Keynote address by Cathie Armour, ASIC Commissioner, at the International Swaps and Derivatives Association (ISDA) AGM 2019, (Hong Kong) 10 April 2019.
1. Introduction
Good afternoon everyone.
I would like to take this opportunity to thank ISDA for having ASIC here today to speak to you about our approach to our supervisory responsibilities and important developments in our financial markets globally.
You will have heard much today, and you will hear more tomorrow, on how markets are changing, evolving and adapting to new regulation, technology and innovation.
As a market and conduct regulator, ASIC has a role to play in this changing environment, both domestically and internationally. As a regulator:
- we care about how financial regulators promote international cooperation
- we care about facilitating change, innovation and new technology
- and most importantly, we care about the impact of financial markets on investors and the real economy.
I would also like to offer an Australian perspective over the next few years, which is critically focused on the concept of fairness.
Recently, ASIC’s Chair, James Shipton, said to the Australian domestic audience that the fairness imperative runs through financial services and its norms of behaviour. In the wholesale and global market context, this concept is also relevant when we look back to the genesis of many recent market regulatory reforms, and forward to 2020. Fairness is very relevant in:
- how firms and market infrastructure operators provide their services, not just to Australian markets, but globally
- whether the way in which these services are provided continues to promote the fair and efficient functioning of financial markets and economies, for both wholesale and retail sectors, and
- how the banks and sell-side entities – and market infrastructure operators – serve their clients, both wholesale and retail.
Also, importantly, conduct and culture continues to remain a focus for us.
More than ever there is a spotlight on conduct in the financial services industry in Australia, emphasised by the Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which was published in February of this year.
How is this Australian Royal Commission into the financial services industry relevant for this AGM?
The final report of the Royal Commission highlighted the harms that unlawful and unethical conduct can inflict on consumers and investors. What resonated with the Australian public was that unethical conduct - as much as fraudulent behaviour - produce unfair outcomes for clients and erodes their trust.
While consumer car loans and financial advice can seem very different from the world of central clearing or the ISDA CDM, I would suggest that the fundamental need for trust and fairness are the same and intrinsically linked.
ISDA has emphasised the role of the derivatives market in supporting real economy activities. This, to me, also means the dealers and participants in this market should conduct themselves in a professional way to produce fair outcomes and retain the trust of their clients - and the public in the real economy.
The Royal Commission report outlined six basic 'norms of behaviour' – which are:
- obey the law
- do not mislead or deceive
- be fair
- provide services that are fit for purpose
- deliver services with reasonable care and skill, and
- when acting for another, act in the best interests of that other.
I am sure you will agree - these norms of behaviour are not new. In Australia, we have been reminded again and again that it‘s not just about chasing the next bonus or commission, it comes back to how financial institutions handle other people’s money (and in many cases affect their financial security).
In an ISDA context I would rephrase this as: it‘s not just about managing today’s P&L – what you do and how you conduct your business has an impact on your clients or counterparties, and potentially your institution’s reputation.
Today I will touch on:
- continuing to improve culture and conduct
- changing behaviour through supervision
- regulatory developments impacting global markets, and
- financial benchmarks and IBOR.
2. Continuing to improve conduct and culture
ASIC acknowledges the importance of the Royal Commission's work and its recommendations. These recommendations have informed and expanded ASIC’s priorities and strategic direction moving forward.
I should say that while ASIC plays a role in improving conduct and building trust, I emphasise that it is the people who are licenced to provide financial services or credit services and their employees that have the frontline role to comply with relevant laws and keep customers top of mind. This is particularly true in sectors such as insurance and pensions, where consumers may have no choice but to entrust their financial security to you.
Behaviours that reflect the norms of conduct should form the very basic level of a culture and conduct framework in your business, which is supported and overseen by the most senior levels of management, directors and officers, and embedded throughout the organisation.
These foundational principles apply to financial and non-financial risks, including conduct risk and operational risks such as cyber resilience, privacy and data management.
ASIC, as a conduct regulator, is keeping this at the forefront of our minds whilst embedding and expanding new supervisory approaches and promoting best practice and innovation in regulation.
One good example of how ASIC is combining our focus on conduct, and supporting innovation, is our supervision approach, alongside the Reserve Bank of Australia and Australian Competition and Consumer Commission, for the Australian Securities Exchange’s program to replace its post-trade equities clearing and settlement infrastructure with a distributed ledger technology (or DLT) based system.
This system will be one of the first uses of DLT in a country's financial system anywhere in the world. It has the potential to deliver simplicity, to be more efficient and functional for participants, to be more resilient and scalable, and to allow ASX to build additional functionality in the future to respond to changing market needs.
ASIC supports innovation in clearing and settlement infrastructure. We are particularly interested in the possibilities for efficient and effective access to data about our regulated population, including brokers, clearing participants, and the clearing house itself.
However, we are conscious of the significant change this represents for the Australian equities market, being the first time that ASX has replaced its core clearing and settlement infrastructure in more than 25 years.
