Introduction
In Australia, providing financial services, particularly ‘making a market’ for financial products, requires an Australian Financial Services Licence (AFSL). An AFSL, authorised under the Corporations Act 2001 (Cth), is essential for any financial services business intending to provide financial services in Australia by ‘making a market’.
This guide is a crucial resource for businesses seeking to understand and navigate the AFSL requirements for ‘making a market’ as a financial service. It provides essential guidance on the authorisation needed from ASIC and the regulatory requirements that licensees must meet to provide these financial services in Australia.
Defining “Making a Market” Under the Corporations Act
Regular Price Quotation for Financial Products
Under the Corporations Act 2001, defining “making a market” for a financial product hinges on several key elements. One core component is the regular quotation of prices. This means a person, not being a market licensee, must regularly state the prices at which they propose to either acquire or dispose of financial products. This activity can occur through a facility, at a specific place, or even otherwise.
This regular price quotation is a crucial indicator of “making a market” as it signals an ongoing intention to trade in specific financial products. For example, regularly publishing buy and sell prices for a particular derivative product would likely meet this requirement.
Reasonable Expectation of Regular Trading
Beyond simply stating prices, the definition of “making a market” also requires that other persons have a reasonable expectation they will be able to regularly effect transactions at those stated prices. This element ensures that the price quotations are not merely indicative or sporadic but represent a genuine commitment to ongoing trading.
To illustrate, consider a scenario where a person consistently advertises prices for a certain financial product. If, based on this consistent behaviour, others reasonably believe they can routinely execute trades at these prices, this condition of “making a market” is likely satisfied. This expectation of regular trading is what distinguishes market makers from entities that might occasionally offer to buy or sell financial products.
Distinction from Operating a Financial Market
It is important to distinguish “making a market” from operating a financial market. The Corporations Act 2001 clarifies that the actions of a person “making a market” should not constitute operating a financial market. This distinction is critical in regulatory terms, as operating a financial market involves a different set of licensing and compliance obligations compared to “making a market”.
For example, imagine a situation where an entity sets up a platform that facilitates trading in financial products among multiple buyers and sellers, operating like an exchange. This activity is more likely to be considered operating a financial market. In contrast, “making a market” typically involves a person dealing on their own account, offering to buy or sell financial products at stated prices to those who wish to trade with them directly, rather than operating a broader exchange facility.
Why an AFSL is Essential for Market Makers in Australia
AFSL Authorisation for Financial Services
An AFSL is a legal cornerstone for entities providing financial services in Australia, as defined under the Corporations Act. Without an AFSL, businesses cannot legally engage in activities classified as financial services, making the licence a fundamental requirement for legitimacy within Australia’s financial services sector.
Importantly, the scope of an AFSL is not one-size-fits-all. Instead, the Australian Securities and Investments Commission (ASIC) tailors each licence to align with the specific financial services or financial products a licensee intends to offer. For instance, an AFSL may authorise activities such as dealing in derivatives, providing custodial or depository services, or making a market for financial products. This tailored approach ensures that the authorisation precisely matches the licensee’s activities, defining the boundaries of their legal operations.
“Making a Market” as a Specific Financial Service
“Making a market” is specifically classified as a financial service that requires AFSL authorisation. Financial services, cover a wide range of activities, including providing financial advice, dealing in financial products, operating managed investment schemes, and making a market for financial products. Among these, market making holds particular regulatory significance due to its critical role in providing liquidity and facilitating trading.
Engaging in market making without the appropriate AFSL authorisation constitutes a regulatory breach. Entities that engage in such activities must hold an AFSL explicitly authorising market making. This requirement ensures that businesses involved in this crucial financial service are regulated under the ASIC framework, providing oversight and accountability in financial markets.
ASIC’s Regulatory Focus on Market Making Authorisation
ASIC devotes significant regulatory attention to ensuring that market makers hold the necessary AFSL authorisations. For example, ASIC has identified cases where licensees were issuing complex financial products, such as Contracts for Difference (CFDs), without the required market-making authorisation. Such instances reflect ASIC’s proactive role in monitoring and enforcing compliance across financial markets, particularly in areas involving complex instruments.
