On 25 February 2010, the Australian Securities and Investments Commission (ASIC) released its much anticipated consultation paper, Proposed ASIC Market Integrity Rules – ASX and SFE Markets (Paper), which recommends new market integrity rules to apply to real-time trading on the Australian Securities Exchange (ASX) and the Sydney Futures Exchange Limited (SFE) markets.
The proposed market integrity rules are based on existing rules regulating these markets, and are intended to clarify the supervisory responsibilities of ASIC and market operators. According to ASIC Chairman Tony D’Alosio, the market integrity rules ‘are an important step in creating an improved regulatory framework with less duplication and a more streamlined and efficient approach to the monitoring of trading’.
The market integrity rules are part of a broad reform of the Australian financial services industry through the Corporations Amendment (Financial Market Supervision) Bill 2010 to:
- improve confidence in the integrity of the markets by removing perceived conflicts of interest where market operators supervise their own markets, and
- create a regulatory framework that allows for more efficient supervision of cross-market trading.
While the proposed reforms apply to both the ASX and the SFE, the focus of this article is on the changes and likely effects the reforms will have on the ASX.
Reforms to market supervision
Under the Corporations Act 2001 (Cth) (Act), Australian market licences may be granted to applications if the Minister is, in addition to other factors, satisfied that the applicant can adequately supervise the market (including how it handles conflicts of interest), monitor participants’ conduct and enforce compliance with the market’s operating rules. Market operators must also ensure that their markets are fair, transparent and orderly.
Until recently, the ASX has been in charge of supervising and enforcing all market and trading rules in respect of its markets. Although the ASX undertakes market supervision and regulation under ASX Market Supervision Pty Limited (ASXMS), a separate market entity, there has been strong public criticism regarding the ASX’s ability to effectively and transparently supervise its own market. In particular, it has been suggested that the ASX has an inherent conflict of interest between its supervisory obligations and the operation of its market. Recent disclosure and reporting problems surrounding short selling and margin lending practices more generally have also brought these issues to light.
Recognising that confidence in the integrity of the financial system is central to its effective operation, on 24 August 2009, the Federal Government announced plans to transfer responsibility for the supervision of market participants in licensed Australian based financial markets to ASIC. An exposure draft of the Corporations Amendment (Financial Market Supervision) Bill 2009 was released on 2 December 2009 to give effect to these proposals, with the Corporations Amendment (Financial Market Supervision) Bill 2010 (Bill) subsequently introduced to Parliament on 10 February 2010. The Bill has now passed through both the House of Representatives and the Senate without amendment, making the proposed reforms one step closer to complete implementation.
Proposed market integrity rules
The Bill inserts a new Part 7.2A into the Act, which provides that ASIC is to adopt responsibility for supervising domestic licensed financial market operators and authorises ASIC to introduce market integrity rules in support of this role.
The market integrity rules will apply to market participants, operators of licensed markets and prescribed entities trading in Australian markets.
To supplement the ASIC-set market integrity rules, the following reforms have been proposed under the Bill:
ASIC proposes to establish a market disciplinary regime similar to the ASX Disciplinary Tribunal.
Under the amending legislation, a court may order a maximum penalty of up to $1,000,000 for individuals and $5,000,000 for corporations for the breach of a market integrity rule, a notable increase on the current $1,000,000 maximum penalty.
Each market integrity rule that includes a penalty amount will be categorised as Tier 1, Tier 2 or Tier 3. Tier 3 penalties have been proposed for Management Requirements (management structure, supervisory procedures and persons involved in the business) while proposed Tier 2 penalties include retail client advisers failing to obtain accreditation, most rules concerning clients trading in products for the first time and those regarding trading records. Rules that relate to minor and technical or procedural matters will either be subject to a Tier 1 penalty or no penalty. These penalty amounts equate to the maximum amounts for Level 1, Level 2 and Level 3 contraventions summarised in the Disciplinary Tribunal Sanction Guidelines.
Infringement notice and enforceable undertaking regime
As an alternative to civil proceedings, the regulations to the Bill propose to establish an infringement notice and enforceable undertaking regime that can require a person to pay a penalty, undertake or institute remedial measures (for example, education programs) or accept sanctions other than payment of a penalty.
These remedies, which are not dissimilar to the contentious infringement notice regime introduced for breaches of the Act’s continuous disclosure obligations in July 2004, will provide ASIC with quicker and more efficient alternatives to court proceedings. It will be interesting to see whether ASIC is as forceful in issuing infringement notice for breaches of market integrity rules as it initially was for breaches of continuous disclosure duties, particularly given the significant penalty increases.
ASIC will determine whether a breach warrants civil court proceedings, an infringement notice or an enforceable undertaking.
The Bill provides for compensation orders to be made by a court where damage results from the contravention of a market integrity rule. Market operators, however, are excluded from the compensation provision. The Explanatory Memorandum to the Bill acknowledges that if compensation orders could be sought against market operators, the central controllers of the financial system, this could potentially expose them to claims from all market participants for a breach of a market integrity rule. Market operators are therefore excluded from this enforcement option.
All market integrity rules will first be subject to approval by the Minister of Financial Services, Superannuation and Corporate Law. ASIC’s ability to make market integrity rules is solely to ensure that markets are fair, orderly and transparent. ASIC will have authority to make or amend rules without prior Ministerial approval where it considers it necessary and in the public interest to protect market participants dealing in a financial product or class of financial products. In this event, ASIC must immediately substantiate to the Minister in writing the urgent need for the rule or amendment, and revoke or amend the rule in accordance with any written direction given by the Minister. It is expected that such acts will occur only in limited circumstances where there is insufficient time to obtain prior Ministerial approval.
ASIC has sought to minimise duplication with existing provisions under the Act, though some rules (reporting, client money and confirmation) will still have some overlap with the Act.
Retained supervisory responsibilities
The ASX will continue to be responsible for:
- the oversight of all listed entities, including surveillance monitoring for continuous disclosure and corporate governance disclosure
- the admittance of new market participants, and
- the monitoring and enforcement of compliance with its operating rules for market, clearing and settlement participants.
It is expected that ASIC will commence its additional supervisory responsibilities in the third quarter of this year. The proposed market integrity rules would apply from the date of transfer of supervision.
At this stage, aside from having an ongoing regulatory impact on market operators and participants in Australian financial markets and increasing penalties for breaches, the introduction of market integrity rules is unlikely to significantly change the regulatory landscape. ASIC Chairman Tony D’Aloisio has affirmed that ASIC does ‘not propose to change the substance of the rules at this time. Our intention is to introduce rules that are generally the same as currently apply and work with the market over time to improve supervision of our markets and build on the ASX’s work over many years in this area’. It will be interesting, though, to see whether over time ASIC introduces additional rules and regulations or seeks oversight of the ASX’s remaining regulatory activities as it becomes comfortable with its new responsibilities.
The comment period on the Paper closed on 26 March 2010.