Compliance: Theory and Practice in the Financial Services Industry

12C. ASX 24 Futures Broking

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Outline

   Introduction
   Admission and Accreditation
   General Obligations of Participants
   Client Documentation
   Client Segregated Accounts
   Trading Rules
   Confirmations
   Margin Calls
   Error Trades

Unless otherwise indicated, all references in these lecture slides to MIR and OR are to the ASX 24 MIR and the ASX 24 OR respectively. We looked at the ASX 24 MIR and OR relevant to front running in lecture 3; market manipulation, order records and client order precedence in lecture 4; and confidentiality, telephone taping and self-reporting obligations in lecture 9.

 


Introduction

ASX 24 Markets and Clearing Houses
•     ASX 24 (formerly the Sydney Futures Exchange) - trades futures and options contracts
•     ASX Clear (Futures) - clears and settles futures and options contracts

Click here to access the ASX 24 Operating Rules (OR) and the ASX Clear (Futures) Operating Rules (CR).

Classes of ASX 24 Participants
•    Trading Participant (see OR 1000)
•    Clearing Participant (see CR 4)
•    Principal Trader (see OR 1001)

A 'Principal Trader' is a trading participant with trading permission for one or more ASX 24 products which limits it to trading on its own behalf.

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Admission and Accreditation

OR 1000 - Trading Participant Admission Requirements
For an applicant to be eligible for admission as a trading participant, the applicant must lodge an application in the form prescribed by the Exchange and satisfy the Exchange that it:
•     is a body corporate carrying on business in its own right and not as a trustee of a trust;
•     holds an AFSL which authorises it to carry on its business as a trading participant (unless such a licence is not required by the Corporations Act);
•     is of high business integrity;
•     has adequate resources and processes to comply with its obligations as a trading participant under the Operating Rules;
•     has adequate resources and processes to prevent any action or inaction which might result in a market for a product not being both fair and orderly or which might interfere with the operational efficiency or proper functioning of the trading platform; and
•     has in place and will maintain adequate clearing arrangements including, where relevant, a clearing guarantee from a guarantor clearing participant.

MIR 2.4.1 requires a market participant that is a foreign entity and that does not hold an AFSL, before it enters into any market transactions, to provide to ASIC a deed for the benefit of and enforceable by ASIC and the other persons referred to in CA s659B(1) submitting to the non-exclusive jurisdiction of the Australian courts and covenanting to comply with any order of an Australian court in respect of any matter relating to the activities or conduct of the market participant in relation to the ASX 24 market or in relation to financial products traded on that market.

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General Obligations of Participants

OR 1400 – Ongoing Requirements
A trading participant must at all times comply with the following general requirements:
(a)   continue to satisfy the applicable admission requirements;
(b)   comply with any conditions imposed on a trading participant under the Rules;
(c)   comply with the Rules, directions, decisions and requirements of the Exchange;
(d)   not dispose, transfer, lease, assign or encumber any rights or obligations under the Rules, except as expressly permitted by these rules or with the prior written approval of the Exchange; and
(e)   notify the Exchange of the matters set out in the Procedures in the time and manner set out in the Procedures.

Under Procedure 1400(e), a trading participant must notify the Exchange, among other things, of: (a) any change of name or address; (b) any appointment, removal or resignation of a director; (c) any change to any licence or other authorisation which authorises it to carry on its activities as a participant; and (d) any material change in information concerning its business as a participant from that previously provided to the Exchange.

