We know it’s a global issue - Part II
In 2023, ASIC Chair Joseph Longo foreshadowed increased regulatory interest in the market practice of pre-hedging, noting that his commission was aware of industry calls for guidance on the topic.
ASIC followed this up with their Guidance for market intermediaries on pre-hedging in February. While this no doubt has been welcomed by the sell-side, there remains little to guide those who actually bring large or sensitive transactions to market on the buy-side.
In this blog I follow up my earlier work on this topic and put forward some possible points of buy-side guidance.
We’ve heard your calls for guidance, and we hope to provide some soon.
With this, ASIC Chair Joseph Longo acknowledged what most who’ve worked on major deal risk-transfers know well – the available guidance on pre-hedging is written up in many places, none of which could be described as being definitive.
ASIC made good on their Chair’s hopes in February, squarely directing a new note: Guidance for market intermediaries on pre-hedging, at “market intermediaries,” with the Commission seeking to:
raise and harmonise minimum standards of conduct related to pre-hedging
improve transparency so that clients are better informed when making investment decisions
promote informed markets and a level playing field between market intermediaries, and
uphold integrity and investor confidence in Australian financial markets.
Adding a now familiar reminder:
Market intermediaries need to manage confidential client information very carefully and have robust, closely monitored and frequently tested arrangements for ensuring conflicts of interest are appropriately managed and in compliance with the Corporations Act 2001 (Corporations Act).
What we have noted is that a heavy set of obligations is now placed squarely on sell-side intermediaries in relation to pre-hedging. The default responsibility is for sell side firms to “minimise market impact”, and ensure they achieve “the best overall outcome for clients,” which we thoroughly unpacked in our recent work summarising the obligations – see here and here.
As we have noted, this latest guidance is consistent with global equivalents, providing intermediaries “with clear reference to the relevant Australian legislation and regulatory guidance.” But as we have also written before, there remains a gap in guidance with respect to guidance for buy-side.
Why guide the buy side?
While ASIC defines those bringing large deals to market as “clients” this is a simplification in any setting that includes exceptionally large risk transfers. When an entity brings a deal that is larger than the combined risk-limits of major bank dealing desks the notion of there being a client-party in any traditional sense becomes blurred. “Parties to a risk transfer” might be a better description, with one party seeking to lay off its risk problem to one or more others.
As we have seen, the conduct of the buy side can be exposed within court proceedings when exceptional deals turn to dispute, including in the most recent high-profile case.
Which suggests that minimum guidance for those who bring deals in which pre-hedging may feature is overdue.
This could include guidance aimed at:
Encouraging firms to establish an appropriate deal strategy prior to passing information-sensitive details to market intermediaries
Ensuring proper communications plans and controls are in place before large deals are brought to market –to make certain that execution-consistent comms are planned for, restricting sensitive information to a strict “need to know”, and avoiding information slippage
Removing the risk that Chinese walls inconsistent with their intended approach to deal execution, with partitions between corporate finance, credit, and operations teams, and the dealing teams who may be asked to manage market risks
Avoiding unveiling credit or collateral deal mechanics and related topics such as deal novation to relevant market risk dealers
Carefully controlling the number and type of firms that may be placed in contest for deals, while ensuring suitability-of-counterpart is considered
Reducing the chance that execution dry runs don’t transmit key information beyond that necessary to gauge price and/or ensure no market disruption can arise
Ensuring buy side parties consider time-of deal and time-to-clear liquidity considerations relative to the available depth of the market in question
Placing the onus on buy side parties to clearly and in written agreement specify pre-hedging assent if any, the manner, and type of approval required to permit pre-hedging deals and the recording of such dealings
Creating a genuine, level playing field through equal treatment of market intermediaries to be asked to quote
If provided, such guidance could be argued as raising and harmonising minimum standards of conduct for those who carry large positions they wish to disperse into the market. Such treatment would be consistent with the status of clients as dealing parties as specified within the Global FX Code and acknowledge conformity with International Organization of Securities Commissions (IOSCO), the European Markets Authority (ESMA), and the Financial Markets Standards Board (FMSB).
As the Global FX Code states, the code:
‘is expected to apply to all FX Market Participants that engage in the FX Markets, including sell-side and buy-side entities, non-bank liquidity providers, operators of FX E-Trading Platforms, and other entities providing brokerage, execution, and settlement services.’
With “clients” defined as:
‘a Market Participant requesting transactions and activity from, or via, other Market Participants…’
Market Intermediaries
The essence of our view is that market intermediaries now bear a disproportionate responsibility for conflict-free, non-disruptive risk transfers of large deals.
With the best intentions and fully complying with ASIC’s latest guidance, it’s entirely possible, even under the best conditions, that dealing outcomes convey an impression of having been the result of conflict or having disrupted a market, based on how the aggressor firm acts – what communication they convey and what style of execution conducted.
It’s little wonder that market intermediaries are now wary of large deals and have sought improved guidance. After all, if the existing pre-hedging guidance were clear, the ASIC Chair would not need to have acknowledged the widespread calls for it.
Placing clear and reasonable markers for those who bring large deals could ultimately help ASIC achieve its stated aim of promoting informed markets and a level playing field between market intermediaries.