In brief 9 min read
On 15 April 2020, the Australian Securities and Investments Commission (ASIC) released updated INFO 230 Exchange traded products: Admission guidelines (INFO 230) which outlines ASIC's view of good practices to help ensure that admission and monitoring standards for exchange traded products (ETPs) continue to support fair, orderly and transparent markets. This is particularly in the context of ETPs with unique or novel features, such as certain actively-managed exchange traded funds (ETFs).
Updated INFO 230 paves the way for renewed activity in the active ETF space, post-COVID-19.
INFO 230 outlines measures firms should take to manage market integrity risks associated with internal market making, including:
- only using publicly available information as the input for market-making quotes;
- establishing information barriers to ensure bids and offers are not submitted to the market by persons or systems with knowledge of the current portfolio holdings;
- maintaining adequate arrangements for identifying and responding to instances of substantial information asymmetry in the market; and
- maintaining appropriate compliance and supervision arrangements.
In July 2019 (see 19-195MR), ASIC stopped the admission of actively managed ETFs that did not disclose daily portfolio holdings and used internal market making (whereby the fund's responsible entity acts as the market maker on the fund’s behalf submitting bids and offers itself, or uses a market making agent to execute its instructions). The pause allowed ASIC to review the regulatory settings for these products in light of material changes in the market, including international developments in the United States and Hong Kong, and concerns around market integrity risks. At the time of the admissions pause, internal market making funds represented approximately 6% of ETPs by funds under management.
Following an extensive review and industry consultation, ASIC lifted the halt on the admission of 'non-transparent' ETFs in December 2019 (see 19-348MR), and on 15 April 2020, issued updated INFO 230.
- Licensed Australian exchanges;
- Product issuers; and
- Market-making execution agents.
Approving ETP issuers
For each new product application, regardless of whether an issuer has previously issued other products, licensed exchanges are required to assess whether the issuer is able to fulfil its obligations in relation to that product. This includes confirming, among other things, that the issuer has:
- registry, portfolio calculation agent, market-making and custodian agreements in place, and that these include appropriate information barriers where required. If the issuer seeks to perform any of these functions itself, it should have the resources, systems and controls necessary to reliably do so in a way that adequately manages conflicts;
- appropriate technology systems in place;
- established internal policies, procedures, systems and controls, particularly related to information barriers where required, for both it and its service providers; and
- adequate financial resources and senior personnel with the requisite skills and experience.
If a new application has unique or new attributes for the Australian market, licensed exchanges should make a detailed assessment of these features, and the application, against the current regulatory framework, including relevant ASIC guidance. ASIC expects to be consulted before an admission decision is made.
Licensed exchanges should be satisfied of a range of factors, including that:
- the underlying assets of an ETP have robust and transparent pricing mechanisms to support market liquidity and give retail investors confidence that they can transact at a price at, or close to, the net asset value (NAV) of the underlying portfolio;
- where products have more complex or less liquid elements, a robust and transparent pricing mechanism exists in a range of market conditions, including those with a degree of market stress. ASIC also expects exchanges to consider whether any additional retail investor protections are appropriate where underlying assets are considered illiquid, high risk or complex;
- where the underlying securities are fixed-income instruments (such as debentures and bonds), they should generally be constituents of an index that is widely regarded by industry as having robust and transparent governance arrangements; and
- issuers of ETPs with underlying holdings that include derivatives can reliably measure the value of those positions daily on a mark-to-market basis.
ASIC expects that:
- for ETPs with a strategy reliant on the use of derivatives (both exchange traded and OTC) for more than an immaterial extent (broadly, total notional value of more than 5% of the ETP's NAV), the licensed exchange will impose regular (at least monthly) disclosure obligations and other additional requirements on the issuer (including acceptable counterparties and acceptable collateral); and
- where an issuer intends to rely on using derivatives with total notional value of less than 5% of the ETP's NAV, the licensed exchange should impose rules requiring the issuer to notify the market as soon as practicable when exceptional circumstances occur resulting in this limit being exceeded.
Disclosure of portfolio holdings
ASIC expects that licensed exchanges will generally require ETPs to publish, daily, the full portfolio of the ETP’s holdings (or a creation/redemption basket generally reflecting the portfolio) along with the NAV per unit at the end of the trading day; and that, where an indicative NAV (iNAV) is provided, it is calculated through systems that can be independently verified or by an independent third party, and is updated to reflect live market prices for underlying assets traded during Australian trading hours (or adjusted closing prices for assets traded outside Australian trading hours).