MIR 2.2.1(1) - Trading Limits
A market participant must demonstrate prudent risk management procedures, including, but not limited to:
(a)   set and document appropriate pre-determined order and/or position limits on each of its client accounts, including a volume per order limit, an aggregate loss limit and an aggregate net session limit, based on the market participant’s analysis of the clients’ financial resources or other relevant factors;
(ab)   set and document appropriate pre-determined order and/or position limits on each of its house accounts, including a volume per order limit, an aggregate loss limit and an aggregate net session limit, based on the market participant’s analysis of its financial resources or other relevant factors;
(b)   set and document maximum price change limits;
(c)   the limits determined in (a), (ab) and (b) must be input by a market participant’s risk manager into trading platform account maintenance and will be established as preset accounts;
(d)   limit setting capability must exist in the market participant’s order system which reflects prudent account risk management and the order system must have order rejection capability where orders are in excess of limit parameters set by the market participant;
(e)   the market participant may amend the pre-determined order and/or position limit based on the market participant's analysis of the clients' financial resources (in the case of a client account) or its financial resources (in the case of a house account) or other relevant factors; and
(f)   orders in excess of the agreed pre-determined limits must be rejected by the market participant’s order system and may be rejected by the trading platform.

Breach of MIR 2.2.1(1) attracts a maximum penalty of $1,000,000.

MIR 2.2.1(3) - Obligations Prior to Client Connection
Prior to permitting any client to connect to a terminal the market participant must:
(a)   satisfy itself that the client has the necessary skills, facilities and procedures to operate such a facility;
(b)   satisfy itself that the client understands the risks and obligations attached to the use of such a facility;
(c)   ensure that each order so placed, and any order system complies with the MIR;
(d)   provide appropriate controls on the connection of its clients and its staff to such systems;
(e)   provide appropriate controls on the access to passwords of its clients and its staff to such systems; and
(f)   ensure appropriate controls are implemented for the security of its clients' premises and physical access of its clients and its staff to such systems.

MIR 2.2.1(2)(a) provides that any market participant who has permitted its client to connect to a terminal will be responsible under the MIR for any orders entered through the terminal by the client.

MIR 2.2.1(2)(b) empowers ASIC to give a notice to a market participant requiring it to terminate a client connection, either generally or in relation to a particular individual, client, system or device or class of system or device.

Breach of MIR 2.2.1(3) attracts a maximum penalty of $1,000,000.

MIR 2.2.1(4) - Obligations Prior to House Connection
Prior to connecting to a terminal for the purpose of trading for a house account, and at all times while connected to a terminal for the purpose of trading for a house account, a market participant must:
(a)   have the necessary skills, facilities and procedures to operate such a facility;
(b)   understand the risk and obligations attached to the use of such a facility;
(c)   ensure that each order so placed, and any order system complies with the MIR;
(d)   provide appropriate controls on the access to passwords of the market participant and its employees to such systems; and
(e)   ensure appropriate controls are implemented for the security of its premises and physical access of the market participant and its employees to such systems.

MIR 2.2.1(2)(ab) provides that any market participant who has connected to a terminal for the purposes of trading for a house account will be responsible under the MIR for any orders entered through the terminal.

MIR 2.2.1(2)(b) again empowers ASIC to give a notice to a market participant requiring it to terminate a house connection, either generally or in relation to a particular individual, system or device or class of system or device.

Breach of MIR 2.2.1(4) attracts a maximum penalty of $1,000,000.

MIR 2.2.2(1) – Concentration of Risk
A market participant other than a principal trader must not permit any one client to represent such a percentage of the trading by the market participant as may prejudice or diminish the ability of the market participant to meet its obligations under the Market Integrity Rules and at law.

For these purposes, "client" includes all persons, partnerships and corporations related to, associated with or affiliated with the client or otherwise financially dependent upon the client (MIR 2.2.2(2)).

Breach of MIR 2.2.2 attracts a maximum penalty of $100,000.

MIR 2.2.3 – Prohibited Employment
A market participant must not employ any person who has been a market participant (or a director, partner, employee or representative of a market participant) if that person has to the knowledge of the first mentioned participant taken part or been concerned in any failure to comply with the Market Integrity Rules or the Operating Rules, which failure has been found to have occurred by ASIC or the Exchange (as the case may be).

