Regulatory Impact Statement: Settlement Systems, Futures, and Emissions Units Bill
Executive Summary
To provide a signal that trades in securities and other products can be cleared and settled in New Zealand through systems that meet the expectations of international and domestic participants, the preferred option is to extend the current payments system designation regime under Part 5C of the Reserve Bank of New Zealand Act 1989 to settlement systems, make the Securities Commission a joint regulator with the Reserve Bank of New Zealand (the Reserve Bank), and make explicit reference to relevant international standards as a matter that the joint regulators may have regard to when designating systems.
The preferred option for futures exchanges is to reduce administration and compliance costs by amending the Securities Markets Act 1988 to align the regulation of exchanges seeking to operate in both the securities and futures markets and codifying that participants approved by the operator of an authorised futures exchange are authorised futures dealers. New Zealand Exchange Limited (NZX) expects to benefit from these amendments through a reduction in costs.
Emissions units are a relatively new product in New Zealand's markets NZX asserts that in order to trade emissions units and emissions units futures products on an exchange, and to clear and settle those transactions adequately, the treatment of emissions units under New Zealand legislation needs to be clarified. The objective of the Emissions Units Bill is to clarify the regulatory treatment of emissions units to support the development of the market for emissions units, which is given effect through technical amendments to New Zealand's personal property securities, securities, and securities markets legislation. None of these technical amendments are necessary for the operation of the New Zealand Emissions Trading Scheme.
Adequacy Statement
The Ministry of Economic Development considers the regulatory impact statement and the regulatory impact analysis undertaken to be adequate.
Status Quo And Problem
Settlement systems
Part 5C of the Reserve Bank of New Zealand Act 1989 currently provides for the Reserve Bank to designate a settlement system that settles payments. It is also currently possible to designate a settlement system that settles products, but the designation may only provide protection of irrevocability to the settlement of the payment component of a transaction and not to the settlement of the property component of the transaction. Therefore, if the payment was made in consideration for a transfer of title to property such as securities, the transfer of title may not be protected.
Designation lends statutory backing to the settlement of transactions. Designation is approved if the system meets certain criteria and subjects itself to ongoing regulatory oversight. 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 their exchange to emissions units and futures products.
International standards can be met without designation. However, without an explicit regulator of settlement systems in New Zealand it can be difficult to convince participants that a settlement system meets international standards. Designation 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 in the very high level of penetration of New Zealand's debt and equity markets by overseas investors compared to most other countries.
Futures
The Australian Securities Exchange (ASX) is the current market operator of futures and options trading and clearing services for the New Zealand market. These products are currently traded through the Sydney Futures Exchange and centrally cleared through SFE Clearing Corporation Pty Ltd. NZX currently has an agreement with ASX regarding derivative products on NZX traded securities. NZX has recently announced its intention to enter the futures market independently.
Registered securities exchanges and authorised futures exchanges are regulated slightly differently from each other under existing New Zealand legislation. NZX has asked for the regulation of futures and securities exchanges to be aligned in the situation where an exchange is seeking to perform both functions, in order to reduce their compliance costs and the Securities Commission's administrative costs.
In addition, New Zealand legislation currently only provides for the Securities Commission to authorise futures dealers, although there are class authorisations under the Authorised Futures Dealers Notice (No 2) 2004 and the Authorised Futures Dealers Notice (No 3) 2004. The effect of these class authorisations is that the Sydney Futures Exchange and the NZX can authorise exchange participants as futures dealers. NZX is seeking to provide futures products on its exchange and has requested that the existing exemption be given the authority of legislation.
Emissions Units
Emissions units fall into two broad categories: units issued under binding regulations such as the New Zealand Emissions Trading Scheme; and units issued in the voluntary market. The Government regards the voluntary carbon market as complementary to the regulated market, useful for meeting consumer demand for action on climate change, and a valuable testing ground for new emissions reduction measures.
Emissions units are a relatively new product in New Zealand's markets. In some instances, it is unclear how emissions units will be treated when traded within New Zealand's existing regulatory environment. NZX has established TZ1, which is developing an exchange platform for trading emissions units. NZX asserts that in order to trade emissions units and emissions units futures products on an exchange, and to clear and settle those transactions adequately, the treatment of emissions units under New Zealand's personal property securities, securities, and securities markets legislation needs to be clarified. However, the Australian Securities Exchange submitted that there is nothing within the existing regulatory framework to prohibit or restrict firms in New Zealand or elsewhere from providing over the counter and exchange infrastructure to support the New Zealand Emissions Trading Scheme.
