Category: Financial Markets

Wither The Bond Rally?

Speculation by market commentators that the 35-year bond rally is finally coming to an end is nothing new, writes Nikko Asset Management’s Roger Bridges in InvestorDaily today.

Given that the yields on these securities are now negative, it is hard to believe that they can continue to drive global bond yields much lower.

Unless, for some reason, US Treasuries begin to narrow from current spread levels, it is hard to be too bullish on bonds.

However, I don’t believe that means we should necessarily be bond bears. Even if the great bond rally is drawing to a close, that doesn’t mean that it is now going to reverse violently.

It is more likely that we will see a period when bonds trade within a range, with any rally reversing fairly quickly and any sell-off likely to meet the same fate.

Potential causes of a bond sell-off

In my view, it is unlikely that a sell-off will emanate from US Treasury movements as it did in 2008.

JGBs and Bunds are more likely to be the catalyst for higher global bond yields, as they were in 2003 (JGBs) and 2014 (German Bunds).

Chart 1: 10-year JGB, Treasury and Bund yields

The 2013 ‘taper tantrum’ saw the sell-off in US Treasuries driving global bond yields.

Since then, however, global bond markets (including the US) have been very much dominated by Bund and JGB movements, with their spreads to US Treasuries widening to their current level of around 1.6 per cent for both markets (see chart 2).

Chart 2: Spread of JGB and Bund yields to US Treasuries

This rally in Bunds and JGBs is being driven mainly by the quantitative easing programs of the European Central Bank (ECB) and the Bank of Japan (BoJ).

However, the performance of the bank sector in both those markets also helps to explain bond movements.

Chart 3 shows that US Treasury yields have been closely correlated to the performance of European banks, particularly in the past year.

Chart 3: Relationship between 10-year US Treasuries and European bank bond yields

In July, we saw a sell-off in JGBs due to market disappointment over the lack of a rate cut from the BoJ.

Since this meant that interest rates weren’t pushed any further into negative territory, Japanese banks outperformed, causing longer-dated JGBs to sell off.

This sell-off was largely contained within the Japanese market and didn’t have much effect on US Treasuries since they were still being supported by the underperformance of European banks.

US Treasuries currently look expensive

Ten-year US Treasuries currently appear quite expensive due to negative interest rates in Germany and Japan and the continuing underperformance of those countries’ banks.

What would be fair value for US 10-year rates? According to the Laubach-Williams model, an estimate for the current neutral level of the Fed funds rate is around 0.18 per cent.

Adding the Federal Reserve’s target of 2 per cent for inflation would give a fair value rate at around 2.2 per cent.

Interestingly, that is in line with the Federal Reserve Bank of New York model for the term 10-year structure of short-term interest rates.

Based on this, the NY Fed’s model sees the current term premium for US 10-year Treasuries at -0.6 per cent.

However, the historical average for the Fed’s favourite measure of inflation is only 1.7 per cent and not 2 per cent, which is not very different from the market’s current pricing for inflation in 5 years’ time at 1.68 per cent.

This back-of-the-envelope calculation puts an upper limit on the current fair value for US Treasuries at between 2 and 2.2 per cent, focusing only on the US and ignoring interest rates prevailing globally.

Bunds and JGBs will be the likely culprits in any sell-off

US rates have been fairly range-bound in recent weeks. Hedging costs have increased as a result of the recent rise in 3-month LIBOR for both Euro- and Yen-based investors, which in turn has reduced the hedged return on US 10-year Treasuries for foreign investors (see chart 4).

Chart 4: Return on US Treasuries from 3-month currency hedging for foreign investors

This has resulted from regulatory changes on money market funds which will be implemented in October and so the impact is likely to reverse unless the Fed starts raising interest rates.

The impact on the long end of the US Treasury curve has been minimal, which may suggest that a gradual interest rate tightening by the Federal Reserve may also have limited long-term impacts on that end of the curve.

Over the past three months, the JGB sell-off and the rise in LIBOR rates have had limited effects on US 10-year bond yields.

Since the Federal Reserve is likely to be slow in raising rates, this may indicate that Fed hikes will be tolerated and may in fact provide buying opportunities.

The real risk is that we see both Bunds and JGBs sell off together, reversing the reason for much of the recent bond rally.

