As 2016 draws to a close, our FSR team has again reflected on their forecast for the significant regulatory developments in 2017.
This year, we highlight three global trends we anticipate will affect our clients across all markets in which they operate. We then take a closer look at some themes we expect to see over the coming year in our domestic market.
Before we launch into 2017, let’s pause to reflect on our predictions for 2016:
- “Culture” was the buzzword amongst global regulators, with a continued focus on “weeding out” corporate wrongdoing.
- Individual accountability received increased emphasis, with the commencement of the UK’s Senior Managers Regime, the implementation and codification by the DOJ of the principles set out in the Yates Memo and consultation regarding the SFC’s Manager in Charge regime in Hong Kong. By contrast, the response of ASIC and the Australian Government to suggestions that a formal Senior Managers regime (similar to the UK approach) be implemented in Australia was lukewarm.
- In Australia, there were continued rumblings regarding the possible introduction of a “product intervention” power for ASIC, following similar powers having been implemented in the UK, EU and US.
- Regulators continued their focus on behavioural economics to increase understanding of, and to better respond to, consumer and market problems. ASIC’s Deputy Chair Peter Kell explained in a speech delivered in October 2016 that this focus “started with a frustration with key elements of what we might call more ‘traditional’ approaches to retail financial market regulation … and behavioural economics helped to underline that we needed a more diverse regulatory toolkit”. The FCA recently commented on the subject that “we need to be able to rely on good quality evidence in order to understand the markets we regulate and the consumers we protect”.
- Remediation programs were also front and centre. ASIC released Regulatory Guide 256 concerning client review and remediation conducted by advice licensees. This highlighted the need to “address systemic issues caused by misconduct or other compliance failures, and have robust … processes in place to protect and compensate their clients”, and to “allocate adequate resources” to ensure timeliness and efficiency.
- Innovation and digitisation transformed the way our markets operate. As expected, our regulators are increasingly seeking to engage with the industry to understand and regulate this brave new world – and to emphasise their expectation that this technology be utilised to enhance risk and compliance capabilities (and not just profit margins).
What’s ahead for financial services regulation in 2017? Partners Luke Hastings, Fiona Smedley and Karen Anderson explain what financial services regulators will be focused on in 2017, both globally and in Australia.
Market misconduct – same, same but different as surveillance moves to T+0
Market misconduct will remain at the forefront of global regulators’ hit list in 2017 – but expect to see a continuing divergence in approach.
New regulations and standards are emerging in many jurisdictions, in response to both past misconduct and the proliferation of new trading platforms and technologies. Regulators are increasingly turning their attention to misconduct in the non-equities markets, particularly Fixed Income, Currency and Commodities.
The significant extraterritorial effect of the EU’s Market Abuse Regulation (MAR), in application since July 2016, is affecting the way in which transactions are conducted outside the EU by non-EU firms (particularly in relation to the sounding out of investors or shareholders). More generally, the MAR is necessitating substantial changes in controls, systems and procedures relating to the handling and disclosure of inside information, production of investment recommendations, and the detection and reporting of suspicious orders and transactions.
We may also begin to see enforcement action of the kind taken by the CFTC and FERC in relation to manipulative activity across the natural gas physical and derivatives markets in the US, given the MAR’s focus on manipulation across commodities and financial markets.
Despite increased co-operation between global regulators, significant differences in market abuse regimes in leading jurisdictions remain. In Europe, anyone who trades on a tip or recommendation that they know, or ought to know, is based on inside information can be liable for insider dealing – there is no need to establish that the tippee was subject to a duty of confidentiality, or that the tipper acted for personal gain. In US case law, non-corporate insiders who are tipped off about inside information can only be liable if the tipper breached a fiduciary duty for their personal gain, and the tippee knew or should have known about the breach or where the tippee agrees to confidentiality duties regarding the information. The US Supreme Court’s findings in United States v Salman seem likely to make prosecutions easier going forward.
