Save Search

Note: Where available, the PDF/Word icon below is provided to view the complete and fully formatted document
Corporations (Fees) Amendment Bill 2010

Bill home page  


Download WordDownload Word


Download PDFDownload PDF

2008-2009-2010

 

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

 

 

 

HOUSE OF REPRESENTATIVES

 

 

 

corporations amendment (financial market supervision) bill 2010

CORPORATIONS (FEES) AMENDMENT BILL 2010

 

 

 

 

EXPLANATORY MEMORANDUM

 

 

(Circulated by the authority of the Minister for Financial Services, Superannuation and Corporate Law, the Hon Chris Bowen MP)

 



T able of contents

Glossary.............................................................................................................. 1

General outline and financial impact............................................................ 3

Chapter 1            Amendment of obligations on operators of licensed markets        5

Chapter 2            ASIC supervision and market integrity rules.................. 9

Chapter 3            Regulation impact statement.......................................... 17

Index................................................................................................................. 27

 

Do not remove section break.



The following abbreviations and acronyms are used throughout this explanatory memorandum.

Abbreviation

Definition

AAT

Administrative Appeals Tribunal

Act

Corporations Act 2001

AFMA

Australian Financial Markets Association

ASIC

Australian Securities and Investments Commission

ASX

Australian Securities Exchange

Bill

Corporations Amendment (Financial Market Supervision) Bill 2010

Fees Bill

Corporations (Fees) Amendment Bill 2010

IOSCO

International Organization of Securities Commissions



Outline

The Corporations Amendment (Financial Market Supervision) Bill 2010 (the Bill) amends the Corporations Act 2001 (the Act) to provide for the Australian Securities and Investment Commission (ASIC) to supervise trading on financial markets with a domestic Australian market licence.  The Bill contains three key measures:

•        The Bill removes the obligation on Australian market licensees to supervise their markets, replacing it with an obligation to monitor and enforce compliance with the markets’ operating rules. 

•        The Bill provides ASIC with the function of supervising domestic Australian market licensees. 

•        The Bill provides ASIC with additional powers including the power to make rules with respect to trading on such markets and additional powers to enforce such rules. 

The Corporations (Fees) Amendment Bill 2010 (the Fees Bill) is a supporting Bill which contains amendments regarding chargeable matters in support of the measures in the main Bill.  This is required to be in a separate Bill for constitutional reasons.

Date of effect The Bill commences on a single day fixed by Proclamation.  If commencement does not take place within 12 months of the day the Act receives Royal Assent, then the provisions are repealed.  Commencement of the Fees Bill takes place on the date the main Bill commences.     

Proposal announced The measures are based on proposals announced by the Government in a media release on 24 August 2009, and included in an exposure draft and consultation paper released on 2 December 2009. 

Financial impact :   Nil.  The Government will incur capital costs of approximately $6 million associated with the acquisition of the relevant market supervision software and fitout requirements.  The total operating costs associated with ASIC’s new responsibility are expected to be $53.5 million over the five years to 2013-14.  The costs associated with preparing ASIC for the performance of the supervisory function and the ongoing performance of supervision by ASIC will be fully recoverable by ASIC over the forward estimates via a levy on market operators.

Compliance cost impact The Bill will have a compliance cost impact on market operators and participants who will be required to comply with the new ASIC-set market integrity rules.  The amount of compliance cost impact will depend on the rules to be set by ASIC.  As such, it is not possible to quantify the costs until the rules are made.  Also, there will be levies applied to market operators under the Fees Bill, the details of which will be set out in the Regulations.  The cost as a result of this levy will to some degree be offset by the fact that market operators will have lower operational costs as a result of the removal of the obligation on market operators to supervise trading on their markets. 

Summary of regulation impact statement

Regulation impact on business

Impact The amendments will have an ongoing regulatory impact on market operators and participants in Australia’s financial markets. 

Main points :

•        Supervision by ASIC will consolidate the current individual supervisory responsibilities into one entity, streamlining supervision and enforcement, and providing unified supervision of trading on the market.  ASIC’s role as a whole-of-market supervisor is expected to enhance the stability and integrity of the market. 

•        The amendments will remove the regulatory obligation currently imposed on market operators to supervise their markets. 

•        The amendments will require market operators and participants to comply with the ASIC-set ‘market integrity rules’. 

•        The amendments provide for ASIC to levy market operators to recover the cost of supervision.



C hapter 1     

Amendment of obligations on operators of licensed markets

Outline of chapter

1.1                   The Corporations Amendment (Financial Market Supervision) Bill 2010 (the Bill) amends the obligations imposed on operators of licensed markets, and prospective market licensees, under the Corporations Act 2001 (the Act) with respect to supervision of their markets. 

Context of amendments

1.2                   The amendments contained in the Bill give effect to a decision of the Government to transfer the responsibility for supervising participants in markets from market operators to Australian Securities and Investments Commission (ASIC) as announced jointly by the Treasurer and the Minister for Financial Services, Superannuation and Corporation Law on 24 August 2009 (Media Release No.093).