In its Market Integrity Update (MIU) Issue 138, ASIC specifically addressed the need for CFD issuers to obtain market-making authorisation, even when relying on third-party pricing. ASIC clarified that market-making authorisation is typically required if an entity quotes prices at which they will trade with customers, executes transactions on its own behalf, and creates a reasonable expectation among customers to regularly transact at those quoted prices.
This guidance highlights ASIC’s diligent oversight of entities engaged in market making and underscores its commitment to ensuring that participants in this sector remain compliant with licensing requirements. By doing so, ASIC helps maintain the integrity and stability of Australia’s financial markets.
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Key Regulatory Obligations for “Making a Market” AFSL Licensees
Demonstrating Financial Competence and Resources
Licensees authorised to “make a market” must demonstrate financial competence and maintain adequate financial resources. This is a core regulatory obligation under an AFSL. These requirements are assessed by ASIC on a case-by-case basis, ensuring that licensees can meet their financial commitments and operate a sustainable financial services business.
To meet these obligations, applicants for an AFSL with market-making authorisation must provide proof of sufficient capital. This proof, referred to as ‘B5 Financial Resources’ in ASIC’s application process, must demonstrate the applicant’s capacity to meet both liquidity and risk management requirements. Licensees need to comply with the financial resource standards outlined in ASIC Regulatory Guide 166 (RG 166), which provides detailed guidance on these requirements.
Managing Conflicts of Interest and Risk Frameworks
Managing conflicts of interest and establishing robust risk management frameworks are critical regulatory obligations for AFSL licensees making a market. Licensees must have comprehensive procedures in place to identify, disclose, and manage conflicts of interest, particularly when dealing with clients. These procedures are essential to ensure the integrity of the market and protect retail clients.
Furthermore, licensees are required to maintain adequate risk frameworks. This includes implementing policies for identifying and managing various risks, such as liquidity risk and operational risks. These frameworks must also incorporate specific measures for preventing price manipulation and managing market volatility, ensuring a stable and fair market for financial products.
Navigating Intersecting Regulatory Requirements
Licensees authorised to “make a market” must navigate a complex web of intersecting regulatory requirements. These obligations extend beyond just the Corporations Act 2001 and include ASIC Regulatory Guides and anti-money laundering (AML) laws. Compliance with these diverse regulations is crucial for maintaining an AFSL and operating lawfully in the Australian financial services landscape.
The complexity arises from the nuanced nature of “making a market” activities and the overlapping requirements from different pieces of legislation and ASIC regulatory resources. Licensees must ensure they understand and adhere to all applicable regulations, including those related to anti-money laundering and counter-terrorism financing, to maintain their authorisation to provide financial services in Australia.
Key Proofs Required for a “Making a Market” AFSL Application
Business Description (A5 Proof)
When applying for an Australian Financial Services Licence (AFSL) with authorisation to “make a market”, ASIC requires a comprehensive business description. This A5 proof should clearly articulate the scope of your market-making activities.
Your business description needs to cover several key aspects:
- Explanation of Market-Making Activities: Detail precisely what your market-making activities will entail. This should provide a clear picture of your day-to-day operations in making a market.
- Financial Products: Specify the types of financial products you will be making a market for. This includes clearly identifying the financial products you intend to regularly quote prices for.
- Client Base: Describe your target client base. Outline whether you will be engaging with retail clients, wholesale clients, or both, and provide details about the types of clients you expect to serve.
- Operational Structure: Explain your operational structure. This should illustrate how your market-making activities will be integrated into your broader business operations and how different functions will interact.
Financial Resources (B5 Proof)
Demonstrating financial stability is crucial for obtaining an AFSL for market making. The B5 proof focuses on your financial resources and requires you to provide evidence of your financial competence.
Key components of the B5 proof include:
- Proof of Sufficient Capital: You must demonstrate that you possess adequate capital to meet both liquidity and risk management requirements. This proof is essential to assure ASIC that your business has the financial robustness to operate as a market maker.
- Compliance with RG 166: Your financial resources must comply with the standards outlined in ASIC Regulatory Guide 166. This regulatory guide provides detailed guidance on the financial requirements that AFSL licensees must meet, ensuring they can sustain their financial services business.