The likely cause of such a sell-off would be a reversal of local bank underperformance, which could result from a change in European policy on how non-performing loans are handled or if Japan changes its policy on negative interest rates such that local banks will be less negatively affected.

Perhaps we have seen the end of the bond rally, but a severe reversal is unlikely, in my view. One potential strategic trade in the current environment could be to go long US Treasuries against either JGBs or Bunds.

If the market rallies, then it is likely that this will happen via a US spread narrowing.

A major sell-off is also likely to see spread narrowing as US Treasuries are probably closer to fair value than JGBs or Bunds, the major drivers of the bond market rally in recent years.

Roger Bridges is a global rates and currencies strategist at Nikko Asset Management.

Reporting Season Shows Impact of Low-growth Era

According to The West Australian, there are two main lessons from the 2016 earnings season. First, the Australian economy is well and truly in a low-growth era and second the earnings-growth potential of some of the nation’s favourite blue-chip stocks is not invincible. The economy is now basically a zero-sum game and few companies have any pricing power left. For example, CBA chief executive Ian Narev admitted last week over the medium term the bank could only grow profits at roughly the same rate as GDP.

This is creating an inter-generational structural problem, because policy overly skewed to supporting the housing market is continuing the Australian ‘tradition’ of making the community debt slaves to the banks.

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Solid dividend growth has proved not to be nearly as bankable as many income-dependent investors believed.

The market severely punished companies that missed forecasts or downgraded guidance but, by and large, they have ignored the steady lowering of the earnings bar over which companies are expected to jump.

No doubt most long-term shareholders have not yet lost faith in the profit potential of Wesfarmers, Commonwealth Bank and its three major bank rivals, the corporate behemoths that straddle the Australian continent like no others.

But it can no longer be argued they do not carry real downside profit risks as wage growth limps along at record lows, the workforce is increasingly “casualised” and world-beating household debt levels nudge 125 per cent of GDP, all of which pose severe risks to bad debts and weak spending trends.

This means the economy is now basically a zero-sum game and few companies have any pricing power left.

The management fad of cost-cutting to profit growth is perpetuating a negative feedback loop into deflating nominal GDP growth — growth not adjusted for inflation — that has begun to bite hard into revenue and profit potential in Australia and around the world.

One company’s cost saving is another’s lost revenue but there is little “fat” left to be cut after three years of corporate austerity to pay the juicy dividends investors have demanded.

CBA chief executive Ian Narev admitted last week over the medium term the bank could only grow profits at roughly the same rate as GDP, and that’s true for a Wesfarmers and many of the bigger companies too.

Nominal GDP roughly equates to the sum of the transactions upon which all companies can draw revenues and profits, and it has has sunk to a 60-year low of 2.1 per cent, a third to a quarter of levels prevailing prior to 2007.

That’s why even with a dominant national consumer footprint Wesfarmers’ Coles managed just 4.2 per cent revenue growth as rival Woolworths headed headed into a tailspin, reporting a 1.2 per cent drop in revenue last year. The average of their sales growth equates to nominal GDP growth.

CBA once demanded a 20 per cent price-earnings valuation premium to its rivals but the country’s biggest lender grew earnings just 2 per cent as the banking regulator began to rein in east-coast speculators driving house-price growth at multiples to income growth.

Overall, with just a handful of companies still to report, earnings have dropped about 8.5 per cent, dragged down by an average 48 per cent slump in resource profits — 15 per cent down for miners and a whopping 60 per cent for energy stocks.

Along with banks, industrial earnings have slipped too, down about 3 per cent on average according to Deutsche Bank analyst Tim Baker.

“Momentum is still strong for those with US dollar exposure, and for many domestic cyclicals,” he said.

“But falling profits in food retail and non-bank financials have hurt, as has ongoing softness in resource-exposed earnings.”

But analysts have tried to remain upbeat, supporting high valuations and slimmer dividend yields for now.

UBS strategist David Cassidy said, “defying the naysayers”, the 2017 outlook for S&P-ASX 200 stocks was a positive 6 per cent for the average non-resource stock.

Forecasts are one thing, however, and meeting them another, something all too many company executives and shareholders are learning the hard way after being mesmerised by lofty share prices and fooled by headline “real” GDP and unemployment data.