Objectives
The policy objective for settlement systems is to signal that trades in securities and other products in New Zealand can be cleared and settled through systems that meet the expectations of international and domestic participants.
The policy objective for futures exchanges is to reduce compliance costs by aligning the regulation of exchanges seeking to operate in both the securities and futures markets and codifying that participants approved by the operator of an authorised futures exchange are authorised futures dealers.
The policy objective for emissions units is to clarify the regulatory treatment of emissions units (for market operators and market participants) to support the trading of emissions units and the development of the market for emissions units.
Alternative Options
For the policy on settlement systems, the alternative options available are to—
- maintain the status quo; or
- require all settlement systems in New Zealand to be designated; or
- undertake a general review of clearing and settlement law in New Zealand.
For the policy on futures exchanges, the alternative options available are to—
- maintain the status quo; or
- undertake a general review of the regulation of registered securities exchanges and authorised futures exchanges.
For the policy on emissions units, the alternative options available are to –
- maintain the status quo; or
- to restrict the technical amendments to emissions units traded in regulated emissions trading schemes.
Maintaining the status quo
Maintaining the status quo for settlement systems does not meet the policy objective of signalling that trades in securities and other products in New Zealand can be cleared and settled through systems that meet the expectations of international and domestic participants.
Maintaining the status quo for authorised futures exchanges does not meet the policy objective of reducing compliance costs by aligning the regulation of exchanges seeking to operate in both the securities and futures markets and codifying that participants approved by the operator of an authorised futures exchange are authorised futures dealers.
NZX maintains that technical amendments are required to New Zealand's legislation in order to trade emissions units and emissions units futures products on an exchange in New Zealand, and to clear and settle those transactions adequately. Exchange trading is a useful step in the development of any new market. Maintaining the status quo for emissions units is therefore not sufficient to meet the policy objective to support the development of the market for emissions units.
Requiring all settlement systems in New Zealand to be designated
The characteristics of different settlement systems vary to service the needs of a particular market segment or product. Mandatory designation could reduce the options available to consumers of settlement services while potentially increasing the cost of those services. The policy objective for settlement systems does not require that all trades be cleared and settled through a designated system.
General review of clearing and settlement law
Undertaking a general review of clearing and settlement law in New Zealand before introducing the requested legislative amendments is not preferred. The stated policy objective is much narrower than the scope of a general review of clearing and settlement law in New Zealand. A general review, including analysis and engagement with stakeholders, would take some time.
NZX would prefer the requested legislative amendments to be in force before their settlement system becomes operational, or alternatively at least have the necessary legislative amendments progressing through parliament. NZX's upgraded settlement system is still under development. In a recent meeting with Ministers, NZX's CEO said that the new system may not be operational until April 2009. However, NZX has indicated publicly that it will be ready in October 2008.
Although NZX currently operates a settlement system without designation, NZX advises that they will not be able to operate a central counter party without designation because they will have difficulty accessing the necessary synthetic capital required to support this model of settlement. Any delay will cost NZX lost revenue from their expanded services and upgraded services.
General review of the regulation of securities and futures exchanges
A general review of Parts 2B and 3 of the Securities Markets Act 1988 is not preferred to meet the policy objective. A general review of those parts of the Securities Markets Act 1988 would be broader than the amendments required to give effect to the stated policy objective for futures and securities exchanges. NZX would incur costs under both regimes until such time as a general review was complete.
Restricting technical amendments to regulated emissions units
Restricting the technical amendments to emissions units traded in regulated emissions trading schemes would simplify the amendments since regulated emissions units are well defined in existing legislation. There are many challenges inherent in any attempt to adequately define voluntary emissions units because the market is still developing and consistent standards and practices have not yet evolved. However, excluding voluntary emissions units from the technical amendments would be inconsistent with the policy objective and the Government's regard for the voluntary carbon market.
