AFSL – Making a market, or a mess?

An Australian Financial Services Licence (AFSL) authorises a person or entity to provide financial services in Australia as defined under the Corporations Act 2001 (Cth).

These services may include providing financial advice, dealing in financial products, making a market for financial products, operating managed investment schemes, or providing custodial or depository services.

The scope of activities permitted under an AFSL can vary significantly depending on the authorisations granted by ASIC, which are tailored to the specific financial services or products the licensee intends to offer. Variability in an AFSL arises from factors such as the type of financial products involved (e.g., NCPs, securities, derivatives, FX, superannuation, or digital assets) and whether the services are provided to retail or wholesale clients. Licensees must meet stringent compliance obligations, including those relating to training, financial resources, and conduct, to maintain their licence.

Market makers

Under section 766D(1) of the Corporations Act, a person (other than a market licensee) makes a market for a financial product where they regularly state the prices at which they propose to acquire or dispose of the products on their own behalf, and other persons have a reasonable expectation that they will be able to regularly trade at the stated prices.

The complexity and confusion around making a market under an AFSL stem from the nuanced and overlapping regulatory requirements within the Australian financial services regime.  As stated, "Making a market" involves regularly quoting buy and sell prices for financial products, creating liquidity and enabling trading; however, distinguishing it from activities like broking or dealing can be challenging.

For example, ASIC outlined in Issue 138 of its Market Integrity Update (June 2022) (MIU) that it has observed some Australian Financial Services licensees issuing CFDs without the appropriate market-making authorisation.

In the MIU, ASIC stated that “typically, CFD issuers require a market-making authorisation… even when they trade on prices set by a third party”. ASIC further detailed that a market-making authorisation is required for a CFD issuer where:

• the issuer quotes prices that it will trade with customers. This includes where the issuer uses the prices set by a third-party such as a liquidity provider;
• the issuer enters into the CFD transactions with customers on its own behalf; and
• customers have a reasonable expectation that they will be able to regularly effect trades at the quoted prices.

The rise of complex financial instruments such as derivatives and digital assets further blurs the boundaries, leaving many businesses uncertain about whether their activities meet the definition of "making a market" or require additional authorisations. These products are complex in and of themselves, and require consideration of the structure of the product, leverage, underlying collateral, liquidity, valuations and disclosures.

Application

The regulatory obligations under an AFSL for making a market include demonstrating financial competence, managing conflicts of interest, and maintaining adequate resources and risk frameworks, all of which are assessed on a case-by-case basis. Adding to the complexity is the need to navigate intersecting obligations under the Corporations Act, ASIC’s Regulatory Guides (e.g., RG 166 and RG 212), and anti-money laundering laws, each with its own nuances.

There are numerous ASIC ‘proofs’ that are required for a ‘market making’ AFSL, and we have summarised the key areas of focus below:

Practical steps

In drafting applications for “market making” AFSLs, or in assessing them, we would suggest starting with diagrams.  If a business is not able to articulate, simply, the key stages in several key pathways, there is considerable risk.  In our experience, mapping is essential for: 1) customer onboarding journey, complete with disclosure; 2) funds flow, including “client monies”; and 2) trade execution e.g. issuer, broker/dealer and platform. An illustrative example is set out below:

Drafting these diagrams, then the surrounding operational details, products, policy & procedure framework, disclosures, contractual infrastructure, systems and people allows businesses hoping to become marker makers to form a solid foundation to then overlay various regulatory requirements e.g. design & distribution regime, liquidity and capital requirements. It is an initial investment, with very high returns.