Over the past six years every rate cut has been forecast to be the bottom by growth optimists and yet nominal GDP has continued to decline deeper into recession levels with little room left to cut further.

“Our nominal growth today is lower than our real growth, by a full percentage point,” Treasurer Scott Morrison said this week.

“This is an uncommon predicament and a core challenge in working to bring the budget back to balance.”

Outgoing Reserve Bank governor Glenn Stevens pointed to the problem two weeks ago when he said “someone, somewhere” needed to be willing to borrow money and spend it.

Strategists at Patersons explained why this was difficult.

“Policy overly skewed to supporting the housing market is continuing the Australian ‘tradition’ of making the community debt slaves to the banks and is a huge disservice to the next generation who also need to afford to buy shelter, along with things like a university education that used to be supplied by the government through the taxation system in a former world where promoting higher community education was seen as economically beneficial and worth supporting,” they said.

“There is too much passive investment in the Australian economy, passive, idle cash sitting in assets like housing and stocks, and not enough funds pushing productivity, technological initiatives and creating real tangible benefits for the economy and wider community.”

Low productivity creates a dividends pickle

From InvestSMART.

Believe it or not, that smartphone in your pocket has more computing power than all of NASA circa 1969. Okay, so it won’t get you to the moon but it can get you a pizza, or anything else. The silicon revolution that spawned the internet has created global companies and upended centuries-old industries. It’s the kind of creative destruction Schumpeter would appreciate, making us (labour, that is) more productive and the companies in which we invest more profitable.

Except that there’s no evidence of that actually happening, at least not since the 1990s. Earlier this month the US announced that non-farm productivity fell for the third consecutive quarter, the longest period of decline since 1979. It’s strange, don’t you think? Here we are in the midst of a transformative era of Uber, AirBnB, gene splicing and coffee cups that give you a kiss* – and the country that’s leading the way is experiencing falling productivity.

Theories abound as to why; from lazy workers and poor data to income inequality and under-investment (a story I will one day get to). Facebook investor Peter Thiel is so concerned he’s lovingly published a beautiful online lament (one must be careful about what one says about dear Peter), titled ‘What happened to the Future?’ It claims the rate of technological innovation is actually slowing, which is why we got Twitter’s 140 characters instead of flying cars.

The truth is more banal; no one really knows why productivity growth has been in long-term decline.

Investsmart2 The Treasury chart shows Australia’s performance is better than most, although that’s not saying much. It’s been decades since Western countries experienced the rates enjoyed in the 1950s and ’60s. We might be transitioning away from the mining boom with some success, via an investment-led property boom, but slow productivity growth is a global problem.

This issue looms large over negative interest rates, currency wars and sovereign debt; all of which would be less of an issue if productivity growth were stronger. Rising productivity drives increases in household income, which boosts economic growth and corporate profits. In the long run we can’t expect dividends to increase without it. And yet dividends have been increasing faster than corporate profit growth.

InvestsmartHigher dividend payout ratios mean lower levels of reinvestment but that’s what investors demand, sacrificing higher future income in favour of cash right now. And companies have all the excuses they need to comply. Hurdle rates are ridiculously high compared with interest rates and they, like their customers, are worried about the future. Why not spend earnings on mergers, acquisitions, share buybacks and dividends? So, enjoy the sounds of those fat cheques hitting the doormat over the next few months, they may not be quite as high in years to come.

Reading between the lines, Commonwealth Bank chief executive Ian Narev might hold a similar view. At the bank’s recent results presentation he said that “dividends are not annuities”, a bland statement of fact but a rebuke of sorts to dividend-chasing investors. Our banking analyst, Jon Mills, meanwhile, believes the big banks “are going to find it tough to raise earnings and dividends over the next few years”.

It’s a common view among brokers and fund managers and has been for quite a while. Increased capital requirements and regulatory costs, potentially higher provisioning and slower credit growth could be a drag on the sector’s earnings. Last week, corporate trailing indicator Moody’s joined the slumber party, putting the sector on a negative credit outlook – not an actual downgrade but the threat of one.

