ASIC’s Westpac Charges Have Echoes of Johnson, Cartel, FX Cases
Posted by Colin Lambert. Last updated: May 6, 2021
The Australian Securities and Investments Commission (ASIC) says it has commenced proceedings against Westpac for insider trading, unconscionable conduct and breaches of its financial services licensee obligations. The case raises questions about banks’ ability to risk manage and pre-hedge transactions.
The allegations relate to Westpac’s role in executing a $12 billion interest rate swap transaction with a consortium of AustralianSuper and a group of IFM entities. The transaction occurred on 20 October 2016 and was associated with the privatisation of a majority stake in the electricity provider Ausgrid by the NSW government. The transaction remains the largest interest rate swap transaction executed in one tranche in Australian financial market history.
ASIC alleges that by about 8:30am on 20 October 2016, about 90 minutes after the acquisition documents were signed, Westpac knew, or believed, it would be selected by the Consortium to execute the interest rate swap transaction on that morning. ASIC alleges this was inside information.
It further argues that when the market opened at 8:30am, whilst in possession of the alleged inside information, Westpac’s traders acquired and disposed of interest rate derivative products in order to pre-position the bank in anticipation of the execution of the swap transaction. The Consortium, via a special purpose vehicle, executed the interest rate swap transaction with Westpac at 10.27am.
Unlike in FX markets, pre-hedging is not a widely-recognised practice in fixed income markets, even less so since more products have been forced onto regulated trading venues. This case also has echoes of that brought against former HSBC head of FX cash trading Mark Johnson, who was convicted of Wire Fraud by a US jury and has appeals and attempts at re-hearings dismissed. In that case, HSBC pre-hedged a large client transaction.
In the Westpac case, ASIC alleges that its trading occurred “while it was in possession of information that was not generally available to other market participants including those that traded with Westpac that morning”. It adds, “Prohibitions against insider trading are a fundamental tenet of market integrity.”
This raises the interesting question of whether or not a bank is able to conduct their normal activities ahead of a large client order in OTC markets? The FX Global Code highlights how participants can continue to conduct normal business, the language used by ASIC suggests that in interest rate swap markets at least, it doesn’t agree.
Of course, ASIC’s full allegations when the case is heard in court, may highlight that Westpac traders dealt in a specific direction and actively took a position in front of the order, which may not be construed as conducting normal business. The really interesting question for the court will be what does this mean if, rather than entering a position, the traders were exiting it? There will, if that were the case, inevitably be arguments about protecting shareholder interests, even though many in the industry argue that exiting a position should be done alongside the client’s order, not in front of it.
Perhaps tellingly, ASIC alleges that Westpac’s trading on the morning of 20 October 2016 had the potential to impact the price of the swap transaction to the detriment of the Consortium or the special purpose vehicle. Significantly, and this brings echoes of the Johnson case in the US, ASIC is also alleging that Westpac failed to disclose to the Consortium its intention to “pre-position its trading books prior to and with notice of the execution of the swap transaction”, and that this amounted to “unconscionable conduct”.
What is not made clear by the ASIC filing is exactly how some Westpac traders knew of the AusGrid transaction. It notes that the Consortium approached “several” banks to enquire about the transaction but has, to date at least, only charged Westpac.
Noting that the details of the transaction were not generally available, the filing names Nicholas Allen, Benjamin Mitchell and Shane Dorman on Westpac derivatives trading desk, as well as Simon Masnick (head of fixed income trading), Michael Correa (managing director of corporate and institutional distribution and origination in Financial Markets) and Lyn Cobley (chief executive of Westpac Institutional Bank), as knowing “some or all” of the information.
ASIC says that in the two hours between the signing of the deal and the execution of the swap trade with the Consortium, Westpac executed 692 trades to position itself ahead of the transaction. The bank apparently sold 35,902 3-year Commonwealth Treasury Bond Futures Contracts (Bond Futures), which had a total notional value of $3,590,200,000, and 8,189 10-year Bond Futures, which had a total notional value of $818,900,000, each expiring in December 2016.
It also executed 21 trades by which it received the total notional amount of $2,075,000,000 for 5-year, 7-year and 10-year Australian dollar denominated 6s3s tenor basis swaps;
35 trades by which it paid the total notional amount of $3,980,000,000 for 3-year, 5-year and 10-year Australian dollar denominated interest rate swap exchange for physicals; and
128 trades by which it sold 6,109 Bank Accepted Bill Futures Contracts, which had a total face value of $6,109,000,000, expiring in September 2017, December 2017, March 2018 and September 2018.
This meant, ASIC argues, that Westpac had hedged up to 50% of the expected trade by the time it actually won the deal.
As noted previously, the case could present several questions for FICC markets participants, not least is this pre-hedging or front running? A key aspect for the Federal Court of Australia to consider could be whether or not the transactions were included in the price quoted to the customer. The inference from ASIC is they were not, rather these transactions actually affected the price quoted by Westpac and as such were to the clear detriment of the client.
Westpac did quote the execution margins and spread ahead of time to the Consortium, which suggests it may face tricky questions over so many trades that resulted in such a large position. As the FX Global Code states, any pre-hedging has to be for the benefit of a client, however the Code also says that pre-hedging can only take place on “anticipated” orders. Unless proven otherwise, Westpac would have considered this an anticipated order and as such may try to argue it was pre-hedging to reduce market impact.
Another factor that may come into play is what happened at the other banks that were also informed of the trade? The ASIC allegations include Westpac’s use of information that was not generally known, but it also states that other banks were approached about the trade. Westpac clearly had counterparties to the trades it did ahead of the Consortium transaction, the assumption is some of these other parties were also institutions that had knowledge of the trades? If this is the case, this doesn’t put Westpac’s information security in a good place.
If, however, the defence argues that other institutions were also trading in that direction and as such the market impact and movement in the price could not be laid solely at Westpac’s door, the case could take a very different path – not least what might be called the “Cartel” defence, that “everyone was doing it”, which saw charges against three members of an FX chatroom dismissed by a New York jury. Sources with knowledge of the issue tell The Full FX that investigations did indeed take place at other institutions, the assumption is that no wrongdoing or suspicious behaviour was found.
Whatever the outcome of the case, banks will be watching closely, not least to see if the findings do have implications for other OTC FICC markets. The likelihood is they will not, but if nothing else, this should encourage the Global FX Committee to accelerate its own work on pre-hedging to provide much-needed clarity to FX market participants. As for fixed income markets, perhaps the time has come for regional work, such as that done in the UK with the Money Markets Code, to be leveraged globally?