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

ASIC has now publicly stated 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 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 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 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” to investors.

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 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.