As such, we will work with ASX and other agencies to monitor the risks to the system closely, and will be seeking to ensure that, in all areas, the new system is as operationally robust, resilient, and recoverable as the current clearing and settlement system, and that the design of the replacement system adheres to the regulators’ competition, governance and conduct expectations of ASX.
This includes a focus on how ASX considers the impact this transition will have on market users and ensures the fairness imperative is forefront when considering risks, as the transition is implemented. In a world of new technological advancements, it is vital for regulators to supervise innovation in the market, but also to utilise advances in technology for our frontline market surveillance. At ASIC we are achieving this through our ‘Future state surveillance strategy’ and the expansion of our Markets Data Analytics Hub.
We have broadened the range of markets that we proactively supervise across to Fixed Income Currency and Commodities markets and crypto-assets and are developing a holistic future state surveillance model across these new areas. Our development will aim to extend our current capabilities to incorporate innovative approaches such as Machine Learning and Natural Language Processing that can be readily deployed to gain insights from structured and unstructured data sets.
The implementation of this functionality will help deliver analytical insights for frontline supervision across developing markets.
That analysis will also further enable us to support our focus on identifying potential misconduct, fraudulent behaviour and insufficient culture and conduct frameworks.
We should never forget that every cent in the financial system is other people's money and although financial relationships are becoming increasingly digitalised, behind each digital transaction lies the expectations of a real person.
3. Changing behaviour through supervision
As markets change and adapt, we continue to work on developing the regulatory frontier – that is regulation’s 'next generation' of tools and approaches through leading developments in data analytics and regulatory technology.
Achieving behavioural change is also an important part of our work. By changing behaviour, we may be able to avoid future instances of risky conduct and breaches, and prevent investor losses before they occur.
For example, we commenced our onsite reviews into the management of conflicts of interest and confidential information in wholesale foreign exchange (FX) businesses in Australia. The onsite reviews are an opportunity to review the conduct and operational practices of several firms.
These reviews form part of a broader strategic program of work on wholesale FX markets, including collaboration with our international regulatory counterparts, to review last look practices, margins and mark-ups, high-frequency trading, and close monitoring of the implementation of commitments made in previous court enforceable undertakings by several firms.
We also enhanced our approach to supervising the most significant market intermediaries, to gain a deeper understanding of their business models, cultures and behavioural drivers, and to engage directly and at the most senior levels to facilitate early detection of potential harms and foster constructive and timely behavioural change.
We continued to conduct annual compliance liaison meetings with these market intermediaries and have increased our engagement with them through additional onsite visits, requests to meet with a wider range of people within the businesses, requests for demonstrations of systems and processes, and requests for books and records.
This enhanced supervision approach aligns with our broader shift to close and continuous monitoring of significant financial institutions and other initiatives.
4. Regulatory developments impacting global markets
I would now like to turn to regulatory developments that will impact global markets, including the APAC region.
It is important that regulators of major financial markets work together to ensure we support the interests of our markets, market participants, and regulators.
ASIC engages closely with our regulatory peers in Asia and beyond, to ensure we respond quickly and collectively to regulatory issues that impact on our region.
International regulatory co-operation helps promote more consistent approaches to regulatory policy, enforcement and increasingly supervision. Although it may sound counter intuitive to market participants, co-operation between regulators, in my view, doesn’t increase your 'regulatory risk'. Instead, it reduces it because it maximises the chance of more consistent approaches across borders.
Through effective international co-operation, we've seen that regulators can help reduce differences in regulatory requirements in different jurisdictions and work towards more effective and consistent regulation.
I am pleased to say that this approach to international cooperation has resulted in two recent equivalence proposals for our markets.
In the context of Global Benchmark reform, a topic I will delve into further in a moment, I welcome the assessment, and recent publication of the draft determination, by the European Commission for equivalence with the EU regime, for both the Australian and Singaporean financial benchmark regimes.
Many major financial benchmarks administered in APAC are used by European market participants and this draft decision enables administrators to continue to provide this service to a global market and maintain an equivalent standard of regulatory compliance.
I am also pleased to say that the CFTC unanimously approved a comparability determination, finding the margin requirements for uncleared swaps under the laws of Australia and the regulations of the Australian Prudential Regulation Authority (APRA), comparable in outcome to those under the Commodity Exchange Act (CEA) and CFTC regulations.
This means that market participants can rely on one set of rules – in their totality – without fear that another jurisdiction will seek to selectively impose an additional layer of regulatory obligations.
These developments are evidence of effective international coordination which supports efficient global markets functioning and cross-border cooperation and we will continue to work towards such outcomes in the future.
As you will know, market fragmentation is currently an area of focus at IOSCO and the FSB, and a key priority of the Japanese G20 Presidency.
IOSCO and the FSB are preparing reports for the G20 Finance Ministers and Central Bank Governors meeting in June.
While IOSCO is examining fragmentation in the securities markets including swaps/OTC derivatives, the FSB’s approach to fragmentation is from a financial stability perspective and extends to markets and activities beyond the remit of securities regulators.