We also expect to see a shake-up in surveillance practices driven in part by the MAR. The burden on the market will continue to increase as regulators demand more information and move closer to real time surveillance. The FCA is developing a new surveillance tool for detecting anomalous LIBOR submissions. From January 2018, European regulators will start to receive significantly enhanced pre- and post-trade reporting data. US regulators and at least two exchange operators are also developing in-house programs that bring together trading data and other data, and are testing artificial intelligence software being developed in-house for surveillance.
Regtech – do android regulators dream of electric sheep?
In 2017, expect to see global regulators moving towards the use of Artificial Intelligence (including distributed ledger technology and smart contracts) and biometrics as part of their compliance toolkit.
Fintech (including machine learning and predictive coding) has been a critical part of many firms’ front end processes in recent years. Firms have also benefitted from targeted use of big data to understand their customers better. This has revolutionised their marketing and behavioural analytics capabilities, enabling data matching and client targeting to drive results on the product dissemination side.
To date, regulators have been playing “catch-up” with technological innovation, which has generally run ahead of their ability to either analyse its effects or use it to their own advantage. In the current world of fast-paced globalisation, regulators need to be able to quickly and efficiently track a colossal number of transactions and assets, which often move across multiple borders and involve numerous counterparties.
Artificial Intelligence and biometric tools will be invaluable to regulators in collecting, analysing and responding to data, as well as predicting and detecting financial services wrongdoing. A key challenge will be navigating the increasing threat posed by cyber-attacks to ensure privacy and security are maintained. And after 2017, who knows? Perhaps traders of the future will be wired up to electrodes monitoring key biological markers, enabling global regulators to predict market volatility before crashes occur…
This increased use of regtech by regulators should not be construed as an implicit intention to suppress the use of fintech by firms. Indeed, the last year has demonstrated that regulators around the world (including ASIC) are actively promoting innovation. This can be seen by:
- the recent introduction of regulatory sandboxes in multiple jurisdictions (including Australia, the UK, Hong Kong and Singapore), enabling fintech start-ups to more effectively manage the regulatory risks of innovative offerings;
- general support for the development of peer-to-peer lending products and marketplaces;
- the Australian Government’s commitment to address the double taxation of digital currencies; and
- ASIC’s release of guidance on providing digital financial product advice to retail investors, which supports the development of the digital advice market in Australia, describing it as a “… convenient, low-cost option for retail clients.”
I say tomāto, you say tomăto, I say potāto, you say potăto...
In 2017, market participants operating across multiple jurisdictions will face the increasing challenge of divergence and discrepancies in the approach of regulators to investigations and enforcement.
While your internal investigation may be sufficient to satisfy the regulator in one jurisdiction that you are taking your compliance obligations seriously, the same investigation may not satisfy the regulator in another of the jurisdictions in which our clients operate. Similarly, ASIC’s efforts to promote proactive breach reporting and penalise failures to do so pale in comparison to Hong Kong’s stringent requirements in this area (these extend across borders and to group entities not themselves operating in Hong Kong).
Donald Trump’s victory will generate additional uncertainty as to the approach likely to be adopted by the SEC and DOJ given his apparent focus on de-regulation (while at the same time proposing to reinstate the Glass-Steagall Act, which prohibited commercial banks from participating in investment bank business). We expect to see a further divergence in strategy between US regulators and their global counterparts.
Mobility of key personnel between regulators in 2017 will see the continued influence of their individual approaches and views on enforcement on the mandate of their new organisations.
Mark Steward’s recent move from Hong Kong’s SFC to the UK FCA is an example, taking with him an approach to enforcement where suspected breaches are more likely to be considered by the regulator’s Enforcement function than left with Supervision. The regulatory musical chairs saw Thomas Atkinson move from the Ontario Securities Commission to take up Mr Steward’s former position as the SFC’s Director of Enforcement, prompting a swift change of focus from the SFC to streamline and reduce its unresolved investigations.
The culmination of Greg Medcraft’s term as ASIC Chairman in November 2017 will no doubt prove to be of interest to other regulators on the hunt for new talent, given his experience on both sides of the regulatory fence, as well as in global financial regulation through his Chairmanship of the IOSCO Board.