Preferred Option
To provide a signal that trades in securities and other products can be cleared and settled in New Zealand through systems that meet the expectations of international and domestic participants, the preferred option is to extend the current payments system designation regime under Part 5C of the Reserve Bank of New Zealand Act 1989 to settlement systems, make the Securities Commission a joint regulator with the Reserve Bank, and make explicit reference to relevant international standards as a matter that the joint regulators may have regard to when designating systems.
NZX and the Reserve Bank are both expected to seek designation for their settlement systems under the new law. The cost of complying with the new regulatory regime is optional for settlement system operators. Although NZX has been the catalyst for these amendments to Part 5C of the Reserve Bank of New Zealand Act 1989, the preferred option is to design an opt-in designation regime for settlement systems that is available to any provider of settlement services in New Zealand who applies for designation and meets the relevant criteria, and is thus of general benefit to the development of the New Zealand financial market.
In parallel, the Government will undertake a general review of New Zealand's settlement and clearing infrastructure in response to concerns raised during consultation.
The preferred option for futures exchanges is to reduce compliance costs by amending the Securities Markets Act 1988 to align the regulation of exchanges wanting to operate in both futures and securities markets and codifying that participants approved by the operator of an authorised futures exchange are authorised futures dealers. The NZX expects to benefit from these amendments through a reduction in costs.
The preferred option is to give effect to the policy objective for both voluntary and regulatory emissions units through technical amendments to New Zealand's personal property securities, securities, and securities markets legislation. While it is already possible to trade emissions units through over the counter transactions and other means, registered exchange trading of emissions units and emissions units futures products would provide an additional trading option for those in the market. Exchange trading generally supports liquidity, aids price discovery, and can reduce transaction costs, while the availability of futures products can assist businesses to manage their emissions reduction liabilities.
The proposed amendments should not impose any costs on the market, but rather should improve certainty for those trading in emissions units and related products and make it possible to provide an additional trading mechanism for emissions units.
Implementation And Review
The Settlement Systems, Futures, and Emissions Units Bill gives effect to the policy objective for settlement systems through an extension of the existing regime for the regulation of designated payment systems in New Zealand under Part 5C of the Reserve Bank of New Zealand Act 1989. The Bill provides settlement systems operating in New Zealand with the option of applying for designation and being regulated to relevant international standards by the Reserve Bank and the Securities Commission. In return, a designated settlement system receives additional legal protections to support the integrity of the system in the case of a participant's default, including through an amendment to the Personal Property Securities Act 1999. Once the amendments take effect, the operators of any settlement systems seeking designation will still need to apply for approval from the joint regulators.
The Settlement Systems, Futures, and Emissions Units Bill gives effect to the stated policy objective for futures exchanges by amending the Securities Markets Act 1988 so that an exchange registered under Part 2B of that Act may be registered either with respect to securities markets only or with respect to both securities markets and futures markets. The Settlement Systems and Futures Bill also provides that market participants who have been approved by an authorised futures exchange under its operating rules shall be deemed to be authorised to deal in futures contracts under section 38 of the Securities Markets Act 1988.
The Settlement Systems, Futures, and Emissions Units Bill gives effect to the preferred option through technical amendments to the—
- Personal Property Securities Act 1999 to give more certainty as to the effect of that Act in relation to emissions units, which will include emissions units in the property category of investment securities, and facilitate the trading of emissions units on an exchange:
- Securities Act 1978 to ensure that the issue of emissions units will not need to meet the requirements of the regulatory regime for offers of securities or the relevant provisions of the Securities Markets Act 1988 unless they are part of an investment scheme:
- Securities Markets Act 1988 to include emissions units in the definition of commodity, providing certainty that futures contracts in emissions units are regulated by the Securities Markets Act 1988.
None of these technical amendments are necessary for the operation of the New Zealand Emissions Trading Scheme.
Consultation
The Securities Commission, the Reserve Bank of New Zealand, and the Treasury, have been closely consulted in the preparation of the Settlement Systems, Futures, and Emissions Units Bill as part of an inter-agency working group. The Department of the Prime Minister and Cabinet, the Ministry of Agriculture and Forestry, the Ministry for the Environment, and the Emissions Trading Group have also been consulted.