There are common themes between their work, including: the trading and clearing of derivatives across borders; and data reporting and the sharing of information across borders.
Australia has a very broad toolkit in terms of international co-operation and sharing of information, but we would welcome any enhancements, particularly if they were reciprocal (and multilateral), that arise from the work undertaken by IOSCO and FSB.
We would support the development of next steps to outline a work program, framework or guidelines for authorities to address practical challenges that are identified by IOSCO and the FSB. We believe that standardisation of deference and recognition would be helpful to make assessments more efficient and less resource intensive.
5. Financial benchmarks and LIBOR
Now let me turn to a topic that I know will be given further focus in tomorrow’s agenda, and that is the global upheaval of financial benchmarks and the ongoing program of interest rate benchmark reform.
Following the global financial crisis, several financial benchmarks were found to have been subject to manipulation attempts by market participants. This had a far- reaching impact into sectors of the market including those who provide key services to meet the needs of communities.
In response to this, global regulators initiated IBOR reforms and have been working with markets to:
- strengthen the interbank offered rates,
- identify alternative risk-free rates (RFRs) and
- to ensure contracts referencing current interbank offered rates (IBORs) include robust fall-back provisions.
Additionally, many jurisdictions have implemented new regulations, largely adopting the IOSCO Principles for Financial Benchmarks, to supervise provision of benchmarks, led by the implementation of the EU Benchmarks Regulation.
This includes jurisdictions such as Australia and Singapore, for which, as I’ve mentioned, the European Commission have published draft equivalence decisions.
The development of these jurisdictional regimes, amongst many other global developments, is necessary for improving the accuracy and credibility of financial benchmarks and ensuring robust frameworks for integrity of markets.
It is vital for effective international markets and market participants, that a consistent standard of requirements is applied, and I believe that we are well placed in APAC to meet and contribute to maintaining that standard.
We have seen the impact to global markets when the fairness imperative was not embedded in the conduct framework in various examples of benchmark misconduct. In response, several benchmark’s governance frameworks and calculation methodologies have been strengthened in order to rebuild trust and strengthen the robustness of the rates.
From the Australian perspective, a strengthened calculation methodology for BBSW was developed and implemented in May last year, which calculates the benchmark directly from market transactions during a longer rate-set window and involves a larger number of participants.
While ASIC is confident that the work done to strengthen the resilience of BBSW will ensure BBSW remains a key benchmark in the years ahead, part of the effort to deliver sound financial benchmarks markets is to ensure that, even for those interest rate benchmarks that are robust, appropriate fall-back provisions are included in contracts to ensure that potential future disruptions are minimised.
The development and adoption of alternative reference rates globally provide market participants the opportunity to assess their needs when choosing a financial benchmark, and I encourage users to ensure that the inherent attributes of the benchmark are appropriate for their intended use and the needs of their clients/counterparties.
However, despite reform efforts, strengthening the framework for provision of a rate is not always sufficient and this is the case for one benchmark in particular. I am speaking about the London Interbank Offered Rate (LIBOR), for which the problems have been well documented.
LIBOR is deeply embedded in financial markets globally and is likely to be used by many of you here today in financial contracts and in the plumbing of your business, and this is certainly the case for the financial industry in Australia. Therefore, you will likely be affected by the expected end of LIBOR at the end of 2021.
ISDA has been working on mechanisms and language for fall-back provisions, which significantly reduces the risks of widespread disorder in derivatives markets when LIBOR ends. These mechanisms should be adopted for new and legacy contracts in preparation for a smooth transition.
I am pleased to see in the agenda that there are many opportunities to discuss and consider this in further depth tomorrow.
6. Conclusion
Today I have touched on conduct and culture which are concepts that ASIC have spoken about many times and will continue to be important not just to us as a conduct regulator, but to market participants, as an important driver of outcomes for investors and financial consumers.
As a regulator, we are not in the detail of how firms assess and implement complex changes, but I'd like to remind you of my earlier comments on the concept of fairness and the importance of ensuring a robust culture and conduct framework as you embark on reforms that impact various parts of your business.
My message to you, is that the fairness imperative is a concept that is applicable across global wholesale markets and is foundational in considering how financial institutions handle other people’s money. As the 2008 financial crisis reminded us, there is an indisputable link between the actions of participants in wholsesale financial markets and the real economy.
These concepts are inherently embedded in ASIC’s priorities and strategic direction moving forward whilst we promote best practice and innovation in regulation.
Finally, I would like to extend an invitation to ISDA to participate in IOSCO's 44th Annual Meeting that is being hosted by ASIC in Sydney from 13-17 May 2019. I also invite all ISDA Members to join me at the ASIC Annual Forum – a two-day conference – following the IOSCO Annual Meeting, to discuss the theme 'Other People’s Money'. Information about these events can be found on IOSCO’s website.
Thank you again to Scott, (O’Malia ISDA CEO) and the team for inviting me to speak today, and we look forward to continuing to work with our regulatory colleagues and industry to help financial markets thrive.