Bank shareholders shouldn’t be too concerned. InvestSMART’s research director James Carlisle, who excitedly told me yesterday the banks are within spitting distance of joining the Buy list, certainly isn’t. If investors are reaching for yield, they’re not leaning the banks way.

Perhaps a change is afoot. Wealth manager IOOF Holdings and conglomerate Wesfarmers, both of which in the past have registered extremely high dividend payout ratios, recently announced dividend cuts. Neither were punished for it, which is as it should be. Dividends should reflect the state of a company’s finances and the opportunities it has to reinvest capital. When boards get hung up on maintaining dividends bad decisions can be made on both those fronts.

Kudos, too, to BHP Billiton, where management rather than mine-quality is the problem. It has committed to pay out at least 50 per cent of underlying earnings as dividends. With one hand tied behind its back the company’s capacity to make more overpriced acquisitions is therefore halved. Sometimes, a company unable to reinvest too much capital is a good thing.

There’s another lesson here, too, one that might be echoed in the banking sector should a credit downgrade actually occur. Deputy research director Gaurav Sodhi, in his review of BHP, put it thus: “It’s not good enough to wait for improvements in business conditions before buying shares. Uncertainty and pessimism are what create opportunity and expectations will always lead reality.” Investors aiming to outperform the market must lead, and we can’t do so from the back.

Another factor evident this reporting season is the effect bond yields are having on growth. Low bond rates have caused a weird reversal, one where bonds are purchased for capital growth and shares for income. Highly-leveraged, tick-tock infrastructure stocks like Transurban and Sydney Airport, plus just about every Australian Real Estate Investment Trust (AREIT) you can think of, have enjoyed huge share price increases as a result. We’re currently at the point where high yield usually implies higher share price risk.

Now it’s the turn of growth to get a little love. Earnings growth expectations were low this reporting season and any company that managed to beat them, even by a bit, has benefited. ASX and Trade Me – the latter still on our Buy list and the former only recently removed from it (disclosure: I’m a shareholder) – are good examples. Whether this is the return of common sense or an early preview of another episode of crazy we’ll just have to wait and see.

All of these examples, though, point to the incredible influence the bond market is having on share prices. Bond yields that are either negative or in low single digits are the widespread numerical expression of Larry Summers’ belief in secular stagflation. In non-economists speak, that means structurally lower global growth, accompanied by lower-for-longer rates as a consequence. So common is this thesis it’s hard to find anyone of note that contradicts it. Right now “lower for longer” seems the epitome of a cheery consensus, which is perhaps the best reason to worry about it. Time to kiss the coffee cup for good luck perhaps?

*Korean designer Jang Woo-Seok’s ‘Human Face Coffee lids’:

Investsmart3

Directors of Storm Financial found to have breached their director duties

ASIC says the Federal Court has found that the directors of Storm Financial, Emmanuel and Julie Cassimatis, breached their duties as directors.  The Court also found that Storm Financial provided inappropriate advice to certain investors.

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Since around 1994, Storm Financial operated a system created by the Cassimatises, in which what ASIC considered to be “one-size-fits-all” investment advice was recommended to clients.  The advice recommended that clients invest substantial amounts in index funds, using “double gearing” (Storm Model).  This approach involved taking out both a home loan as well as a margin loan in order to purchase units in index funds, create a “cash dam” and pay Storm’s fees.  Once initial investments took place, “Stormified” clients would be encouraged to take “step” investments over time.

By the time of Storm’s collapse in early 2009, approximately 3,000 of its 14,000 client based had been “Stormified”.  In late 2008 and early 2009, many of Storm’s clients were in negative equity positions, sustaining significant losses.

The case that ASIC advanced against the Cassimatises centered around a sample of investors who were advised to invest in accordance with the Storm Model.  ASIC alleged that the advice provided to those investors by Storm was inappropriate to their personal circumstances, considering that each of the investors were alleged to be over 50 years old, were retired or approaching and planning for retirement, had little or limited income, few assets and had little or no prospect of rebuilding their financial position in the event of suffering significant loss.

Among other things, it was also alleged that Storm failed to properly investigate the subject matter of the advice given to those investors.  As such, ASIC also alleged that Storm failed to do all things necessary to ensure that the financial services covered by its licence were provided efficiently, honestly and fairly.

