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New Zealand Securities Commission |
Last Updated: 16 November 2014
OVERSIGHT REVIEW OF NZX
2008
SECURITIES COMMISSION
Level 8, Unisys House
56 The Terrace
PO Box 1179
WELLINGTON
Ph (04) 472 9830
Fax (04) 472 8076
E mail seccom@seccom.govt.nz
Website www.seccom.govt.nz
23 December 2009
TABLE OF CONTENTS
STRUCTURE OF NZX AND ITS MARKETS..................................................................... 2
A. ABOUT THIS REVIEW ................................................................................................... 3
B. EXECUTIVE SUMMARY ............................................................................................... 3
C. INTRODUCTION.............................................................................................................. 6
D. MATTERS ARISING FROM THE REVIEW OF THE 2007 YEAR .......................... 6
E. NZX’S FRONTLINE REGULATION ............................................................................ 7
F. RELATIONSHIP OF NZX’S EXPANDING COMMERCIAL ACTIVITIES TO ITS
REGULATORY
FUNCTION...........................................................................................
7
G. NEW ZEALAND MARKETS DISCIPLINARY TRIBUNAL ...................................... 8
H. THE SPECIAL DIVISION OF THE NZMDT ............................................................... 9
I. NZX’S RISK-BASED APPROACH TO SUPERVISION ............................................. 9
RISK ASSESSMENT PROCESSES................................................................................................. 9
ON-SITE INSPECTION ............................................................................................................. 11
NZX’S SUPERVISION OF MARKET PARTICIPANTS................................................................... 13
IMPLEMENTATION OF THE ON-SITE INSPECTION PROGRAMME
............................................... 13
J. RESPONSIBILITY FOR THE SUPERVISORY FUNCTION................................... 14
K. CONCLUSION ................................................................................................................ 16
APPENDIX ............................................................................................................................. 19
GLOSSARY OF KEY TERMS AND ABBREVIATIONS ................................................................... 19
SCOPE OF REVIEW ................................................................................................................. 20
BACKGROUND TO REVIEW..................................................................................................... 22
PROCESS
...............................................................................................................................
23
STRUCTURE OF NZX AND ITS MARKETS
NZX Limited
Registered exchange
NZSX Market Equity securities Largest companies
NZAX Market
Equity securities
Non-standard Issuers
Small or medium companies
NZDX Market
Debt securities
A. ABOUT THIS REVIEW
1. The Securities Commission, pursuant to the Securities Act 1978, undertakes an annual oversight review of NZX’s supervision of its markets. This is the fourth annual review completed. It covers the period from 1 January until 31 December
2008.
2. The review covers NZX’s performance of its regulatory
functions as a registered exchange under the Securities Markets
Act 1988. NZX
has regulatory obligations under section 36G of the Securities Markets Act 1988
to ensure compliance with its Listing
and Participant Rules, and to perform any
obligations that lie on NZX under those rules.
3. The review examines NZX’s regulatory performance in the following
areas:
• Matters arising from the review of the 2007 year
• NZX’s frontline regulation
• New Zealand Markets Disciplinary Tribunal
• Special Division of the New Zealand Markets Disciplinary Tribunal
• NZX’s risk-based approach to supervision
• Responsibility for the supervisory function
4. Whilst the review covers mainly calendar year 2008, during the
course of the review a number of matters came to the attention
of the
Commission, and the Commission believed it appropriate to discuss some of these
matters in this report as they include some
important improvements and
developments in the performance of NZX’s supervision of its
markets.
B. EXECUTIVE SUMMARY
5. The Commission’s overall conclusion is that NZX is satisfying its obligation to operate its markets in accordance with its Conduct Rules. NZX’s performance as a registered exchange according to the requirements of the Securities Markets Act
1988 is good.
6. The Commission has made findings which are summarised below.
Matters arising from the review of the 2007 year
7. The Commission is satisfied that the matters arising from the
review of the 2007 year have been resolved appropriately.
NZX’s frontline regulation
8. The Commission is satisfied with the processes which NZX uses in
considering admission or approval of listed issuers and
market participants to
its markets. The Commission is satisfied that NZX is taking appropriate action
to minimise the risk of non-compliance
by listed issuers and market participants
in relation to their obligations under the Listing Rules and Participant
Rules.