1.3                   To this end, the Bill amends the obligations on Australian market licence holders and prospective licence holders. 

Summary of new law

1.4                   The Bill amends the obligations on operators of licensed markets with respect to supervision of their markets as set out in section 792A of the Act. 

1.5                   The Bill also amends the factors to be taken into account when the Minister decides whether to grant a domestic Australian market licence as set out in subsection 795B(1) of the Act.

Comparison of key features of new law and current law

New law

Current law

Obligation to have adequate arrangements for operating the market. 

Obligation to have adequate arrangements for supervising the market. 

Removal of the obligation. 

Obligation to have adequate arrangements to monitor the conduct of participants on or in relation to the market.

Obligation to have adequate arrangements for monitoring and enforcing compliance with the market’s operating rules. 

Obligation to have adequate arrangements for enforcing compliance with the market’s operating rules. 

Detailed explanation of new law

1.6                   The Bill amends the obligations on market licensees to reflect that ASIC will now have primary responsibility for supervising Australia’s financial markets. 

1.7                   Under the current law, Australian market licence holders are required to have arrangements for supervising their markets, including monitoring the conduct of participants.  Australian market licensees are also required to have sufficient resources to, amongst other things, supervise their market.

1.8                   The Bill changes these obligations.  The Bill instead provides for market licensees to have adequate arrangements for operating their market, including for monitoring and enforcing compliance with the market’s operating rules.  Market licensees will still need sufficient resources for operating the market.  [Schedule 1, items 7 and 9]  

1.9                   This change reflects the decision of the Government to have ASIC take over responsibility for the supervision of domestic licensed financial markets.   However, market operators will retain the responsibility for making sure participants admitted to their market comply with the operating rules.  The Bill requires market operators to monitor and enforce compliance with the market’s operating rules.  Operating rules include the listing rules set by markets, responsibility for the supervision of which has not been transferred to ASIC.  [Schedule 1, item 8]

1.10               The Bill extends the changes to the obligations on market operators to the circumstances which are to be considered by the Minister when deciding whether to grant a domestic Australian market licence under subsection 795B(1) of the Act.  Specifically, the Bill requires the Minister to consider whether the applicant has adequate arrangements for operating the market, and for monitoring and enforcing compliance with the market’s operating rules.  [Schedule 1, Item 12] , [Schedule 1, Item 13]

1.11               Changes were not made to subsection 795B(2) of the Act, relating to any application for an Australian market licence in respect of an overseas market, as such operators will be subject to the changes by implication.  The Act already provides that an overseas market can only be granted a licence where the Minister is satisfied that the regulatory regime the market is subject to is sufficiently equivalent to Australia’s. 

Application and transitional provisions

1.12               All provisions in the Bill, including the ones altering the obligations on market operators and applicants, will take effect on a date fixed by Proclamation.  If commencement does not take place within 12 months of the day the Act receives Royal Assent, then the provisions are repealed.  Commencement of the Corporations (Fees) Amendment Bill 2010 (the Fees Bill) takes place on the date the main Bill commences.  [Schedule 1, Item 34, section 1511]     

1.13               The 12 month time period for commencement is necessary, as there is a considerable amount of transitional work to be done in order for ASIC to be capable of performing the supervisory functions, including acquiring the necessary systems.  This has the potential to take a significant amount of time and possibly longer than six months but less than a year.  It is appropriate that the provisions be repealed if the Bill does not commence within a year, as it is not appropriate to have the obligations on market operators amended without ASIC taking over responsibility for supervision.     

1.14               The provisions applying to market licence applications apply in relation to applications made before the commencement of the Act, but not yet decided on when the Act takes effect.  [Schedule 1, item 34, section 1512]

Consequential amendments

1.15               The Bill makes consequential amendments to the qualified privilege sections of the Act to reflect that markets will now be responsible for operating not supervising their markets.  [Schedule 1, items 17 and 18]



Outline of chapter

2.1                   The Corporations Amendment (Financial Market Supervision) Bill 2010 (the Bill) inserts a new Part 7.2A into the Corporations Act 2001 (the Act) relating to Australia Securities and Investments Commission’s (ASIC’s) new function of supervisor of domestic licensed financial markets in Australia. 

Context of amendments

2.2                   At present Australian market licensees are primarily responsible for setting rules in relation to behaviour on Australia’s financial markets.  This is done through the market’s operating rules.   

2.3                   As part of the decision to transfer supervisory responsibility to ASIC, ASIC will be given the ability to set rules in relation to Australia’s financial markets and additional powers to enforce these rules. 

2.4                   These amendments were part of an exposure draft and consultation paper which was released for public consultation on 2 December 2009.

Summary of new law

2.5                   The amendments confer on ASIC the function of supervising Australia’s domestic licensed financial markets. 

2.6                   The amendments establish a regime whereby ASIC can set rules in relation to domestic licensed financial markets, and provide ASIC with additional methods for enforcing compliance with the rules. 

