The freeze on new active ETFs entering the market was implemented in July, with the regulator raising alarms about “internal market makers” and non-disclosure of daily holdings.
Internal market making occurs when the fund’s responsible entity acts as the market maker for its own fund on the fund’s behalf, either by submitting bids and offers itself or by engaging a transaction agent that executes its instructions.
Funds using the model tend not to disclose their portfolio holdings daily and are also usually actively managed funds.
But funds engaging in internal market making only represent around 6 per cent of funds under management in exchange-traded products.
One of the key outcomes to come out of ASIC’s review is that several funds’ internal market making practices used in Australia raised integrity concerns.
The regulator noted internal market makers have access to non-public information when making decisions about the market quotes they provide.
While the review was taking place, BlackRock supported the regulator’s scrutiny, with the asset management giant saying it has held back from entering the Australian active ETF market due to lax transparency standards.
But the regulator has since decided that with controls in place, internal market making can be an appropriate framework for the trading of actively managed funds that do not have daily disclosure.
In some models, market-maker quotes are lead indicators of changes to fund portfolio values rather than a response to publicly available information such as indicative net asset values (iNAVs).
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 integrity risks, ASIC said, particularly whenever the “fair value” in question deviates from the publicly available iNAV.
While it hasn’t banned the practice, ASIC has recommended responsible entities and market making agents should review their current arrangements.
The regulator has asked that they ensure that:
- 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 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 said it has also reviewed alternative markets in other jurisdictions for conducting market making in actively managed funds that do not disclose their portfolio holdings daily.
There has been regulatory approval in the US and Hong Kong of alternative frameworks.
The Australian regulator has indicated it will continue to monitor international developments.