Competency of Key Personnel (B1 Proof)
ASIC assesses the competency of key personnel to ensure that individuals managing the market-making operations have the necessary expertise and qualifications. The B1 proof focuses on demonstrating the competency of your responsible managers.
This proof requires you to provide:
- Evidence of Expertise: Demonstrate that your responsible managers possess the necessary expertise to oversee market-making activities. This includes showing a deep understanding of financial markets and the specific financial products you will be dealing with.
- Qualifications of Responsible Managers: Provide detailed information on the qualifications of your responsible managers. This typically includes resumes that highlight relevant experience and training in financial services and market making.
- Role Descriptions: Include clear role descriptions that align with market-making responsibilities. These descriptions should illustrate how each responsible manager’s role contributes to the oversight and competent operation of the market-making function.
Market Maker Statement (C3 Proof)
A critical component of your AFSL application is the Market Maker Statement, known as the C3 proof. This statement provides a detailed overview of your intended market-making operations and how you will manage associated responsibilities and risks.
The C3 proof needs to outline:
- Market-Making Activities: Clearly describe all market-making activities you plan to undertake under your AFSL. This should encompass the full spectrum of services you intend to offer as a market maker.
- Client Use Cases: Explain the typical scenarios and purposes for which clients will utilise your market-making services and financial products. This helps ASIC understand the practical application of your services from a client perspective.
- Responsible Manager Oversight: Detail how your Responsible Managers will oversee the market-making activities. Specify the mechanisms and processes they will employ to ensure compliance and effective risk management.
- Risk Management Strategies: Describe the strategies you will implement to manage the risks inherent in market-making. This section should demonstrate a proactive approach to identifying, assessing, and mitigating potential risks.
Systems and Technology Proof
Robust systems and technology are essential for efficient and reliable market-making operations. The Systems and Technology proof requires you to detail the technological infrastructure supporting your activities.
This proof must include:
- Description of Trade Execution Systems: Provide a comprehensive description of the systems used for trade execution. This should cover how trades are processed, confirmed, and settled within your operations.
- Pricing Systems: Detail the systems you will use for price determination and quotation. Explain how prices are derived, updated, and disseminated to the market.
- Risk Management Systems: Describe the technology employed for risk management. This includes systems for monitoring market risk, credit risk, and operational risk, ensuring real-time risk oversight.
- Cybersecurity Frameworks: Demonstrate robust cybersecurity frameworks. Outline the measures in place to protect your systems and client data from cyber threats and ensure data integrity.
- Disaster Recovery Frameworks: Explain your disaster recovery frameworks. Describe the plans and procedures to ensure business continuity and system recovery in the event of disruptions or disasters.
Risk Management Framework Proof
A well-defined risk management framework is paramount for maintaining the integrity and stability of market-making activities. The Risk Management Framework proof requires you to detail your policies and procedures for managing risks.
This proof should include:
- Policies for Risk Identification: Describe the policies you have in place for identifying various types of risks. This includes processes for systematically identifying potential risks across all aspects of your market-making operations.
- Policies for Risk Management: Detail your policies for managing identified risks. Explain the strategies and controls you will use to mitigate and manage risks effectively, ensuring operational resilience.
- Liquidity Risk Management: Specifically address policies for managing liquidity risk. Outline how you will ensure sufficient liquidity to meet trading obligations and manage potential liquidity crunches.
- Operational Risk Management: Detail policies for managing operational risks. This includes addressing risks related to system failures, human error, and process inefficiencies.
- Measures for Price Manipulation Prevention: Describe specific measures to prevent price manipulation. Explain the controls and surveillance mechanisms in place to detect and deter any attempts at market manipulation.
- Measures for Market Volatility Management: Outline measures for managing market volatility. Detail how you will handle periods of high market volatility to maintain orderly trading and manage risk exposures.
Compliance Framework Proof
Adherence to regulatory requirements is non-negotiable for AFSL licensees. The Compliance Framework proof requires you to demonstrate how you will maintain ongoing compliance with ASIC rules and market integrity obligations.
