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Chapter 2

Issues raised with ASIC

2.1        The committee's hearing with the Australian Securities and Investment Commission (ASIC) officials on 28 November 2008 raised a number of issues relating to ASIC's regulatory responsibilities. These included a number of issues stemming directly from the global financial crisis that escalated in the second half of 2008:

• ASIC's decision to ban short selling to reduce market volatility;
• hardship exemptions for frozen mortgage fund redemptions; and
• new licensing and reporting arrangements for credit rating agencies.

2.2        The committee also discussed with ASIC a number of issues that were of interest at previous oversight hearings. These included:

• the regulation of insider trading, false rumours and market manipulation;
• ASIC's strategic review;
• workload and budgetary issues;
• superannuation projections and shadow shopping;
• financial literacy; and
• professional indemnity insurance for financial planners.

Short selling

2.3        On 19 September 2008 ASIC announced a package of measures to regulate short selling. This included a ban on naked short sales and the requirement to disclose covered short sales to the Australian Securities Exchange (ASX) via brokers.[1] Two days later ASIC announced that all short selling would be temporarily banned, to be reviewed in 30 days.[2] Following the market confusion that ensued, ASIC made a number of announcements clarifying the operation of the prohibition, particularly with respect to existing hedging positions.[3] On 21 October the ban on covered short selling was extended for a further 30 days (until 19 November) and until 27 January 2009 for financial stocks.[4] This ban on short selling financial securities was subsequently further extended to 6 March 2009.[5] The ban on naked short selling remains in place following the passage through parliament of the Corporations Amendment (Short Selling) Bill in December 2008.

2.4        In anticipation of the lifting of the covered short selling ban on 19 November, on 28 October ASIC announced the disclosure requirements that would apply to covered short sales. Sellers are required to inform brokers whether a sale is a short sale, and brokers in turn are required to inform the ASX. The regulator then provides a daily report at 9.00am each day of short sales executed for the 24 hours up to 7.00pm the previous day.[6]

2.5        The passage of the Corporations Amendment (Short Selling) Bill legislated to set up a disclosure regime for covered short selling that broadly reflects ASIC's previous announcement. Details of the disclosure of short selling data will be dealt with by regulation following consultation with the industry.[7]

2.6        The committee was interested in why such strong measures had been taken to curtail short selling activities since the previous ASIC oversight hearing. While noting that 'liquidity and price discovery are important contributions that short selling can make', ASIC indicated that circumstances had changed since its meeting with the committee in June:

In the period leading up to our last meeting we had taken the view that the way that short selling was operating in the market was not showing disorderly aspects that concerned us, hence we left the short selling to play out, although we and the ASX did say to government that there should be better disclosure of so-called covered short selling.[8]

2.7        ASIC told the committee that global financial market turmoil and regulatory moves in other jurisdictions led to ASIC implementing what it described as a 'circuit breaker':

The issues that were concerning us were the lack of confidence in the market, with buyers staying out and short sellers using strategies to push down prices, and also allegations of false market rumours. We felt that we needed a circuit-breaker to come into line with what was happening internationally.[9]

2.8        ASIC also explained the reason why financial stocks continued to be subject to the short selling ban:

...short selling coupled with rumours can actually depress prices further. In the case of financials, that is an extremely worrying issue. If the stock price of a financial gets to a particular level it runs a risk of being rerated for credit purposes, so it might drop from AA to something else. That, of course, is your worst nightmare because that then precipitates a further decline, and, of course if you are the short seller, you keep shorting the stock.[10]

2.9        In response to a question on notice about the effect the ban had had on market liquidity, ASIC stated that trading had decreased following the ban but that it was difficult to attribute a causal relationship between the ban and reduced trading:

ASX's monthly activity report released for the November period revealed a decrease (9%) in trades during the period of the short selling ban when compared to the period from 1 July to the commencement of the ban on 22 September. Given the volatility in market activity internationally, we are unable to assess whether that decrease is directly related to the short selling ban.

