MIU – Issue 156 – February 2024

Westpac unconscionable conduct for interest rate swap

The Federal Court declared Westpac Banking Corporation (Westpac) engaged in unconscionable conduct in October 2016 when executing a $12 billion interest rate swap transaction, the largest of its kind in Australian financial market history.

Westpac was ordered to pay the maximum penalty of $1.8 million in relation to the conduct, together with $8 million for ASIC’s litigation and investigation costs.

Westpac’s unconscionable conduct arose when it engaged in pre-hedging ahead of an interest rate swap transaction with a consortium comprising AustralianSuper and IFM entities. The interest rate swap related to managing interest rate risk associated with the consortium’s purchase from the NSW Government of a majority stake in electricity provider, Ausgrid.

The Court declared Westpac’s conduct was unconscionable because:

• Westpac was aware of its client’s concern about trading prior to the swap transaction (pre-hedging) that had the potential to adversely affect the price of the swap transaction to their detriment. Every basis point increase to the price of the swap transaction would involve a cost to the consortium of about $4.7 million
• despite being aware of its client’s concerns, Westpac acted on an internal plan to pre-hedge up to 50% of the interest rate risk by trading in significant volumes of interest rate derivatives in the market before the swap transaction was executed
• Westpac failed to obtain client consent or give clear and full disclosure about the extent of its planned pre-hedging
• once Westpac commenced its on-market pre-hedging trading, the consortium could not protect itself against the risk that Westpac’s trading would increase the price of the swap transaction to the consortium.

The Court also declared that Westpac failed to have adequate arrangements to manage the conflict of interests between it and the consortium and did not do all things necessary to ensure that the swap transaction was provided to the consortium efficiently, honestly and fairly. 

• Read the media release

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ASIC’s guidance on pre-hedging 

We’ve published a letter to market intermediary CEOs setting out our guidance on pre-hedging practices in Australia.

Pre-hedging has a role in markets, including in the management of market intermediaries’ risk associated with anticipated client orders and may assist in liquidity provision and execution for clients. However, it can also create significant conflicts of interest between a client and the market intermediary which actively trades in possession of confidential information about the client’s anticipated order or trade.

We anticipate market intermediaries that undertake pre-hedging will:

1. document and implement pre-hedging policies and procedures
2. disclose pre-hedging practices to clients clearly and effectively
3. obtaining client consent to pre-hedging prior to each transaction, where practical
4. monitor execution and client outcomes and seek to minimise market impact from pre-hedging
5. restrict access to confidential client information and adequately manage conflicts of interest arising in relation to pre-hedging
6. have robust risk and compliance controls for effective supervision of pre-hedging activity
7. record key details of pre-hedging undertaken for each transaction
8. undertake post-trade reviews of the quality of execution for complex and large transactions

If pre-hedging is not carried out in an appropriate manner it can be unfair, unconscionable and result in poor client outcomes. This may adversely impact investor confidence and undermine market integrity.

• Read the news item

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Block Earner crypto product needs financial services licence

The Federal Court has found fintech company Block Earner engaged in unlicensed financial services conduct when offering its crypto-backed Earner product.

From March 2022 to November 2022, Block Earner offered consumers the Earner product which allowed them to earn fixed yield returns from different crypto-assets.

In one of the first decisions on the application of the financial services law to crypto-backed products, today the Court found that Block Earner provided unlicenced financial services and operated an unregistered managed investment scheme when offering Earner. This is because the Earner product met the definition of a managed investment scheme and a facility for making a financial investment under the law.

We were unsuccessful in our allegation that Block Earner's variable yield crypto-asset based offering, known in our proceedings as the Access Product, was a financial product. Block Earner markets this product as giving consumers access to decentralised finance (DeFi) lending protocols. We considered this to be a financial product as it had the characteristics of a managed investment scheme, investment facility or derivative. However, the Court did not accept this characterisation.

We’ll now seek orders from the Court imposing pecuniary penalties. The proceedings have been listed for a case management hearing on 1 March 2024.

• Read the media release

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Cameron Waugh pleads guilty to insider trading

Former corporate adviser Cameron Waugh has pleaded guilty to insider trading in relation to the gold exploration and mine development company Genesis Minerals Limited (Genesis).

We alleged that over a seven-day period from 14–21 September 2021, Mr Waugh applied to acquire, and subsequently acquired, 747,626 shares in Genesis while in possession of inside information.

It’s alleged that through his role at Omnia Company Pty Ltd, at the time of his share applications, Mr Waugh was aware of a funding proposal that included a multi-million-dollar placement of Genesis shares and a restructure of the Gensis board that would see Raleigh Finlayson and Neville Power join the board.

On 22 September 2021, this information became public when Genesis published an ASX announcement titled ‘Raleigh Finlayson to Cornerstone Strategic Funding Package’ which subsequently saw the Genesis share price rise 187%.

Mr Waugh pleaded guilty on 24 January 2024 to one count of applying for shares while in possession of inside information in breach of s1043A of the Corporations Act 2001. Mr Waugh will be sentenced on 26 March 2024.

