Outcomes of review into internal market making for quoted managed funds

ASIC has concluded a review of internal market making practices of non-transparent actively managed funds that are traded on exchange markets.

The review identified market integrity risks under certain internal market-making models-particularly those models where a market maker uses non-public information as part of its pricing methodology. In some models, market-maker quotes are lead indicators of changes to fund portfolio values rather than responding to publicly available information such as indicative net asset values (iNAVs).

ASIC has identified measures firms can implement to manage these risks, set out below. Subject to these controls, ASIC has requested that exchange market operators lift the pause on the admission of new managed funds with internal market making (refer ).

ASIC intends to work with market operators and other stakeholders to ensure new funds being admitted for quotation use compliant models, and changes that are required to existing models are made as soon as possible. ASIC also intends to provide stakeholders with more information about our findings and update Information Sheet 230 () in early 2020 with guidelines on better practices for managing non-public information.

Some key outcomes of the review are:

Several internal market making practices currently used in Australia raise market integrity concerns because internal market makers have access to non-public information when making decisions about the market quotes they provide.
Note: In particular, the use of the fund’s portfolio composition information by the responsible entity or its market making agent to generate an internal, non-public ‘fair value’ as the reference price for market making may raise market integrity risks whenever this ‘fair value’ deviates from the publicly available iNAV. This includes circumstances where the only difference between the iNAV and the ‘fair value’ methodologies is the frequency of calculation.
To manage these risks responsible entities and market making agents should review their current arrangements and ensure that:

the input for market-making quotes is a reference price or other information that is publicly available
internal compliance and supervision arrangements are adequate
information barriers are established to ensure decisions to buy or sell units are not made by persons or systems with knowledge of the current portfolio holdings
there are adequate arrangements for identifying and responding to instances of substantial information asymmetry in the market, which may include cessation of market making activities or requesting a trading halt.

ASIC has also reviewed alternative frameworks in other jurisdictions for conducting market making in actively managed funds that do not disclose their portfolio holdings daily. We will continue to monitor international developments. ASIC’s current position is that, with the aforementioned controls in place, internal market making can be an appropriate framework to facilitate the trading of actively managed funds that do not disclose their full portfolio holdings daily on exchange markets.

Background

In July 2019, ASIC requested that exchange market operators not admit any managed funds that do not disclose their portfolio holdings daily and have internal market makers while it undertook a review during the remainder of the calendar year (refer ).

ASIC conducted an extensive review of current internal market making practices, including reviewing documents gathered using compulsory powers, meeting responsible entities and market making agents, speaking to other key stakeholders, and analysing trading data.

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