'Other people’s money' and changing global markets
Keynote address by ASIC Chair, James Shipton, at the Asia Securities Industry & Financial Markets Association (ASIFMA) Annual Conference, 'Developing Asia's Capital Markets', Tokyo, Japan, 10 October 2019
Good morning everyone.
I would firstly like to thank ASIFMA for inviting me to speak to you today. And it is great to be back in Tokyo.
Over the next two days, you will hear many different perspectives on how markets are changing, evolving and adapting to new regulation, technology and innovation.
I will also touch on regulatory developments which are not only shaping the future of ASIC, but the future of global markets in which we all operate.
However, I will start off on an important topic that I have been speaking about for some time now – that is, 'Other people’s money'.
This is because I worry that some people in finance still only see numbers on a computer screen and don’t recognise that every cent in the financial system ultimately belongs to people.
Even in wholesale and institutional markets, that your firms mostly participate in, every cent ultimately belongs to a person.
A sovereign wealth fund only exists for citizens, a pension fund for pensioners, and a mutual fund for individual investors.
Its all other people’s money.
1. Other people’s money
The financial services industry can better focus on the end user – people – and explore how financial market participants can better meet public expectations when dealing with 'other people's money'.
We need to ensure finance stays true to its ultimate function of serving the economy, and people individually and collectively. In other words, expand the discussion beyond finance’s economic role and explore its societal one.
The role of finance
Finance is a vital part of real people’s lives.
Because we are dealing with other people’s money, we must never forget that when things go wrong in the financial system this can be catastrophic to people relying on that system.
The financial system provides vital functions for the economy and for the society. Finance exists to serve people: it is a means to an end; but not an end in itself.
Therefore, finance always needs to be anchored to the core functions it serves for society.
One of the best descriptions of the broader societal role of finance is from Professor John Kay’s book Other People’s Money. It has four parts:
- The first function is capital allocation – matching those who need capital with those with excess capital.
- Second, inter and intra generational transfers of wealth – such as retirement schemes.
- Third, hedging and insuring against risks – In your world you automatically think of the derivative and options markets. But most of society hedge via personal insurance products.
- And finally, the payment system itself – the core plumbing of our modern economy and society.
This means the financial industry needs to look at its broader value proposition to people as people and not just some abstract concept removed from the world of finance.
Crucially, the financial industry, and the people in it, need to do more to support the proper functioning of the financial system towards these goals.
And part of this is that they need to take more of a leadership role in promoting:
- professionalism, as well as
- an awareness that finance ultimately serves people and communities.
Both of these goals, I believe, is ultimately helped by embedding the concept of ‘fairness’ into every corner of the financial system.
The fairness imperative
For there to be meaningful improvement of the financial markets, financial institutions must embrace and embed fairness into everything they do.
Fairness is not just a ‘retail’ concept. This is because fairness actually means 'just treatment or behaviour without favouritism or discrimination'.
No one could possibly argue that this concept should not have universal application in our markets.
In a global market context, the concept of fairness is relevant when we reflect on many recent market regulatory reforms, and look forward to the future.
Fairness is very relevant in:
- how firms and market infrastructure operators provide their services
- 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
- how the banks and sell-side entities – and market infrastructure operators – serve their clients, both wholesale and retail, and
- support the integrity of the system more broadly.
Here I would like to explore some broader concepts of what market integrity means as a practical matter.
According to its definition, integrity has two meanings or connotations:
- the first is 'the quality of being honest and having strong moral principles', and
- the second is 'being whole and undivided'.
I believe the first limb of honesty and morality connotes strong human elements; whilst the second limb connotes structural concepts.
Unless each and every component of the market is acting with integrity – that is, acting honestly and ethically – you cannot have structural soundness nor can you, critically, have confidence in the markets.
This important starting point means that the entire market ecosystem needs to be working to the common goal of market integrity.
The industry is also better served by applying an ethical standard – this will in turn go a long to bridge the trust deficit facing the industry.
However, despite all the efforts and initiatives, we are a long way from where we need to get to. There must be an undivided and whole awareness and commitment by all to act with integrity.
Ensuring market integrity, and the related challenge of restoring trust in the entire system, is fundamental to both market stability and economic growth.
2. Changing global markets
As I said, every cent in the financial system ultimately belongs to people.
This point is even more pertinent as global markets are changing.
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.
At ASIC, we are observing many structural and environmental changes that have the potential to impact on the size and efficiency of Australia’s capital markets.
Broadly, these changes can be categorised into the following themes:
- investor consolidation,
- growth in passive investments and ETFs, and
- technological changes.
Investment funds are consolidating into a smaller number of larger players. This is accompanied by a move by many of these larger funds to internalise a portion of their research and investment management functions.
While this has the potential to reduce costs and give funds greater control, we are aware of the potential impacts this may have on capital markets, particularly, the ability of emerging companies to access equity capital.
As these larger funds seek a broader range of investment opportunities, we are observing growth in private debt and equity markets.
This is contributing to a global trend of de-equitisation of equity markets and a contraction in the number of companies listed on public markets.
This is fast moving in a direction where regulators will need to consider the impact on public markets in the next 5 or 10 years and their ability to price and allocate risk capital.
As Professor John Kay also indicated, the stock market is no longer a means of putting money into companies but a means of getting it out.
