Market Integrity Update - Issue 111 - December 2019

Issue 111, December 2019

• Pause lifted on admission of managed funds with internal market makers

• Recommendations made following assessment of ASX Limited’s AQUA market

• Pershing Securities Australia charged with breaching client money obligations and accepts additional licence conditions

• Report on mining and exploration IPOs identifies better practices

• Practices in wholesale FX markets highlighted in report

• Update on assessments of cyber resilience capabilities of financial markets firms

• On the lookout for EOCY ‘window dressing’

• Apology to John Dawkins AO and Federal Court hands down penalties in action against Vocation Limited (in Liquidation) and three officers

Pause lifted on admission of managed funds with internal market makers

We’ve concluded our review of internal market making practices and lifted the pause on the admission of new managed funds with internal market making, subject to controls.

The review, which examined internal market making practices of non-transparent actively managed funds that are traded on exchange markets, identified compliance risks under certain internal market making models.

Particularly, risks were identified in models where a market maker uses non-public information as part of its pricing methodology. In some models, market maker quotes are lead indicators of changes to fund portfolio values rather than responding to publicly available information such as indicative net asset values (iNAVs).

We identified several measures firms can implement to manage these risks, including ensuring that:

• the input for market making quotes is a reference price or other information that is publicly available
• internal compliance and supervision arrangements are adequate
• information barriers are established to ensure decisions to buy or sell units are not made by persons or systems with knowledge of the current portfolio holdings
• there are adequate arrangements for identifying and responding to instances of substantial information asymmetry in the market, which may include cessation of market making activities or requesting a trading halt.

We intend to work with market operators and other stakeholders to ensure new funds admitted for quotation use compliant models, and changes that are required to existing models are made within a reasonable timeframe. We also intend to provide more information about our findings and update Information Sheet 230 in early 2020, with guidelines on better practices for managing non-public information.

• Read the media release

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Recommendations made following assessment of ASX Limited’s AQUA market

We’ve made recommendations to improve ASX Limited’s (ASX) compliance with its market licence obligations, following an assessment of the AQUA market for exchange traded products (ETPs) operated by ASX.

Report 644 Assessment of ASX’s arrangements for exchanged traded AQUA products makes recommendations focusing on three key areas:

• AQUA market governance, risk and strategy
• arrangements for operating the market, including supervision and enforcement of compliance with the AQUA rules
• human resourcing of the AQUA market.

The AQUA ETP market is a comparatively new area of operation for ASX. As new market segments grow and become increasingly sophisticated, we expect market operators to review, revise and adapt their arrangements for operating the market accordingly—and to be aware of incremental changes to the market over time. Our recommendations are aimed at challenging ASX to more proactively set the direction and standards for this market segment in the next phase of its development.

Other ETP market operators we regulate are encouraged to review the findings and recommendations to determine what is applicable to their market operation.

We’ll monitor ASX’s implementation of our recommendations to ensure the work is completed in a timely manner.

• Read the media release

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Pershing Securities Australia charged with breaching client money obligations and accepts additional licence conditions

Pershing Securities Australia Pty Ltd (PSAL) has been charged with two counts of failing to pay client money into an account and one count of failing to comply with requirements relating to a client money account.

We allege that between June 2016 and December 2018, PSAL failed to comply with client money obligations in contravention of criminal offence provisions under sections 993B(1) and 993C(1) of the Corporations Act 2001 (the Act).

Client money is:

• money paid to a financial services licensee in connection with a financial service that has been provided, or will or may be provided, or
• money paid to a licensee in connection with a financial product held by a person.

Under section 981B(1) of the Act, an Australian financial services (AFS) licence holder must ensure that client money is paid into a client money account. An AFS licence holder is only permitted to make payments out of a client money account as specified by the Corporations Regulations 2001.

The maximum penalty for each of the charges for a body corporate is 250 penalty units (approximately $45,000).

The matter has been adjourned until 4 February 2020.

Separately, PSAL has accepted additional licence conditions we’ve imposed on their AFS licence. The additional conditions require PSAL to:

• appoint an independent expert to conduct a review to assess and report on whether they have the current and ongoing ability to comply with the client money requirements of the Act. Where necessary, the expert will identify remedial actions and PSAL must provide ASIC with a plan identifying the remedial actions it proposes to implement.
• provide ASIC with attestations from a senior executive and non-executive board member within PSAL. The senior executive must confirm that PSAL has taken all reasonable steps to identify and remediate all client money related breaches identified between December 2017 and the date of the attestation. If remedial actions are necessary, PSAL is also required to withhold any bonuses payable to the PSAL senior executive with primary responsibility for implementing any required remedial action, until PSAL believes the remedial action has been fully and satisfactorily completed.

• Read the media release

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Report on mining and exploration IPOs identifies better practices

Our review of mining and exploration initial public offers (IPO) has found that companies, directors and lead managers need to implement better practices that take account of the unique characteristics and vulnerabilities of the micro-cap sector.

Report 641 An inside look at mining and exploration initial public offers considered IPO practices and processes from inception through to on-market trading.

