The Commerce Committee has recently reported back to the House on the Settlement Systems, Futures, and Emissions Unit Bill (Bill) which will provide an opt-in regulatory regime for the approval and oversight of designated settlement systems in New Zealand. The Bill intends to align New Zealand's clearing and settlement system with international best practice which will make New Zealand a more attractive place for financial trading.

Back ground of the Bill

The Bill was first introduced to Parliament in September 2008 in response to New Zealand Exchange Limited's (NZX) request to upgrade its existing clearing and settlement system and expand its exchange traded products to include futures and emissions units.

The Bill aims to:

  • clarify the regulatory treatment of emissions units to support the development of the market for emissions units;
  • 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;
  • align the regulatory environment for exchanges seeking to operate in both the securities and futures markets (which will reduce compliance costs) so that an exchange registered under the Securities Markets Act 1988 may be registered either in relation to securities markets only or in relation to both securities and futures markets; and
  • codify that participants approved by the operator of an authorised futures exchange are authorised futures dealers (currently only the Securities Commission can authorise future dealers).

Although the Bill's principal purpose is to support the trading of emissions units in New Zealand, it will play a key part in addressing any systemic risk in New Zealand's capital markets.

What is a settlement system ?

A settlement system is a system or arrangement used to give effect to transactions, for instance, to effect and complete the transfer of ownership of assets such as securities, commodities and other products. New Zealand currently has two settlement systems: Austraclear New Zealand run by the Reserve Bank (which clears and settles debt securities and equities among wholesale counterparties) and NZX's FASTER system (which clears and settles listed securities traded on the NZX). Under the current rules, statutory backing is only an option for payment systems involving cash. The new regime will extend Part 5C of the Reserve Bank of New Zealand Act 1989 to cover a system that settles both payments and products.

What are the changes?

The changes will give the government authority to designate settlement systems and clearing houses. The Securities Commission and the Reserve Bank of New Zealand will have a joint role in recommending designation of a settlement system and the regulation of the regime.

Designation of a settlement system will give statutory backing to the system's rules – providing finality of settlement and also ensuring stability of the system if a participant becomes insolvent. The Bill provides certainty that settlements conducted through a designated settlement system will be final and cannot be challenged. This ensures that completed settlements cannot be reversed on the subsequent insolvency of a participant. The Commerce Committee has recommended that finality protection should extend for 24 hours after the commencement of an insolvency, regardless of when the settlement system's contact person had notice as proposed in the Bill. This would remove any uncertainty over the receipt of notice. The Commerce Committee has also recommended a new definition for 'insolvency' which provides a clear point in time at which a participant becomes subject to an insolvency event, being the date (and time) an insolvency officer is appointed.

The Bill also amends the Personal Property Securities Act 1999 as it relates to collateral provided in a designated settlement system. Certain operators of designated settlement systems will have statutory priority ('superpriority') in relation to any collateral provided in the settlement system by a clearing participant in the event of an insolvency event by that participant. This means the process for realising that collateral will be simplified to enable immediate realisation of the collateral.

What does this mean?

Participants who wish to become designated and maintain that status must ensure their operating rules meet certain standards and must be approved by the joint regulators according to criteria that includes relevant international standards. The designated settlement system will be subject to the ongoing oversight of the joint regulators who 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. In light of the recent financial market failures, the Commerce Committee has recommended considering the adequacy of the settlement system's financial resources when deciding whether to grant, vary or revoke a designation.

Note that designation merely provides statutory backing of a settlement system. The government has emphasised that the regime remains voluntary and international standards can be met without designation. However, without a clear regulator of settlement systems in New Zealand, it could be difficult to convince participants that a settlement system meets international standards.

Finally, holders of registered security interests need to be aware and may find that their security interests would take a lower priority claim on the same collateral provided by a participant of a designated settlement system who has super priority status.

Where to now ?

The Bill will be read for the second time shortly. We will keep you posted as the Bill progresses through the House. We can also help you be ready for the new regime by advising on the implications that it will have for your business.

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