REP 475 Market integrity report: July to December 2015
Financial markets facilitate the raising of capital and the efficient allocation of resources and risk. They can't do this without the trust and confidence of investors.
You hear these words a lot from ASIC, but what do they actually mean?
Put simply, if you don't trust that our markets are operating fairly, you won't invest your money in them. If lots of people feel and act this way, market liquidity (that is, the ease of trading shares) will decrease.
Conversely, trust and confidence encourages investor participation, which increases liquidity. This makes it easier for companies to raise money, which enables them to grow. This in turn creates jobs and economic growth.
So you see, market integrity matters to us all.
ASIC's Market Integrity Group is responsible for ensuring that Australia's financial markets are fair, orderly transparent and efficient. We are dedicated to pursuing this goal.
Market misconduct benefits a few at the expense of many – at the expense of you, me, and the 6.5 million other Australians who own shares or other listed investments. We are determined to stamp it out!
The Market Integrity Group undertakes an enormous range of activities. We set standards and education, pursue behavioural change and take enforcement action in the most serious instances.
This report highlights some of the activities we undertook between 1 July and 31 December 2015, and outlines our key priorities for 2016.
Most people who manipulate the market do so for individual gain – to increase the value of their own or their clients' investment, to earn a bigger bonus, or sometimes to promote their reputation or career.
Robert Dulhunty was sentenced to 18 months in jail for conspiring to manipulate the share price of Healthzone Limited (Healthzone). Mr Dulhunty was a director of Healthzone. By intentionally and repeatedly conspiring to manipulate the market Mr Dulhunty abused the trust of Healthzone investors.
Nigel Heath was sentenced to two years and three months in jail, related to his trading in shares and contracts for difference in four resource companies. Mr Heath's trading artificially increased the price for the shares of these companies on the ASX market, causing investors to pay more for Healthzone shares than they needed to.
Proceeds of crime seized
ASIC and the Australian Federal Police worked together to prevent the distribution of profits generated by an illegal internet hacking, market manipulation, and money laundering operation. This occurred after ASIC detected suspicious trading in the online accounts of retail clients and traced it to a suspected Russian hacker. In this instance, we were literally able to ensure that 'crime didn’t pay'!
Compliance with regulatory requirements
We accepted an enforceable undertaking from three J.P. Morgan foreign financial service providers after they failed to comply with the disclosure conditions of their class order relief. This relief exempts foreign financial service providers from holding an Australian financial services licence if they are regulated by an equivalent overseas regulatory authority and disclose this to prospective Australian wholesale clients before they provide financial services.
We examine the effect of different types of behaviour on our markets so that people are informed about the trading environment.
High-frequency trading and dark liquidity review
We completed reviews of high-frequency trading and dark liquidity. We found that current levels of high-frequency trading and dark liquidity are not adversely affecting the function of our markets or their ability to fulfil their role for companies and investors. We concluded that the existing regulatory settings are largely adequate and effective.
In July 2015, we released Report 440 Financial benchmarks. The report highlights the importance of financial benchmarks in the Australian economy and outlines the consequences if benchmarks are not robust and reliable. The report touches on the investigations ASIC is undertaking into benchmark-related conduct and makes a number of forward-looking recommendations that dealers, wealth managers and other clients of dealers and administrators of benchmarks should adopt to avoid conduct issues in relation to financial benchmarks.
Since then, we have been working with members of the Council of Financial Regulators (CFR) and industry stakeholders on options to reform the methodology for the calculation of the bank bill swap rate (BBSW). A discussion paper (and proposal) on the evolution of the BBSW methodology was published in February 2016, which interested parties are encouraged to consider.
OTC derivatives reforms
We achieved major milestones towards Australia's implementation of over-the-counter (OTC) derivatives market reforms, including rules for a mandatory central clearing regime.
The OTC regime will improve market integrity by enhancing the transparency of transaction information, promoting financial stability and preventing market misconduct.
Achieving behavioural change is an important part of our work. Through early intervention, we may be able to prevent risky conduct or potential breaches – and investor losses – before they occur.
We've been using behavioural insights to better regulate market conduct. We designed an education campaign about suspicious activity reporting, and launched a new form on the Market Entity Compliance (MECS) portal to make lodging these reports faster and easier.
Variable interest entity (VIE) structures
ASIC and the licensed listing exchanges agreed to a moratorium on initial public offerings of companies with VIEs. This decision was taken to protect Australian investors in light of:
- the uncertainty with which these structures are regarded by international regulators, and
- negative investor experience with VIE's in other jurisdictions.
Futures bond roll activity
We identified conduct affecting the ASX 24 quarterly roll markets. It appeared that a few participants were crowding out the roll market with excessive numbers of orders during the contract expiry period, to gain higher priority in the bid/ask spread, and cancelling orders with unfavourable priority. This behaviour was leading to higher costs or passive execution risks for other market users.
After monitoring this behaviour, we contacted the participants involved to discuss order entry. During subsequent roll periods, we saw a marked improvement in overall roll activity, which was better for other market users.
Cyber threats, handling of confidential information and conduct risk remain the key issues facing Australia's financial markets (and ASIC) in 2016. We have previously undertaken extensive work on these issues and last year established three taskforces to target them more deeply. We will comment on the progress and findings of these taskforces throughout the year.
Over the coming months, we will:
- conclude our review of Australia's retail OTC derivatives industry and report our findings
- explore additional opportunities to share our cyber resilience model with industry and regulatory agencies
- work with CFR agencies to consider the need for regulatory change to address benchmark-related conduct issues
- test for conduct and other issues relating to financial benchmarks, such as key interest rate and foreign exchange benchmarks
- educate stakeholders about the need for client money handling reform, as proposed by Treasury, and
- continue to meet with market intermediaries to communicate our expectations on conduct.
- 96 matters under investigation at any one time (on average)
- 14 significant enforcement outcomes
- two enforceable undertakings
- 21,350 trading alerts
- 102 market surveillance inquiries
- 118 industry meetings
- 32 compliance surveillances, and
- 11 risk-based assessments.
 This included one criminal conviction for insider trading, two continuous disclosure outcomes, three market manipulation outcomes and eight outcomes for ASIC market integrity rule breaches. This figure does not include outcomes where a guilty plea has been entered but sentencing has not yet occurred.
 The corresponding figure for 1 January to 30 June 2015 was 18,388, representing an increase of 16% in the current period. We attribute this to increased market activity and volatility in the second half of 2015.