Market Integrity Update - Issue 64 - September 2015

Issue 64, September 2015

S&P/ASX 200 A-REIT index futures and use of the off-market block trade facility

ASIC has decided to adopt a limited no-action position with respect to participants who use the block trade facility to execute roll business in the S&P/ASX 200 A-REIT index futures contract during the September 2015 and December 2015 expiries. Importantly, this position only applies to this contract and only for the September 2015 and December 2015 expiries.

At the request of participants, the Australian Securities Exchange (ASX) approached ASIC to seek a class waiver from Rule 3.4.2 (2) (ASX 24) of the ASIC Market Integrity Rules (ASX 24 Market) 2010 (ASIC Market Integrity Rules (ASX 24)) for the S&P/ASX 200 A-REIT index futures contract. Rule 3.4.2(2) (ASX 24) prohibits participants from using the block trade facility to execute roll business. This prohibition is also reflected in ASX 24 Operating Rulebook Procedure 4820.

ASIC understands that the use of blocks to effect roll business is a long-standing practice in this contract dating from before its transition late last year from ASX Trade (where this prohibition did not apply) to ASX Trade24.

ASIC has discussed this matter with participants and the ASX. Given the proximity of the September 2015 expiry, and to avoid any risk of market disorderliness, we have decided not to take action against participants who continue with this practice for this contract during the September 2015 and December 2015 expiries.

ASIC has decided to adopt this position for the September 2015 and December 2015 expiries to allow further time to carefully consider this issue. We will continue this consideration with a view to communicating a final position before the March 2016 expiry, including allowing sufficient time for participants to take appropriate action in an orderly way.

ASIC's approach to this no-action position will be generally consistent with Regulatory Guide 108 No-action letters (RG 108), in particular RG 108.12–19.

• Read RG 108

Conduct affecting ASX 24 quarterly roll markets

ASIC is aware of ongoing order activity issues in the ASX 24 quarterly roll markets leading up to the expiry of the following contracts:

• ASX 24 Three Year Commonwealth Treasury Futures
• ASX 24 Ten Year Commonwealth Treasury Futures, and
• ASX 24 SPI 200 Index Futures.

It appears that a small number of participants and clients may be using multiple gateways and trading accounts to 'crowd out' other participants and clients through order proliferation at the opening of each trading session in the week before the expiry for the relevant contracts. This conduct floods the quarterly roll markets with multiple quotes and cumulative volumes that are substantially higher than the levels actually traded.

The pattern of order activity suggests that some participants and clients are submitting orders to gain higher price/time priority in the bid/ask spread, and cancelling orders with unfavourable priority before an opportunity to trade on them arises. As a result, other participants and clients seeking to trade in the roll have to cross the spread at an expense.

ASIC has been monitoring this behaviour for some time and is concerned that it is becoming more prevalent. We estimate that more than 20,000 orders per quarter are affected by this behaviour. We are investigating a number of instances of this conduct and will take action where we identify breaches of the ASIC Market Integrity Rules (ASX 24).

Participants must ensure they comply with Rule 3.1.2 (ASX 24) (false or misleading appearance) and Rule 3.1.3 (ASX 24) (entering orders without an intent to trade). Participants must ensure that each order is entered with the intention of trading the volume entered.

Order behaviour that ASIC examines in determining whether there is an intent to trade an entered order includes but is not limited to, one or more of the following; order entry patterns, cancellation patterns, position accumulation, wash trading, financial capacity to fund orders placed and intra-day positions accumulated

Does the transition to T+2 affect short selling reporting?

The ASX will transition from a T+3 to a T+2 settlement cycle for cash equities in March 2016. This change will not affect the short selling reporting obligations which currently apply to institutional investors and brokers engaged in short selling.

ASIC has received inquiries regarding the impact of a T+2 settlement cycle on the short selling reporting obligation under the Corporations Act 2001 (Corporations Act). Under section 1020AB(3) of the Corporations Act and regulation 7.9.100(4)(b) of the Corporations Regulations 2001, sellers are required to report their short position(s) in section 1020B products, above the reporting threshold, as at 7.00 pm. Reports must be made to ASIC on or before 09:00 am AEST, three reporting days after the date of the short position.

The move to a T+2 settlement cycle does not affect the deadline for short position reporting, because this is a legislative requirement. Short positions will continue to be reported to ASIC on or before 9.00 am three reporting days after the date of the short position. Likewise, there will be no changes to ASIC short position reporting Financial Information eXchange (FIX) 'position report' messages and no testing requirement for short position reporting solution providers.