This proof needs to include:
- Comprehensive Compliance Policies: Provide comprehensive policies for monitoring compliance. These policies should cover all relevant ASIC rules, regulations, and market integrity obligations.
- Policies for Reporting: Detail your policies for compliance reporting. Explain the processes for generating and submitting compliance reports to ASIC and internal stakeholders.
- Policies for Maintaining Compliance: Describe policies for maintaining continuous compliance. This includes procedures for regularly reviewing and updating compliance measures to adapt to regulatory changes and evolving business practices.
- Internal Systems for Compliance Adherence: Explain the internal systems designed to ensure adherence to market integrity obligations. These systems should facilitate proactive compliance monitoring and prompt issue resolution.
Practical Steps for a Successful “Making a Market” AFSL Application
Diagrammatic Mapping of Key Processes
When preparing an application for an AFSL to “make a market”, a practical initial step involves creating diagrams to clearly articulate key operational processes. Mapping these processes is crucial for businesses to understand and effectively present their operations to ASIC. This diagrammatic approach is particularly useful for illustrating complex pathways in a simple and understandable manner.
In drafting applications, businesses should focus on mapping key stages across several essential pathways. These pathways are fundamental to demonstrating a comprehensive understanding of the business operations related to providing financial services. Mapping is essential for at least three key areas:
- Customer Onboarding Journey: This diagram should detail the complete process of bringing a client onboard. It must clearly show each step of the customer onboarding journey, including all necessary disclosure requirements to ensure transparency and compliance.
- Funds Flow, including “Client Monies”: This map needs to illustrate the flow of funds within the business, specifically addressing how client monies are handled. It should provide a clear picture of how funds are managed, segregated, and reconciled, adhering to regulatory requirements for client money handling.
- Trade Execution: This diagram should outline the end-to-end process of trade execution. It needs to cover all stages from order placement to final settlement, including the roles and obligations of all parties involved such as the issuer, broker/dealer, and platform.
Articulating Operational Details and Frameworks
Building upon the foundation of process diagrams, the next practical step involves clearly articulating the surrounding operational details and frameworks. These details are essential for demonstrating to ASIC a robust and well-considered approach to providing “making a market” financial services. Drafting these detailed descriptions provides a solid foundation for addressing various regulatory requirements.
Businesses seeking to become market makers should focus on clearly articulating several key elements:
- Operational Details: Provide comprehensive details of day-to-day operations. This includes how the market-making activities will be conducted, managed, and integrated within the broader financial services business.
- Product Information: Clearly describe the financial products for which market-making services will be offered. This description should cover the nature, features, and complexities of these financial products, ensuring ASIC understands the scope of products involved.
- Policy and Procedure Framework: Develop a robust framework of policies and procedures that govern all aspects of the market-making business. This framework should address compliance, risk management, and operational protocols, demonstrating a commitment to regulatory best practices.
- Disclosures: Outline all necessary disclosures that will be provided to clients. These disclosures must be comprehensive and transparent, ensuring clients are fully informed about the services, products, and associated risks.
- Contractual Infrastructure: Establish a sound contractual infrastructure that underpins the market-making activities. This includes agreements with clients, service providers, and other relevant parties, clearly defining roles, responsibilities, and obligations.
By methodically drafting these diagrams and surrounding details, businesses aspiring to become market makers can establish a strong foundation. This structured approach not only aids in the AFSL application process but also ensures operational readiness and compliance with regulatory expectations, including liquidity and capital requirements.
Conclusion
In summary, navigating the Australian regulatory landscape for “making a market” as a financial service necessitates a clear understanding of the Corporations Act 2001 and the critical role of an AFSL. Businesses engaging in activities that meet the definition of “making a market” must recognise the importance of AFSL authorisation from ASIC. This authorisation is not merely a procedural step but a fundamental requirement to lawfully provide financial services in Australia.
For businesses seeking to confidently navigate the complexities of AFSL applications for market making, AFSL House stands ready to assist. Our unparalleled expertise in Australian financial services licensing ensures that your application is robust, comprehensive, and aligned with ASIC’s regulatory expectations. Contact AFSL House today to book your consultation and ensure your business is authorised to provide financial services in Australia, including “making a market”, with clarity and compliance.