An examination of price levels, volatility and liquidity does not provide a clear view about the effect of the ban in Australia. However, none of these indicators suggest that ASIC should not have placed the bans. ASIC's action to ban covered short selling of all quoted stock was necessary when considering the aims it set out to achieve, that is, to act as a circuit breaker to assist in maintaining confidence in Australia's financial markets; as a response to bans imposed overseas; and to deal with high levels of rumourtrage.[11]

2.10      With the passage of the Corporations Amendment (Short Selling) Bill through the parliament in December 2008, there has also been considerable debate about the disclosure regime for covered short sales. As referred to above in paragraph 2.4, under ASIC's applicable class order clients are required to advise brokers whether a sell order is a short sale, with brokers required to advise the ASX daily of gross short sales executed on the previous day. Whether this system will be retained under the regulations to the Corporations Amendment (Short Selling) Act 2008 has yet to be determined by the government.[12]

2.11      ASIC informed the committee that it would be consulting with industry about the disclosure regime until the end of January 2009, when the ban on covered short sales of financial stocks is likely to be lifted:

...there are issues around whether reporting should be net or gross and whether daily reporting is needed, but we will talk to industry and the ASX over the next couple of months and particularly to the industry associations. We will also continue to talk to our fellow regulators, the RBA, APRA and Treasury in particular, and we hope through that to improve the disclosure regime for the market.[13]

2.12      Acknowledging that there would be different views on how the disclosure regime might operate, particularly from traders who do not want their short positions disclosed, ASIC indicated that its preference is for the market to have all the information ASIC has received:

...is the market better by not having it disclosed or having it disclosed? We are saying that it is better to disclose it and let the traders sort it out rather than holding the information and then the market is not aware of how much of the trading that has gone on is covered by borrowed stock.

... ... ...

At the moment the disequilibrium is that covered short selling goes on in the market but the rest of the market does not know the extent of the short selling of a particular stock or what percentage of its capital is being shorted. We think that the best place to put that information is in the market, not for it to be held by ASIC and then for ASIC to decide when it will choose to release that data.[14]

2.13      Officials emphasised that the steps they have taken were not perfect and would continue to be refined but were a 'significant move in the right direction'.[15]

2.14      ASIC also told the committee of its involvement with international regulators in better co-ordinating regulatory responses:

...it has become more fundamental for ASIC through its good international credentials and its role on IOSCO, which comprises 95 per cent of the world’s capital markets regulators, to be part of the reform agenda. At present our work on IOSCO will essentially be to advise government here and have input where we can on the reform agenda, which will necessarily unfold as we look back on what precipitated the crisis and what has occurred. We are involved in some specifics around that such as the short selling task force. We think it is important that short selling be treated as a global issue. Because different jurisdictions have different systems, different disclosure regimes and different prohibitions, in the heat of mid‑September and in October the leading capital markets were taking different positions, which made it much more difficult for Australia to position its short selling regime.[16]

2.15      Officials emphasised the importance of understanding the broader international regulatory environment:

For Australia it is quite important that we are there, because we have a small market, and what you do not want is not to know what the settings are so that government can assess whether it will take those settings into account when it formulates policy.[17]

2.16      In response to a question on notice, ASIC indicated that 'the common international principles that will be developed as a result of the IOSCO Technical committee task force will inform [the content of the disclosure regime]'.[18]

Committee comment

2.17      The committee is of the view that short selling serves an important function in assisting with liquidity and price discovery in the market. The rationale for banning short selling seems to be underpinned at least in part by the regulators' inability to prevent unlawful profiting from short selling during volatile periods via spreading false market rumours (for instance, on impending margin calls) or insider trading. The committee will monitor the effectiveness of the new disclosure regime closely to ensure that improved transparency assists in identifying and prosecuting such practices and removes the need for such drastic action in the future.

2.18      With respect to using the regime to inform the market, the committee's preference is for more transparency about short selling in the market rather than less, in line with the view expressed by ASIC at the committee's hearing. Market participants should be able to identify the extent of shorted stock without undue delay, and traders can manage their short positions accordingly.

2.19      The committee also welcomes ASIC's involvement with other regulators at the international level. It is important that Australia understands the global regulatory environment when formulating its own capital market regulation and that Australia contributes to a more consistent global approach to issues such as short selling. For a small yet interconnected market such as Australia's, such consistency is important when establishing our own regulatory settings.     