Information about the transition to a T+2 settlement cycle, including the key dates, is located on the ASX website

• Read more about the ASX transition to a T+2 settlement cycle

Information about short selling obligations, including the short position reporting requirements, is contained in Regulatory Guide 196 Short Selling (RG 196).

• Read RG 196

Comparative disclosures by superannuation trustees

ASIC is aware that trustees often correspond directly with employers to encourage them to select a particular fund as the default fund for their employees. In doing so, trustees may make direct comparisons to competitors and their products. ASIC wishes to remind trustees that comparative disclosures are subject to prohibitions on misleading or deceptive conduct and false and misleading representations. Employers, by selecting a default fund for their employees, have the capacity to have a significant impact on consumers. As such, we consider it especially important that disclosures to this group meet our good practice guidance.

ASIC has provided industry with guidance in Regulatory Guide 234 Advertising financial products and advice services including credit: Good practice guidance (RG 234) about our expectations with regards to disclosure, including comparative disclosure. We expect that messages given by trustees to employers are accurate and balanced, and that where comparisons are made about one feature of a product, trustees understand that it may be misleading to make this comparison if other key features are ignored.

One of ASIC's strategic priorities is promoting investor and financial consumer trust and confidence. ASIC may review disclosure material provided by trustees to employers. Where we see false or misleading representations in this material we will take strong action, including issuing infringement notices and stop orders.

Trustees should ensure they are familiar with the content of RG 234.

• Read RG 234

Corporate finance report – Fundraising by emerging market issuers

Last month, ASIC published Report 446 ASIC regulation of corporate finance: January to June 2015 (REP 446). REP 446 gives companies and their advisers information about ASIC's oversight of fundraising, mergers and acquisitions transactions, corporate governance and other general corporate finance areas.

One of the issues discussed in REP 446 is ASIC's focus on public fundraisings from issuers whose business and management are primarily located in an emerging foreign market. While Australia provides a very open capital raising market, we have identified a number of concerns in this area.

We are seeing a significant number of initial public offerings (IPOs) to Australian investors from emerging market issuers. Offers of this kind may present regulatory issues, including verification difficulties and differences in corporate governance practices and legal regimes.

In response, we are closely scrutinising prospectuses in this area as well as looking at the due diligence practices in many of these offerings. Our aim is to ensure that investors understand the risks associated with investing in these types of companies.

We have also noted that an increasing number of these offers have shareholdings that are overwhelmingly concentrated in the hands of a small number of foreign investors. This can make it more difficult for these issuers to meet ASX shareholder spread requirements. In response, we are looking at the practices employed by issuers and their advisers to obtain requisite shareholder spreads.

• Read REP 446

Treasury publishes industry funding consultation paper

Treasury has published a public consultation paper on a proposed industry funding model for ASIC. ASIC encourages industry and other stakeholders to participate in the consultation.

The proposed industry funding model will be based on the Government’s Cost Recovery Guidelines, where the cost of ASIC's regulation will be recovered directly from the sectors and entities that create the need for regulation. This will be through a system of industry levies and fees. Currently only 15% of ASIC’s regulatory costs are recovered through industry levies and fees. The cost of using ASIC’s resources has grown significantly out of line with the revenue collected from sectors regulated.

'An industry funding model is about ensuring that those industries that need the most regulation should pay for it, rather than taxpayers,' said ASIC chairman Greg Medcraft.

'And an industry funding model will also improve ASIC's transparency and accountability. That means business will better understand the job we do by having greater visibility of the cost of doing that job.'

The consultation paper proposes that if the existing market supervision and competition cost recovery funding regime is incorporated into ASIC's industry funding arrangements, a planned 2016 review of those arrangements will not proceed. Interested parties are invited to comment on whether they support not proceeding with the planned review.

Responses to the consultation paper can be sent to asicfunding@treasury.gov.au. The closing date for submissions is 9 October 2015.

• Read Treasury’s consultation paper

Interpretation of 'market making' under the Corporations Act

ASIC wishes to clarify how we will apply the definition of 'market making' to the activities of a proprietary trader in listed equities, derivatives and futures products on the ASX, ASX 24 and Chi-X markets.