ASIC further alleged that because the Cassimatises were responsible for the day-to-day significant decisions in relation to the provision of financial services to Storm’s clients and exercised a high degree of control over its systems and processes, they had caused Storm to contravene its obligations under the Corporations Act and did not exercise their powers as directors of Storm with the degree of care and diligence that a reasonable person would have exercised in that situation.

In a 217 page judgment, Justice Edelman found that:

  • Storm provided advice to certain investors, that was inappropriate to their personal circumstances and failed to give such consideration to the subject matter of the advice and did not properly investigate the subject matter of the advice given.
  • “A reasonable director with the responsibilities of Mr and Mrs Cassimatis would have known that the Storm model was being applied to clients such as those who fell within this class and that its application was likely to lead to inappropriate advice.  The consequences of that inappropriate advice would be catastrophic for Storm (the entity to whom the directors owed their duties).  It would have been simple to take precautionary measures to attempt to avoid the application of the Storm model to this class of persons.” (paragraph 833)

Commissioner Greg Tanzer said, “This is an important decision which emphasises the importance of directors’ duties to ensure that they do not cause the companies that they control, to breach the law.  The decision also highlights the significant obligation on financial services licensees to provide financial advice that is appropriate to the persons to whom it is given.”

The matter will be listed for a further hearing at a later date to determine what civil penalties and disqualification orders should be imposed on the Cassimatises as a result of the breach of their director duties.

‘Reliable’ equities not a replacement for bonds

InvestorDaily says income-seeking investors should be wary of buying Australian equities despite their strong dividend payouts over recent years, says State Street Global Advisors (SSGA).

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In a note to investors, SSGA said Australia’s equity market is one of the highest yielding in the developed world, and its “perceived reliability” could mistakenly cause some investors “to think of the market as almost bond-like”.

“This is a potentially dangerous misunderstanding: the capital value of an equity security is far more at risk than a bond, furthermore, unlike bond coupon payments, dividend payments are not fixed,” SSGA said.

The firm cautioned that data from the past five years shows that payout ratios in aggregate have climbed, while dividend yields held steady.

“This reflects a period during which resource companies and, to a lesser extent, banks held their dividends unchanged while experiencing a fall in earnings,” SSGA said.

For Australian market dividend yields to be maintained at the current level, SSGA warned, earnings need to improve since current payout ratios “cannot increase much further, and probably need to come down”.

“There is no guarantee that last year’s dividend payment will be repeated this year, or even that forecast dividends from sell-side analysts will be paid this year,” SSGA said.

“A strategy of blindly buying companies with the highest reported dividend yield could expose investors to some high-risk securities.”

SSGA added that while investing for dividends “may have long-term merit”, a different approach was needed by investors looking for short-term capital stability.

Super funds return three per cent

According to Financial Standard, superannuation funds have returned an average of 2.9% for the 12 months to 30 June as measured by the SelectingSuper workplace default option MySuper Index, thanks to relatively high returns from property and fixed income investments. Equity and cash dragged overall performance down.

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The SelectingSuper workplace default option MySuper Index showed a negative 0.9% monthly return in June. However combined with the positive return in the period March to May, the rolling 12 month performance for the 2015-16 financial year was a positive 2.9%.

The monthly fall in superannuation performance in June was driven by a fall in both Australian and international equities. The negative return for super funds in the latest month comes at the end of a period of relatively volatile returns in the first six months of the 2016 calendar year.

The positive 2.9% performance for funds in the 2015-16 financial year, although lower than prior years, was nearly 2% above inflation for the period.

The performance over multi-year time periods benefits from the positive impact of high returns in the years 2013-15. Reflecting this, three-year rolling MySuper returns are 8.3% pa and five-year returns are 8.1% pa. The longer term 10-year return is a more modest 5.2% pa although this period incorporates the full effect of the GFC and is overlaid by a lower inflation environment.

On an annual basis, Australian equities, often the largest asset class in many balanced funds, positively contributed with 0.6% return as the market has progressively drifted down since early 2015. The contribution of international equities has been a positive 0.4%, although this impact has been muted by many funds through hedging in-built within their portfolios.

Property has continued to provide a significant positive impact on fund investment outcomes with the listed property sector having a positive 24.5% return in the 12 months to end June. To further highlight the positive impact buffering that property has had on superannuation returns, the three year average return to June 2016 from listed property is 18.5%.