And the wolf blew and blew, but this house was made of culture
Regulatory preoccupation with culture is not going away. ASIC continues to promote rigorously the importance of good culture because “it is a key driver of how people behave within their organisations” and “can be a driver of poor conduct, and we regulate conduct”. One in three speeches given by ASIC Commissioners this year featured “culture” in the title.
Culture remains significant because the regulators see it as an early warning sign for potential misconduct. Early detection of poor culture, says ASIC, will enable it to intervene before misconduct occurs. One way ASIC hopes to achieve this is by incorporating considerations of culture into its audit inspection and surveillance programs. If “poor culture” is detected, ASIC will communicate its findings to the regulated firm. ASIC is not alone on this – APRA will be conducting pilot risk culture reviews, which it says will be a key component of its work in assessing risk culture.
But exactly how does ASIC plan to enforce and regulate culture? ASIC will continue to encourage corporations to formulate their own good cultural practices that are individualised and values-based, by incorporating cultural factors into its risk-based surveillances (particularly in key areas of focus including remuneration, recruitment, whistleblowing, conflicts of interest, complaints and remediation and corporate governance), continuing to raise awareness of the importance of culture and focusing on promoting good governance practices. ASIC Chairman, Greg Medcraft has rejected the notion of a “one size fits all” approach to culture. This change in ASIC’s approach is welcome.
Before you relax, there is some political impetus to prosecute poor corporate culture, with the terms of reference of the Senate Inquiry into foreign bribery including reference to the offence of failure to create a corporate culture of compliance. The Senate Inquiry is due to resume and report in mid-2017. This may be a catalyst for ASIC to lobby for a better culture “stick”, and some pressure for ASIC to use it.
“Not unsuitable” – navigating the double negative to responsible lending
ASIC’s focus on responsible lending shows no signs of abating in 2017. Institutions offering consumer credit will need to be ever vigilant to ensure that they are complying with their obligations, including assessing whether the proposed credit contract is “not unsuitable”.
ASIC has become increasingly active in its enforcement of responsible lending laws. Payday lenders, broker businesses and large providers of consumer credit were all in ASIC’s sights. Armed with $57m in extra funds, ASIC has foreshadowed that this focus will continue in the year ahead.
ASIC’s activities in the enforcement of the consumer credit laws have led to the cancellation or suspension of 33 credit licences, 19 banning orders, as well as the imposition of 87 infringement notices, in the year to 30 June 2016. It has also successfully obtained declaratory relief for breach of the responsible lending obligations from the Federal Court.
ASIC has also sought to engage with the consumer credit industry, including releasing reports which detail its expectations in relation to “interest only” home loan lending, completing a review of margin lenders and publishing an information sheet for marketplace (or peer-to-peer) lending. ASIC is currently completing a review of mortgage broker remuneration and has also foreshadowed a new focus upon credit card issuers.
Regulators competing to regulate competition
In 2017, we expect to see greater activity by the ACCC, ASIC and Parliament on competition issues in financial services. The emergence of competition issues in the financial services markets will heighten as firms continue to attract regulatory scrutiny for an apparent lack of robust competition.
Both the ACCC and ASIC are keen to promote innovation and strike a balance between protecting consumers and promoting competition and innovation. We expect to see continued cooperation between both regulators consistent with their MoU. In accordance with the FSI recommendations, we may see ASIC given a new competition objective (following the lead of such an objective for the UK FCA).
Barriers to entry into the banking market for smaller players, and increased access to account portability through open data, were the subject of discussion in Parliament. ACCC Chairman, Rod Sims, also confirmed recently that the ACCC was conducting two "in-depth" investigations into cartel behaviour by Australian banks – one of which has now become public.