Section 766D of the Corporations Act states that a person makes a market for a financial product if:

• either through a facility, at a place or otherwise, the person regularly states the prices at which they propose to acquire or dispose of financial products on their own behalf
• other persons have a reasonable expectation that they will be able to regularly effect transactions at the stated prices, and
• the actions of the person do not, or would not if they happened through a facility or at a place, constitute operating a financial market because of the effect of section 767A(2)(a).

The application of this provision to the activities of a proprietary trader on  markets like the ASX, ASX 24 and Chi-X markets has led to confusion and inconsistent interpretation in the market. This has been especially the case where a proprietary trader's trading activities are frequent enough to cause other people to have a reasonable expectation that they can trade with a proprietary trader. Changes in market structure have also contributed to uncertainty about what constitutes market making.

In light of this, ASIC will administer the Corporations Act on the basis that proprietary trading in listed equities, derivatives and futures products on the ASX, ASX 24 and Chi-X markets does not, by itself, constitute market making under the Corporations Act.

Participants that have market-making obligations under an agreement with market operators will be market making under the Corporations Act, and will require an Australian financial services (AFS) licence with the appropriate authorisation.

Conduct affecting financial benchmarks

Report 440 Financial benchmarks (REP 440) contains important recommendations to ensure our financial benchmarks remain robust and reliable. We recommend that dealers, benchmark administrators and wealth managers (and other clients of dealers) familiarise themselves with the contents of this report. In brief:

• To minimise the risk of benchmark-related conduct issues occurring, dealers are encouraged to review their internal arrangements thoroughly, including compliance systems, controls, procedures, policies, governance and senior management oversight arrangements, as well as incentive structures. We also urge dealers in relevant markets, including fixed income and foreign exchange (FX) markets, to proactively review past conduct to ensure there has been full compliance with the law, and to make remedial reports where required.
• Administrators of systemically-important benchmarks are encouraged to adopt and implement the International Organization of Securities Commissions (IOSCO) Principles for financial benchmarks and to publish self-assessments against these principles. Administrators of other benchmarks are encouraged to do the same in a manner that is proportionate to the size and risk of the benchmark and the benchmark-setting process.
• Wealth managers (and other clients of dealers) are encouraged to engage with dealers to understand exactly how their orders and confidential information are handled to ensure their legitimate interests and those of any beneficiaries to whom they owe fiduciary duties are not (and have not been) compromised. ASIC encourages them to conduct their own due diligence on execution by dealers. It cannot be assumed that trading at a benchmark rate necessarily represents the best execution available.

• Read REP 440

ASIC consults on 'sunsetting' market class orders

ASIC is currently consulting on a number of 'sunsetting' market class orders. Consultation paper 236 Remaking ASIC class orders on dematerialised securities and CHESS units of foreign securities (CP 236) proposes to maintain some relief from certain obligations under the Corporations Act, but to withdraw other relief that ASIC has previously provided.

The instruments which ASIC proposes to remake are:

• Class Order [CO 02/281] Dematerialised securities traded on Austraclear, and
• Class Order [CO 02/312] Part 7.11, Division 4 financial products for ASTC.

[CO 02/281] ensures the same legislative treatment of e-notes (including electronic certificates of deposit) and e-bills (both dematerialised securities) traded on Austraclear Limited to that of their respective paper-based equivalents, promissory notes (including certificates of deposit) and bills of exchange.

[CO 02/312] extends the statutory warranties and indemnities provided for in the National Guarantee Fund provisions to additional financial products, including CHESS Depository Interests (CDI) over foreign securities and interests in foreign managed investment schemes.

We consider that these class orders are operating effectively and efficiently, and continue to form a necessary and useful part of the legislative framework. However, we are proposing to reduce the application of [CO 02/281], so that it no longer provides relief for e-notes. This change is consistent with legislative amendments made in 2009 for promissory notes.

ASIC proposes to repeal [CO 00/2449] ASX Online—relief from paper form lodgement because we no longer consider it to be necessary in facilitating lodgement through ASX Online. We are also proposing to repeal [CO 02/1296] ASX managed investment warrants—FSR Act transition because we have formed the view that it is no longer required and does not form a necessary and useful part of the regulatory framework.

Submissions on CP 236 are due by 21 September 2015.