Freeze on redemptions from mortgage funds and cash management trusts

2.20      On 12 October 2008 the government moved to provide an unlimited guarantee for all bank deposits in Australian accounts. This was introduced to support confidence in Australian banks in an environment where stressed banks in other jurisdictions had been given similar protection. However, the guarantee does not cover cash management trusts and mortgage funds, prompting investors to shift their money to government‑backed bank deposit accounts. In order to maintain stability, many of the affected (non-guaranteed) funds responded by putting a freeze on redemptions. On 24 October the government applied a fee for deposits above $1 million to reduce the distorting effects of investors accessing the guarantee, and on 31 October ASIC announced that it would provide regulatory relief to enable withdrawals from frozen funds on hardship grounds.[19]

2.21      The operators of the frozen schemes apply the hardship provisions where a request is made by a member of their scheme. Trustees may provide hardship payments only where the hardship criteria are met, and they are required to comply with their statutory duty to act in the best interests of the members of the scheme as a whole.[20]

2.22      ASIC reported that the freeze on mortgage trust redemptions had been widespread: 'something in the order of 52 or so mortgage trusts have frozen redemptions, which affects about $30 billion of the $32 billion of that market'.[21] ASIC officials indicated that it was too early to collect accurate information on the extent of applications for allowing partial redemption on hardship grounds. However, in evidence ASIC suggested that, as of 28 November, around 100 to 110 applications had been made across three or four funds.[22]

2.23      ASIC declined to comment on the policy merits of the government's bank deposit guarantee. Officials told the committee that their role in this area relates to the following:

We see our role as being, now that it is in place, first in the broad area of misleading and deceptive conduct and making sure that the products that have the guarantee and those that do not are clearly differentiated, for example, so that there is no misleading conduct in the market in the way that the guarantee may be administered. Secondly, we are looking...at the mortgage trust area to see where we can assist with hardship relief if areas of those markets have their assets frozen for a period. So our work is very much centred on looking at how the market is handling the guarantee and responding.[23]

Committee comment

2.24      The committee understands that ASIC's responsibility is for administering the hardship provisions applying to frozen funds, rather than for the bank deposit guarantee that led to this occurring. The committee will seek further information about the application of this relief at its next oversight hearing, when events relating to the guarantee have unfolded.

Credit rating agencies

2.25      Investor reliance on credit rating agencies' (CRAs') positive assessments of complex securitised debt products that subsequently failed was a contributor to the financial crisis spreading as widely as it did. The complexities of the products and CRAs' conflicts of interest in rating them have been suggested as reasons for their inaccurate ratings.

2.26      In August ASIC announced that it was working with Treasury on a review of how CRAs operate.[24] This review included investor reliance on CRAs' assessments, the diligence taken in making assessments, and possible conflicts of interest. On 13 November Minister Sherry announced that the regulation of CRAs is to be reformed. This includes removing the exemption from holding an Australian Financial Services Licence and requiring CRAs to issue an annual compliance report, which includes reporting on rating processes and managing conflicts of interest.[25]

2.27      ASIC told the committee that it would be responsible for administering the new arrangements:

...credit rating agencies is a priority of the government that will occupy us. We agree with that priority and will be moving to remove the current exemptions of mid-CRAs not to hold AFSL licences. We will be also moving on requiring credit rating agencies to produce to ASIC annual compliance reports outlining in detail how the credit rating agencies have complied with the IOSCO code of conduct, which is a fundamental underpinning to the licensing regime.[26]

Committee comment

2.28      The assessments of CRAs contributed to the ill-founded market confidence in securitised debt products that triggered the current financial and economic crisis. The committee therefore commends any action taken to address deficiencies in the way CRAs perform their functions. It will seek further information from ASIC at future oversight hearings to determine the effectiveness of these proposed measures.

Market regulation

2.29      ASIC's responsibility for investigating and prosecuting instances of insider trading, false rumours and market manipulation continues to be of interest to the committee. In its August 2008 oversight report, the committee called on ASIC to improve the way it cooperates with the ASX to act against these practices, to ensure investors have confidence in the market.