At the same time as investigating banks for potentially collusive behaviour, the ACCC is effectively considering bolstering the bargaining power of four of the large banks. Earlier this year, CBA, NAB, Westpac and Bendigo and Adelaide Bank sought authorisation to enable them to engage in what would otherwise be prohibited collective negotiations with Apple and other providers of third-party digital wallet services – to offer their own digital wallets on iPhones and other devices. Apple is opposed to the application (having struck a deal with ANZ) and the ACCC has recently issued a draft determination proposing, on balance, to deny authorisation.
Now you see it, now you don’t
In 2017, we predict the debate around ASIC’s new product intervention power to take a more granular form, with a focus on:
- the scope of, and limits on, the power; and
- the policy that ASIC intends to apply when using, or threatening to use, the power which may be more important than the scope of the power itself.
The debate that we predicted for 2016 in relation to ASIC's new product intervention power has commenced, energised by the Treasurer's announcement in April that additional funding will be given to ASIC for it to implement “a product intervention power to enable ASIC to respond to market problems in a flexible, timely, effective, and targeted way”.
While waiting for Treasury to release fuller details of the scope of this new power, we have been working with industry groups such as the Financial Services Council and industry participants. Together with our overseas colleagues, we are drawing on lessons learned from the application of intervention powers overseas, particularly in the UK, to work through how the power may be implemented in Australia. Our focus has been on identifying mechanisms that would be appropriate to balance consumer needs while providing a degree of business certainty for product issuers and distributors, and without stifling innovation.
While the current political environment favours the introduction of new and heavier regulation, maintaining industry and consumer confidence in the appropriateness of this regulation is as imperative as ever.
A bigger truncheon for ASIC
The recently announced ASIC Enforcement Review Taskforce is this year’s stand-out development in financial services regulatory enforcement, and one which will have an impact in 2017 and beyond.
The Taskforce will be led by a Panel of representatives from government agencies including ASIC and the Commonwealth Director of Public Prosecutions. The Panel will be supported by an Expert Group “drawn from peak industry bodies, consumer groups and academia”. However, of the Expert Group members announced to date, none are from industry bodies, and there is yet another consultation group to provide input from international and domestic regulators. We hope this is addressed in the short term.
The terms of reference are very broadly drawn. They include the level of penalties and types of remedies that ASIC can seek, widening the use of infringement notices, establishing a peer review panel for financial advisers, ASIC’s powers in respect of certain licensees, and the scope of breach reporting.
ASIC will no doubt be seeking a significant increase in its enforcement abilities and the remedies which it has available. In particular:
- Given ASIC’s long term lobbying for an increase in penalties, we expect that this is a theme ASIC will continue, and that it is likely ASIC will succeed in its strategic aim.
- ASIC will strongly advocate for the creation of the peer review panel and for the use of infringement notices to be enhanced. This will be particularly attractive to ASIC given the Government’s funding of ASIC’s work in respect of financial advisers and the need for ASIC to be seen to deliver outcomes from that funding.
- Australian financial services licensees and Australian credit licensees are likely to be subject to further powers for ASIC to cancel those licences. It is also apparent that ASIC seeks greater power to intervene in those businesses, and this may extend to ASIC restricting the ability of businesses to serve particular markets or offer particular services. Such a power reminds us of the “macroprudential” actions that APRA takes.
- Greater information may become available to ASIC in its investigations through the use of search warrants, and we expect ASIC will seek to significantly widen breach reporting obligations.
About the authors
This article was written by Luke Hastings (Regional Head of Practice – Dispute Resolution, Australia), Andrew Eastwood (Partner, Sydney), Fiona Smedley (Partner, Sydney), Karen Anderson (Partner, London), Clive Cunningham (Partner, London), Will Hallatt (Partner, Hong Kong), Andrew Procter (Partner, London), Ruth Overington (Partner, Sydney), Steven Rice (Special Counsel, Sydney), Simone Fletcher (Senior Associate, Sydney), Tania Gray (Senior Associate, Sydney), Kate Tonkin (Senior Associate, Melbourne), Brendan Donohue (Solicitor, Melbourne), Jonathan Goodliffe (Professional Support Lawyer, London), Geng Li (Associate, New York) and Alexandra Payne (Solicitor, Sydney).
The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2020