For these purposes, the words "to employ" and cognate expressions include agreeing or arranging with a person for that person to act as the market participant's representative to advise or solicit instructions from other persons or to trade on the market participant's behalf in relation to dealings in futures contracts (MIR 2.2.3(2)).

Breach of MIR 2.2.3 attracts a maximum penalty of $1,000,000.

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Client Documentation

Client Agreements
•     A market participant must have in force, prior to the commencement of trading for a client, a duly signed agreement with that client, containing the prescribed minimum terms (MIR 2.2.5(1)).
•     A trading participant must include the minimum terms specified in the Procedures in client agreements in the circumstances set out in the Procedures. The client agreement may include other terms and conditions agreed between the trading participant and the client, provided those terms are not inconsistent with the terms set out in the Procedures. To the extent of any inconsistency, the terms set out in the Procedures will prevail (OR 3801).

The prescribed minimum terms under MIR 2.2.5(1) include:

(a)    

the client will upon the participant's request, provide all information and documentation relevant to the client's trading on the Exchange, to the participant and the participant is authorised by the client to provide the information and documentation to ASIC;

(b)    

various acknowledgements in relation to margin calls;

(c)    

an acknowledgment by the client that the client's telephone conversations with the participant can be recorded by the participant;

(d)    

an acknowledgement of the right of the participant to refuse to deal on behalf of the client; and

(e)    

various acknowledgements about termination and closing out of positions.

MIR 2.2.5(1) does not apply to a principal trader or where the client is another market participant and the Market Operating Rules deem an agreement to have been entered into which contains the prescribed minimum terms (as the ASX24 Operating Rules do under Operating Rule Procedure 3801). It also doesn't apply where the market participant is performing execution business only and has an agreement in place with the client that incorporates the provisions set out in the International Uniform Brokerage Execution Services ("Give-Up") Agreement 2008 (both client and trader versions) (MIR 2.2.5(2)).

Breach of MIR 2.2.5 attracts a maximum penalty of $100,000.

Under ASX 24 Operating Rules Procedure 3801, a client agreement required under MIR 2.2.5 in relation to futures market contracts must incorporate the following minimum terms:

(a)    

the client and participant are bound by the ASX 24 Operating Rules and the customs, usages and practices of the ASX 24's markets;

(b)   

the client will upon the participant's request, provide all information and documentation relevant to the client's trading on the Exchange, to the participant and the participant is authorised by the client to provide the information and documentation to the Exchange;

(c)    

any benefit or right obtained by any participant upon registration of a contract with ASX Clear (Futures) by way of assumption of liability of ASX Clear (Futures) under any contract or any other legal result of such registration is personal to the participant and the benefit of such benefit or right does not pass to the client;

(d)    

in relation to all trades conducted on the Exchange by the participant and all contracts registered by the participant with ASX Clear (Futures), the client has no rights, whether by way of subrogation or otherwise, against any person or corporation other than the participant;

(e)    

an appointment by the client of the managing director of ASX Clear (Futures) as the client’s attorney to do all things necessary to transfer any open position held by the participant on the client’s behalf to another participant where the participant status of the participant has been suspended or terminated; and

(f)    

an acknowledgement by a client who has access to electronic order facilities about the use they can make of Exchange data.

OR 3801 and the accompanying Procedure do not apply to a principal trader. Nor do they apply where the client is another trading participant, in which case an agreement containing the above terms is deemed to have been entered and come into effect immediately upon the trading participant accepting the first instruction from the client to enter a contract on the Exchange’s markets. They also do not apply where the trading participant is performing execution business only and has an agreement in place with the client that incorporates all the terms of an agreement determined by the Exchange to be appropriate for use when a trading participant is performing execution business only. For these purposes, the Exchange has determined that the provisions set out in the International Uniform Brokerage ("Give-Up" Agreement) (both client and trader versions) approved from time to time by the Futures Industry Association and Futures and Options Association is appropriate for use by a trading participant when performing execution business only.

