ASIC’s Report 741 offers a broad survey about the conduct risks in Australian wholesale fixed income markets. Although ASIC based the review on findings from nine significant dealers, it is relevant to all participants in Australian fixed income markets.
- The report highlights the importance of monitoring for cross-market manipulation and the need for a properly calibrated surveillance tool. Given the vast range of correlated fixed income instruments, there is a clear benefit to a self-calibrating tool such as MAST.
- It found a wide range of practices relating to the management of conduct risk, sales and trading, monitoring and surveillance and
training, supervision and governance. In some instances, ASIC found an insufficient understanding of fixed income conduct risks which produced gaps in surveillance coverage alongside ineffective calibration of alerts.
- The report is aligned to guidance provided by other regulators around the world, focusing on fixed income surveillance. Recent examples include the FCA’s Market Watch 56 and the AMF’s penalty against Morgan Stanley for ramping European bonds.
- The report notes that fixed income markets are particularly challenging from a compliance/trade surveillance perspective. Notably, fixed income markets can be opaque and have varying liquidity. In addition, cross-asset correlations mean that the potential for abuse is higher which makes detection more difficult.
- The report noted the importance of a fit-for-purpose surveillance system and risk-based reviews of high-risk time periods. This highlights the benefit of MAST’s model and risk-based solution for detecting a wide range of market abuse behaviours. Also significant here is MAST’s ability to account for each instrument's liquidity and volatility in order to recognise trades and orders that present increased risk.
Key conduct risks in fixed income markets
The report first identifies the key conduct risks across dealers’ sales, trading, repo and bond syndication activities. Where dealers had treasury desks, ASIC reviewed their treasury’s activities as large buy-side customers due to the additional conflicts of interest.
Misleading or deceptive conduct
- Participants need to ensure any pricing, market and product information that is communicated to others has a reasonable basis.
- Market commentators or analysts may engage in misleading or deceptive conduct to influence their market to their benefit by spreading rumours, mispricing OTC securities on end of day rate sheets or misstating secondary turnover statistics to issuers to gain business fees.
Conflicts of interest
- Participants should identify conflicts of interest that arise in their fixed income activities and manage or avoid these. These can occur between dealer and customer, between staff and customer/dealer, or between customers.
- A typical example between a dealer and customer is front running where a trader has knowledge of a forthcoming customer order. They then position themselves ahead of the anticipated price impact to make money or avoid loss.
Insider trading
- Participants should closely supervise and have enhanced controls for activities which may pose heightened risk of communicating inside information or trading while in possession of inside information. To determine whether the information is inside information, its materiality should be assessed.
- Examples of activities with higher inside information risks include:
- Unpublished information about an upcoming primary issuance.
- Issuer communications with public-side staff.
- Forthcoming large transactions.
- Unpublished price-sensitive research or macroeconomic data.
Market manipulation
- Participants should be aware of the potential for market manipulation, which can undermine market integrity. This includes influencing an asset's reference price or financial benchmark, as well as creating or maintaining an artificial price.
- Although there are several different variations of this abuse, they tend to involve trading intended solely to manipulate the price. Examples include:
- Aggressive trading, also known as ramping, in which a trader drives the price in a certain direction before abruptly closing their position.
- Marking the close, in which a trader drives the price during a closing window to influence the fix-settled price.
- Layering/Spoofing, in which a trader places non-genuine orders to drive the price in a direction before cancelling them.
Review findings
The review then assesses how each dealer managed these risks across different areas of their business.
Managing conduct risk
- Participants should ensure their compliance framework is effective for controlling misconduct in their fixed income activities.
- This means ensuring policies and procedures address Australian laws and reflect business activities and current market practices. They should clearly outline ownership responsibilities by both business function and individual, and also map conduct risks to specific controls.
- There should be periodic assessments of the effectiveness of existing controls, including regular internal audits. This should be aided by detailed recordkeeping of incidents and complaints.
Sales and trading
- Fixed income sales and trading staff should understand the key conduct risks in their activities and how these are controlled.
- There should be guidance on how to avoid front running customer orders as well as clear protocols and responsibilities for managing activities. There should be reviews to ensure services, including quoted prices, are fair.
- Detailed conflicts of interest registers should be maintained with each conflict mapped to preventative and detective controls.
- Dealing staff should be prohibited from using unapproved or monitored communication channels.
Monitoring and surveillance
- Dealers should have fit-for-purpose monitoring and surveillance systems and processes to detect misconduct.
- Teams should monitor market and cross-market manipulation, including spoofing, ramping and layering. They should also monitor for other indicators of abuse including spoofing, ramping and layering. They should also monitor for other indicators of abuse including orders/trades into close, high volumes of trades, unusual trade/order sizes and others.
- Teams should also monitor front running by reviewing hedges for material transactions.
- Teams should monitor for insider trading using control room information.
- Teams should monitor quote, order and trade data across all fixed income securities, including repos.
- All communication channels used by dealing staff should be recorded and monitored.
- There should be testing of surveillance models through mock misconduct scenarios.
- There should be risk-based reviews of high-risk time periods, activities and customers/staff.
Training, supervision and governance
- It is essential that dealer's training, supervision and governance support effective conduct risk management and oversight.
- This includes conduct training including case studies, scenarios and dilemmas.
- Supervisors should actively supervise staff and use dashboards which track tasks.
- Risk committee packs should contain detailed information on the current state of conduct risk management, including monitoring and surveillance arrangements.
TradingHub's view as a 3rd party trade surveillance SaaS provider:
TradingHub's MAST product provides comprehensive trade surveillance of all asset classes, including fixed income instruments such as bonds, repos and various derivatives such as interest rate and credit default swaps. It employs a fundamentally novel approach to surveilling fixed income trading. Rather than viewing them as individual trades, it interprets them as expressions of interest rate or credit risk. This enables MAST to understand how a trader positioned themselves along an underlying interest rate or credit curve, and ultimately whether a trader intended to manipulate these curves. This lets it detect instances where a trader used correlated securities to perpetrate cross-product abuse.
MAST then leverages self-calibrating models to detect true instances of abuse. It models the dynamics of each instrument to estimate the degree to which a trader's activity could realistically influence an asset's market price. This underpins MAST's ability to identify genuine attempts at market manipulation and rate each alert by severity. Market impact modelling reinforces MAST's ability to accurately detect several abuse types, including:
- Front running
- Marking the close
- Ramping
- NAV manipulation
- Layering and spoofing
These metrics and others such as Insider Trading and Wash Trading all benefit from MAST's risk-based approach to detect cross-product abuse in all asset classes. In addition, MAST offers Calculation as a Service (CaaS) as a full suite reporting tool which enables you to customise metrics or create entirely new ones to fit your precise surveillance needs. You can also run reports to identify stand-alone indicators of abuse such as high volumes of trades or high profit or loss.
We have compiled a matrix detailing the benefits of our coverage alongside the key concerns raised by the ASIC report. Access the report here.
For more information on our approach, please view our series on fixed income coverage:
Part 1: Why Fixed Income is Different
Part 2: The Surveillance Problem
Part 3: The Challenge of Cross-Product Surveillance