Our review found that:

• Some lead managers give preference to a select subset of investors. Retail investors not associated with a lead manager or their networks had limited access to IPO investments. One potential consequence of this can be an environment encouraging a rapid return on the initial investment rather than an investment aimed at medium to longer term returns.
• This can be exacerbated by the fact lead managers often initiate the IPO origination. In this way, some professional advisers target the sector in order to generate those immediate returns on an investment, gaining a disproportionate benefit through their early, direct involvement in the process.
• The prevalence of conflicts of interest is a significant concern, leading to potential misconduct and unfair outcomes. This is because lead managers may act for both the company and investing clients, hold direct interests in the company, have representatives on the board or provide other ongoing services.
• Promotional materials such as investor presentations, explanatory material and email marketing methods are often subject to substandard compliance controls, and yet they can have a significant influence on investors’ perceptions and actions.
• IPO transaction design and structure may lead to a distorted and unsustainable market demand in the securities’ short-term trading, at the expense of longer investment horizons more appropriate for the delivery of exploration programs.

We encourage companies, directors and lead managers to consider the better practice recommendations outlined in the report and eliminate, or at least recognise and appropriately manage, conflicts of interest.

• Read the media release

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Practices in wholesale FX markets highlighted in report

Our latest report on wholesale foreign exchange (FX) markets in Australia has highlighted our observations of better practices and some poorer practices used by participants operating in the market.

Report 652 Wholesale FX practices in Australia, also summaries our work in wholesale FX markets in 2018–19, which is a key part of our enhanced focus on wholesale fixed income, FX and commodities (collectively ‘FICC’) markets.

The work included various onsite and thematic reviews of participants, as well as monitoring ANZ, CBA, Macquarie, NAB and Westpac’s compliance with the requirements under their respective FX court enforceable undertakings.

The report provides our observations in the areas of governance and supervision, FX mark-ups, last look, handling confidential client order information, surveillance and monitoring, staff training on conduct risk and staff personal trading. Participants should review these observations and practices and consider how the better practices may be applied in their own FX businesses to enhance their approach to managing conduct risk.   

The report builds on Report 525 Promoting better behaviour: Spot FX (REP 525). Released in 2017, REP 525 described how conduct in the wholesale spot FX businesses of some of Australia’s largest market participants had fallen short of our expectations, and the enforcement action we took where regulatory obligations were not complied with.

• Read the media release

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Update on assessments of cyber resilience capabilities of financial markets firms

We’ve published an update on the cyber resilience capabilities of firms operating in Australia’s financial markets.

Report 651 Cyber resilience of firms in Australian’s financial markets: 2018–19 highlights an improvement in the cyber resilience of firms assessed in the two years since we published Report 555 Cyber resilience of firms in Australia’s financial markets (REP 555) in November 2017.

Some key insights from our assessments demonstrate that:

• the gap between large firms and small-to-medium enterprises (SMEs) identified in REP 555 is gradually closing, with the overall improvement in cyber resilience across the industry largely driven by SMEs
• larger firms have continued to refine and improve their cyber resilience through targeted investment
• supply chain risk management is now accepted as an industry-wide challenge that requires attention over the next period.

While the cyber resilience of firms has improved, firms have struggled to meet the targets in REP 555. Continued investment and strong leadership from senior management is critical to ensuring a firm’s ability to meet these targets and maintain strong cyber resilience.

We encourage all financial markets firms to consider and discuss the information in the report as they develop or enhance their cyber resilience framework.

• Read the media release

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On the lookout for EOCY ‘window dressing’

As we near the end of the calendar year, we’d like to remind you to be on the lookout for any unusual trading that may affect share price valuations and end of calendar year performance figures. This activity is known as 'window dressing'.

Window dressing is a form of market manipulation by parties who have a financial incentive to influence share prices around key reporting dates. These parties include directors, large shareholders and fund managers who periodically report to clients about investment performance.

We encourage you to take active steps to identify possible misconduct through system controls and pre-trade filters, as well as through post-trade reviews of any abnormal trading behaviour. You must notify ASIC if you identify or suspect ‘window dressing’. This can be done through Form M57 Suspicious Activity Report (SARs) on the market entity compliance system (MECS) portal, or by emailing SARs at markets@asic.gov.au.

We’ll continue to monitor unusual price movements that may indicate market manipulation. If we identify any trading that we believe should have been reported to ASIC, but wasn’t, we’ll contact you for an explanation.

• See Regulatory Guide 265 Guidance on ASIC market integrity rules for participants of securities markets and Regulatory Guide 266 Guidance on ASIC market integrity rules for participants of futures markets for more information about SARs

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Apology to John Dawkins AO and Federal Court hands down penalties in action against Vocation Limited (in Liquidation) and three officers

This media release provides an update on the Federal Court’s recent judgment on penalties and final orders in ASIC’s civil proceedings against Vocation Limited (In Liquidation) and its officers.

It also includes the following apology to Mr John Dawkins AO:

In late May 2019, ASIC published a media release about Federal Court Proceedings concerning Vocation Ltd and its directors, including former Australian Treasurer, John Dawkins AO.

The headline of that release, if read in isolation from the balance of the statement, may have incorrectly conveyed to a reader that the officers of Vocation Limited (in liquidation), including Mr Dawkins AO, were found to have made misleading statements to the market. No such findings were made by the Court and ASIC did not intend to suggest otherwise. After communications between Mr Dawkins AO’s lawyers and ASIC, a corrected release was subsequently published by ASIC on 5 June 2019.

ASIC apologises to John Dawkins AO and his family for any distress caused to them by the publication of the initial media release.

• Read the media release

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