2.7                   The Bill makes consequential amendments to other provisions in the Act to reflect the establishment of a new rule making regime, and to extend other provisions to include these rules. 

Comparison of key features of new law and current law

New law

Current law

Conferral of supervision functions on ASIC. 

No current law. 

Creation of market integrity rules by ASIC. 

No current law.

Breach of market integrity rule is contravention of a civil penalty provision. 

No current law.

Alternatives to civil proceedings. 

No current law.

Detailed explanation of new law

2.8                   The Bill contains a variety of amendments to provide ASIC with the tools necessary to perform supervisory functions in relation to domestic licensed financial markets. 

ASIC and financial market supervision

2.9                   The Bill confers on ASIC the function of supervising domestic licensed financial markets.  This function involves ASIC utilising systems to monitor the trading of financial products on domestic licensed financial markets.  Having this function will allow ASIC to more easily detect and enforce the market misconduct provisions in the Act as well as enforce the new rules which it will make.  [Schedule 1, item 14, section 798F]

2.10               A decision was made not to require ASIC to directly supervise overseas financial markets which are licensed to operate in Australia as the Act allows such markets to operate in Australia on the basis of sufficiently equivalent regulation. 

Market integrity rules

2.11               The Bill provides for ASIC to make market integrity rules.  These market integrity rules can deal with the activities and conduct of licensed markets, and of persons in relation to licensed markets and financial products traded on licensed markets.  [Schedule 1, item 14, subsection 798G(1)]

2.12               ASIC intends to consult with stakeholders regarding the introduction of the proposed market integrity rules.  In cases where it is not possible to consult prior to the introduction of a market integrity rule, ASIC intends to subsequently review implementation arrangements relating to the rule.

2.13               These rules do not apply in relation to overseas markets with an Australian market licence.  This is because operators of such markets are expected to be subject to the changes by implication.  The Act provides that an operator of an overseas market can only be granted a licence where the Minister is satisfied that the regulatory regime the market is subject to is sufficiently equivalent to Australia’s.  In the future this would include taking into consideration the new regulatory framework applying to domestic Australian market licence holders.  [Schedule 1, item 14, subsection 798H(2)]

2.14               The Bill allows ASIC to make market integrity rules in a wide range of areas.  The current law already allows markets to make operating rules, which also cover a wide range of areas.  Operating rules and market integrity rules will operate together, but to the extent of any inconsistency the market integrity rule will prevail and the operating rule will have no effect.  The regime is designed to be flexible and to allow ASIC to make rules to cover new and emerging issues as the market adapts and innovates, while also recognising that every market is different and needs operating rules tailored to the specifics of that market.  [Schedule 1, items 11 and 14, subsection 798G(1)]

2.15               A breach of a market integrity rule will be a breach of a civil penalty provision of the Act, and subject to a pecuniary penalty of up to $1 million.  ASIC will set a penalty amount for the breach of a market integrity rule where it is appropriate to do so.  This reflects the broad range of matters which the market integrity rules are expected to cover.  Some rules will relate to minor and technical or procedural matters and it will be appropriate that a lower penalty level, or no penalty, attach to those rules.  [Schedule 1, items 14, 25 to 27, subsections 798G(2) and 798H(1)]

2.16               Before ASIC can make a market integrity rule, ASIC must have the written consent of the Minister.  The Bill does provide for ASIC to be able to make a market integrity rule without the prior approval of the Minister in emergency situations.  If ASIC does so, on the following day it must justify to the Minister in writing the need for the rule, and revoke or amend the rule in accordance with any written direction of the Minister.  These provisions are included to ensure that ASIC has the capacity to respond instantly to serious emerging market situations, while also ensuring that the role of the Minister is maintained.  It is expected that ASIC will make rules without seeking the Minister’s prior consent only in limited situations where ASIC needs to respond swiftly to a situation and there is insufficient time to get the prior written approval of the Minister.  [Schedule 1, item 14, subsections 798G(3) to (5)]    

2.17               The Bill states that the consent provided by the Minister for the making of a market integrity rule, and a direction by the Minister to ASIC to vary or revoke a rule, are not legislative instruments.  This provision clarifies that these instruments are not legislative instruments as such documents are only interim steps in the rule making process.  The market integrity rule, when made, will be a legislative instrument and subject to parliamentary scrutiny.  [Schedule 1, item 14, subsection 798G(6)]

2.18               Market integrity rules will be enforceable against operators of, and participants in, licensed markets.  The Bill also provides a regulation making power allowing for the regulations to specify other entities that the rules may be enforced against.  This regulation making power is needed to allow the framework to develop to meet innovations and new players in the market.  The financial market is by nature fluid and often involves complex and changing financial arrangements.  It may be necessary to apply these rules to additional entities.  If it becomes clear that this is necessary, the rules may need to be applied swiftly to ensure the integrity of the market is maintained.  The regulation making power will allow the framework to adapt quickly to developments in the market.    [Schedule 1, item 14, section 798H]