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Client Segregated Accounts

MIR 2.2.6(a) - Requirement to Have Account
A market participant who holds client monies must comply with the following:
(i)   All money received by the market participant from its clients or by a person acting on behalf of the client under the Market Integrity Rules or Operating Rules must be deposited in an account maintained by the market participant and designated as a clients' segregated account.
(ii)   If the account is operated outside Australia and the law in force in the jurisdiction where it is maintained requires the account to be designated in a particular way, the market participant must designate the account in that way.
(iii)  

Where omnibus accounts are operated by a market participant (eg on behalf of another broker), a house account and client account are to be maintained separately at all levels in the chain to the clearing and settlement facility level.

(iv)   A market participant must not net off the client account against the house account.

For the purpose of Rule 2.2.6, the expression "client" excludes a related body corporate or a division of the participant (MIR 2.2.6(l)).

A market participant is prohibited from making any agreement with a client that the client's money is not to be held or does not need to be held in a segregated account for the benefit of the client (MIR 2.2.6(g)).

A market participant is also prohibited from using a clients' segregated account to meet any initial or variation margin liabilities which relate to trading by that participant on its own behalf or on behalf of a related corporation (MIR 2.2.6(j)).

Breach of MIR 2.2.6 attracts a maximum penalty of $1,000,000.

MIR 2.2.6(b) - Type of Money to be Paid into Account
Only the following monies are permitted to be paid into a clients' segregated account:
(i)   all money received by the market participant from its client or by a person acting on behalf of its client;
(ii)   interest on the amount from time to time standing to the credit of the account;
(iii)   interest or other similar payments on an investment, and the proceeds of the realisation of an investment; and
(iv)   any other money as required by the Market Integrity Rules or Operating Rules or the law to be paid by the market participant into a clients' segregated account.

 

MIR 2.2.6(c) - When Money Must be Paid into Account
The money must be paid into a clients' segregated account on the day it is received by the market participant, or on the next business day.

 

MIR 2.2.6(d) - Permitted Withdrawals
Withdrawals from a clients' segregated account made in any of the following circumstances are permissible:
(i)   paying margins and the settling of dealings;
(ii)   making a payment to, or in accordance with the written direction of, a person entitled to the money;
(iii)   defraying brokerage and other proper charges;
(iv)   paying to the market participant money to which the market participant is entitled, whether at law or pursuant to the Market Integrity Rules or Operating Rules; and
(v)   making a payment that is otherwise authorised by law.

A market participant is required at all times to maintain such accounting records as accurately indicate each withdrawal from a clients' segregated account (MIR 2.2.6(k)).

MIR 2.2.6(h) - Permissible Investments
Where a market participant invests money from a clients' segregated account, the following kinds of investments may be made:
(i)   investment in any manner in which trustees are for the time being authorised by law to invest trust funds;
(ii)   investment on deposit with an eligible money market dealer;
(iii)   investment on deposit at interest with an Australian ADI or an approved foreign bank;
(iv)   the acquisition of cash management trust interests;
(v)   investment in a security issued or guaranteed by the Commonwealth or a State or Territory;
(vi)   investment on deposit with a licensed clearing and settlement facility; or
(vii)   an investment in accordance with the specific direction of a client.

MIR 2.2.6(i) requires that a market participant must, prior to investing any amount, obtained the client's written agreement to the following matters:

(a)  

the making of the investment;

(b)  

how earnings on the investment are to be dealt with;

(c)  

how the realisation of the investment is to be dealt with;

(d)  

how any losses made on the investment are to be dealt with; and

(e)  

the fee (if any) that the participant proposes to charge for the investment,

and that such investment must be readily realisable and no less than 50% of monies invested must be on 24 hour call.

