The Australian Securities and Investments Commission (ASIC) today released the findings of its industry surveillance review examining the independence of research analysts within the investment banking industry.
The review was established to consider the extent to which investment banks identify and manage ‘conflicts of interest’. This issue has generated debate both domestically and overseas, primarily in the United States (US).
In conducting this project, ASIC reviewed the practices and activities of research analysts in Australia, the standards of conduct and supervision of research analysts, and the effect of current regulatory requirements.
‘The review indicates that Australia is unlikely to have experienced the extent and seriousness of misconduct that occurred in the United States. This is also consistent with the position found to exist in the United Kingdom by the Financial Services Authority’, ASIC Executive Director of Financial Services Regulation, Mr Ian Johnston said.
‘ASIC emphasises that the review was conduced as a surveillance campaign rather than an investigation, because no breaches of the law have been detected. While none of the findings in the report are indicative of breaches of the law, ASIC cannot say that the industry is without flaw or is immune from misconduct, because its review was necessarily limited to a sample selection of entities and a limited period of time.
‘However, the review has identified a number of compliance issues that require further improvement, particularly relating to the independence of research analysts and the processes for managing conflicts of interest when they are identified.
‘Our findings will form the basis for our policy proposal paper on managing conflicts of interest.
‘These policy initiatives will further support the legislative reforms introduced through the Federal Government’s CLERP 9 Bill, and the statement of principles currently being prepared by the International Organization of Securities Commissions (IOSCO), of which ASIC is a member’, Mr Johnston said.
Surveillance methodology
In undertaking the review, ASIC has sought to determine whether conflicts of interest are being adequately identified and managed, and whether the processes and systems currently in place effectively protect the independence of the research analyst function.
The project was carried out in two stages. The first stage was a high-level review of the research practices of eight investment banks, comprising three US, three European and two Australian investment banks. Four of these entities were selected for closer examination in the second stage of the review.
The review was conducted in an environment of enhanced compliance procedures, following on from the implementation of regulatory changes in the United States and internationally. The positive impact of these compliance enhancements was observed between the first and second stages of the project, but may also be attributable to ASIC’s publicised campaign, proposals by the Australian Stock Exchange (ASX) and the Federal Government’s CLERP 9 reform agenda. ASIC was pleased with the level of co-operation it received both from the entities it reviewed, as well as their representative associations.
Report findings
The review identified some particular compliance deficiencies relating to the management and disclosure of conflicts of interest within the investment banking industry in Australia. While these deficiencies are not systemic in nature, ASIC was concerned to find that some of the entities it reviewed had failed to implement adequate conflict management procedures, and placed an unreasonable level of reliance on their staff to identify, and then manage and disclose conflicts of interests. In particular, while many of the entities reviewed had some form of conflicts management procedure, most failed to fully and effectively implement, monitor and enforce them.
ASIC’s review also suggested that the industry guidelines developed by the Securities and Derivatives Industry Association (SDIA) and the Securities Industry of Australia (SIA) have not been adopted as closely as intended. ASIC considers that there is still a risk that conflicts of interest will occur and will remain unmanaged. Even if fully implemented, ASIC does not believe that these industry guidelines adequately address the deficiencies identified in this report.
‘There are some clear opportunities for improving the current practices to ensure conflicts are either avoided, or in circumstances where they cannot be avoided, appropriately disclosed and effectively managed’, Mr Johnston said.
It is important that any policy or regulatory changes introduced domestically are consistent with international regulations, and represent a “best practice”, principles-based approach.
‘ASIC will undertake extensive consultation with government, industry and other regulators* in order to develop an appropriate policy response based on the findings of this report. We anticipate that a policy proposal paper will set out high-level principles and guidance for Australian Financial Services (AFS) licensees generally about managing conflicts of interest, with more detailed guidance for providers of research reports.
‘The paper will also provide guidance about what ASIC would expect of AFS licensees in complying with their obligations for managing conflicts of interest.
‘The paper will address a request by the Federal Government to develop policy in response to a new conflicts management obligation on all AFS licensees that the Government proposes to introduce as part of the CLERP 9 law reform’, Mr Johnston said.
ASIC expects to release the draft policy proposal paper soon after the introduction of draft legislation for CLERP 9.
* ASIC acknowledges the assistance of the market regulatory authorities, the Australian Stock Exchange, and the Sydney Futures Exchanges, as well as the relevant industry associations, the Securities Institute of Australia, the Securities and Derivatives Industry Association, the Australian Banking Association, the Investment and Financial Services Association, and the International Banks and Securities Association, in undertaking this project.
End of release