AT1 phase-out prompts product rethink from ETF providers

ETF providers are looking to phase out bank hybrids in their product development plans as fixed income ETFs see a rise in inflows.

APRA announced at the end of last year that AT1s – also known as hybrid bonds – will be phased out in 2027, as the regulator was concerned about their reliability and complexity in a future crisis. This is because they carry greater credit risk than corporate bonds due to their subordinated status in the capital structure. 

The bonds are popular with private wealth and retiree clients for their consistent, franked income, and there are currently $44 billion in issue, while around 20–30 per cent of ASX hybrids are owned by retail investors.

With billions of assets set to seek a new home, including $1.7 billion from the phasing out of a Westpac hybrid later this month, ETF providers are considering how they can help investors out through active or fixed income (or both) ETFs. 

According to Betashares, fixed income ETFs saw flows of $4.4 billion in the first half of 2025, while numerous providers such as PIMCO, Schroders and Perpetual have launched active fixed income funds in the space this year.

VIEW ALL

View all

Speaking to Money Management, providers said they are looking into products investing in subordinated debt, corporate bonds, and investment grade as suitable replacements. 

Blair Hannon, head of ETFs, Australia, at Macquarie Asset Management, said the launch of the Macquarie Subordinated Debt Active ETF in February was already in development, but APRA’s announcement had “provided an impetus” to launch sooner rather than later. 

The firm already has a suite of four active fixed income ETFs and three equity ones.

“We are spending a lot of time in this space as we believe we do have the most natural replacement for hybrids with an active subordinated debt ETF,” he said.

“Subordinated debt is slightly higher up the capital stack of a bank than a hybrid. A key reason why we indicate it’s the most natural replacement is the decision by APRA stems around asking the banks to replace their hybrid funding with subordinated debts on their balance sheets.”

Currently, around $120 billion is issued in subordinated debt by major Australian banks, offering higher yields than senior bonds or cash with a lower capital risk than equities while still maintaining exposure to regulated Australian banks.

Stephen Parker, portfolio manager at Global X ETFs, agreed with Hannon that the transition was impacting product design.

“The phase-out is materially impacting product design – hybrids are some of the highest yielding securities in the domestic market and well loved by investors (especially due to the franking credits that come with them). Replacing them poses challenges – the closest bond equivalent to hybrids, Tier 2 subordinated bonds, tend to have slightly lower yields and are unfranked, so there is no like-for-like natural replacement.”

Global X offers an Australian Bank Credit ETF (BANK) which provides exposure to hybrids as well as Tier 2 capital and subordinated debt and Parker said Global X is engaging with index provider Solactive to discuss potential adjustments. 

"The objective is to ensure that the ETF continues to reflect the changing composition of the banking credit market effectively, maintaining its objective of owning the broader Australian banking debt capital stack, ensuring a seamless transition for investors," he said.

Finally, Chamath De Silva, head of fixed income at Betashares, suggested investors could look to areas such as investment grade or corporate bonds, as well as subordinated debt. Betashares offers a range of fixed income ETFs in this space, such as Betashares Australian Bank Senior Floating Rate Bond (QPON) or Hedged Investment Grade Corporate Bond (HCRD).

“In recent years, we’ve witnessed a proliferation of active managers launch ETFs to harness investor interest in the ETF wrapper. These same fund managers are now seeking to rebadge their investment strategies as replacements for AT1 bank hybrids, as they seek to capture a slice of the $40 billion that will be returned to investors over the coming years.

“For investors seeking alternatives, subordinated bank bonds are a natural starting point, and Betashares Australian Major Bank Subordinated Debt ETF (BSUB) offers exposure to Tier 2 floating rate bonds from the major banks.”

Betashares noted that it already has an existing large allocation to hybrids through its passive Australian Major Bank Hybrids Index ETF (BHYB) and its active Australian Hybrids Active ETF (HBRD) which has a 27 per cent weighting to bank hybrids.  

“Given HBRD’s mandate, the fund is under no threat from APRA’s recent announcement and will continue to operate as a full capital structure solution,” the firm said.

Regarding the passive fund, it said: “Given the lengthy run-off period, with the next first call date not until June 2026 and approximately 50 per cent of the portfolio due to be called between 2029 and 2032, we see little need to make any immediate product or index changes.”

But all commentators, as well as financial advisers, warned any adviser or investor making the change needs to carefully consider the differences between the assets, do their own due diligence, and consider their investment objectives.

This includes considerations such as the access to liquidity, likelihood of a loan defaulting and how that has been priced in. 

“Investors will likely have to alter their portfolios, potentially considering different risks and trade-offs that can enhance yield like duration or leverage, to arrive at a ‘new normal’ in a post-hybrid world,” Parker said.

Roger Perrett, financial adviser at Freshwater Wealth, said: “Although new products provide opportunities for investors, they can also create risk for those that do not understand them completely.”