Following its review of internal market making practices of non-transparent actively managed funds traded on exchange markets, ASIC has provided guidance on better practices for internal market making arrangements in its updated Information Sheet 230 Exchange traded products: admission guidelines (INFO 230). The guidance relates to licensed Australian exchanges, product issuers and market making execution agents.
Below is a brief summary of the key updates and our view on the likely impacts of these.
Background – ASIC’s review of ‘internal market making’
Product issuers generally appoint an independent third party that is a market participant to act as lead market maker in order to fulfil their liquidity obligations. However, in very specific circumstances, licensed exchanges may allow the issuer to adopt the role of market maker (i.e. an internal market-making arrangement) on the fund’s behalf rather than using an independent third-party trading participant.
Issuers typically seek internal market making arrangements if there is a concern others will use their exchange traded product’s (ETP) intellectual property, for example, by replicating the investment strategy to the ETP’s detriment.
In late 2019, ASIC’s review of internal market making practices found that internal market making arrangements were being used in ways beyond protecting intellectual property, and identified market integrity risks associated with certain models.
ASIC raised concerns with internal market making practices which involved a market maker using non-public information as part of its pricing methodology. In particular, ASIC flagged the use of the fund’s portfolio composition information to generate an internal, non-public 'fair value' as the reference price for market making whenever this 'fair value' deviates from the publicly available indicative net asset value (iNAV).
ASIC’s complete findings can be found here.
Updated Info 230 – key points
With the conclusion of its investigation, ASIC has updated its guidelines for internal market makers on better practices for managing non-public information.
On 15 April 2020, ASIC released an updated INFO 230 and introduced new measures to manage market integrity risks associated with internal market making. In ASIC’s view, firms should:
- Ensure the input price for market-making quotes is limited to publicly available information, for example, the iNAV, publicly available portfolio holdings disclosures, general market conditions and trading activity.
- Given the nature of the fund, ensure the iNAV is as accurate and frequently disseminated as practicably possible. For example, some funds trading in futures may only be able to incorporate adjustments to reflect market movements in underlying assets, since these are not traded during Australian market hours.
- Delay portfolio holdings disclosure only when there is a genuine need to protect the issuer’s intellectual property. For example, it may be better for funds with higher portfolio turnover rates to provide full portfolio holdings disclosure more frequently than ones with lower portfolio turnover, as the risk of intellectual property being replicated is lower.
- Establish information barriers so that bids and offers are not submitted to the market by persons or systems with knowledge of the current portfolio holdings. For instance, issuers engaging execution agents to provide market making services should ensure material non-public information is segregated from the execution agent in connection with the execution agent providing other services.
- Provide additional PDS disclosures that the fund will bear the risk of market-making activities, which may result in a profit or loss to unit holders.
- Avoid using ‘treasury stock’ in the course of conducting internal market making (i.e. units in the ETP that are part of the scheme property and held for market-making inventory purposes).
- Have appropriate compliance and supervision arrangements to support these measures.
While ASIC undertook its review, it requested that exchange market operators not admit any managed funds that do not disclose their portfolio holdings daily and have internal market makers. ASIC has now lifted that suspension, so managed funds using internal market making arrangements may resume applying for admission to trading status.
ASIC has emphasised in INFO 230 that licensed exchanges will conduct ongoing supervision of internal market making arrangements to ensure market integrity. Importantly, new and existing issuers that wish to engage in internal market making will need to review their resources, systems and controls in order to adhere to ASIC’s revised guidelines.
This publication is introductory in nature. Its content is current at the date of publication. It does not constitute legal advice and should not be relied upon as such. You should always obtain legal advice based on your specific circumstances before taking any action relating to matters covered by this publication. Some information may have been obtained from external sources, and we cannot guarantee the accuracy or currency of any such information.