 

MIR 2.2.6(f) - Top-up Requirement
(i)   Where 5 clear business days (inclusive of the day of the call) after a call has been made on a client for initial or variation margin in accordance with the Operating Rules, or such call should have been made in accordance with those Operating Rules, the call which was or should have been made has not been satisfied by payment of monies into a clients' segregated account or lodgement of cover, then the market participant shall pay into the clients' segregated account an amount of money not less than either:
  (A)   the liability of the client under such a call; or
  (B)   the amount which the market participant would be obliged to call the client on the day after 5 clear business days (inclusive of the day of the call) has elapsed, whichever is the lesser.
(ii)   Subject to MIR 2.2.6(f), such monies may only be withdrawn in accordance with MIR 2.2.6(d) and only after such monies have been received by the market participant.
(iii)   A market participant must pay into the clients' segregated account after 5 clear business days any amount (which has not been met by the client) which arises as a result of debit balances of a client resulting from realised losses or otherwise.

MIR 2.3.2(1) requires a market participant to perform an accurate reconciliation, by 7pm on the business day after the business day to which the reconciliation relates, of the aggregate balance held by it at the close of business on each business day in clients' segregated accounts maintained under MIR 2.2.6 and the corresponding balance as recorded in the market participant’s accounting records. MIR 2.3.3(1) requires a market participant to perform accurate monthly reconciliations of client's segregated accounts.

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Trading Rules

MIR 3.1 – Improper Trading Practices
A market participant must not:
•     withhold an order with an intent to obtain a counterparty/counterparties or withhold two or more orders with the intent to avoid trading with the market (MIR 3.1.8);
•     withdraw orders in whole or in part for the benefit of another person (MIR 3.1.9);
•     arrange the details of a potential trade between two or more parties unless market participants have been made generally aware of all relevant details of the potential trade, or unless specifically permitted otherwise under the Market Integrity Rules (MIR 3.1.10); or
•     execute or attempt to execute trades with the intent to exclude other market participants or their representatives (MIR 3.1.11).

See generally OR 4013 and accompanying Procedures for the phases of trading on the ASX 24 market.

The prohibition against withholding orders in MIR 3.1.8 is subject to MIR 3.3.1(1)(a) (pre-negotiated business orders) and 3.4.1(b) (block trades).

The prohibition against pre-arranging trades in MIR 3.1.10 is also subject to MIR 3.3.1(1)(b) (pre-negotiated business orders) and 3.4.1(a) (block trades).

Rules for "pre-negotiated business orders" are set out in OR 4401 and accompanying Procedures. Rules for "block trades" are set out in OR 4820 and accompanying Procedures.

Breach of MIR 3.1.8 attracts a maximum penalty of $1,000,000 and MIR 3.1.9-3.1.11 attracts a maximum penalty of $100,000.

MIR 3.1.13(1) - Acting in Accordance with Client Instructions and Client’s Best Interests
A market participant must:
(a)   act on behalf of a client only in accordance with that client's instructions, unless to do so would be contrary to the Rules; and
(b)   not act in a manner which has, or is intended to have, a detrimental effect, on the client's best interests.

For these purposes, the expression "client" includes a related body corporate or a division of the market participant which is separate from the market participant’s futures division (MR 3.1.13(2)).

Breach of MIR 3.1.13 attracts a maximum penalty of $100,000.

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Confirmations

•     Nothing in ASX 24 Market Integrity Rules or Operating Rules.
•     Governed by CA requirements.