In very limited circumstances, issuers may disclose full portfolio holdings on a delayed basis, rather than on a daily basis, including where:
- Internal market making is in place to protect the intellectual property of the fund - full portfolio holdings disclosure should only be delayed to the extent necessary to protect the issuer’s intellectual property, and full portfolio holdings disclosure must be provided at least quarterly with a delay of no more than two months. The disclosed iNAV should be disseminated as frequently as practicably possible, given the nature of the fund, and should be the issuer’s best estimate of the ETP’s value per unit throughout the trading day.
- The issuer adopts a 'material portfolio information' (MPI) disclosure model – the issuer agrees with the market maker on the characteristics of the MPI to be published to the market daily (eg disclosure of a basket of proxy assets, rather than the actual fund holdings), with disclosure of an iNAV at the start of each trading day and at least every 15 seconds during the trading day; tracking performance between the disclosed information and the full portfolio quarterly; and the full portfolio holdings at least quarterly with a delay of no more than two months.
Liquidity provision and market making
Licensed exchanges should have rules requiring product issuers to provide adequate product liquidity to enable investors to consistently trade at a price close to the NAV of the ETP, noting that product issuers can employ a range of strategies, including:
- appointment of a lead market maker; or
- in very specific circumstances, adopting the role themselves (ie internal market making when there is a genuine need to protect the issuer’s intellectual property).
Licensed exchanges are also encouraged to proactively monitor product liquidity on a regular basis (ideally daily) to ensure:
- market makers are not absent from the market for unacceptable periods; and
- that the agreed liquidity parameters for the ETP are being complied with.
Appropriate action may be required by the exchange (eg suspension of trading, revoking admission or additional market-making obligations) if either of the above factors is not met.
Further, licensed exchanges are encouraged to make average bid-offer spreads for all ETPs available on a regular basis to enable investors to assess the cost of entering and exiting their investments.
Further internal market making guidance
Exchanges should only allow internal market making when the issuer has a genuine need to protect its intellectual property. In assessing internal market-making arrangements, factors the licensed exchange should consider include whether:
- the issuer and the trading participant/execution agent have the appropriate competencies, resources, policies, procedures, systems and controls necessary to carry out their roles;
- the arrangement complies with the Corporations Act, including the prohibitions on market manipulation and insider trading, and the duties to act in the best interest of members, manage conflicts of interest and maintain compliant withdrawal provisions;
- the input for market-making quotes is limited to publicly available information (such as the iNAV, publicly available portfolio holdings disclosures, general market conditions and trading activity). Effective information barriers must be established at the issuer and its execution agent so that bids and offers are not submitted to the market by persons or systems with knowledge of the current portfolio holdings. If the execution agent also provides other services for the issuer (such as transaction hedging), the issuer should not provide the execution agent with material non-public information about the fund’s portfolio holdings unless appropriate information barriers are established;
- the iNAV is as accurate, and is disseminated as frequently, as possible. For example, it may be better practice to incorporate adjustments (such as index futures) to reflect market movements in underlying assets that are not traded during Australian market hours. The licensed exchange should also be satisfied that the issuer has robust processes in place to maintain the integrity and continued distribution of the iNAV (eg by way of the issuer undertaking its own monitoring and integrity checks or contracting with a second, backup iNAV provider);
- the extent of the delayed disclosure is appropriate, given the nature of the fund and only to the extent necessary to protect the ETP's intellectual property. For example, it may be better practice for funds with higher portfolio turnover rates to provide full portfolio holdings disclosure more frequently than those with lower portfolio turnover;
- the arrangements regarding the bid-offer spread, minimum order size and time in market each trading day support investors being able to transact at fair and orderly prices;
- risk management processes (including processes to identify and respond to instances of heightened volatility and illiquidity events) are robust;
- the contracts underpinning the arrangement are appropriate (eg do not give rise to risk of non-compliance with the insider trading prohibition);
- there is adequate disclosure in the product disclosure statement (PDS) about the additional risks of the ETP product.
ASIC also sets out best practice guidance for issuers relating to periods where there are substantial information asymmetries in the market (eg by informing the market and ceasing market making until the asymmetry is resolved, or requesting a trading halt).
INFO 230 also contains valuable guidance regarding:
- market makers operating under a licensed exchange’s fee rebate incentive scheme;
- for issuers of ETPs that engage in securities lending, adequate disclosure in the ETP's PDS;
- ongoing supervision of ETPs and issuers by licensed exchanges;
- the availability of waivers from the operating rules of a licensed exchange to accommodate new ETP features; and
- product-naming guidelines for various types of ETP.
If you are:
- contemplating design of a new ETP product, or admission of a new product to a licensed exchange;
- seeking to provide market-making services to a new ETP;
- wishing to review your internal market-making arrangements or ETP disclosure documents in light of updated INFO 230;
- considering whether to consult with a licensed exchange and/or ASIC in respect of your ETP product; or
- would like to discuss any of the issues raised in this Insight,
please contact any of the people below.