Enforcement of the market integrity rules

2.19               The Bill provides that a breach of a market integrity rule will be a breach of a civil penalty provision [Schedule 1, item 27] .  This enables a Court to order a person to pay a pecuniary penalty to the Commonwealth if a declaration of contravention has been made.  However the maximum that a Court can order a person to pay for contravention of the rule will be the amount set by ASIC in the market integrity rule.   The maximum penalty amount that ASIC can set for breach of a market integrity rule is $1 million.  This reflects that the market integrity rules will cover a variety of areas, and the penalties will range in severity in line with the nature of the rule.  [Schedule 1, item 28]

2.20                The Bill also provides for compensation orders to be made by a Court where damage has resulted from the contravention of a market integrity rule.  The Bill does not provide for compensation orders to be made against market operators.  This is because market operators are at the centre of the financial system, and therefore are potentially open to claims from all participants in financial markets for a breach of a market integrity rule.  There would be systemic risks in opening markets up to claims for compensation of an indeterminate liability.  For this reason market operators have been excluded from the compensation provision.  [Schedule 1, item 29]

2.21               The Bill also establishes a framework, to be developed in regulations, for there to be alternatives to civil proceedings.  It is important that ASIC has a wide range of options at its disposal for enforcing the market integrity rules.  Currently markets have the ability to deal with breaches of their operating rule expeditiously and efficiently, with penalties ranging from fines, suspension of participation and enforcing the establishment of education and compliance programs.  The Bill allows ASIC to deal with breaches of the market integrity rules expeditiously by providing for a person to make a payment and/or undertaking to do something, such as instituting remedial measures or entering into an enforceable undertaking as an alternative to civil proceedings.  If a person decides to enter into an alternative to civil proceedings the monetary amount payable cannot exceed three-fifths of the maximum that a court could require payment of.  [Schedule 1, item 14, section 798K]

2.22               The details of the alternatives to proceedings will be established in the regulations.   The regulations will establish an infringement notice and enforceable undertaking framework under this provision.    

2.23               The alternatives to civil proceedings work on the basis that persons who are alleged to have contravened a market integrity rule, which in turn will be a breach of a civil penalty provision, can opt to enter into an infringement notice or enforceable undertaking with ASIC, as an alternative to ASIC pursuing the matter in Court.  Such remedies are vital to the ongoing success of the market integrity rule framework as they provide ASIC with a fast and effective remedy, akin to the remedies available to markets under the current operating rule framework. 

2.24               The regulations will also set out things such as the detailed requirements for the issue and service of a notice, matters to be included in the notice or undertaking, effect of the issue and compliance with a notice or undertaking, the effect of failure to comply with a notice or undertaking, the compliance period for a notice or undertaking, the withdrawal of a notice or undertaking, and the publication of the notice or undertaking.  It is appropriate that such details are set out in the regulations as they are technical and procedural in nature. 

2.25               Th e Bill provides ASIC with a power to issue directions in relation to entities dealing in financial products, or a class of financial products, or in relation to such dealings.  This directions power is necessary so ASIC can intervene to halt dealings in a financial product in order to protect people and thereby ensure the integrity of the market.  For example, ASIC could direct a broker to stop trading in a product where the dealings would lead to contravention of the Act or a market integrity rule, or would impact on the integrity of the market.  Such directions will be enforceable by the Court.  [Schedule 1, item 14, section 798J]

Application and transitional provisions

2.26               All provisions in the Bill, will take effect on a date fixed by Proclamation.  If commencement does not take place within 12 months of the day the Act receives Royal Assent, then the provisions are repealed.  Commencement of the Fees Bill takes place on the date the main Bill commences.  [Schedule 1, item 34, section 1512]     

2.27               The Bill provides for regulations to be able to make exemptions from and modify the legislation.  Provisions which allow similar exemption and modification are spread throughout the Act.  Including such a provision in this new Part is in line with the construction of the Act and similar provisions applying in respect of existing Parts.  This regulation making power is needed to allow the framework to develop to meet innovations in the market.  The financial market is by nature fluid and it may be necessary to apply the rules differently to different entities.  If it becomes clear that this is necessary, the rules may need to be modified swiftly to ensure the integrity of the market is maintained.   The regulation making power will allow the framework to adapt quickly to developments in the market.  [Schedule 1, item 14, section 798L]

2.28               In addition, the Bill allows regulations to provide for transitional arrangements.  This will allow arrangements of a transitional nature to be implemented if it is determined that they are required.  This will be important if practical issues arise over the coming months with the transfer of responsibility for supervision from market operators to ASIC.  [Schedule 1, item 34, section 1513]

Consequential amendments

2.29               The Bill proposes a number of consequential amendments to other provisions in the Act to reflect the new functions of ASIC.