• Read the media release (refer: 15-223MR)
• Read CP 236

Overseas entities agree to stop providing unlicensed FX services

Following ASIC concerns, British Virgin Island company FIBO Group Limited (FIBO) and a Cyprus company, Trading Point of Financial Instruments Limited (also known by the trading name XM.com) (Trading Point), have each agreed to cease providing unlicensed financial services to Australians. Both entities have Australian clients but neither is appropriately licensed to provide financial services in Australia.

The entities were advertising their services on their respective group websites. Each website contained information about an Australian group entity (with a similar name), which held an AFS licence.

ASIC was informed by the AFS licence holder for each entity that they had not commenced providing financial services. As such, they each said they were not required to meet a number of obligations, including complying with the $1 million minimum net tangible asset requirements.

ASIC Commissioner Cathie Armour said, 'ASIC has received a number of complaints from investors who have mistakenly believed they are being provided services by an AFS licensee when in reality the agreements are with a different company.

'Often these investors have signed up via a website run by a group of entities that heavily promotes one company within the group as having an AFS licence and being regulated in Australia. What makes it even more disappointing in these cases is the Australian entities' services'.

AFS licensees advertising and offering their services on websites before they are able to commence providing those services could be found to have engaged in misleading and deceptive conduct.

• Read the media release (refer: 15-233MR)

MECS – Tip of the month

New forms for financial market infrastructure operators

A number of new forms were recently added to MECS for market operators, clearing and settlement (CS) facility operators and Australian derivatives trade repository (ADTR) operators. These forms further expand the already extensive list of forms available to operators on MECS. A total of 13 new forms were added, including:

• M01 – Provision of report on trading activity
• M02 – Provision of information or report under co-operation arrangements
• M07 – Changes to SEGC Operating Rules
• M09 – Variation to a market licence
• M10 – Variation to a market licence for a name change
• M14 – Variation to a CS facility licence
• M15 – Variation to a CS facility licence for a name change
• M19 – Changes to compensation rules under s884C(1)
• M21 – Changes to compensation rules under s884B(2)
• M27B – Change to voting power of a Market Operator
• M28B – Change in voting power to a CS Facility Operator
• TR102 – Application for imposition or variation of conditions on an ADTR licence
• TR113 – Change in voting power of a Trade Repository Operator

Market and CS facility operators whose reporting year ends on 30 June are reminded that their annual regulatory report (as required under s792F and s821E) is due on 30 September. You can use form M13 or M29 to lodge this report. Lodging these forms on MECS is quick and easy, and ensures that there is a record of your lodgement for record keeping purposes.

Enforcement outcomes

Former Hanlong Mining managing director pleads guilty to insider trading

Hui Xiao, the former managing director of Hanlong Mining Investment Pty Ltd (Hanlong Mining), has pleaded guilty to two charges of insider trading involving 65 illegal trades in financial products related to Sundance Resources Limited and Bannerman Resources Limited in July 2011. The offences were committed while he was managing director of Hanlong Mining.

Mr Xiao, who has been in custody since his arrest in Hong Kong in January 2014 and his extradition from Hong Kong to Australia in October 2014, also admitted a third insider trading offence involving 37 additional illegal trades related to the July 2011 conduct.

• Read the media release (refer: 15-239MR)

Stories from the beat

The majority of market integrity outcomes ASIC achieves are not publicised in the media, but this does not detract from their importance. Every day, ASIC officers work to ensure our markets are fair and efficient. These are their stories.

Participant B notified their ASIC Relationship Manager that they had appointed a new responsible executive (RE). The Relationship Manager requested that Participant B provide additional information about the individual's qualifications, work history and experience. Participant B confirmed that the individual had successfully completed an RE examination while working for a previous employer and emailed us a copy of his resume.

The resume revealed that the individual had not worked for a participant for over 12 months before commencing with Participant B, and had spent extended periods on sabbatical since last acting as an RE. In addition, they had not satisfied the Compliance Education Requirements necessary to maintain their qualification as an RE.

It was apparent to the Relationship Manager that Participant B had not undertaken the necessary checks to ensure that the individual had the appropriate skills, knowledge and experience to act as an RE, as required by Rule 2.3.1 (ASX) of the ASIC Market Integrity Rules (ASX Market) 2010. This raised some concerns about their understanding of the obligations relating to the appointment of REs.

On bringing this information to the attention of Participant B and reiterating the requirements for appointing an RE, the notification was promptly withdrawn. Although action was not taken against Participant B in this instance, a file note was created for future reference.