Westpac’s fine over $12b pre-hedging trade in Australia puts regulators under spotlight

Rick Steves

“Currently, there’s no global guidance on this, emphasizing the existence of a grey area and underscoring the need for better regulatory oversight to uphold market integrity and safeguard investor interests.”

The Federal Court of Australia has found Westpac Banking Corporation guilty of engaging in unconscionable conduct during a major financial transaction in October 2016. This involved a $12 billion interest rate swap, the largest transaction of its kind in the history of the Australian financial market.

Westpac is ordered to pay a $1.8 million penalty, the highest possible for this case, along with $8 million to cover the Australian Securities and Investments Commission’s (ASIC) litigation and investigation costs.

The issue arose when Westpac, in dealing with a Consortium consisting of AustralianSuper and IFM entities, engaged in pre-hedging before executing an interest rate swap. This swap was crucial for managing the interest rate risk linked to the Consortium’s purchase of a majority stake in Ausgrid from the NSW Government.

The draws attention to the intricate and somewhat unclear nature of practices like pre-hedging and pre-close calls in the financial industry. These methods allow investors who have access to non-public information to strategically execute trades. By doing so, they can anticipate and respond to potential market movements, thus hedging their risks. This advantage adds a level of opacity to market operations and may lead to market shifts that are detrimental to clients and, in certain instances, may resemble insider trading due to the informational advantage they confer.

There is, however, a lack of uniform global guidelines on these practices which require the urgent need for more robust regulatory oversight in this domain.

“Appropriate conduct for pre-hedging is an issue of global significance”

ASIC Deputy Chair Sarah Court said: “This is a significant outcome which assists to clarify expectations regarding pre-hedging, particularly around disclosure and consent where the pre-hedging can have a detrimental impact on the counterparty to the transaction. Appropriate conduct for pre-hedging is an issue of global significance. In this case, Westpac’s behavior was unconscionable and exposed its client to significant risk. Westpac’s conduct was also in stark contrast with several other banks. We share the Court’s concern regarding the maximum penalty available in relation to the conduct, and note that had Westpac engaged in similar conduct today the maximum available penalty would have been significantly higher.”

The court identified Westpac’s conduct as unconscionable because it was aware of the Consortium’s concerns about pre-hedging, which could adversely impact the swap transaction price. Yet, Westpac proceeded with significant pre-hedging trades without obtaining client consent or providing full disclosure.

Westpac profited $20.7 million

Westpac’s derivatives trading desk gained a profit of approximately $20.7 million from this transaction, raising further questions about its conduct. The court also noted Westpac’s failure to manage conflicts of interest adequately and to ensure efficient, honest, and fair service to the Consortium.

A decision is pending on whether Westpac will be required to undergo a compliance program with an independent review of its pre-hedging practices and conflict of interest management.

Background information reveals that ASIC’s original allegations against Westpac included insider trading, unconscionable conduct, and breaches of obligations as a financial services licensee. This case has highlighted the evolution of civil penalties since 2016, with current penalties for similar misconduct now significantly higher.

ASIC emphasizes that pre-hedging practices are of global concern, and the organization is actively involved in addressing these issues with the International Organisation of Securities Commissions (IOSCO).

No global guidance on pre-hedging and pre-close calls

“The parallels between pre-hedging and pre-close calls highlight a complex and somewhat ambiguous area within the industry,” said Matt Smith, CEO of SteelEye, a market surveillance solution provider.

“These practices enable investors with access to non-public information to strategically position trades, anticipating specific market moves to hedge their risks, giving them an advantage and adding a layer of opaqueness to the market. In many cases, this can lead to market shifts against clients and, in certain cases, raise concerns resembling insider trading.

“Currently, there’s no global guidance on this, emphasizing the existence of a grey area and underscoring the need for better regulatory oversight to uphold market integrity and safeguard investor interests.”

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