Settlement Systems
11. Settlement systems are used to give effect to transactions in our financial markets. Once the parties to a transaction have agreed to buy or sell an asset, a settlement system can be used to effect and complete the transfer of ownership of that asset. The asset could be a financial instrument (e.g. securities), but there are also systems that settle commodity products (e.g. oil). A payment system (such as a system for settling foreign currency) settles transfers of funds between parties, and can stand alone or form part of a settlement system.
12. Designation of a settlement system gives statutory backing to the system's rules, to support finality of settlement and the effectiveness of netting arrangements, by providing that certain aspects of the operating rules of a designated settlement system are valid and enforceable despite any law or agreement to the contrary. That in turn gives a designated settlement system protection against claims that might otherwise be made by the liquidator of a failed participant.
13. The design of some systems relies on participants to supply collateral to back their obligations. In this case, in the event of a default, a designated settlement system will receive primacy of interest (or "super-priority") in collateral posted as margin by the participant, through an amendment to the Personal Property Securities Act.
14. Designation confers certain benefits, therefore to become designated and maintain that status, the operating rules of a settlement system are required to meet certain standards. To receive designation under the Settlement Systems, Futures, and Emissions Units Bill, a settlement system must have its rules approved by the joint-regulators (the Reserve Bank of New Zealand and the Securities Commission) according to criteria that can include relevant international standards. If the designated settlement system subsequently seeks to amend its operating rules, the joint-regulators have the power to disallow the rule change e.g. where the rule would no longer have met the designation criteria.
15. The designated settlement system is subject to the ongoing oversight of the joint-regulators. The joint regulators also have the power to recommend that the conditions of a designation be varied, including by adding a condition requiring a change to the rules of the settlement system. Such a variation is made by the Governor-General, by Order in Council, on the advice of Ministers given in accordance with a joint recommendation by the joint regulators. The legislation sets out the purposes for which such powers must be exercised and the matters that may be taken into account by the joint regulators in making such a recommendation. These purposes and the matters that may be taken into account set out the detail of what constitutes the public interest in this context, noting that the Cabinet decision limited the joint-regulators' ability to require rule changes to situations where a change was "in the public interest" (CAB Min (07) 44/4b).
16. At present, New Zealand's legislation provides for the designation of payment systems under part 5C of the Reserve Bank of New Zealand Act 1989. Settlement systems could also be designated under this provision, but designation may only provide the protection of irrevocability to the payment component of the transaction, and not to settlement of the property component of the transaction i.e. if the payment was made in consideration for a transfer of title to property, the transfer of title may not be protected under existing legislation. Under the Settlement Systems, Futures, and Emissions Units Bill, the designation regime in part 5C will be extended to systems that clear and settle products as well as payments.
17. Although NZX currently operates a settlement system without designation, NZX asserts that the upgraded settlement system they are developing needs to be designated in order to meet the expectations of international and domestic participants when NZX extends its exchange to emissions units and futures products. NZX also advises that they will not be able to operate a central counterparty without designation, because they will have difficulty accessing the necessary synthetic capital required to support this model of settlement.
18. International standards can be met without designation. Designation merely provides an official stamp of approval for a settlement system. There are no obvious international concerns about the overall payment and settlement system in New Zealand, primarily because our central bank operates the core infrastructure and the dominant settlement system. This is evidenced by the International Monetary Fund's positive financial sector assessment of New Zealand and by the very high level of penetration of New Zealand's debt and equity markets by overseas investors compared to most other countries. However, NZX's settlement system is not operated by New Zealand's central bank. Without an explicit regulator of settlement systems in New Zealand, it could be difficult for a private operator to convince participants that a settlement system meets international standards.
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