• Read the media release

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Unfair contract terms for institutional markets

Following commencement of the unfair contract terms (UCT) reforms on 9 November 2023, we’ve granted a limited class no-action position for institutional markets.

The Australian Financial Markets Association (AFMA) made an urgent application for no-action relief in advance of the changes to the UCT regime. AFMA cited concerns on behalf of industry that the amended UCT regime would apply to certain sophisticated participants in financial markets who are not consumers or small businesses intended to be covered by the UCT regime.

We don’t intend to take action for a contravention of the relevant UCT provisions or related obligations in relation to the class of counterparties and standard form contracts outlined in the no-action letter.

The no-action letter does not prevent third parties (including the Director of Public Prosecutions) from taking legal action in relation to the conduct it outlines.

• Read the class no-action letter

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Consulting on changes to OTC derivatives transaction rules

We’re seeking feedback from reporting entities, including small-scale exempt entities, on our proposed changes to the ASIC Derivative Transaction Rules (Reporting) 2024 (the 2024 Reporting Rules) and minor and related proposed changes to the ASIC Derivative Transaction Rules (Clearing) 2015 (the Clearing Rules).

Consultation Paper 375 Proposed changes to the ASIC Derivative Transaction Rules (Reporting): Third consultation (CP 375) proposes changes to the 2024 Reporting Rules to:

• simplify the exclusion of exchange-traded derivatives
• simplify the scope of foreign entity reporting
• remove the alternative reporting provisions
• clarify the exclusion of FX securities conversion transactions
• add additional allowable values for two data elements.

Additionally, CP 375 proposes minor changes to the Clearing Rules to:

• simplify and align the exclusion of exchange-traded derivatives with the 2024 Reporting Rules 
• make minor updates to re-reference the changed location of definitions in the Corporations Act 2001 which have been moved by the Treasury Laws Amendment (2023 Law Improvement Package No. 1) Act 2023.

Our proposed changes would commence on 21 October 2024, except for the changes to the scope of foreign entity reporting and removal of alternative reporting provisions which would commence on 1 April 2025.

Email your feedback on the proposals to otcd@asic.gov.au by 5pm on 28 March 2024.

• Read the news item

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Vigilance required to combat ransomware threats

Ransomware continues to be a significant threat to all organisations because of its profitable nature for criminal organisations and state actors. In the 12 months to 30 June 2023, the Australian Signals Directorate (ASD) observed a 23% increase in reports of cybercrime to around 94,000 reports. Ten per cent of ASD incident responses related to ransomware.

Ransomware involves the use of malicious software to encrypt, exfiltrate or deny an organisation access to data and systems – with threat actors demanding payment of a ransom to return access or not publish stolen data. Due to the profitability of ransomware as a service (Raas) and reliance on technology to store and transact data, it’s likely these attacks will continue to increase in frequency and impact. Firms should actively scan for this threat and manage their technology risks to remain resilient to cyber-attacks.

The ASD’s Australian Cyber Security Centre (ASD’s ACSC) publishes advisories that empower organisations to act on up-to-date intelligence to harden their systems. In December 2023, the Federal Bureau of Investigation (FBI), Cybersecurity and Infrastructure Security Agency (CISA) and the ASD’s ACSC published a joint advisory calling on organisations to help mitigate cyber threats from Play and Lockbit ransomware as part of its #StopRansomware campaign. These advisories provide technical details and mitigations that can be employed to shore up an organisation’s defences.   

Numerous other advisories have been published notifying organisations of other critical vulnerabilities. We encourage all organisations to become an ASD partner or sign up for alerts to receive actionable intelligence to enhance their cyber resilience. This is an easy step that all organisations – including those with obligations under the market integrity rules – can take to stay on top of known risks and respond appropriately.

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Disgorgement of profits from unlicensed conduct

We remind Australian financial services (AFS) licensees to ensure that the financial services being provided to clients are covered by the authorisations in their AFS licence.

A licensee self-reported to ASIC that it had been making a market in over-the-counter and foreign exchange derivatives to wholesale clients without the required market-making authorisation. Consistent with the guidance set out in Regulatory Guide 277 Consumer remediation (RG 277), the licensee has agreed to return the profits it made as a result of its unlicensed activity to 18 wholesale clients affected by the breach. Payments totalling over $1 million will be made to those wholesale clients.

When calculating compensation, we expect licensees to return the affected clients back to the position they would have been in, or as close to as possible, had the breach not occurred. The payment to the licensee’s clients included an interest component.

Clients also have rights under Division 11 of Part 7.6 of the Corporations Act 2001 (Corporation Act) to rescind agreements and recover brokerage, commissions and other fees paid to a person who does not hold an AFS licence covering provision of the financial service and is not exempt. The licensee offered clients the option to unwind open positions – however, none chose the option.

We’ve previously conveyed our position on market making and remind licensees that under section 766D(1) of the Corporations Act, a person (other than a market licensee) makes a market for a financial product where they regularly state the prices at which they propose to acquire or dispose of the products on their own behalf. Further, other persons have a reasonable expectation that they will be able to regularly trade at the stated prices.

We'll continue to monitor existing and new offerings to ensure licensees hold the appropriate authorisations and we will take action for breaches of the law where appropriate.

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