Banking giant Westpac last week admitted its fixed income trading desk engaged in “unconscionable conduct” in 2016, after a long-running prosecution by securities regulator the Australian Securities and Investments Commission (ASIC).
The bank hammered out a settlement with ASIC at the Federal Court, leading to a $1.8 million fine that Justice Michael Lee described as “risible”. Westpac also has to pay around $8 million in ASIC’s legal costs.
The case involved “frontrunning” by the bank’s traders, who double-crossed their clients in the run-up to executing one of the largest trades in the history of Australian money markets. The trade was an interest rate hedge on behalf of the consortium buying a majority stake in the New South Wales government electricity transmitter AusGrid in 2016.
The details of Westpac’s rogue trading make for fascinating reading for anyone interested in corporate governance in Australia. One of the nation’s largest banks used privileged information it gleaned as a party to a huge privatisation deal to place profitable trades on the money market before the deal was announced to markets.
The $16 billion AusGrid privatisation was an unsolicited offer to the NSW government, then led by former premier Mike Baird. The privatisation was later criticised by the NSW auditor-general in a stinging report. Put together by the financial wizards at IFM, and backed by the muscle of the huge AustralianSuper industry super fund, the deal hinged on a $16 billion debt package assembled by the consortium.
The consortium gave the job of hedging interest rate risk to global risk-management firm PMC Treasury. PMC shopped around for a trading desk that could do a $12 billion interest rate swap. Westpac offered the best deal with the cheapest spread, so PMC eventually gave it the gig.
But prior knowledge of the huge deal proved a little too tempting for the hot shots on Westpac’s fixed interest desk. Unbeknown to PMC, IFM and AustralianSuper, Westpac’s traders decided to seize the opportunity on behalf of the desk.
Given that it was about to place a $12 billion position, Westpac’s fixed interest desk was able to get ahead of the markets. As soon as markets opened at 8.30am on November 20, 2016, Westpac’s trader started buying and selling interest rate derivatives, in what ASIC describes as an effort “to pre-position Westpac in anticipation of the execution of the swap transaction”.
These weren’t exactly small side trades. ASIC’s originating application provides details, including a purchase of $4.4 billion of Australian government bond futures, a $3.98 billion buy on interest rate swaps, and a $6.1 billion sale of futures contracts — all “while possessing inside information”. The trades were so big that Westpac’s desk had to get special internal permission from the bank’s risk office to increase its trading limits to enable the trade for the consortium; the memo to the risk office explained that “the desk’s preference is to pre-hedge up to 50% of the deal”.
The evidence before the Federal Court is eye-opening. ASIC appears to have obtained recordings of many of the key phone calls. Some of the transcripts are like scenes from the HBO/BBC series Industry, as Westpac traders and key executives exchanged increasingly agitated dialogue about to how to pull off their “pre-hedging” before the privatisation was announced to the market.
The statement of agreed facts — signed off on by Westpac as part of the settlement — includes this delicious line by Westpac’s Simon Masnick, who was then head of the fixed income desk:
Yeah I mean — I think that’s the key, is we’ve got to make sure they understand, um, it’s — we don’t want them to think it’s — it’s frontrunning.
But “frontrunning” is exactly what Masnick and his hard charging traders embarked on. With the knowledge they were about to run a massive interest rate swap, Masnick and his desk placed a series of bets they knew they would win.
As Westpac poured billions of dollars of trades into the market, the spreads on swaps started to blow out, costing the consortium millions. Needless to say, this got the attention of the suits at IFM and AustralianSuper. They could see the spreads starting to move, indicating that someone in the market was placing big positions.
PMC’s Chris Danielian was pulled into a conference call by AustralianSuper executive Nik Kemp to explain what was going on. He then rang Westpac’s Masnick:
Kemp (AustralianSuper): Where are the rates at?