2.30               The Bill updates provisions to refer to the new form of civil penalty and new directions power.  [Schedule 1, items 1 to 4 and 15]

2.31               The Bill extends the application of qualified privilege provisions to the giving of information to ASIC in relation to a contravention or suspected contravention of a market integrity rule.  This is important to ensure concerns about breaching confidentiality do not prevent ASIC from being able to perform its functions.  [Schedule 1, item 16]

2.32               The Bill amends the court order provisions of the Act to apply to contraventions of market integrity rules.  This ensures that a Court has wide powers to issue orders which the Court deems necessary when hearing a case concerning the contravention of a market integrity rule.  [Schedule 1, items 19 to 23 and 30 to 33]

2.33               The Bill also excludes certain decisions from review of the Administrative Appeals Tribunal (AAT).  This is done to remove any doubt and to confirm that such decisions are not subject to AAT review.    It is appropriate that such decisions are not subject to review by the AAT, as the decisions excluded are more akin to policy and rule-making decisions and should not be subject to merit review.  [Schedule 1, item 24]

Supporting amendments

2.34               The Bill confers new functions and responsibilities on ASIC.  The Wallis Inquiry, which reported in 1997, made a recommendation that regulatory agencies should collect enough revenue from the financial entities which they regulate to fund themselves.  The principle is that for reasons of equity and efficiency, the costs of financial regulation should be borne by those who benefit from it. 

2.35               In line with this principle, the Fees Bill provides ASIC with the ability to impose a fee on market operators in relation to the functions it will be performing under the Bill.  The Regulations will specify how the fee will be calculated and when it will be imposed.  [Schedule 1, items 1 and 5 of the Corporations (Fees) Amendment Bill 2010]

2.36               The Bill places no cap on the amount that ASIC can charge in relation to the performance of its supervisory functions [Schedule 1, item 3 of the Corporations (Fees) Amendment Bill 2010] .  This is because the amount it will cost to supervise the market, and therefore also the amount it will be necessary for ASIC to recover, will change dramatically as financial markets enter and leave Australia, and as the amount of trades executed on markets in Australia fluctuate in response to market conditions.  The formula for calculation of the levy on market operators will be set out in the Regulations and will be consulted upon with industry before being introduced.  [Schedule 1, item 4 of the Corporations (Fees) Amendment Bill 2010]

2.37               The commencement of the Fees Bill is linked to the commencement of the main Bill as the two bills are connected.   The Fees Bill will come into effect on the same date that the Bill does.  Do not remove section break.



Assessing the Problem

Conflict of interest issues

3.1                   Under section 795B of the Corporations Act 2001 (the Act), an Australian market licence may be granted to an applicant if the Minister is satisfied that, among other things, the applicant has adequate arrangements for supervising the market, including arrangements for handling its commercial conflicts of interest, monitoring the conduct of participants, and enforcing compliance with the market’s operating rules.  The Act also requires that market operators ensure their markets are fair, orderly and transparent. 

3.2                   At present, there are 16 licensed financial markets operating in Australia, five of these being licensed overseas markets.  The largest of these is the Australian Securities Exchange (ASX) which as at 30 June 2009 had a domestic market capitalisation of AUD $1.09 trillion.  For the month of December 2009 there were 9,349,000 equity trades on the ASX market.

3.3                   Australian Securities and Investments Commission (ASIC) annually assesses market licensees’ compliance with their supervisory obligations, including their conflict of interest arrangements.  Failure to adequately supervise a market can result in the Minister directing the market licensee to do specified things to promote compliance, suspension of the licence or cancellation of the licence. 

3.4                   Australian market licensees work closely with ASIC, which is responsible for enforcing the corporations legislation.  Market operators are obliged under the Act to notify ASIC of certain matters, including suspected contraventions of the market’s operating rules or the Act and matters that may adversely affect the ability of a participant to meet its obligations as a financial services licensee.  As such, market operators are effectively the primary identifiers and referrers of instances of on-market trading misconduct to ASIC.  ASX and ASIC have a Memorandum of Understanding which provides guidance on the referral of supervisory matters from ASX to ASIC. 

3.5                   Market operators are also the primary determiners of acceptable conduct by participants on Australia’s financial markets, as market operators are responsible for setting and enforcing their own operating rules.  Operating rules cover areas such as client-participant relations and rules regarding the preventing of manipulative trading.   

3.6                   There has been strong public criticism recently that market operators have an inherent conflict of interest between their supervisory obligations and the operation of their market.  Some have stated that the commercial interests of market operators may encourage them to maximise transaction volumes without due regard for market integrity.  Commentary has included:

•        Professor Clarke from the University of Technology Sydney stated in The Australian on 12 March 2008 that ASX had done a good job with compliance, but ‘the time had come for the ASX to end its conflict of interest by spinning out its regulatory and supervisory division’. 

•        Commonwealth Bank of Australia chief executive Mr Ralph Norris on the front page of the Australian Financial Review on 22 April 2008 stated that the ASX has failed to properly regulate the stock market because it cannot overcome an inherent conflict in its interest as both the market regulator and listed, profit seeking company.  He added, ‘I don’t believe the ASX can be both market participant and a regulator’.

