In a speech delivered at an ACI Australia event in Sydney this week, Commissioner Cathie Armour of the Australian Securities and Investment Commission (ASIC) observed that the regulator “continues to respond to a high incidence of misconduct in the retail OTC derivatives sector and to see large sums of client losses”.
In 2018 ASIC published results of a review that found the percentage of unprofitable clients was up to 80% for binary options, 72% for CFD traders and 63% for margin FX trader, however Armour noted that both the numbers of clients and the number of complaints received by regulators in Australia regarding service providers increased “significantly” over the past year.
Armour also told the more than 200 attendees at the event that over 80 percent of OTC retail derivatives clients reside offshore, including in high risk anti-money laundering (AML) countries and countries which have restricted the sale of these products. She added that Australian licensed issuers hold over $2.9 billion on behalf of clients, an increase of 45% from ASIC’s previous review and that many margin FX issuers offer leverage of 400:1 and higher. “Let me be clear, a leverage ratio of 400:1 provides $2 million exposure on a $5,000 investment. That’s staggering exposure,” she stated, continuing, “We will continue to review the data we’ve gathered and will address the key themes and concerns that arise from the review. Where we see that products or practices in this sector have resulted in, or are likely to result in, significant consumer harm then we will address this harm using the full range of power available to us.”
Armour also observed that regulators in many jurisdictions, such as in China, Europe, New Zealand, Israel, Japan and North America have restricted or prohibited the provision to retail investors of certain OTC derivatives. Recently ASIC publicly warned Australian issuers that they may be dealing with offshore investors illegally and to cease any non-compliant activities. “There may be consequences overseas for potential breaches of overseas law, but in any event, ASIC will consider whether breaching overseas law is consistent with obligations under Australian law to provide services efficiently, honestly and fairly,” she told the event.
ASIC also regulates wholesale FX market activity in Australia and Armour explained the regulator’s new enhanced supervision, which, she said, aims to be more strategic, forward looking and pre-emptive. “It is about promoting permanent cultural and behavioural changes in firms individually and across the financial services industry more broadly,” she said. “Our goal is to encourage firms to look beyond current known non-compliance and consider instead, the things that create a significant risk of future breaches. We will focus on cultural, organisational and management failings that may lead to conduct problems, breaches of the law and unfair outcomes. This involves understanding and testing the strategies, business models and risk management processes that are operating in the marketplace, as well as conducting benchmarking reviews across sectors of the financial industry.
“Combining this approach with the use of market analytics, means ASIC will be positioned to detect misconduct early and adjust our regulatory approaches in response to the complexity, innovations and continuous change in firms and markets,” Armour continued. “We are applying this enhanced supervision approach to our surveillance and supervision of fixed income, currency and commodities markets.”
In 2016 and 2017, ASIC brought regulatory actions against the four major Australian banks plus Macquarie over their failure to ensure that their systems and their controls were adequate to address inappropriate conduct in their FX businesses.
“ASIC is working with these banks, and the independent expert firms that have been appointed, to ensure that the banks comply with the CEU and implement the required organisational changes,” she said. “This has, at times, been a rocky process. We want to see a strong commitment from these banks to improve their systems and controls, sooner rather than later. ASIC will report on some of these improvements in due course.”
ASIC has also recently conducted onsite reviews of the local banks’ FX businesses with a particular focus on mark ups, order handling, pre-hedging and last look. “Across the four banks, there were differing levels of systems and controls in place, and differences in the level of compliance with the FX Global Code,” Armour told the event. “We required a number of changes at those banks where we felt improvements were needed.”
She went on to praise the role played by the FX Global Code that was endorsed by ASIC in 2017, which she said was “particularly useful in providing granular and testable requirements for the conduct of FX market participants”.
She warned, however, that ASIC also found some areas where it believes the Code can be strengthened, and pointed to the impending three-year review of the Code by the Global FX Committee, observing, “We found that Principle 11 of the Code on pre-hedging activity appears to be interpreted with some ambiguity particularly, the statement that “Pre-Hedging of a single transaction should be considered within a portfolio of trading activity, which takes into account the overall exposure of the Market Participant.” Banks seem to adopt different approaches with regards to the pre-hedging of client stop loss orders. One option to strengthen the interpretation of this Principle might be additional guidance and worked illustrative examples of good and bad conduct.”
On last look, Armour said that while in general, we found that client trade request rejections were “reasonably low”, ASIC did notice hedge fund or HFT-style clients received higher trade request rejection rates than real money clients. “The use of last look, is an area we will continue to monitor,” she said.
The speech was followed by a panel looking at the future role of the FX Global Code.