Over the year ended June 2016, the fixed interest index return was a strong 7%, although, on average, fixed income portfolios within superannuation funds underperformed this index. Meanwhile cash returned a modest 2.3% over the same period.

In net terms this means funds with relatively high exposure to Australian equities and international equities underperformed in the 12 months to end April. Similarly funds with relatively larger holdings in property and potentially fixed interest, outperformed in the period.

Regarding the market segments, the gap between not-for-profit (NFP) funds and retail funds within the Workplace sector continues. The 12 month return gap is now at 120 basis points in favour of NFP funds. The long term five-year segment gap is 30 basis points in favour of NFP funds.

ASIC review highlights inconsistent practice by firms handling confidential information and conflicts

An ASIC review of risks related to the handling of confidential information and conflicts of interests, particularly in the provision of sell-side research and corporate advisory services, has found that most firms have policies and procedures in place to deal with these risks. However, there remain instances of poor and inconsistent practice in their application.

Investment-PigReport 486 Sell-side research and corporate advisory: Confidential information and conflicts of interest details the review’s findings and highlights areas of concern requiring a greater focus and care.

Between September 2014 and June 2016, ASIC conducted reviews of the policies, procedures and practices of a range of investment banks and brokers active in the Australian market and reviewed a sample of transactions, including initial public offerings (IPOs) and secondary offerings. This review followed on from previous monitoring and surveillance work undertaken by ASIC that had indicated some poor practices in these areas.

While most firms have specific policies and procedures in place, the review found considerable variation in the following market practices:

  • Identification and handling of confidential information: Some organisations do not have appropriate arrangements to handle situations where staff members come into possession of confidential information. This includes the inadequate use or supervision of information barriers and restricted trading lists.
  • Management of conflicts of interest: There is an inconsistency in how conflicts of interest are managed. This includes the structure and funding of research, insufficient separation of research and corporate advisory activities (particularly the involvement of research in soliciting business during the IPO process), decisions about share allocations in capital raisings, and mixed practices in relation to the disclosure of conflicts of interest.
  • Staff and principal trading:
    • There is also considerable variation in the strength of controls to manage staff trading, including trading by corporate advisory and research staff. In particular, some questions remained as to whether the approval process adequately addressed the conflicts of interest, and whether a staff member might be in possession of confidential information.
    • In mid-sized firms, it is more common for staff to participate in capital raising transactions that the firm is managing. This presents an increased risk of unacceptable or questionable activity that firms need to be aware of and manage.

ASIC Commissioner Cathie Armour said the purpose of the review was to understand current market practices and identify areas of particular concern.

‘The proper handling of confidential information and the management of conflicts is a key element in preserving and promoting market integrity, improving market efficiency and increasing investor confidence,’ she said.

‘Where confidential information is mishandled or conflicts are not managed appropriately there is a risk that a breach of financial services laws may occur. This may include insider trading, market manipulation, misleading and deceptive conduct, and breaches by Australian financial services licensees of their general obligations.

‘All firms should review this report and consider whether their controls – including policies, procedures, training and monitoring – are appropriate and sufficiently robust to meet legal and regulatory requirements’, Ms Armour said.

ANZ May Sell Share Trading Platform

ANZ today announced it is exploring strategic options for ANZ Share Investing that may include a sale of its share trading platform.

Bus-GrapghAs part of this process, ANZ has issued an Information Memorandum to a number of international and domestic specialist providers.

ANZ Managing Director Pensions & Investments Peter Mullin said: “ANZ is committed to providing customers with access to a market leading share trading platform at a competitive price.

“As we have seen with ANZ’s recent introduction of Apple Pay and Android Pay, the days of a bank needing to own every piece of technology are gone.

“We believe we can achieve better outcomes for our customers by partnering with a specialist provider committed to the technology investment and product innovation needed to provide a world-class offering.

“The process is expected to take a number of months to finalise and in the meantime it’s business as usual for both our customers and staff,” Mr Mullin said.

