A floating rate moves with an underlying reference rate plus a margin. An indexed structure links payments to the consumer price index.
Distribution matters here as much as structure. ASIC records that corporate bonds in Australia are mainly issued and traded over the counter, that the minimum parcel is typically large and can reach $500,000, and that issues to the retail market are uncommon. Many corporate bond issues also carry a rating from an external agency, which means part of the credit assessment has already been performed and published by a third party before the investor looks at it.
Some corporate bonds have quoted prices, secondary market trading and external ratings. Investors should check whether these features apply to the particular bond.
What a secured note is
A note is, in the first instance, a borrowing arrangement. The Corporations Act defines a debenture broadly, as a chose in action containing an undertaking by a body to repay money deposited with or lent to it, and states that the chose in action may, but need not, include a security interest over the body’s property (s 9, Corporations Act 2001 (Cth)). Security is treated as an optional feature of the instrument rather than a defining one.
Where security exists, it shapes how the instrument may be described, and the test is statutory rather than descriptive. For debentures subject to the Part 2L naming rules, “secured note” may be used only where the conditions in ss 283BH(4) and 283BHA are met. Investors should examine the actual security documents, assets and ranking.
There is an important limit on that regime. Those naming duties sit in Part 2L.2 of the Act, and s 283BA applies them to a borrower that is required to enter into a trust deed under s 283AA. Section 283AA is itself triggered by offers of debentures that need disclosure to investors under Chapter 6D, which is to say retail offers. Where notes are offered only to wholesale or sophisticated investors under the exclusions in s 708, the statutory naming discipline and the trustee requirement do not attach in the same way.
The same boundary applies to ASIC’s guidance. Regulatory Guide 69 sets out disclosure guidelines for unlisted debentures and notes offered to retail investors, built around eight benchmarks that an issuer addresses on an “if not, why not” basis. Regulatory Guide 156 sets advertising standards for the same products in the retail market.
For a wholesale investor this is worth reading carefully. It does not mean a wholesale note is deficient. It means the disclosure scaffolding that surrounds a retail offer is not automatically present, and the analysis it would otherwise prompt sits with the investor and their adviser.
Five differences that matter in practice
Where repayment comes from. Depending on the issuer and terms, a bond may be serviced from the operating cash flows of a trading business with multiple revenue lines, while a note may depend on a defined pool of loans, projects or assets. The number of things that need to go right, and the correlation between them, can be very different.
What the security actually does. A security interest establishes what an investor can claim against, and in what order. It does not alter the likelihood that the borrower generates the cash to pay. Enforcement takes time, carries cost, and produces a recovery that depends on what the underlying property realises when it is sold, rather than on what it was valued at when the note was issued.
Who has performed the credit assessment. A rated bond arrives with a published external opinion. Unlisted notes are frequently unrated, which relocates the analysis to the investor. That is a difference in process rather than automatically a difference in quality, but it changes what a review needs to cover.
Exit. Bonds have a secondary market, even if an over-the-counter one. ASIC describes debentures and notes as unlisted investments that cannot be bought and sold on an exchange, leaving the investor dealing directly with the issuing company. Terms are set, commonly running from a few months to five years, and money generally cannot be withdrawn before the term ends unless the note is at call. Neither structure is a defect. A mismatch between the structure and an investor’s own cash needs is a separate question, and one an SMSF with pension obligations may need to answer with dates attached.
What happens at the end of the term. ASIC notes that where an investor takes no action before a term expires, a note may roll over for a further period equal to the original, with access to the money deferred until that new period ends. The borrower’s financial position at the point of rollover may not be the position that applied at the original decision.
What the label does not settle
Three questions survive the word “secured”, and they tend to be where the substance sits.
The first is what the security is over, and what that property could realise on a sale under pressure rather than in an orderly market.
The second is priority. First ranking is a statement about position, and a position can be shared, carved out by permitted prior security, or eroded where the same property secures other obligations.
The third is cash flow. Security is a remedy that applies once something has gone wrong. It is not a substitute for understanding how the borrower intends to pay while things are going right.
ASIC describes a secured-note investor whose issuer failed six months after investment, illustrating that security does not guarantee repayment.
Four questions before the label does any work
For an adviser or a trustee assessing a note alongside more familiar fixed income, four questions cover most of the ground.
- What specific property secures the note, who valued it, on what basis, and where is that security registered?
- What is the ranking, and what claims are permitted to sit ahead of it or alongside it?
- Who holds the security on behalf of investors, and what events allow enforcement to begin?
- What is the term, what are the rollover mechanics, and what recourse exists if repayment does not occur on the agreed date?
A holding that can be described in those terms has been understood. A holding described only as “secured” has been named.
The point of the comparison
A corporate bond and a secured note are both ways of lending money to a company, and either can perform the job an investor gave it. The difference lies in what an investor knows about the borrower before committing, how the position can be exited, which disclosure regime applied to the offer, and what the security does when it is called upon.
The label is where that analysis starts. It is not a summary of it.
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