2.30      Strategies for cracking down on insider trading and market manipulation are currently being considered as part of a review being conducted by the Corporations and Markets Advisory Committee (CAMAC). One of the matters referred to CAMAC by the Minister for Corporate Law and Superannuation, Senator Nick Sherry, is the spreading of false and misleading information to benefit from artificial movements in price.[27] CAMAC has been asked to look at the way overseas jurisdictions regulate this practice and propose regulatory change if necessary.[28]

2.31      This follows ASIC's Project Mint investigation into the effect of false rumours and collusion on market integrity, launched in March 2008. Although not complete, ASIC told the committee that the project had established that the burden of proof required and the elusive nature of rumours made prosecutions difficult. ASIC officials suggested that the most useful leads come from direct complaints and that some brokers could do better in preventing the circulation of rumours.[29]

2.32      ASIC stated that dealing with insider trading and market manipulation had been given high priority by the regulator:

We have worked hard in cooperation with ASX to deal with the referrals that we get ... in addition to added resources within ASIC to that sector, principally headed by Commissioner Belinda Gibson. The benefits of that work are coming through with the prosecutions and the referrals to the DPP ... and I think you will see more of the benefits of that going forward.[30]

2.33      ASIC reported that:

Since January this year the ASX has referred to us some 90 instances of insider trading, market manipulation and market conduct. All of them have been actioned. Currently we have 12 of those matters before the court—two insider trading matters, five market manipulation matters, two on continuous disclosure, one on directors’ duties, one on misleading statements and one on short selling—and another 11 matters before the Commonwealth Director of Public Prosecutions. Our work on rumourtrage, in the sense of coming down as hard as we can on false rumours in the market has continued, and our so-called Project Mint has extended its inquiries to deal with those investigations and those issues.[31]

2.34      The committee heard that ASIC had systems in place to identify unusual trading activities that may indicate rumourtrage and market manipulation:

The ASX has a technological system that oversees the market and alerts us to odd activities or things that are outside the projected normal bands, and that will lead us to look into what might be manipulative, which is more often a course of trades over a time frame that look to be odd and out of the ordinary course. We also look for spikes in trading, which tends more to suggest inside trading or an inside deal. What we then have to do on the rumourtrage is tie back where we hear of a rumour or believe that there is a rumour in circulation and look at what happened to the course of trading, so that it is a matter of linking fact of rumour to course of trading and, if at all possible and ultimately if prosecution is to proceed, linking the party doing the trading to the rumour.[32]

2.35      In response to a question on notice ASIC advised that referrals for insider trading and market manipulation in the calendar year 2008 were more than double that of the 2005/2006 financial year.[33]

2.36      There have been suggestions that some of the ASX's market supervision responsibilities may be shifted to ASIC. These are a result of criticism that the ASX is conflicted in its dual role of market operator, where there is an incentive to maximise trading volumes, and market regulator.[34] The possibility of the government ending the ASX's monopoly on market services would also have implications for its regulatory role, given the conflicts associated with regulating its competitors.

2.37      ASIC informed the committee that it had advised the government on market competition licensing and that the matter is now with the government for their decision.[35]

Committee comment

2.38      It is critical that investors have confidence in the regulators' ability to identify and prosecute insider trading, false rumours and market manipulation. The committee recognises that the complex and elusive nature of these activities makes it a difficult task for ASIC. Project Mint and the recently announced CAMAC review are welcome initiatives designed to better tackle the problem, and the committee encourages ASIC to continue to work closely with the ASX in identifying these practices.  

ASIC strategic review

2.39      At the committee's previous oversight hearing ASIC outlined a number of changes within the organisation following its strategic review. This included additional investment in market research and analysis, the planned appointment of an external advisory panel, a major staffing restructure and improved staff development. In August, ASIC announced its senior executive appointments within the new stakeholder and deterrence teams.[36] In response to a question on notice, ASIC indicated that since the restructure there had been only a slight increase in staff turnover from the corresponding period last year, but that ASIC had 'not experienced any significant increase in exits from the organisation'.[37]

2.40      The strategic review followed a survey of the regulator's stakeholders in April 2008, which highlighted mixed opinions about ASIC's performance. There was a view that ASIC is process-driven and concentrates on prosecuting easy targets. Only 21 per cent of respondents agreed with the proposition that ASIC was good at identifying emerging problems, while the survey results also indicated a lack of confidence in ASIC's ability to identify and prosecute instances of dishonesty and misconduct, and insider trading and market abuse.[38]

2.41      ASIC told the committee that the stakeholder survey was an important basis for the strategic review:

Feedback is important if you are going to make changes. We did a strategic review of the organisation and made changes that we felt were needed but we felt that we needed a base, and the best base is to talk to your customers or to your stakeholders.[39]

