Market Integrity Update - Issue 74 - August 2016
Review of Australian equity market cleanliness
On 9 August we released a report that found an overall improvement in the cleanliness of the Australian listed equity market over the past decade.
Report 487 Review of Australian equity market cleanliness, looked at possible insider trading and information leaks ahead of material, price-sensitive announcements by looking at price movements or shifts in trading behaviour before these announcements.
The results suggest that behaviour has improved over the past decade. The review used an established market cleanliness measure and a new market cleanliness measure developed by ASIC to come to this conclusion.
The new measure examines timely and profitable trading before material announcements. It compares the trading behaviour of individual accounts to their historical trading behaviour and the trading of others in the market. We developed the new measure using our advanced surveillance system and data analysis capabilities.
Based on the new measure, 95% of material announcements exhibited no (or negligible) anomalous trading patterns ahead of an announcement in the period 1 November 2014 to 31 October 2015.
We also identified a gradual improvement in market cleanliness over time and across different segments of Australia’s listed equities market. We will continue to monitor this and use our surveillance and enforcement capabilities to detect market misconduct.
Handling confidential information and conflicts of interest
We recently completed a review of the handling of confidential information and conflicts of interests, particularly in the provision of sell-side research and corporate advisory services: see Report 486 Sell-side research and corporate advisory: Confidential information and conflicts of interest.
We looked at the policies, procedures and practices of a range of investment banks and brokers active in the Australian market, focusing on a sample of transactions, including initial public offerings (IPOs) and secondary offerings.
We found that, while most firms have specific policies and procedures in place, there is considerable variation in how these are applied. For example, we found variation in:
- the identification and handling of confidential information, including inadequate use or supervision of information barriers and restricted trading lists
- the management of conflicts of interest, for example:
- inconsistent structure and funding of research departments
- insufficient separation of research and corporate advisory activities (particularly during the IPO process)
- inconsistent decisions about share allocations in capital raisings, and
- mixed practices on the disclosure of conflicts of interest, and
- staff and principal trading, including variation in the strength of controls to manage staff trading by corporate advisory and research staff.
Firms should review this report and consider whether their policies and procedures are appropriate and sufficiently robust to meet legal and regulatory requirements.
June quarter equity market data
We have published equity market data for the June quarter 2016.
In summary, the ASX accounted for 82.8% of the total dollar turnover in equity market products, and Chi-X accounted for the remaining 17.2%. On-order book turnover (excluding ASX auctions) as a proportion of total dollar turnover increased to 68.9% in the June quarter, up from 68.3% in the March quarter. Trade reporting turnover as a proportion of total dollar turnover increased by 1.6 percentage points to 18.3% over the quarter.
Overall daily turnover in the equity market averaged $5.7 billion in the June quarter, unchanged from the March quarter, and a decrease from $5.8 billion in the June quarter 2015.
Intraday and interday volatility eased from the peaks seen in February. The weighted average interday volatility for the S&P/ASX 200 index was 1.9% in the quarter, down from 2.1% in the previous quarter.
The weighted average quoted bid-ask spread for securities in the S&P/ASX 200 index fell by 1.0 basis point (bps) to 13.8 bps of the midpoint price in the quarter, and rose by 0.9 bps to 24.4 bps of the midpoint price for all securities. The overall order-to-trade ratio decreased slightly to 8.0:1 in the quarter driven by falls on both Chi-X and ASX.
Below block size dark liquidity represented 12.6% of total value traded in the June quarter. Turnover in block size dark liquidity was 12.6% of total value traded, slightly up from the previous quarter.
This data is available in table and graph format on our website.
Due diligence practices in IPOs
Our review of issuer due diligence in IPOs has found a close correlation between defective disclosure in a prospectus and poor due diligence: see Report 484 Due diligence practices in initial public offerings.
In the context of IPOs, due diligence is a process adopted by issuers of securities to determine whether they have properly prepared their prospectus.
Key observations from the review include:
- poor due diligence practices often produced prospectuses with defective disclosure
- an effective due diligence process can mitigate the risk of any future liability from a poor-quality prospectus
- directors of issuers and their advisers should be actively engaged in the due diligence process
- additional procedures may be required to overcome the additional challenges of foreign laws, language barriers and supervision for emerging market issuers, and
- a low-cost due diligence process may often lead to delays, further work and cost to an issuer.