Growth in passive investments and ETFs
A trend we are observing in global markets is the continued growth in low cost, passive investment and ETF products.
We are working with international regulators at IOSCO to consider the potential impact that an increased use of passive investment strategies may have on listed equity markets.
As you well know, technology and innovation are disrupting and reshaping the world we live in, and both consumers and investors have a lot to gain from this.
In Australia, we are closely monitoring the ASX’s proposed replacement of the CHESS equities clearing, settlement and asset registration system with a system based on distributed ledger technology.
ASX has begun user software testing with the system expected to go live in March/April 2021.
We also continue to monitor developments in crypto assets and digital currencies.
There is a trend for financial service and investment firms to use artificial intelligence, machine learning and algorithms in their business, including in trade execution and portfolio management.
The integrity and robustness of these systems is critical, so they do not exacerbate market volatility.
In the short time I have left with you this morning, I’d like to share a few of ASIC’s significant pieces of work which affect us all as global financial regulators.
Recognising the cyber landscape is fast evolving, ASIC is adopting an evolutionary approach that reviews and raises the bar on a periodic basis.
We will also adapt our surveillance processes driven by key events, for example, the emergence of new regulation or new types of cyber threats previously not anticipated.
Also, cyber resilience cannot be tackled by entities working alone. Collaboration between industry and regulators, including across borders, is essential to ensuring cyber resilience across the financial markets ecosystem.
Benchmarks and LIBOR
Global regulators have introduced various reforms to enhance the integrity and robustness of benchmarks, to restore market confidence. Many Asian jurisdictions have implemented new regulations, largely adopting the IOSCO Principles for Financial Benchmarks.
The development of these regulatory regimes will ensure that consistent standards can be applied to the administration of benchmarks globally, and I believe APAC has played an important role in upholding that standard.
From Australia’s perspective, we have implemented a legal and supervisory framework to govern financial benchmarks. This framework has recently been recognised as equivalent by the European Commission, as was Singapore’s.
Despite all these reform efforts, strengthening the framework is not always enough to ensure the long-term robustness of a rate. Some rates may simply become unrepresentative of the market they seek to measure, and there is no better example to showcase this than LIBOR.
Referenced in more than US$350 trillion worth of financial contracts globally, LIBOR is deeply embedded in the plumbing of businesses worldwide.
Through recent engagement with CEOs of selected financial institutions in Australia, we are acutely aware the transitional impact of LIBOR will be substantial and far-reaching.
We will release a statement on our findings and strongly encourage firms to highlight the issue of LIBOR transition with their stakeholders, particularly end consumers, to achieve greater industry outreach.
As you will know, market fragmentation is currently an area of focus at IOSCO and the FSB, and was a key priority of the Japanese G20 Presidency.
This work helps us to better understand where and why regulatory-driven market fragmentation is occurring, and what actions regulators could pursue to minimise its adverse effects.
This is a welcome development from an Australian perspective and from many of our fellow-regulators in Asia.
It supports our work to create fair, strong and efficient financial services systems that facilitate the operation of cross-border businesses and capital flows, while maintaining appropriate protections.
Domestically, ASIC seeks to mitigate the adverse impacts of market fragmentation through various tools and techniques.
For a relatively small open market like Australia, the ability to recognise and defer to overseas regimes has proved to be important and beneficial, both for foreign participants or infrastructure operators accessing the Australian market, and Australian participants accessing global markets.
It is also important to foster close cooperation with our regulatory counterparts - which provides the basis on which to build open and integrated financial markets.
The work by international bodies on market fragmentation also provides an opportunity to incorporate regional perspectives and explore possible regional solutions that help facilitate closer and deeper supervisory collaboration and cooperation.
Tomorrow, my colleague Ged Fitzpatrick will talk about a significant region-wide initiative launched in February – the Asia Region Funds Passport.
This passport enables funds that meet commonly agreed standards to passport into other participating economies in Asia on a streamlined basis and without the requirement to meet duplicative regulatory requirements.
ASIC is also carefully monitoring Brexit developments in the UK and we have been liaising closely with the UK’s financial regulators, other Australian financial authorities, and our regulated stakeholders to identify and plan for potential Brexit-related impacts.
Through our pre-emptive work, we aim to limit any disruption to Australian financial services and markets. This includes contingency planning in the event the UK leaves the European Union in a 'no deal' scenario.
Surveillance of FICC markets
A key priority for ASIC is enhancing our oversight of OTC fixed income, currency and commodity market participants.
We have identified differences in the practices of FICC market participants, including across their trade surveillance functions, risk controls, governance, conflict management and their compliance culture more broadly.
Our FICC strategy addresses threats to these markets, which may cause harms to the real economy and consumers. We are expanding our oversight of these markets through proactive surveillance, enhancing standards and driving behavioural change.
Again, I genuinely believe, having worked at the wholesale end of the markets (and having once been Vice Chairman of ASIFMA), that falling into a mindset that community considerations don’t apply to your business is a significant risk to your business.
Accordingly, we must always remember we are dealing with other people’s money.
I think we would all agree that global markets have changed significantly in recent years – it is a crucial time to be a regulator.
One constant that has not changed since I was Vice Chairman of ASIFMA to now, is the need for regulatory cooperation, both locally and internationally, and constructive industry engagement as we face these challenges together.
This is why I firmly believe that events like today are so important, and I look forward to engaging during the conference.