•        An article by Adele Ferguson in The Australian in June 2009 stated that ‘As a listed entity, the ASX is one of the few exchanges in the world that has been allowed to keep all its supervisory powers intact and continue to police its own customers.  As one market watcher once said: “Having this dual role is like the police force being allowed by law to operate a money making business alongside its regulatory duties.  The obvious conflict of interest would undermine law enforcers’ capacity to perform their duties efficiently” ‘.

3.7                   Confidence in the integrity of the financial system is central to its operation.  Perceptions of conflicts of interests in market operators supervising themselves remain, despite the significant improvements in conflict handling arrangements made by markets such as the ASX.  The continued perception of the presence of conflicts of interests could result in decreased confidence in the integrity of the market by market participants, which in turn could lead to individuals being unwilling to invest in the market for fear of market misconduct, potentially affecting the liquidity and stability of the market.  Confidence is particularly important in times of global market uncertainty such as those recently experienced. 

Current arrangements preclude competition between market operators

3.8                   In addition, the current regulatory arrangements effectively preclude the consideration of competition in the same listed securities between market operators in Australia.   In the last three years, three organisations have lodged Australian market licence applications for trading in ASX listed securities with ASIC.   While well established in some other major jurisdictions, allowing multiple venues to trade in the same securities is a new development for Australia.  An environment where multiple markets trade in ASX listed securities would raise market supervision and surveillance concerns never before confronted in Australia. 

3.9                   For example, the shareholders in AXE ECN Pty Ltd, one of the companies which has made an application for a market licence to trade in ASX listed securities, are large investment banks and brokers.  Five of these shareholders are also participants on the ASX market and are among the ten largest participants in terms of volume and value of market turnover.  If a market licence was given to AXE ECN Pty Limited these banks and brokers would individually trade on the AXE market and also the ASX market, while also partly owning a direct competitor to the ASX.  Under the current regulation market operators are required to supervise trades on their market, take disciplinary action where breaches of the market rules occur and notify ASIC of any misconduct on the market.  The potential would arise for ASX to perform their supervisory functions, including investigation and disciplining, against the substantial shareholders of a competing market operator.  This would create a serious conflict of interest which would be difficult to adequately manage.  At the very least, there would be a perception that ASX was not exercising its powers impartially, but in a way that would damage those brokers with a stake in its competitor, or who are major users of a competitor’s market.  This would have a chilling effect on competition.  Similarly there would be concerns about the impartiality of an operator supervising a participant that is also a major shareholder in the operator. 

3.10               Issues also arise concerning the detecting of market misconduct when trading in the same securities takes place on multiple markets.  If a person can trade the same securities on different markets which are supervised independently of each other, it is easier to conceal market misconduct.  Market misconduct may involve trading activities on more than one market. 

3.11               For example, the offence of market manipulation can involve creating the false or misleading appearance of active trading of a financial product on a financial market.  The ‘false or misleading appearance’ aspect arises where a person trades with themselves or an associate in an attempt to create a false impression of demand for a financial product, and consequently increase the price for the financial product.  Where there are multiple markets trading in the one security this sort of misconduct would be more difficult to detect.  It would be possible for an individual seeking to make a false or misleading impression of demand for a product to trade with themselves on multiple markets.  As the conduct would be dispersed across different markets, the actions being performed on each of those individual markets may seem innocuous.  It would require a whole-of-market view to pick up the offensive behaviour. 

3.12               As this example shows it may not be possible to identify potential misconduct only by observing what occurs on one market; and intervention to prevent or take disciplinary action against suspected misconduct may require co-ordinated action by different market operators.  The potential for misconduct to occur undetected if ASX listed securities were able to be traded on markets other than the ASX means that the current regulatory regime, whereby markets self supervise, effectively precludes the consideration of competition for market services. 

Objectives of Government Action

3.13               Confidence in the integrity of the operation of the market is central to its effective functioning.  The present situation whereby the market operators set their rules and supervise compliance with those rules raises a number of significant issues, as outlined above.

3.14               The objective of Government action in this area is to improve confidence in the integrity of Australia’s financial markets by removing the perceived conflict of interest which markets have in supervising their own markets and also to create a regulatory framework which, should competition amongst financial markets be progressed in Australia, would allow for more efficient and effective supervision of cross-market trading activity. 

Options

3.15               The International Organization of Securities Commissions (IOSCO) has previously stated in relation to approaches to financial market supervision that ‘there is no universal right regulatory path to follow’ and ‘there does not appear to be a definitive blueprint that can be adopted by all jurisdictions’.  Nevertheless, in the last decade, there has been a clear move in major jurisdictions towards centralised and independent regulation or, in some cases, government regulation of markets and/or market participants.  Canada has introduced independent, non-government supervision of trading activity in all of its equity security markets, while the United States has separated participant supervision from market supervision and established a non-government, industry supervisor for market participants.  In the United Kingdom, the Financial Services Authority, an independent non-governmental body given statutory powers, regulates company listings. 