2.42      The response has been to better develop skills within the organisation and improve technological efficiencies:

Firstly, it is essentially about training to develop skills and the development of people so that they are much more in tune with the market and understand what is happening so they can give a quick response. Secondly, in terms of systems and processes, ASIC registers 1.3 million companies a year and licenses 11,000 people, and we are using technology to allow people to deal with us more efficiently.[40]

2.43      The committee sought information about the progress of the changes in ASIC following the review.[41] ASIC told the committee that its recruitment had been assisted by instability in the financial markets:

We were very pleased with the external recruitment process and now that we are filling other positions below the senior positions pleased with the applications we are getting. The number of applications are significant. We accept the fact that that is also to do with the current state of the financial markets, but we are going to take it as an opportunity to add skills and talent within ASIC as we fill vacant positions going forward.[42]

2.44      The committee also heard of the need to bring a cultural change to the organisation through a 're-education program':

We have had to turn our staff from processors to thinking about the market first. We are doing a lot of leadership training of staff at the most senior level and trailing that through the organisation so they can look at something and say: 'Does this matter? Why does it matter? What can we do to make a difference?' That is going to take time, but certainly less than the two years. There is a mindset to change.[43]

2.45      However, ASIC emphasised that the benefits would take some time to become apparent:

That training and development and improvement in technology will take place over the next two, three, four or five years. If we did a survey tomorrow I do not suggest that you would see much of a change in the score, but in two years time, when we intend to do another survey, I would expect to see the sorts of things that I have just spoken about pushing up satisfaction quite significantly.[44]

2.46      ASIC also told the committee that its external advisory panel had not yet been appointed. Officials indicated that the current regulatory issues facing ASIC have confirmed the panel's potential benefits.[45]

2.47      From a strategic perspective, ASIC suggested that the success of its new approach is still to be proven:

The way we responded to the mortgage trust issue, the way we dealt with the hardship issue and with short selling, I think it is fair to say...are steps that ASIC has not taken in the past. So we are seeing the benefits of what we are talking about, but we are the first to concede that with a new structure, a new approach, we are still to prove that it will all work...[46]

Committee comment

2.48      The committee supports the changes arising from ASIC's strategic review and commends the regulator's honesty in publishing the disappointing findings from its stakeholder survey. The timing of the financial crisis has assisted with recruitment and ASIC should work hard to retain the expertise as a consequence. The committee can also see the potential benefits of ASIC receiving guidance from its external advisory panel and encourages ASIC to appoint this panel as soon as possible.

Budgetary issues

2.49      Issues stemming from the global financial crisis and the shifting of credit regulation from the states to the Commonwealth have increased demands on ASIC considerably. The committee was interested to ascertain whether ASIC's budget was adequate to effectively handle the increased workload. The committee was told that ASIC's work on short selling, mortgage trust redemptions, additional credit regulation from the states, credit rating agencies and the Financial Literacy Foundation were significant responsibilities that they were dealing with. ASIC officials outlined the budgetary implications for the agency as such:

The current position with our budgets is that we said to government that for the 2008-09 year we felt confident that we could work within the existing budget settings. Recently, through the Prime Minister’s allocation for this financial year, we were allocated an additional $10 million for the crisis work.

...

For this financial year we have enough resources to do what we want to do, and our NPP proposal for the next three to four years is currently with government. In addition to that, again through the Prime Minister’s allocation, or the Treasurer’s allocation, an additional $20 million has been set aside for next year, even before we go through that NPP process. As a commission, we feel that we have the resources at this point to be able to do what we are doing.[47]

2.50      In response to a question taken on notice, ASIC advised the committee that the government had provided ASIC with $66 million to regulate consumer credit nationally.[48]

Superannuation

2.51      In July ASIC released a consultation paper on the best way for superannuation funds to facilitate calculations for members seeking to estimate their necessary contribution levels.[49] It is difficult for members to decide on contribution levels without some guidance as to how much will be required to meet retirement income needs. However, there are presently difficulties for superannuation funds wishing to provide members with projections because they are deemed to constitute personal advice under section 766B of the Corporations Act. Offering personal financial advice requires an Australian Financial Services Licence.