UK Progress On Creating A Fair and Effective Market

A status update has just been released describing some of the steps taken to reform the wholesale Fixed Income, Currency and Commodities (FICC) markets, following the earlier review. Whilst some of the legal and process related issues have been addressed, there are many cultural and behaviourial issues which remain to be addressed by market participants. The review stresses that Firms must create, both individually and collectively, cultures that place integrity, professionalism and high ethical standards at their core to ensure that behaviours are not limited to complying with the letter of regulation or laws. It took years for the ‘ethical drift’ that resulted in misconduct to occur and it will take time to build new ethical norms in financial markets. Progress is at a critical point.

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The Fair and Effective Markets Review (FEMR) was launched in June 2014 to conduct a comprehensive and forward-looking assessment of the way the wholesale Fixed Income, Currency and Commodities (FICC) markets operate; help to restore trust in those markets in the wake of a number of high profile abuses in both UK and global financial markets; and to influence the international debate on trading practices.

On 10 June 2015 a Final Report was published, setting out 21 recommendations to:

  • raise standards, professionalism and accountability of individuals;
  • improve the quality, clarity and market-wide understanding of FICC trading practices;
  • strengthen regulation of FICC markets in the United Kingdom;
  • launch international action to raise standards in global FICC markets;
  • promote fairer FICC market structures while also enhancing effectiveness; and
  • promote forward-looking conduct risk identification and mitigation.

Now a status update has been presented to Chancellor of the Exchequer, the Governor of the Bank of England and the Chairman of the Financial Conduct Authority.

The job is far from done. A key theme that came out of the ‘Open Forum’ held by the Bank in November 2015 was that there remains a lack of trust in financial markets and financial institutions because of past misconduct. Participants saw cultural and ethical changes as an essential component of building a social licence for financial markets.

Responsibility must now fall increasingly to market participants to see through the changes in market practices and behaviours that are necessary to restore the reputation of the industry and thereby deliver markets that are both fair and effective. Firms must create, both individually and collectively, cultures that place integrity, professionalism and high ethical standards at their core to ensure that behaviours are not limited to complying with the letter of regulation or laws. As was indicated in the Final Report, a failure to do so will inevitably lead to further regulation and/or legislation.

While authorities can put in place legislation and regulation, firms are responsible for creating, both individually and collectively, cultures that place integrity, professionalism and high ethical standards at their core to ensure that behaviours are not limited to complying with the letter of regulations or laws. The work of the FMSB to ensure that market practices and structures are consistent with broader principles of fairness and effectiveness is therefore of vital importance and must be sustained. The complementary work of the Banking Standards Board (BSB) to promote high standards of behaviour and competence in the banking sector has a crucial role to play in this area too and we strongly support its work.

They state that the initial momentum must not be lost. It took years for the ‘ethical drift’ that resulted in misconduct to occur and it will take time to build new ethical norms in financial markets. Progress is at a critical point. It requires all involved to see through the changes that have begun, and to be alert to future challenges, if the financial services of tomorrow are to be characterised by the high standards of fairness and effectiveness to which we aspire.

ASIC crackdown on unlicensed retail OTC derivative providers

ASIC has warned of a dramatic increase in the extent of unlicensed conduct by retail OTC derivative providers seeking to expand their market with new customers for their complex and risky products such as binary options.

The recent Report 482 Compliance review of the retail OTC derivatives sector (REP 482) highlighted an increase in activity among licensed and other participants,  especially binary option providers, operating through online platforms or websites that are offering financial services to retail investors in Australia without an appropriate licence or authorisation.

ASIC has raised its concerns with more than 40 unlicensed providers. The majority are binary option issuers but also contacted were some binary option review websites, binary option trading signal providers, binary option broker affiliate websites, margin FX providers and managed FX service providers.

Of those providers contacted, 21 have agreed to co-operate with ASIC and take remedial steps to ensure they are no longer providing financial services in Australia until they are appropriately licensed or authorised.  Remedial actions that have been implemented include:

  • removing references to Australia on their website;
  • ceasing marketing campaigns directed at Australian investors;
  • adding appropriate disclaimers to websites and mobile apps;
  • blocking sign-up access to Australian investors;
  • educating introducing brokers and affiliates to cease targeting Australian investors;
  • closing down existing Australian accounts; and
  • informing Australian investors that the entity is not appropriately licensed in Australia.