Danielian (PMC): They’re — they’re higher. This is — hang on. This is — this is bullshit, quite frankly. They — this — this …
Danielian (call to outside line [i.e., Simon Masnick]): Hey, how are you doing? Yeah, well, not — not so good. This is — this is — this is quite frankly bullshit, man, seriously. Yeah, look, Simon, you know, we both — we can — we can — we can both see the fucking price action, yeah?
Seven years on, the eventual punishment for this conduct is a $1.8 million fine.
“It’s a risible amount in comparison to the nature of the conduct and the size of the organisation,” Lee said while handing out the wrist slap. “There is nothing I can do about that manifest and striking disparity between the nature of the conduct and the maximum pecuniary penalty provided for by the statute.” The bank admitted it made nearly $20 million from the trade in question.
According to ASIC, “Westpac’s derivatives trading desk achieved a trading profit of approximately $20.7 million on the day the swap was executed (of which $3.7 million was allocated to the sales team as commission)”.
The settlement surely raises questions, once again, about the laxity of Australia’s corporate regulation, criticised by former High Court justice Kenneth Hayne is his royal commission on financial services misconduct. Federal fines for corporate wrongdoing of this nature have since been increased, but it’s difficult to see any deterrent in action.
Last week’s settlement also means ASIC decided to drop the insider trading charges. Although Westpac has copped to the unconscionable conduct admission, it would appear that none of the key players in the AusGrid frontrunning will be held individually responsible.
In other jurisdictions, this sort of thing has led to criminal charges and convictions for the individuals involved. For instance, US prosecutors have sent corporate high-flyers such as Martha Stewart and Raj Rajaratnam to jail for insider trading. In 2021, the US attorney for the Southern District of New York successfully prosecuted quant analyst Sergei Polevikov for frontrunning on a big trade for one of his clients. Polevikov received a 33-month sentence.
In Australia, no such consequences have flowed for any of the traders or their bosses at Westpac. Masnick still works for Westpac (though his LinkedIn lists him as “on sabbatical”). ASIC’s originating application in the Federal Court, for instance, named Lyn Cobley as the key figure in the deal. Cobley was the boss of Westpac’s institutional banking division — Masnick’s boss — at the time of the frontrunning that the bank has now admitted was unconscionable conduct. As the Statement of Agreed Facts makes clear, Cobley knew about the trades, supporting the memo to the bank’s chief risk officer for permission to make the trades.
Cobley has left Westpac, but she is still a non-executive director on the board of the Commonwealth Bank. This means CommBank has a board member who oversaw unconscionable conduct as a leader of an investment bank. She’s even on the CBA’s Audit Committee. It’s not a good look.
A spokesperson for the Commonwealth Bank declined to comment on our questions about Cobley’s role in the scandal. Crikey does not allege Cobley played any part in the frontrunning trades herself.
Prudential regulator APRA retains a set of “fit and proper person” rules that might be relevant for board directors who find themselves in hot water. The typically vague rules includes a reference to whether a “responsible person” has “the competence, character, diligence, honesty, integrity and judgement” to properly perform their duties. It will be interesting to see whether presiding over conduct admitted to be unconscionable counts as any of these.
Those following the softly-softly approach of Australian corporate regulators won’t be holding their breath.
Clarification: This article was amended on February 6, 2024 to change a reference to Westpac traders making “some extra money on the side” to Westpac’s traders “decided to seize the opportunity on behalf of the desk”. The term “flagrant insider trading” was removed in line with ASIC’s findings.
Additional context was included about the size of Westpac’s trades: “The trades were so big that Westpac’s desk had to get special internal permission from the bank’s risk office to increase its trading limits to enable the trade for the consortium; the memo to the risk office explained that ‘the desk’s preference is to pre-hedge up to 50% of the deal.'”
Additional context was also included in relation to the money made from the trades: “The bank admitted it made nearly $20 million from the trade in question. According to ASIC, ‘Westpac’s derivatives trading desk achieved a trading profit of approximately $20.7 million on the day the swap was executed (of which $3.7 million was allocated to the Sales team as commission)’.”
