Westpac Fined Over “Unconscionable” Pre-Hedging
Posted by Colin Lambert. Last updated: February 1, 2024
Westpac has been fined just AUD 9.8 million for what an Australian court found to be “unconscionable conduct” in relation to its pre-hedging of an AUD 12 billion interest rate swap deal in 2016, but has dodged an insider trading charge.
The Australian Securities and Investments Commission (ASIC) charged Westpac over its conduct related to deal with a fund consortium comprising Australian Super and IFM entities after they bought a majority stake in power company AusGrid. The bank pre-hedged up to 50% of the transaction in the hour before it was confirmed and executed 876 trades according to ASIC. It made a trading profit of approximately AUD 20.7 million on the day the swap was executed (of which AUD 3.7 million was allocated to the sales team as commission).
Westpac was in reality only fined AUD 1.8 million for its conduct, the other 8 million was to cover ASIC’s costs.
Westpac was one of a number of banks that were approached about executing the deal, which remains the largest single IRS transaction ever executed in Australia. The court found that the bank was aware of its client’s concern about trading prior to the swap transaction that had the potential to adversely affect the price of the swap transaction to their detriment. Every basis point increase to the price of the swap transaction would involve a cost to the consortium of about $4.7 million.
It also found that despite being aware of its client’s concerns, Westpac acted on an internal plan to pre-hedge up to 50% of the interest rate risk by trading in significant volumes of interest rate derivatives in the market before the swap transaction was executed, and failed to obtain client consent or give clear and full disclosure about the extent of its planned pre-hedging.
Once Westpac commenced its on-market pre-hedging trading, the consortium could not protect itself against the risk that Westpac’s trading would increase the price of the swap transaction to the consortium, the court also found.
Appropriate conduct for pre-hedging is an issue of global significance, in this case, Westpac’s behaviour was unconscionable and exposed its client to significant risk
The court also declared that Westpac failed to have adequate arrangements to manage the conflict of interests between it and the consortium and did not do all things necessary to ensure that the swap transaction was provided to the Consortium efficiently, honestly and fairly. The court reserved its decision on whether to make an order requiring Westpac to complete a compliance programme with an independent review of its pre-hedging practices and controls, including relating to conflicts of interest management and client communications.
In handing down the decision, Federal Court Justice Michael Lee, is quoted by local media as saying that the lightness of the penalty is “shocking” and “risible”, asking how a penalty of AUD 1.8 million could act as a deterrent.
ASIC was happier, however, with deputy chair Sarah Court stating, “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,” she continues. “In this case, Westpac’s behaviour was unconscionable and exposed its client to significant risk. Westpac’s conduct was also in stark contrast with several other banks.”
On the Justice Lee’s statement, Court observes, “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.”
According to ASIC the current penalty for unconscionable conduct in such circumstances is at least AUD 15.65 million for a corporation, and for a large entity, the maximum penalty may potentially be AUD 782.5 million or three times the benefit derived (whichever is greater).