Regulating FICC in today’s Age of Uncertainty
Keynote address by ASIC Commissioner Cathie Armour at the ISDA Annual Asia Pacific Conference, 19 October 2021.
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Good afternoon everyone and welcome. Thank you ISDA for inviting me to speak today. I only wish it could be in person.
I am speaking to you from my home in Sydney, Australia. So I’d like to begin by acknowledging the Traditional Owners’ – the Gadigal people of the Eora Nation – ongoing connection and custodianship of the lands I am speaking from. I pay my respects to elders past and present.
The uncertainty wrought by the COVID-19 pandemic, combined with broader economic uncertainty has, and continues to, pose challenges for the fixed income, currency and commodity markets – or FICC markets.
As the financial markets and conduct regulator in Australia, ASIC is keen – in these times of challenge – to work closely with market participants as the landscape for these important markets change.
We know firms have adapted to ensure business continuity and operating resilience during the pandemic at a time when they have also needed to deal with an accelerating demand for technology and innovation across the financial system – acceleration enhanced by the pandemic itself.
Today, I’ll give you ASIC’s perspective on some of the challenges posed in this changing environment:
- first, an update on the LIBOR transition
- second, the overhaul of the OTC derivative transaction reporting rules
- third, how ASIC is supervising conduct by FICC market participants, and
- last, given, the next session’s focus on sustainable finance, I’ll cover our work on greenwashing.
There will be an opportunity to answer questions at the end.
LIBOR transition and relying on fallbacks
So, let’s begin our discussion with the LIBOR transition, which is now well under way in Australia. I know that you discussed progress on LIBOR transition in an earlier session today but perhaps an Australian perspective might be useful.
It is apparent from ASIC’s – and our prudential regulator, APRA’s – supervisory work, that:
- the major Australian financial firms are maintaining momentum in their transition projects, keeping pace with key milestones provided by regulators and risk-free reference rate working groups
- most are now in a proactive transition phase actively reaching out to clients for contract re-negotiation, and
- they have appropriate systems to support alternative reference rates and have confirmed that most of their clients have also made the necessary changes to their systems and infrastructure.
As of 30 June, the total notional LIBOR exposure for key Australian financial institutions was approximately $7.2 trillion (down from $8.7 trillion in June 2020):
- derivatives made up approximately 95% of this number – and, of the derivatives that expire after LIBOR ceases, nearly 95% of them have incorporated robust fallback language (ISDA IBOR Fallbacks Protocol)
- however, only 25% of loans that expire after the cessation dates have incorporated robust fallbacks (though this is up from 14% in March 2021).
Industry-wide adherence to the ISDA IBOR Fallbacks Protocol is important for the orderly transition of LIBOR-referenced derivatives contracts. As of June, 78 Australian firms, including all the major financial institutions, have adhered to the protocol.
But some firms are relying on fallbacks and not taking the next step of considering whether they need to actively transition to alternative reference rates.
We recommend firms:
- consider whether relying on fallback language is the best option for them – active transition is the best method to mitigate litigation and conduct risk, and
- ensure they are operationally ready ahead of the fallback switch.
We expect firms to completely cease offering new LIBOR products after the end of 2021. They should also:
- educate and train staff to ensure new LIBOR contracts are not offered to clients
- have controls to ensure any new contracts referencing LIBOR are picked up and escalated to the right team before they are finalised, and
- ask why these contracts are still being written.
Internationally, regulators like the Bank of England, ESMA and JFSA have consulted on adjusting mandatory clearing obligations for the transition away from LIBOR. At the appropriate time we will also consult with industry on consequential changes to ASIC’s mandatory clearing rules to ensure continuity of the current mandatory clearing policy settings.
Changes to OTC derivative transaction reporting rules
It is now over a decade since the GFC and the introduction of the OTC derivative transaction regime, so we’ve begun a multi-year project to overhaul the original OTC derivative transaction reporting rules.
Last year we released the first of two consultations, with the intention of bringing our rules in-line with international standards. The proposals are aimed at:
- reducing costs and complexity for industry
- improving data quality for Australian regulators
- providing more comprehensive trade details, and
- improving inter-jurisdictional data handling.
We have deferred publication of the second consultation until early 2022. This means subsequent milestones and commencement of the rules will be pushed back until Q3 2023 at the earliest. Early feedback indicates this delay is welcome.
The second consultation will provide:
- Our response to feedback on our first consultation – focusing on industry requests for more flexibility in the UTI rules and relief for smaller funds from the broader reporting requirements.
- Our final proposals for the data and rule elements, including minimisation of data elements unique to ASIC derivative transaction reporting rules.
- Our final draft rules.
In this project, we have worked closely with overseas regulators, particularly those within the APAC region. We have also taken an active role in the governance of data standards through the Regulatory Oversight Committee and the sub-committee for Derivative Identifiers and Data Elements, as we are keen to work through cross-jurisdictional implementation challenges and improve the harmonisation of requirements.
