Alternative options
The alternative options available are:
- maintain the status quo; and
- undertake a general review of clearing and settlement law in New Zealand.
Maintaining the status quo
This option would involve no changes to New Zealand's legislation governing futures exchanges and clearing and settlement systems.
On the basis of market research and discussion with potential traders conducted by NZX, it is believed that without an international benchmark approach to regulation of clearing and settlement systems, the chances of the emergence of a substantial regional emissions unit market based in New Zealand are remote. Futures traders in particular face substantial default risks due to the long term nature of their exposure under futures contracts. Successful futures markets throughout the world depend on appropriate legal and regulatory infrastructure to manage default risks (most commonly though a regulated "central counterparty" clearing and settlement system).
Under the status quo, NZX (or any other entity) could apply to the Securities Commission for authorisation of its proposed emissions futures market as an "authorised futures exchange" under section 37(8) of the Securities Markets Act. Preliminary discussion between NZX and the Securities Commission on this option included proposing as a condition of authorisation that NZX adopt conduct rules and market infrastructure for the futures markets that meet international standards as reflected in the IOSCO recommendations.
However this option does not achieve the objective of enacting a legal and regulatory framework that would allow for the establishment of a clearing and settlement system that meets international standards. A Securities Commission authorisation does not have the power to address the problems in current New Zealand law that give rise to issues when measured against the IOSCO recommendations, namely:
- insolvency risks, and the inadequacies of the New Zealand law approach to insolvency risk in multilateral trading regimes;
- the effect of, and impact on, prior security interests and other third party interests in securities or commodities traded through, or collateral or margin posed with, the clearing and settlement system; and
- evidence of title to the securities or commodities, in particular issues relating to the effect of registration of securities and any tradable commodities that can be registered.
These problems can only be addressed through legislation.
Also, without the technical amendments to the definitions of securities and futures contracts to clarify the legal treatment of emissions units, there is a risk of confusion as to how emissions unit products fit within New Zealand's capital market's regulatory framework. This confusion may result in inefficient transaction costs for potential participants in emissions unit trading activities, and a reluctance by overseas participants to trade on the New Zealand markets.
In light of the above, we do not think that maintaining the status quo is a satisfactory option.
General review
A general review of clearing and settlement law in New Zealand would potentially affect a number of sectors and stakeholders in the New Zealand economy (for example, the Reserve Bank and other banking sector participants, the electricity sector and other securities markets operators). Given the breadth and complexity of the subject matter of a general review, it is likely that a general review, including preparation and consultation with stakeholders on a policy discussion document and proposing and advancing legislation, would take some time.
NZX plan to launch their emissions trading platform in mid 2008 (expected May 2008) and would prefer to have the necessary legislative amendments in place by then (or alternatively at least progressing through parliament so that it can be passed before the end of the current parliamentary term), in order to provide their platform with the international credibility that comes with the regulation of trading functions. Officials expect legislation to be drafted by the end of 2007 for introduction to Parliament in February 2008.
A general review of the law would result in the loss of the opportunity to establish in New Zealand a regional emissions unit market as other likely alternative jurisdictions in the region already have legal and regulatory infrastructure for clearing and settlement systems that meet international best practice standards. Accordingly, undertaking a general review is not a preferred option within the timeframe identified for establishing a emissions unit market.
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