2.52      The committee heard that superannuation projections were an important element of getting people to engage with the task of managing their retirement income. However, ASIC cautioned that work would need to be done to ensure that the projections offered do not constitute ironclad representations about retirement income:

...whatever you call it, you are almost representing to people what they are going to have in retirement. As we have seen, this year equity markets have fallen by round about 50 per cent. So in making these kinds of predictions to the entire superannuation population of 10 million-odd people, some very deep issues are going to have to be worked through. We think it is a very worthwhile project and that people should have this snapshot, this picture, but one has to be very careful that it is not an ironclad representation. After all, these are accumulation funds.

...

...ultimately there will be pretty ironclad assumptions, and inflation rates, earnings rates and those kinds of things are all going to have to be very carefully looked through, probably through the Australian Government Actuary.[50]

2.53      As well as making sure the assumptions used by superannuation account holders are appropriate, ASIC indicated that liability issues where projections have been wildly inaccurate would also need to be addressed.[51]

2.54      ASIC's shadow shopping exercise was again raised by the committee. In its last ASIC oversight report the committee criticised the regulator for not yet repeating its successful superannuation shadow shopping survey. In response, ASIC told the committee that it would maintain its planned timetable:

At the moment we think there are a lot of issues in the market that we need to deal with and we are not sure that in the current crisis situation that accelerating the shadow shopping is the way to go, but certainly it is for us to do.[52]

Committee comment

2.55      Superannuation projections are crucial in assisting people in assessing the level of contributions they need to make towards their retirement income. The fact that the law does not facilitate superannuation funds offering projections to individual fund members hampers the likelihood of them making informed decisions about their superannuation contributions. This has clear implications for Australia's aged pension liabilities in the future. The committee recognises the risks associated with superannuation funds using calculators as a potentially misleading advertising device, but a solution to this problem is overdue. The committee therefore suggests that, despite its other pressing responsibilities, ASIC pursues further work in this area as a matter of urgency.

Financial literacy

2.56      ASIC is also responsible for improving financial literacy amongst Australians to better equip investors to make appropriate investment decisions, mitigating the extent of the harm caused by investment scheme collapses, low-ball share offers and other disreputable investment products. In the context of banking and credit regulation, in particular the risks associated with reverse mortgages, the committee previously suggested that ASIC make greater efforts to gain mainstream press coverage about risky credit products.[53]

2.57      ASIC responded to this suggestion in evidence at the hearing:

Within the retail investor consumer area ASIC now has dedicated teams on financial literacy and a dedicated team on investor education. We think that through those teams we will do more to educate investors, and clearly things like seniors’ magazines and the press will be part of the focus on getting across the message on what really are some fairly fundamental and simple principles about asset allocation, diversity of portfolio, understanding price reward premiums on products and the risk profile.[54] 

2.58      The committee notes that the collapse of Storm Financial Limited occurred after its hearing with ASIC in November. ASIC's investigation into this matter will be dealt with at the committee's next oversight hearing. 

Committee comment

2.59      The committee acknowledges the ongoing work being done by ASIC and government to improve standards of financial literary amongst Australians, including through the publication of ASIC's 'fido' website outlining financial tips and safety checks for consumers.[55] However, the committee reiterates its position that mainstream press coverage is the most effective way of educating Australians about important investment principles. In particular, ASIC should be more visible in promoting these messages when stories about investment scheme collapses are broadcast in the mainstream media. 

Professional indemnity insurance

2.60      The committee's previous ASIC oversight report addressed the new compulsory professional indemnity arrangements for financial planners.[56] The committee was again interested to know whether the regime was operating effectively, particularly with respect to the availability of adequate insurance cover. ASIC told the committee that it was assessing whether the new scheme is working:

The stresses on that are the availability of professional indemnity insurance, its cost and its adequacy in the event of issues occurring. When we implemented the regime we told the market that we would look at it over a two-year period and give government feedback whether the professional indemnity approach to protecting those who get advice from financial planners is adequate or not. We are about 12 to 15 months into that, I think, so we are going to look pretty carefully over the next six months at what issues are unfolding...

2.61      The committee will welcome further information from ASIC on the adequacy of professional indemnity insurance cover at its next oversight hearing.

Mr Bernie Ripoll MP
Chairman

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