We are grateful for the ongoing feedback on our consultation. This engagement and willingness to raise issues and consider workable solutions will help to achieve a fit-for-purpose rulebook that moves the Australian market into the next decade with internationally standardised OTC derivatives data.
FICC market supervision
As I mentioned at the beginning, the uncertainty of the COVID-19 pandemic on FICC markets has contributed to the accelerating demand for technology and innovation across the financial system.
To ensure continuity and resilience in this operating environment, ASIC has worked closely with market participants to gauge their operational resilience.
We remain focused on addressing misconduct in FICC markets and are currently conducting thematic reviews across a selection of firms.
Right now, we are reviewing fixed income sales and trading businesses and, separately, firms’ conflicts of interest management arrangements. Where we have identified areas for improvement, we have worked with the relevant firms on their remediation plans.
It is critical that firms ensure all ‘three lines of defence’ remain adequately resourced to effectively manage risk and ensure compliance with regulatory obligations. Senior management are reminded they bear primary responsibility for ensuring the maintenance of appropriate standards of conduct.
Once we’ve concluded our thematic reviews, we will report on the key issues identified and provide good practice guidance for fixed income and conflicts of interest management.
We will also continue to expand our thematic review program to consider other key conduct themes in these markets.
To ensure fair and efficient FICC markets, we are committed to working with market participants. We have established a twice-yearly industry roundtable – and we are confident that ongoing dialogue between ASIC and industry on key issues in FICC markets can play a valuable role in facilitating higher standards of market conduct.
We recognise there may be a need for more information on standards of conduct in these markets. While the development of industry codes has improved behaviour, we are also considering whether there may be benefits to providing ASIC guidance on certain practices in Australian FICC markets. We welcome feedback from industry on which areas guidance is most needed.
Because of the global nature of FICC markets, we have also been collaborating with overseas regulators when conducting surveillances and identifying emerging risks. We consider this collaboration important to ensuring FICC markets continue to operate fairly and efficiently.
Finally, a word about sustainable finance. ASIC participates in the Australian Council of Financial Regulators’ Working Group on the Financial Implications of Climate Change. A paper from that working group was recently published and last week the Chair of the group, Deputy Governor of the Reserve Bank of Australia, Guy Debelle, gave a speech which drew out the themes from the group’s paper.
The speech describes climate change as ‘a first-order risk for the financial system’. It describes the way the Australian financial regulators are addressing this risk. For those of you who are interested, I recommend you read Guy’s speech which is available on the RBA’s website.
Amongst the work ASIC is looking at in connection with climate risks, is an assessment of the accuracy of disclosure about investment products that purport to be green. ‘Greenwashing’ occurs when a firm misrepresents the extent a financial product or investment strategy is environmentally friendly, sustainable, or ethical. We are particularly looking at the asset management sector in this work.
We have seen an increase in demand for environmental, social and governance (ESG) products:
- In 2020, the responsible investment market grew to almost AUD1.3 trillion, increasing 30% since 2019.
- Assets under management using responsible investment approaches grew at 15 times the entire investment market.
- The number of managers claiming to be engaged in responsible investment grew to 198 in 2020, up from 165 in 2019.
Because there are currently no specific definitions for ‘responsible’, ‘sustainable’ or ‘ethical’ in this area, we are considering whether product disclosures or advertisements are misleading or deceptive under the Corporations Act.
In other words, do public statements about a fund’s investment strategy match what they are doing in practice? Our objective is to ensure the strategy being promoted – be it about climate change or ESG more broadly – matches what is done in practice. Investors should have the information they need to assess whether a product matches their expectations for responsible investment.
Regulating this space is complex – partly because investors make investment decisions on ethical concerns and values, as well as prospective returns.
Because not all investors have the same ethical considerations when it comes to investing, ASIC’s focus is ensuring they have sufficient information to properly assess whether a product is right for them.
ASIC is conducting a review of ESG-focused financial products to understand how they are offered to investors. If misleading and deceptive behaviour is identified, we will be guided by the seriousness, pattern and nature of misconduct. Our action may include:
- engaging with responsible entities or superannuation trustees, and
- providing guidance or publishing investor education to assist current and prospective investors.
We may also consider enforcement action in egregious circumstances.
At an international level, ASIC is part of the IOSCO Sustainable Taskforce considering greenwashing in asset management and investor protection. We’re also looking at approaches taken by international regulators and will follow any market reactions closely.
Fundamentally, for ASIC, misrepresentation of ESG-related products may pose a threat to fair and efficient markets.
While the last year has been a difficult one, with many challenges and much uncertainty, ASIC will continue to adapt as our regulatory environment evolves.
The overhaul of the OTC derivate transaction reporting rules will align our requirements with international obligations and streamline processes for FICC market participants.
And our thematic reviews and surveillance of FICC markets will facilitate higher standards of market conduct.
But we can’t do this in a vacuum, we need the help of all active members of these markets.
To this end, ASIC is committed to keeping lines of communication open in both directions to ensure the strength, fairness and efficiency of FICC markets
Thank you for your time, I’d now like to open the floor to any questions.