The report also provides good practice recommendations for issuers and directors.
Compliance function resources for wholesale financial services
We recently carried out an informal survey into the resourcing of compliance functions within commercial and investment banks servicing wholesale businesses. This included trading, capital markets and institutional banking – but excluded wealth management and asset management.
While we did not find any one standard that firms benchmark against, we did find that the level of compliance resourcing was generally in the range of 4.5–6.5% of business front-office resourcing (apart from a few exceptions).
We also found that firms’ compliance budgets were usually decided using the current year’s budget as a base, with downward or (more usually) upward adjustment to cater for changes in regulatory requirements, business lines and new IT requirements.
Offshoring of a range of compliance functions was very common among the global firms surveyed, and is becoming increasingly common among domestic firms. The functions most commonly offshored were trade and communications monitoring, personal account dealing, significant position monitoring and reporting, anti-money laundering/’know your customer’/sanctions tasks, and control rooms.
Almost all firms reported an increase in the level of compliance resourcing over the past three to five years – with a number of firms reporting over 100% growth in compliance full-time equivalent (FTE) over this period.
Remuneration of compliance staff was found to be increasing for most firms. A number of firms observed that bonus pools for compliance staff tend to be more stable than for other business units, and were not tied to firm revenues.
ASX 24 testing on a live market
We have recently observed an increase in the number of market participants entering orders into the ASX 24 market that, in aggregation, result in the participant holding a very large bid or offer in particular contracts. The orders are usually away from the prevailing market price.
The most common reason for the behaviour was that market participants were testing their new connection and/or new limits on the market.
Participants are reminded that connectivity and limit testing should be undertaken within a test environment and not on a live market. Any order entered on the market needs to be supported by an audit trail, record of instructions and/or a legitimate commercial reason for placement.
Market participants that enter orders for the purpose of testing – specifically those with unusually large volumes at prices not reflective of the current market – may be in breach of Rules 3.1.2(3)(g) and 3.1.3 of the ASIC Market Integrity Rules (ASX 24 Market) 2010.
ASIC consults on new risk management guidance
We have released a consultation paper and proposed regulatory guidance on risk management practices for the managed funds sector: see Consultation Paper 263 Risk management systems of responsible entities: Further proposals.
The consultation paper does not propose any new obligations but gives more detailed guidance on how to comply with the current obligations.
The proposals provide the flexibility to develop and maintain risk management systems that are appropriate to the nature, scale and complexity of specific businesses. They also reflect international standards and developments in risk management.
While the new guidance focuses on responsible entities it may also assist other Australian financial services licensees to comply with their risk management obligations.
Submissions in response to the consultation paper are due by 1 September 2016.
Stories from the beat
The majority of the market integrity outcomes we achieve are not reported by the media, but this does not detract from their importance. Every day, ASIC officers work hard to ensure our markets are fair, orderly and transparent. These are their stories.
Story 1
As part of a recent regulatory process we found an instance where a firm's corporate advisory team had limited oversight by compliance or an independent control function. Management and control of wall-crossings, restricted lists and approval of staff trading were being managed by the corporate advisory team.
We were concerned that the lack of independent oversight from a control, monitoring and audit perspective may result in poor behaviour by those with a conflict of interest. ASIC has taken regulatory action and the firm is now revising its governance structures.
Story 2
In Issue 72 of the Market Integrity Update, we reminded market participants to be alert to unusual trading around the end of the financial year, known as 'window dressing'. This trading can affect share price valuations and end-of-financial-year performance figures.
As part of our normal surveillance, we identified an unusual trade on 30 June 2016 that significantly increased the share price and market capitalisation of a security. The trade appeared designed to have a price impact and caused the price of the security to close at its high for the day. Through our inquiries we were able to establish that the client was an employee of a fund manager and that the fund manager was a substantial holder in the security. As a result, the fund manager would have received a 'window dressing' benefit for the June 2016 quarter. Our inquiries are ongoing.
Similar trading activities have previously resulted in referrals to our Enforcement team and disciplinary action. Market participants need to aware of their obligations as gatekeepers, and should take active steps to identify and report suspicious activity. We would also like to remind investment managers, fund managers and other investors that window dressing is a serious form of market manipulation and may result in penalties under the Corporations Act 2001.