3.16               The move towards centralised or independent regulation in comparable jurisdictions is a direct result of the conflict of interest issues which arise when market operators are responsible for supervision.  Australia cannot realistically adopt the non-government model due to the lack of a suitably equipped industry body, consequently a Government entity needs to take on this role.

3.17               Two possible options were identified and dismissed for not adequately addressing the issue.  These options are:

•        providing for industry to establish a private company which would be responsible for the supervision of the markets — unlike in the United States and Canada which have long established industry self-regulators, there is not a readily identifiable organisation or market stakeholder that might seek, and be competent to perform, such a not for profit role.  In addition, supervisory responsibility is a serious function, central to maintaining market integrity and confidence.  As such there is a need for significant Government accountability in the performance of this function which would not be obtainable if it was given to a private body to perform; and

•        establishing an independent whole-of-market supervisor: the cost of establishing a new entity is a fundamental impediment to this option. 

3.18               Two main options were identified.  These are set out below. 

Option One: Retain the status quo (no regulatory action)

3.19               Section 792A of the Act requires holders of an Australian market licence to have in place adequate arrangements for supervising the market including:

•        handing conflicts between the commercial interests of the licensee and the need for the licensee to ensure the market is fair, orderly and transparent;

•        monitoring the conduct of participants on or in relation to the market; and

•        enforcing compliance with the market’s operating rules. 

3.20               Australian market licensees are currently required to manage their conflicts of interests and conduct supervision of their respective markets and are subject to annual compliance assessments by ASIC.   

Option Two: Move to a Government whole-of-market supervisor

3.21               A single whole of market supervisor would consolidate the current individual supervisory responsibilities into one entity, streamlining supervision and enforcement, and providing supervision of trading on Australia’s domestic financial markets.  Consequently, a whole-of-market supervisor would be expected to enhance stability in the market.

3.22               The transfer of supervisory responsibility to ASIC would address the need for an effective whole-of-market supervisor.  It would also allow for the Government to undertake the development of a framework of common rules required for all markets.  This would in turn allow for consideration of the outstanding market licence applications, which have been awaiting consideration.

3.23               ASIC would perform similar functions to the present market supervisors.  Specifically ASIC would: supervise participants who trade on Australia’s markets, monitor market conduct and trading activity, create rules and enforce compliance with these rules. 

Impact Analysis

Option One: Retain the status quo (no regulatory action)

3.24               This option would have the benefit of imposing no additional regulatory costs on businesses, investors or the Government.  However it would result in the present situation continuing, adding to regulatory weakness, retaining regulatory, supervisory and enforcement gaps and negatively impacting on our market’s ability to spread risk and liquidity across more than one effective monopoly market. 

3.25               This option would prevent Australia from pursuing the benefits flowing from competition between market operators, should it choose to do so.  Under the status quo the barriers to market competition and the risks outlined in the problem section remain. 

3.26               The only way for whole-of-market supervision to take place where markets self-supervise is for there to be information sharing arrangements between the market operators. 

3.27               However information sharing arrangements between market operators are not a satisfactory means of addressing this supervisory issue for a number of reasons.  Firstly, as stated above, this option does not address the inherent conflict of interest problem which occurs when market operators supervise themselves.  Secondly, such arrangements between competitors are problematic.  Thirdly, information sharing arrangements do not provide for sufficient whole-of-market supervision.  The likely outcome is that relevant market misconduct information is likely to fall between the cracks. 

Option Two: Move to whole-of-market supervision by ASIC

3.28               An entity under the jurisdiction of the Commonwealth Government is the most appropriate body to provide whole-of-market supervision.  The present situation whereby the market operators supervise themselves raises a number of significant issues, as outlined above.  In addition, unlike in comparable jurisdictions overseas, there is no organisation or market stakeholder in Australia who might seek and be competent to perform a not for profit supervisory role.  As such it is necessary that the Commonwealth Government take on the role of market supervision.  ASIC is the Government body most appropriate to take on responsibility for supervision of Australia’s financial markets.  ASIC has increased its proximity to the market during its recent organisational restructure, and considers it is capable of performing this function.   

3.29               The Australian Financial Markets Association (AFMA), Australia’s peak industry association for Australia's wholesale banking and financial markets, has conducted an analysis on the market supervision issue and advocated the transfer of whole-of-market supervisory responsibilities to ASIC. 

3.30               This option would have the benefit of eliminating the real or perceived conflict issues which exist in the current model of market self-regulation and would also provide a mechanism for whole-of-market regulation and surveillance.  The transfer of supervisory responsibility to ASIC would allow for one body, ASIC, to be responsible for ensuring compliance with the corporations legislation and any ASIC set rules, consequently adding to the integrity of Australia’s markets.  A single whole-of-market supervisor would consolidate the current individual supervisory responsibilities into one entity, streamlining supervision and enforcement, and providing complete supervision of trading on the market.  Consequently, ASIC’s role as a whole-of-market supervisor would be expected to enhance stability in the market. 