Some of these entities have indicated an interest in obtaining the appropriate licence to operate in Australia and have been provided with information to assist them with that process.

A further nine entities have not directly responded to ASIC regarding our concerns but appear to have made some changes to their websites, including removing references to Australia.

Entities that agreed to implement remedial actions appropriate to their circumstances include:

  • IQ Option Limited and IQ Option Europe Limited trading as IQ Option
  • Rodeler Limited trading as 24Option, Quick Option, 24FX and Grand Option
  • BDB Services (Belize) Ltd trading as Banc de Binary
  • Ouroboros Derivatives Trading Ltd trading as AnyOption
  • NXB Financial Services Ltd trading as Stockpair.com
  • Up & Down Marketing Limited trading as OneTwoTrade
  • AM Capital Ltd trading as Tradorax
  • Centralspot Trading (Cyprus) Ltd and CST Financial Services Ltd trading as Opteck
  • Nuntius Brokerage & Investment Services S.A. trading as Topoption.com
  • OptionRally Limited trading as OptionRally
  • Market Punter Limited trading as Market Punter
  • Terapad services LTD trading as FMTrader
  • Growell Capital Ltd trading as GrowBinary
  • CherryTrade at www.cherrytrade.com
  • Tradersasset.com
  • Binary Options Pty Ltd via www.binaryoptions.net.au, www.binaryoptionsptyltd.com.au, www.privatesignalsgroup.com and www.freesignal.com
  • Best10binarybrokers.com.au
  • 10bestbinarybrokers.com.au
  • Binaryoptionrobot.org
  • Diamond Managed FX
  • Blackwell Global Investments (Cyprus) Limited trading as Blackwell Trader

Entities that have not directly responded to our concerns but appear to have made some rectification actions include:

  • OTP Solutions LTD operating as No1Options
  • Brevspandnz Limited trading as AutoTradingBinary.com
  • Pacificsunrise UK Ltd trading as AAOption.com
  • TTN Marketing LTD trading as Trades Capital
  • Lerona Impex SA and Norske Inter LP trading as Finpari
  • Chemmi Holdings Limited  trading as Binary Tilt
  • Peter Knight Advisors
  • Banc de Options at www.bancdeoptions.com
  • Advanced Binary Technologies Ltd trading as Ayrex

ASIC has also released a number of recent public warnings in relation to the entities that have not responded to our concerns in any way.

ASIC Commissioner Cathie Armour said, ‘The dramatic increase in unlicensed conduct – particularly in entities offering binary options – is of real concern to ASIC.

‘We remind investors to be wary of advertising on websites or unsolicited calls or emails by people offering these types of products, and to verify that product providers are appropriately licensed or authorised before dealing with them’, she said.

Products such as binary options and margin FX are very complex and risky. Australian investors may be exposing themselves to increased risk when they deal with an entity that is not appropriately licensed or authorised in Australia because they will not be able to rely on many of the protections available under Australian regulation.

Australian investors should check ASIC’s professional registers to determine if an entity is licensed to provide financial services in this jurisdiction and should not deal with an entity that does not hold the appropriate authorisation.

Background

A binary option is a financial product, in particular a derivative, under the Corporations Act.   Any entity that deals in, or provides advice about, binary options in Australia must hold an Australian financial services (AFS) licence, or be authorised by an AFS licensee.

Australian clients who receive financial services from an entity that is not appropriately licensed may have the right to rescind their agreement with the entity and may be entitled to recover brokerage, commissions and other fees paid to that entity.

Recent advances in technology have made it more possible for providers of retail OTC derivative products to quickly set up low cost website businesses often from overseas locations which may be largely outside our jurisdictional remit. ASIC has responded to this emerging risk by seeking timely public outcomes to;

  • better inform investors of the risks and give them the tools (e.g. ASIC Professional Register and the Moneysmart website) and information to make  informed investment decisions and promote consumer trust and confidence;
  • encourage industry standards; and
  • improve industry compliance with regulatory obligations.

Where ASIC has identified concerns it has adopted a more facilitative approach to encourage appropriate and timely remediation of unlicensed conduct. Where entities have not cooperated with ASIC, it has issued public warnings. Where the conduct identified is more serious ASIC may take further regulatory action as it considers appropriate.