Internal market making occurs when an exchange-traded managed 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 generally do not disclose their portfolio holdings daily and are also usually actively managed funds, ASIC added.
Internal market making funds represent around 6 per cent of funds under management in exchange-traded products.
The pause on new listings of these products will remain in place until further notice, the regulator reported, giving it time to consider the “appropriate regulatory settings” along with having further consultation during the second half of the year.
There have been recent international developments in internal market making, including regulatory approval in the US and Hong Kong of alternative frameworks.
ASIC has observed the market for ETFs is changing, with substantial recent growth in actively managed funds, continued innovation in fund structures and investment strategies among actively managed fund proposals, and changes to the composition of market makers and the nature of pricing models.
In a report on ETPs published in August, ASIC noted: “The use of internal market making to provide liquidity in an ETP presents a number of conflicts of interest that must be carefully managed.”
The review also said: “As the actual portfolio composition is not publicly disclosed each day, it is difficult for an independent market maker (who does not know the portfolio composition) to compete in market making.
“This may tend to lead to spreads for non-transparent active quoted managed funds which are larger than those for a transparent ETP with underlying securities in the same asset class. A more concentrated underlying portfolio is also likely to contribute to wider relative spread.”
It had recommended issuers who use internal market making should be transparent about the conflicts to investors and also disclose internal market making profits separately in periodic statements.
The halt includes products with admission applications currently being considered.
Existing actively managed exchange-traded managed funds as well as other investment products that do not use internal market makers will not be impacted.
