On 7 September 2009, the Australian Securities and Investments Commission (ASIC) released a consultation paper outlining when ASIC will provide an exemption from the Australian financial market licence (Market Licence) requirements for financial markets accessed by Australian residents. The consultation paper invites comments from the public on ASIC’s proposed criteria to exempt certain professional financial markets (PFMs) from the key Market Licence requirements.
ASIC has traditionally been reticent to exempt market operators from the (onerous) Market Licence requirement. At present, there are only six exempt markets operating in Australia which deal in foreign exchange, government and corporate bonds, interest rate and credit derivatives.
Current regulatory framework and approach to market regulation
The Market Licence requirements are contained in Part 7.2 of the Corporations Act 2001 (Corporations Act). A ‘financial market’ is broadly defined to include a facility through which offers to acquire or dispose of financial products are regularly made or accepted. A person must only operate, or hold out that they operate, a financial market in Australia if the person has a Market Licence that authorises the person to operate the market in Australia, or the market is otherwise exempt from the operation of Part 7.2. The Minister has the power to exempt a particular financial market or type of financial market from the operation of Part 7.2, as well as the power to impose conditions on the exemption. It is ASIC’s role to advise and make recommendations to the Minister in relation to applications for Market Licences and exemptions.
A Market Licensee has a number of obligations with which it must comply, including (among other things) obligations in relation to market supervision, resource requirements (including financial, technological and human resources), compensation arrangements and reporting requirements.
Background to the proposals
ASIC has identified an ‘evolution’ of trading arrangements with professional investors through the development of specialised facilities used exclusively by professional investors for trading in over-the-counter (OTC) products.
Following on from an initial consultation process undertaken in February 2006, ASIC has released a consultation paper and proposed regulatory guidance setting out its proposed criteria for exemptions from the Part 7.2 requirements for professional markets. ASIC has indicated that the proposed approach is based on recognising that the brokers providing the relevant services are regulated under the Australian financial services licensing regime and that the relevant regulatory outcomes desired in respect of the Market Licence provisions can be achieved without the necessarily imposing the requirement for a Market Licence in such circumstances.
In particular, it is recognised that this will facilitate both the movement of OTC trades onto electronic platforms and enable Australian professional investors to benefit from access to such trading facilities. ASIC considers this approach will strike an ‘appropriate balance’ between:
- Maintaining market integrity and investor protection.
- Facilitating greater transparency and oversight in accordance with international regulatory developments.
Applicable criteria for an exemption
ASIC has indicated that, in deciding whether to recommend that the Minister exempt a PFM from the Market Licence requirements, it will usually look for the following characteristics:
- Market users are ‘professional investors’ who participate in the market on their own behalf or on behalf of other professional investors (a ‘professional investor’ includes, among other things, an Australian financial services licensee, a listed entity or a related body corporate of a listed entity or a person that controls at least A$10 million).
- Only financial products that are not usually traded on public markets by retail investors are traded on the facility, e.g. products other than shares or interests in managed funds.
- Trading is not anonymous, i.e. before transactions are entered into, a market user can identify its counterparty or its counterparty can only be one of a limited number of market users known to that user.
- The operator (or its associated entity) must not operate a clearing and settlement facility for the market.
ASIC will also take into account the number of market users, the likely size and volume of trading on the facility, the nature of the financial products traded on the facility, the extent Australian market users will use the facility, whether the facility has suitable systems, controls and risk management procedures in place, how the facility is regulated outside Australia and the likely impact of the operation of the market on the fair, orderly and transparent operation of other financial markets operated in Australia.
Conditions typically applied to exempt PFMs
When ASIC advises the Minister to appoint a PFM from Part 7.2, it will also recommend to the Minister to impose certain conditions on the exempt PFM. These will generally include the following:
- fair and orderly trading – the operator must have rules and procedures to ensure fair and orderly trading and must report to ASIC, without delay, any disorderly trading conditions and any conduct that constitutes, or may constitute, misconduct.
- Australian financial services licence (AFS licence) – the operator of the PFM must hold an AFS licence that covers the financial services associated with the operation of the market unless otherwise exempt. An AFS licence differs from a Market Licence and is the licence generally required to be held by financial services providers operating in Australia, other than market operators. Exemptions from the AFS licence requirements are however available in respect of certain conduct by foreign operators (see below). The operator of a financial market is likely to be engaging in, at a minimum, ‘arranging’ and ‘dealing’ in the financial products that are traded on the relevant facility, which are financial services in relation to which an appropriate AFS licence is required (unless an exemption is available).
- foreign operators adequately regulated in home jurisdiction – ASIC must be satisfied that a foreign operator (particularly where such operator is exempt from the requirement to hold an AFS licence) is sufficiently regulated by an overseas regulator and may impose additional conditions to address any perceived ‘gap’ in the standard of, or approach to, regulation.
- submission to jurisdiction - a foreign operator will be required to submit to the jurisdiction of an Australian court in any action brought against the operator in relation to the facility in Australia.
- registration – a foreign operator must also register with ASIC as a foreign company if required under the Corporations Act and have a local agent.
- clearing and settlement arrangements – the operator (or its associated entity) must not operate a clearing and settlement facility for the market. The purpose of this condition is to limit the nature of the activities that PFM operators may otherwise engage in, although an independent third party will be permitted to provide clearing and settlement facilities for the market.
- periodic reporting requirements – the operator must provide ASIC with certain information on a bi-annual basis, including trading volumes and details of Australian participants. The operator must also notify ASIC about certain events as soon as practical, including material changes to the facility, trading processes and control of the operator, misconduct by the operator or its key staff or any significant contravention of the Corporations Act or the market’s rules and any disciplinary action against the user.
- annual reporting requirements – the operator must prepare an annual report setting out a description of the activities undertaken, material system outages, details of Australian participants, volume of trading, complaints, regulatory issues and any significant conflicts of interest. The operator may also be required to provide an audit report on the annual report.
- record keeping – an operator must retain records relating to orders and transactions undertaken on the market as well as the terms under which participants use the market;
- assistance and cooperation arrangements – the operator must give assistance to ASIC, including providing access to information relating to the facility. The operator must also enter into a written agreement with ASIC to facilitate cooperation and information sharing; and
- operate as set out in the application – the market must be operated in the same way as its operation is described in the PFM application.
Applying for an exemption to operate a PFM
An application for exemption from the Market Licence requirements is to be made to ASIC, and must describe the operation of the PFM, reasons why the requirements should not apply and how the operator will comply with its obligations and likely conditions.
Generally, ASIC aims to advise the Minister about an application within 4 weeks of receipt, assuming all required documents and information are provided for assessment. This excludes time for the applicant to respond to any requests for information.
ASIC has noted that in some cases, public consultation may be required for an exemption application.
As discussed, the proposed criteria for exemptions from the Market Licence requirements for PFMs are yet to be formally implemented. It is anticipated that, following the close of the consultation phase and subject to comments from stakeholders, ASIC will release the regulatory guide in December 2009. The consultation period on the proposed regulatory guidance is set to close on 19 October 2009.
We would expect that the criteria set out in the consultation paper will provide a helpful framework for the review by ASIC of exemption applications made prior to completion of the consultation process.