Fri Aug 16

Australia’s corporate watchdog is suing our largest stock exchange. What’s going on?

Written by: Michael Adams, Professor of Corporate Law & Academic Director of UNE Sydney campus, University of New England

The Australian Securities Exchange (ASX) is unusual in the world of finance.

It is the operator of Australia’s largest stock exchange, and as such is “required to ensure that each of its licensed markets is fair, orderly and transparent”.

At the same time, it is itself a public company listed on that very exchange. It’s as if we’ve enlisted a flock’s shepherd by picking out one of its sheep.

That doesn’t mean the ASX does – or has done – anything wrong. But this has been a known potential conflict of interest since the 1990s.

ASIC Chair Joe Longo. Detail from Lukas Coch/AAP ^[1]

That was when the ASX listed itself as a public company on its own exchange, the first time this had ever happened in the world.

That saw a wide range of regulatory functions ^[2] handed to Australia’s corporate watchdog, the Australian Securities and Investments Commission (ASIC).

So for ASIC to file a lawsuit ^[3] on Wednesday, alleging the ASX misled markets, was significant.

But what exactly does ASIC allege happened? And why do a company’s announcements matter so much in the first place?

What are ASIC’s allegations?

The issue in question is the exchange’s stated progress replacing a key piece of software – “CHESS” – that is used to settle transactions. ASIC alleges the ASX told markets this project was on track and on schedule, despite knowing it wasn’t.

According to ^[4] ASIC Chair Joe Longo:

ASX’s statements go to the heart of trust in the integrity of our markets. We believe this was a collective failure by the ASX Board and senior executives at the time.

ASX chief executive Helen Lofthouse said ^[5] the company acknowledges the “significance and serious nature of these proceedings”.

Lofthouse said the ASX is now “carefully reviewing and considering the allegations”, having “cooperated fully” with the investigation.

What is CHESS? And why does it need replacing?

One of the most important functions of the ASX is to provide a system for recording and settling share transactions. The current system is the Clearing House Electronic Subregister System, or CHESS for short, which we’ve had since 1994.

But for the past decade or so, it has been known that the technology underpinning CHESS is outdated and needs replacing.

According to ASIC’s filing ^[6] in the Federal Court this week, the ASX determined it would replace CHESS in early 2016. By December 2017, it had engaged a company called Digital Asset to build the technology.

This new system was to be based on blockchain technology ^[7], an innovation that excited global markets and would have made Australia a world leader.

A digital board at the Australian Securities Exchange (ASX) is seen in Sydney

The ASX’s system – known as CHESS for short – is used to record shareholdings and settle transactions. Joel Carrett/AAP ^[8]

By March 2020, the ASX had announced that the CHESS replacement project’s initial go-live date in April 2021 would have to be delayed. By October, it had announced a new date: April 2023.

In mid-2021, it published an implementation timetable, and indicated it was still “on-track” to go live in April 2023. But ASIC alleges that in November 2021, the ASX opened an “industry test environment” despite a lack of “full functionality”.

The regulator alleges that about 100 defects in the application “were not addressed”.

According to the filing, the ASX’s own audit and risk committee was informed the CHESS replacement project had a “red” status on February 3 2022 – that is, there was a high risk it wouldn’t be completed on time.

ASIC alleges that despite this, when the ASX published its half-yearly results about a week later, it misleadingly indicated the project was “progressing well” – and still on track for its planned date to go live.

In September 2022, consulting firm Accenture was engaged to review the project. By November, ASX had paused it.

Pre-tax, it had already cost about A$250 million. The use of blockchain technology to replace CHESS has now been abandoned altogether.

Why does this all matter?

Both the ASX and the corporate regulator ASIC need a fully informed securities market to function. There are a number of laws that relate to this need.

Under the ASIC Act, the corporate regulator is explicitly required ^[9] to “maintain, facilitate and improve the performance of the financial system”.

Under the Corporations Act – which is enforced by ASIC – companies must continuously disclose ^[10] material information that could impact on their share price to the market.

More generally, this principle aims to prevent market manipulation and insider trading by companies listed on the stock exchange by preventing misleading or false statements.

With this lawsuit, ASIC has shone a spotlight on what is expected more broadly in terms of disclosures and accuracy, from all publicly listed companies.

The matter will now be decided under usual court processes and future hearings, unless it is settled earlier. Investors and regulators will be watching closely.