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The move of market trading supervision from the ASX to ASIC makes a good deal of sense but if the change is to realise its potential benefits for our financial system, then the Government and ASIC will need to keep the end game in sight. Ineffective over-regulation, as occurred with Sarbanes Oxley in the United States, risks hobbling our markets at a time of intense global financial sector innovation.
Those close to ASIC are confident that the regulator will have the expertise and systems to take over ASX’s supervisory responsibilities. ASIC is now far closer to industry participants and professional services firms involved in the market than it ever has been.
ASIC is already well on the way to developing its “SMARTS” trading monitoring system and should have access to staff with significant expertise in the field. Recent budget increases, combined with the shakeout of the employment market in the financial services sector, have allowed ASIC to recruit senior industry experts.
The change will also enable more streamlined processes for the enforcement of market misconduct and trading rules. Currently ASX conducts preliminary investigations and acts as a referral point for instances of serious abuses, such as market manipulation and insider trading.
ASIC then takes over the investigation with prosecution handled by the Director of Public Prosecutions. This three-step process is a source of inefficiency. Consolidation of monitoring and investigation into one body should speed up outcomes.
Additionally, a single regulatory authority should remove the current situation where market participants are subject to the double jeopardy of enforcement by ASIC on one hand, and discipline by the ASX on the other, due to overlapping responsibilities.
Risks to be managed
However, there are also some risks in the emerging regulatory landscape that the Federal Government, ASIC and other stakeholders must manage, if Australia is to keep pace with global market changes.
Firstly, the development of market trading rules will be a key challenge. A common set of rules or standards for all current and future securities markets clearly has appeal as it will help to eliminate “regulatory arbitrage” between markets, thereby supporting more efficient practices and greater consistency of knowledge.
However, a common set of standards also threatens cross-market competition and innovation. While the Government is clearly keen to create an environment of market integrity and confidence it should also be wary of imposing a regulatory straitjacket that restricts innovation.
Markets are currently evolving around a buzz of dark pools, flash trading and high-frequency trading. Brokers are placing their computer systems next to ASX systems to drop response times to milli-seconds. Soon there will be a push to nano-seconds and integration of broker systems into exchange system architecture.
Pre-trade transparency and pricing controls need to be carefully addressed if these kinds of trading innovations can develop.
Secondly, it is unclear how day-to-day enforcement of market rules and discipline of market participants will operate in the new regime. This requires a nimble enforcement mechanism which is very close to the market.
Currently ASX operates a Disciplinary Tribunal. Just how this function will operate in an ASIC context is unclear. The existing mechanisms in the Corporations Act will not work; in many cases that would be too cumbersome or akin to a sledgehammer cracking a nut.
Recently a “speeding fine” mechanism was introduced into the Corporations Act for breach of continuous disclosure rules. This shows that more flexible enforcement mechanisms are possible and might be the sort of tool necessary to dispense a rough and ready belt to brokers’ ears.
Thirdly, Australia needs to avoid creating a regulatory structure which is outside the experience of those operating offshore markets and therefore deters foreign entrants.
Many major international financial centres, such as the UK, continue with a structure whereby market operators are responsible for monitoring trading and disciplining their market participants. It is critical that the move of responsibility from ASX to ASIC is executed in a way which justifies any departure from international standards.
As a final point, it is worth noting that no matter who supervises our financial markets - or within what regulatory framework - participants themselves have the greatest role to play in ensuring that the Australian financial system is viewed as fair and transparent.
We all suffer if brokers, hedge funds and other participants push trading strategies beyond efficient price discovery towards abusive practices, thereby prompting a strict regulatory response. Respect for the market, combined with flexible and principles-based regulation, will ensure that Australia is well positioned to remain internationally relevant in the battle for future capital.
This article was published in the Australian Financial Review on 15 September 2009.