Keynote address by Cathie Armour, Commissioner, Australian Securities and Investments Commission at the CIMA Society of Australia Annual Conference (Melbourne, Australia), 30 October 2018 and John Price, Commissioner, Australian Securities and Investments Commission (Sydney, Australia), 1 November 2018
Good afternoon everyone and thank you Pauline Vamos and to the CIMA Society of Australia for inviting me here today.
Let me begin by acknowledging the Traditional Owners ongoing connection to and custodianship of the lands on which we meet today, and to pay my respects to elders both past and present.
Today, I will speak about the importance of ethics and professionalism for investment management analysts, and provide an update on some of ASIC's work that might be of interest to CIMA members.
The importance of ethics and professionalism
The Royal Commission has highlighted for everyone the problems that arise when there is a failure of ethics and professionalism. Too often, we have seen that financial services firms have acted other than to serve the ultimate purposes of the financial system. Firms have put their own interests first to the detriment of customers and the public.
And while the investment management industry may not have had the same scrutiny as other sectors in the Royal Commission hearings, this does not mean that similar cultural failings don't apply to the industry. And, of course, investment management professionals may find themselves in the regulatory spotlight soon enough.
And so I think the theme of this conference – 'raising the bar' – is very fitting for our discussion today.
How do we raise the bar for fund managers and investment management analysts? What can CIMA members do to live up to community expectations and community standards? What can or should CIMA members do to help ensure that community expectations and standards are appropriately considered when investment decisions to construct a portfolio are being made?
Well, ASIC believes that heightening professionalism in the finance sector will go some way to raising standards in the sector.
What are the hallmarks of professionalism? Broadly, these are competence – that is having the right skills - and conscientiousness – that is caring about other people and acting ethically.
CIMA and its members are well placed to lead a drive to enhanced professionalism in the sector. As a professional community, the CIMA Society exists to promote and maintain a high standard of knowledge and practice amongst those investment and wealth professionals who construct investment portfolios. The CIMA certification program is a core part of this and requires a certain level of competence amongst investment analysts.
But what about conscientiousness, and acting ethically as an investment professional? How can CIMA members demonstrate conscientiousness in their roles?
Let's take assessment of a fund manager's performance as an example. Too often, the focus is just on short-term returns. Short termism is not the way to go when it comes to professionalism.
A truly professional approach requires considerations of a broader range of considerations. For example, do you consider the fund manager's own approach to ethics and professionalism? What do their governance practices tell you? What about their remuneration practices? Does their remuneration consider long and short-term risks as well as financial and non-financial risks?
As the Royal Commission hearings have highlighted, conflicts of interests have been the root cause of much of the identified misconduct – particularly those embedded in remuneration structures. This must change because conflicts of interest that are imbedded in remuneration become imbedded in corporate culture.
As the ARPA Chairman recently commented in respect of APRA's review of remuneration practices in banks:
'Well-targeted incentive schemes and firmly enforced accountability systems should be viewed not simply as a matter of regulatory compliance but as essential for sustained commercial success.'
We expect this insight applies equally to the funds management sector.
In addition to the role of remuneration structures, in ASIC's experience, a disproportionate amount of poor conduct also arises because of the unfortunate and unproductive interaction between two questions:
- What can my individual firm do?
- What can my industry sector do?
In particular, we regularly confront the argument from firms that, 'I can't change poor practices in my own firm, because everyone else in the industry is doing the same thing'. Poor conduct in your own business is apparently justified because 'everyone else is doing it'.
Such an argument has always been a poor excuse, but it is clear that it is increasingly unacceptable to the community. One implication is that the importance of cross-industry initiatives will only increase. Firms including the funds management industry will need to step up to ensure that not only their own standards, but industry-wide practices, are improved.
And so, this is another area where there is a role for investment management analysts to raise the bar across the industry. CIMA members are uniquely positioned to lead the charge to call out issues that may require industry-wide change in funds management.
It may be that CIMA members want to call for changes similar to those happening internationally. There is a lot happening overseas in funds management – in particular the MiFID II reforms. There is currently not a plan to introduce MiFID II requirements in Australia.
However, the international changes are interesting because they are, in a sense, translating some of the expectations for asset managers acting in the interests of investors into more concrete behaviours. Take for example the principle that asset managers should not incur costs unless the value for the fund has been carefully considered. The unbundling of brokerage research services is potentially creating new norms about how this might apply in practice. Another general principle consistent with how we would expect an asset manager to operate is to transact in a manner that delivers the best outcome for the fund. The best execution requirements emphasise this.
We have seen how some fund managers' approach to their execution responsibilities can led to broader market misconduct. For example, we have seen how fund managers' interests in transacting foreign exchange transactions at a benchmark (commonly referred to as at the Fix) but for no cost, may have contributed to inappropriate trading around the FX benchmark.
These and other behaviours which affected the quality of execution in the foreign exchange market are addressed by the Global Code on FX conduct. ASIC is a strong supporter of the Global FX Code, of which RBA Deputy Governor Guy Debelle, was instrumental in putting into place. FX market conduct is an area that ASIC is increasing its focus on, and the Global FX Code is an essential starting point for firms to follow to improve their practices.