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Margin Calls

MIR 7.2 - Margin Calls
•     As soon as possible after the execution of the client’s instructions, a trading participant must call at least the minimum initial margin that is determined from time to time under the Clearing Rules (MIR 7.2.2(1)).
•     In calculating the amount of initial margin, a trading participant must not offset the initial margin on another contract due by the client to the trading participant unless that other contract is for the opposite position in the same delivery month and in respect of the same commodity (MIR 7.2.2(2)).
•     A trading participant must not accept anything but cash in satisfaction of initial margin from a client, unless the trading participant has agreed to accept and has received cover by way of approved securities (MIR 7.2.2(4)).
•     A trading participant must call variation margin from the client when the client has a net debit variation margin position, unless the client is a clearing participant and the contracts are registered with the clearing facility in the name of that clearing participant (MIR 7.2.3(1)).
•     A trading participant's client agreement must:
  •     provide that a client's liability for initial margin arises upon the execution of the client's instructions irrespective of when a call is made for it, and that liability for variation margin arises at the time that variation comes into existence, again irrespective of when a call for variation margin is made (MIR 7.2.4);
  •     provide that calls for initial and variation margin must be satisfied by payment unless the participant has agreed to accept approved securities (MIR 7.2.5(1));
  •     permit the trading participant to retain the client's approved securities until the client's liability to the participant is extinguished or, if it is not extinguished, permitting the participant to realise the approved securities and apply the proceeds against the client's liability (MIR 7.2.5(2));
  •     provide that time shall be of the essence in respect of payment or lodgement under Part 7.2 (MIR 7.2.6(3)); and
  •     provide that the trading participant shall not be liable to the client for any loss sustained by the client as a result of the trading participant closing out in accordance with MIR 7.2.8(1) (MIR 7.2.8(2)).
•     A trading participant must ensure the liability of a client for initial margin is covered at all times (MIR 7.2.5(3)).
•     The time for payment of calls by a client of a participant must not be greater than 24 hours for a client within Australia or 48 hours if the client's address is outside Australia and a trading participant must not provide credit for a client beyond those periods (MIR 7.2.6(1) and (2)).
•     A trading participant must immediately close out a client's positions to the extent necessary to meet an unpaid call by a client, if the client has not paid a call by the required 24 or 48 hour time period (MIR 7.2.8(1)).

MIR 7.2.2(3) provides that nothing in MIR 7.2.2(1) prevents a trading participant from calling an amount higher than the minimum initial margin.

MIR 7.2.3(2) provides that where the amount of a variation margin call in rule 7.2.3(1) would be $1,000 or less, the making of such a call shall be at the discretion of the trading participant.

MIR 7.2.8(3) provides a trading participant with a discretion in relation to closing out a client's positions taking into account the financial position and expertise of the client, whether any genuine attempts to pay the call have been made and whether a third party's acts or omissions caused the failure to pay.

Breach of the margin obligations in MIR 7.2 attracts a maximum penalty of $1,000,000.

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Error Trades

MIR 2.2.4(3) – Error Records
A market participant must maintain a separate record of all error trades for a period of not less than 5 years from the date of a trade, containing the following information:
•    

a description of the trade including the deal number supplied by the Exchange (if any);

•     the name of the representative responsible for the error trade;
•     the name of the representative responsible for the execution of the trade;
•     a detailed explanation as to how the trade occurred, including details of the original client order (if any) which precipitated the error;
•     any subsequent action taken by the participant in relation to that trade; and
•     the financial result of the trade.

There is a procedure for cancelling error trades before settlement in OR 3200. Effectively this requires quick agreement between the brokers involved. If they can’t agree or if the broker executing in error does not want to employ that process, the error trade gets taken on as a house trade and then a reversing trade done.

The former SFE Procedures 2.2.23 used to state that participants should have a policy to close out errors as soon as they become aware of the error and that traders should not use client orders to work a "positive error". ASIC has said that it will seek to follow the published interpretations contained in pre-existing SFE procedures, including Procedure 2.2.23, but will look to review them and issue replacement ASIC Guidance Notes in due course (see Regulatory Guide 214 Guidance on ASIC market integrity rules for ASX and ASX 24 markets, at para 57-58).

Regulators tend to look very closely at error accounts. They can be a repository of all sorts of improper trades eg attempts by house traders to hide bad trades as execution errors, improper trading on employee or related accounts, attempts to pre-arrange trades that don’t come off etc. Compliance should monitor error accounts closely.

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