ASIC issues guidance for market intermediaries on pre-hedging
The Australian Securities and Investments Commission (ASIC) has published a letter to market intermediary CEOs setting out its guidance regarding pre-hedging practices in Australia.
Pre-hedging is a practice that occurs in financial markets and can help the effective functioning of markets by facilitating trades that could otherwise significantly impact market pricing.
ASIC acknowledges that pre-hedging has a role in markets, including in the management of market intermediaries’ risk associated with anticipated client orders and may assist in liquidity provision and execution for clients.
However, it can also create significant conflicts of interest between a client and the market intermediary which actively trades in possession of confidential information about the client’s anticipated order or trade.
ASIC anticipates market intermediaries that undertake pre-hedging will:
- document and implement policies and procedures on pre-hedging to ensure compliance with the law. They should ideally be informed by consideration of the circumstances when pre-hedging may help to achieve the best overall outcome for clients;
- provide effective disclosure to clients of the intermediary’s execution and pre- hedging practices in a clear and transparent manner.
- obtain explicit and informed client consent prior to each transaction, where practical, by setting out clear expectations for what pre-hedging is intended to achieve and potential risks such as adverse price impact. For complex and/or large transactions, the intermediary should take additional steps to educate the client about the pre-hedging rationale and strategy;
- monitor execution and client outcomes and seek to minimise market impact from pre-hedging;
- appropriately restrict access to, and prohibit misuse of confidential client information and adequately manage conflicts of interest arising in relation to pre-hedging. It is critical that appropriate physical and electronic controls are established, monitored, and regularly reviewed to keep pace with changes to the business risk profile;
- have robust risk and compliance controls, including trade and communications monitoring and surveillance arrangements, to provide effective governance and supervisory oversight of pre-hedging activity;
- record key details of pre-hedging undertaken for each transaction (including the process taken, the team members involved, and the client outcome) to enhance supervisory oversight and monitoring and surveillance; and
- undertake post-trade reviews of the quality of execution for complex and/or large transactions. This should be performed by independent and appropriately experienced supervisory team members.