One area we have looked at recently and which is an area, we think you should be asking fund managers about is the practice in FX markets of 'last look', in which a liquidity provider has the ability to decide over a fraction of a second whether to accept or reject a trade request from a client. While 'last look' may help facilitate a liquidity provider's legitimate risk management, it also introduces the potential to exploit confidential client trading intentions and to otherwise treat clients unfairly. We are also concerned around the quality of client disclosure about the practice, with many clients unaware of the practice. We have recently undertaken a review to better understand 'last look',and will publish our observations and findings in due course. We also intend to conduct surveillance on liquidity providers to check their disclosure and internal processes and procedures. But, when we have asked fund managers about their views on last look we have had a variety of responses- some have tested their FX counterparty's use of the practice and are satisfied, others don't trade with counterparties who use the practice, and many were just not aware of the practice. We think fund managers should be engaged with the way their foreign exchange transactions are being executed and it seems to us, that this is an example of the conscientiousness you should be asking fund managers to display.
So while strictly speaking the broad MIFID II obligations are not part of Australian law already we are seeing some global fund managers change their practices in response to aspects of MIFID II like research unbundling. Whether you'd like to see more of this in Australia is something CIMA members might want to consider.
Update on some of ASIC's work
Next I'd like to turn to some of ASIC's other work that CIMA members might be interested in. Specifically, I'd like to provide updates on our work on equity research and allocations.
In December 2017, ASIC released regulatory guidance on managing conflicts of interest and handling inside information by Australian financial services licensees that provide sell-side research. Firms were required to follow this new guidance from 1 July this year.
Why is this guidance significant?
RG 264 Sell-side research looks at the key stages of a capital raising transaction and provides specific and reasonably detailed guidelines on how AFS licensees should appropriately manage conflicts of interest during each stage. It also provides general guidance on the identification and handling of inside information by research analysts, and about the structure and funding of sell-side research teams.
The timely and accurate flow of information about issuers, securities and other financial products is vital to the fair, efficient and transparent operation of financial markets. Research helps investors make informed investment decisions and should be unbiased and reflect the professional judgment and expertise of the research analyst. The integrity of research directly affects the integrity of our financial markets and investor confidence.
The guidance makes ASIC's position clear on a number of issues where there were divergent practices in the Australian market.
For example, it is now clear that equity research analysts must not be involved in the pitches for capital raising transactions.
As part of the IPO process, research analysts sometimes prepare investor education reports (IER). These contains information about the issuing company provided to institutional investors and is often the first time that investors receive detailed information about an issuing company.
Whilst IER may assist in price discovery and help investor understand the issuing company, there is a risk that inappropriate influence may be applied to the research analyst during the preparation of IER, either from their corporate advisory team or the issuing company.
RG 264 includes guidelines for the preparation, content and review of IER and sets out limitations on the interactions between research analyst, corporate advisory and the issuing company.
Since the release of our guidance we have noted a change in market practice in relation to IER. For example, valuation information is now being expressed on an enterprise or total value and not on a per share value. This minimises the risk of IER being used to influence investors' views on valuation of the issuing company prior to the prospectus being released and reduces pressure on the research analyst to adopt any price target in post IPO research initiation report.
We will be reviewing how industry has been adopting the guidance in RG 264 over the course of the next year. We are particularly interested in any feedback CIMA members have on investor education reports, and their usefulness.
Turning now to our allocations project. ASIC is conducting a review of allocation practices in capital raising transactions with a report to be released before the end of the year. Investor confidence in the allocation process is a key element of efficient capital markets.
We have consulted with a range of stakeholders and reviewed transactions to understand how allocations are conducted and the messaging provided to investors.
Our report will set out our findings on market practices including the factors considered when allocation decisions are made, how messages are provided, who makes them and how potential conflicts of interest are managed. We will set out a range of better practices that industry can adopt to assist them to meet their regulatory obligations.
Some initial findings include:
- Value. Over a 4-year period to 30 June 2018 we observed a median 1-day volume weighted security price increase for our sample of 5.6% for IPOs and 3.0% for placements. So, the question we have is are allocation practices working for the issuer? Is too much money being left on the table for investors as the security price increases might be more than an appropriate risk premium for committing early to a transaction.
- Factors considered. Licensees take into account a range of discretionary factors when making allocation recommendations, such as the size and timing of bid, issuing company objectives, type of investor and the level of engagement with the issuing company. We observed that larger investors generally received larger allocations by value but not necessarily as a percentage of the amount they had bid.
- Impact of underwriting. A licensee acting as an underwriter to a transaction did not appear to materially impact allocations. The main impact was that investors who acted as sub-underwriters appeared to be preferred in allocations
- Price discovery. Investors who assist with price discovery or generate transaction momentum typically receive more favourable allocations.
- Existing shareholders. For secondary raisings, existing shareholders tended to receive better allocations than non-shareholders but did not always receive pro-rata allocation.
- And finally, institutional investors want more transparency about the outcome of the allocation process, and many investors want more information about whether the offer is 'covered'.
Thank you again to Pauline and CIMA for inviting me to speak today.
We look forward to continuing to work with professional bodies like CIMA to enhance professional standards across finance.
I'm happy to take questions.