Following a lengthy consultation process, which began four years ago, Cabinet has agreed to a new legislative regime intended to provide enhanced oversight over financial market infrastructures (FMIs).
FMIs, frequently labelled as the 'plumbing' of the financial system, have come under increased regulatory scrutiny globally following the GFC – largely due to their ability to create, transmit, or exacerbate instability. FMIs are multilateral systems among participating institutions used to clear, settle, or record payments, securities, derivatives or other financial transactions. They include payment systems, securities settlement systems, central securities depositories, central counterparties, and trade repositories.
Under the proposed new regime, the Reserve Bank of New Zealand (RBNZ) and the Financial Markets Authority (FMA) will see their current oversight powers for payment and settlement systems both strengthened and extended to new entities.
The current position and its shortcomings
The current framework for regulating FMIs in New Zealand is contained in Parts 5B and 5C of the Reserve Bank of New Zealand Act 1989. This gives the RBNZ certain information-gathering powers in respect of payment systems (Part 5B) and provides for "designated settlement systems" to enjoy certain statutory protections for settlements that occur within the rules of those systems (Part 5C). The RBNZ and the FMA are the joint regulators for designated settlement systems, other than so-called "pure payment systems", which are regulated solely by the RBNZ.
The RBNZ has identified a number of shortcomings in the current framework, partly as a result of benchmarking that framework against the Principles for Financial Market Infrastructures published in 2012 by CPMI-IOSCO. The shortcomings include:
- The opt-in nature of the designation regime, which means the joint regulators have few powers in respect of systemically important FMIs (SIFMIs) that choose not to become designated.
- The lack of crisis management powers for the joint regulators.
- The designation regime's (narrow) focus on ensuring the finality of settlements, rather than general oversight.
- The limited scope of the designation regime, which only covers payment and settlement systems. Accordingly, other types of FMIs mentioned above fall outside the current framework.
As a result of these shortcomings, the RBNZ (and Cabinet) believe New Zealand is falling behind international best practice.
There are no major surprises in the reform package approved by Cabinet. The extensive consultation undertaken by the RBNZ has meant the main features of the reform have been foreshadowed for some time. Those features are as follows:
- The joint regulators will have information-gathering powers for all FMIs, not just payment systems.
- An FMI that is identified as being 'systemically important' will be required to become designated. In other words, the current opt-in designation regime will, for SIFMIs, become a mandatory regime.
- However, non-systemically important FMIs will continue to be able to opt in to designation and the statutory protections that come with it.
- For all designated FMIs (whether mandatory or voluntary), the joint regulators will have enhanced oversight powers, including powers relating to setting regulatory requirements, overseeing the FMI's rules, investigative and enforcement powers, and crisis management powers. The crisis management powers are likely to be the most intrusive and onerous reform, requiring designated FMIs to have business continuity plans and recovery and orderly wind down plans (similar to the 'living wills' required of banks and others in many overseas jurisdictions). In addition, the joint regulators' crisis management powers will include the ability to recommend the appointment of a statutory manager of an FMI under a new bespoke statutory management regime.
- Not all features of the new regime will apply to all designated FMIs. In a recognition that 'the tail should not wag the dog', the joint regulators will, in the case of offshore-based designated FMIs, largely defer to the regulation in their home jurisdiction.
Who will be caught?
There are currently four designated settlement systems:
- the Exchange Settlement Account System (ESAS) operated by the RBNZ, which settles in real time high value inter-bank payments,
- NZClear, also operated by the RBNZ, which settles securities transactions and cash payments between members,
- NZCDC, which is NZX's securities settlement system, and
- CLS Bank, which settles high value FX transactions (including those involving the NZD) between its members.
These four FMIs would likely be re-designated under the new regime.
A fifth FMI has been identified by the RBNZ as being likely to be systemically important – the Settlement Before Interchange (SBI) arrangements for retail payments operated by Payments NZ and used by local banks.
Four further FMIs are considered by the RBNZ to potentially be systemically important, subject to further analysis. They are:
- the High Value Clearing System (HVCS) operated by Payments NZ and used by local banks for real time payment of high value customer-to-customer payments,
- LCH Clearnet, a UK-based central counterparty, whose Swapclear service clears NZD-denominated interest rate swaps for local banks,
- ASX Clear (Futures), an Australian-based central counterparty, which clears NZD-denominated futures and certain other NZ futures and options traded on the ASX 24 market, and
- DTCC Singapore, a Singapore-based trade repository, to which banks are reporting OTC derivatives under Australian reporting rules.
While, as we note above, the expressed intention is not to saddle offshore-based FMIs with onerous new compliance obligations, one issue they will need to consider is whether designation would bring with it other regulatory consequences not directly arising out of the reform. For example, would designation mean an offshore FMI is more likely to be required to register as an overseas company carrying on business in New Zealand - assuming it has not already done so?
A Financial Markets Infrastructure Bill will be drafted and will undergo the normal Parliamentary process. That should allow those who will be affected by the reform a final chance to voice their concerns. However, given the extent of the consultation to date, and the detail laid out in Cabinet's approval paper, it would be unrealistic to expect any major policy changes.
If you would like guidance on how this proposed reform would affect your business, please contact David Craig or your usual Bell Gully adviser.
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.