3.31               This option would affect the Government and market operators in Australia’s financial market.  The impact on the Government would be derived from the transferring of a responsibility which is currently performed by market operators to ASIC. 

3.32               Market operators would likewise be affected.  The removal of responsibility for supervision of participants and trading would reduce the regulatory burden on market operators.  It would also make it possible for ASIC to consider the outstanding market licence applications. 

3.33               Market operators and participants on Australia’s financial markets will be affected to the extent that they will be required to comply with any rules which are set by ASIC.  The extent of any compliance costs will be determined by the rules which ASIC makes and as such can not be quantified at this stage. 

3.34               The Wallis Inquiry, which reported in 1997, made a recommendation that regulatory agencies should collect enough revenue from the financial entities which they regulate to fund themselves.  The principle is that for reasons of equity and efficiency, the costs of financial regulation should be borne by those who benefit from it.  It is intended that the costs associated with the establishment and ongoing operations of the new whole-of-market supervisor will be fully recoverable by ASIC via a levy issued against market operators.  When the levy is issued it will impose a direct cost on the market operator.  The cost of the levy for market operators will depend on the method of calculation, which will be determined at a later date by amendments to the Corporations (Fees) Regulations 2001.   A separate regulation impact statement will be prepared for these amendments to the Regulations. 

3.35               It is intended that the imposition of fees by ASIC on market operators will not have a significant impact on the cost of trading on financial markets in Australia.  The Government’s decision to transfer supervisory responsibility to ASIC will remove the regulatory obligation on market operators to supervise their markets.  It is expected that this saving to operators will be offset by their need to pay the ASIC fees.  This cost recovery proposal has similarities to the ways in which costs are recovered from market operators and/or market users by a number of self-regulatory organisations responsible for market supervisory activities globally.

Consultation

3.36               A draft bill and consultation paper (the Paper) were released for public comment on 2 December 2009.  In addition Treasury officials conducted roundtable discussions with industry groups, Australian market licensees, and Australian market licence applicants on the paper. 

3.37               The paper sought comments on the proposed regulatory framework, including the establishment of ASIC as a whole-of-market supervisor, the creation of ASIC set market integrity rules, and the provision of additional enforcement powers to ASIC. 

3.38               There were 23 submissions to the paper, including submissions from the ASX, the AFMA, the Stockbrokers Association of Australia, the Investments & Financial Services Association, the Australian Bankers Association and Chi-X Australia Pty Limited.

3.39               Most submissions were supportive of the proposal for ASIC to take on the role of market supervisor.  Based on comments provided in the submissions to the Paper minor changes were made to the Bill. 

 Conclusion and Recommended Option

3.40               This document outlines a range of possible policy options to address the issues which arise with the current regulation of market supervision in Australia.  Options considered include:

•        retaining the status quo (no regulatory action); and

•        moving to a whole-of-market supervision to ASIC. 

3.41               Based on the impact analysis outlined above, option 2 has been selected as the recommended approach.  This option achieves the regulatory outcome of enhancing confidence in the integrity of Australia’s financial markets without imposing significant regulatory burden.  This option primarily proposes to alter the body which performs the supervisory function, transferring the supervisory responsibility from individual markets to a statutory whole-of-market supervisor.  Although minimal transitional regulations may be required to ensure continued market integrity over the transfer period, any such regulations would be designed to have minimal regulatory impact on markets and participants.  In addition, any such regulations would take place via regulatory amendment and would be subject to an additional regulation impact statement. 

3.42               The other options fails to sufficiently address the identified issue as they would retain the real or perceived conflict of interest associated with market operators supervising their own, and others’, markets and would inhibit the development of competition in Australia’s financial market. 

Implementation and Review

3.43               The Government will continue to monitor the application of the regime to ensure that it is operating effectively. 



Schedule 1:  Supervision of financial markets

Bill reference

Paragraph number

Items 1 to 4 and 15

2.30

Items 1 and 5 of the Corporations (Fees) Amendment Bill 2010

2.35

Item 3 of the Corporations (Fees) Amendment Bill 2010

2.36

Item 4 of the Corporations (Fees) Amendment Bill 2010

2.36

Items 7 and 9

1.8

Item 8

1.9

Items 11 and 14, subsection 798G(1)

2.14

Item 12

1.10

Item 13

1.10

Item 14, section 798F

2.9

Item 14, subsection 798G(1)

2.11

Item 14, subsections 798G(3) to (5)

2.16

Item 14, subsection 798G(6)

2.17

Item 14, section 798H

2.18

Item 14, subsection 798H(2)

2.13

Item 14, section 798J

2.25

Item 14, section 798K

2.21

Item 14, section 798L

2.27

Items 14, 25 to 27, subsections 798G(2) and 798H(1)

2.15

Item 16

2.31

Items 17 and 18

1.15

Items 19 to 23 and 30 to 33

2.32

Item 24

2.33

Item 27

2.19

Item 28

2.19

Item 29

2.20

Item 34, section 1511

1.12

Item 34, section 1512

1.14, 2.26

Item 34, section 1513

2.28