Following initial policy engagement with NZX in 2007, the Government undertook targeted consultation with a wider group of stakeholders in the preparation of a discussion document, which was released in February 2008 with an exposure draft of Emissions Units, Settlement Systems, and Futures Bill. The Ministry of Economic Development received 19 submissions on the draft Emissions Units, Settlement Systems, and Futures Bill (the draft Bill). Significant submissions on the draft Bill are summarised as follows:
- submitters were critical of the consultation and policy development process, requesting more time to make comments, wider consultation, workshops, and additional consultation documents. A significant proportion of submitters expressed concern that legislation had been drafted solely to further NZX's commercial interests. The Government has since individually met with a number of submitters to hear their concerns and will conduct further consultation as part of a New Zealand approach to clearing and settlement:
- submitters were concerned that the implications for New Zealand's financial market infrastructure should be further examined given the public utility nature of clearing and settlement systems, and the network effects that could result from a private, vertically integrated monopoly provider. These implications will be examined as part of a New Zealand approach to clearing and settlement:
- submitters suggested that the Government should amend the proposed joint regulator model, and provide a process for managing potential conflicts of interest within the Reserve Bank. Officials are confident that the joint regulator model is the best model for recognising both the Reserve Bank's and the Securities Commission's interests in the regulation of settlement systems. The joint regulators are preparing a memorandum of understanding to govern their roles. Institutional arrangements are in place to ensure a high degree of independence between the Reserve Bank's operations and policy functions. The joint regulator model also addresses potential conflicts of interest relating to the Reserve Bank being the operator of Austraclear NZ:
- submitters were critical of the requirement to seek the regulators' approval for every critical rule change that is material to the designation order. This process has been amended to assume that any rule change is valid unless challenged and disallowed by the regulators:
- one submitter requested that the regulation of designated payment systems be delineated from designated settlement systems. The proposed legislation has been amended to reflect that the Securities Commission has a limited interest in systems that solely settle payments, in recognition of the status quo for payment systems under Part 5C of the Reserve Bank of New Zealand Act 1989:
- submitters suggested that the approval criteria for a designated settlement system should explicitly include adequacy of financial resources and adequacy of the system's arrangements in a default by the central clearing party. These criteria are implicit in the more general criteria outlined in the Bill:
- submitters suggested that improvements could be made to provisions on collateral, priority, and the Personal Property Securities Act 1999. Where possible, these provisions have been refined, but general submissions on the Personal Property Securities Act 1999 are outside the scope of this policy process and cannot be addressed in the Bill.
- submitters were concerned that the proposed amendment relating to the authorisation of futures dealers removed the ability of the Securities Commission to authorise futures dealers independently. This is not the case; the Bill simply codifies the status quo in legislation.
- submitters were confused by the bundling of emissions trading issues with generic financial market reform and felt this was a barrier to understanding the legislative amendments. Officials have therefore been careful to delineate the discrete policy issues for emissions units and settlement systems in their advice. Officials also see merit in separating the technical amendments relating to emissions units into a standalone bill, although not at the expense of the increased administration required to introduce and process two separate bills.
- submitters suggested that the Government should either regulate the quality of voluntary emissions units registers, which were recognised by the draft Bill, or that it should restrict the draft Bill to the compliance market. Excluding voluntary emissions units from the technical amendments would be inconsistent with the policy objective and the Government's regard for the voluntary carbon market. As such, the technical amendments have not been restricted to the compliance market. However, the technical amendment providing that entry on an emissions units register is prima facie evidence to title has been removed, removing the need to define which registers (and which voluntary emissions units) are regulated by the Settlement Systems, Futures, and Emissions Units Bill:
- submitters were critical of the fact that the Government is willing to clarify how futures regulations apply to emissions units, but not other products, and submitted that the technical amendments failed to adequately clarify the difference between futures and physical forward contracts. Officials are satisfied that the technical amendments do not confuse futures and physical forward contracts. The futures regime for other products falls outside the scope of the policy objective for these technical amendments:
- one submitter requested that the definition of emissions units be extended to include other environmental products such as wetlands credits. This issue is expected to be raised at Select Committee. The Ministry of Agriculture and Forestry also asked whether there was potential to address other forms of environmental offsets. For example, in Lake Taupo there is a proposal for trading in nitrogen offsets. This falls outside the scope of the current policy objective.
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