9. NZX informs the Commission that NZX has improved and refined its
frontline regulation processes.
10. During the review period, NZX increased the disclosure requirements
relating to back-door and reverse listings, which is
likely to have positive
outcomes for investors.
Relationship of NZX’s expanding commercial activities to its
regulatory function
11. The Commission is concerned with the risk of potential conflicts
that might arise between its regulatory and commercial
functions as NZX expands
its commercial activities. While we are not aware of any such conflicts at this
time, we will continue to
review this issue in our future oversight review of
NZX.
New Zealand Markets Disciplinary Tribunal
12. The New Zealand Markets Disciplinary Tribunal (NZMDT) is an
independent disciplinary body that deals with market conduct
issues referred by
the NZX. The Commission is satisfied with the New Zealand Markets Disciplinary
Tribunal’s execution of its
function.
13. The review encountered correspondence between the NZMDT and NZX in
regard to referrals from NZX to the NZMDT.
14. The NZMDT believes that the number of referrals from NZX to the
NZMDT is an issue for the Commission to review in regard
to the performance of
NZX and its regulatory function and its oversight of the markets, rather than an
issue for the NZMDT. The
Commission agrees.
15. The Commission supports the implementation of meetings every four
months between the CEO of NZX and the NZMDT Chairman to
improve communication in
this important regulatory relationship.
16. The Commission further recommends that NZX and the NZMDT establish
a protocol for referrals from NZX to NZMDT to improve
the transparency of their
relationship.
17. The Commission notes that the NZMDT believes that NZX has
liberally resourced the NZMDT.
The Special Division of the New Zealand Markets Disciplinary
Tribunal
18. The Special Division of the New Zealand Markets Disciplinary
Tribunal is an independent body that regulates NZX as a listed
issuer, in the
same way that NZX regulates other listed issuers. The Commission is satisfied
with the Special Division’s execution
of its function.
NZX’s risk-based approach to supervision
19. NZX supervises market participants based on their potential
risk of non- compliance with the Participant Rules.
Under this regime,
inspections of high-risk participants are scheduled more than once a year, and
low risk participants less than
once a year.
20. The Commission finds that NZX’s risk-based supervision
programme has an appropriate process for assessing market participants’
risk of non-compliance with the Participant Rules and a thorough on-site
inspection process.
21. In 2008, NZX issued most of its draft inspection reports to market
participants outside the time period outlined in NZX’s
reporting schedule.
The Commission accepts NZX’s position that such timing was caused by
NZX’s necessary and appropriate
reallocation of its regulatory personnel
to manage market risk under the severe market conditions created by the
global financial
crisis. The Commission also recognises that during this
period of extraordinarily difficult market conditions there was no collapse
of
any NZX market participant.
22. While the Commission understands NZX’s position, the
Commission considers that market participants should be able
to expect timely
reports. NZX should resource its supervisory function appropriately so that
feedback can be provided to market participants
in a timely way.
Responsibility for the supervisory function
23. NZX continues to manage appropriately the conflicts of interest
between its commercial and regulatory functions.
24. The NZX Board formally adopted a conflicts management policy in January 2008.
This policy includes a delegation of responsibility for the supervisory
function to both the CEO and the Head of Supervision. Under
Board direction, the
CEO may solely exercise the supervisory function by taking on the role of Head
of Supervision.
25. However, the Commission considers the dual delegation of the
responsibility for the supervisory function inadvisable. The
Commission accepts
that NZX has a different view. The Commission is concerned that the dual
delegation imbeds an inevitable ongoing
source of conflicts of interest between
the NZX’s two roles. The Commission notes that international best practice
is for the
commercial and regulatory functions of demutualised exchanges such as
NZX to be formally separated to remove the potential for supervisory
functions
being deprioritised for commercial reasons.
26. This issue of dual delegation of responsibility for the supervisory
function may be a matter that the Government may wish
to consider in the review
of the regulatory landscape under the Securities Act review later this
year.
C. INTRODUCTION
27. This is the fourth oversight review of NZX’s
performance of its regulatory functions as a registered exchange
under the
Securities Markets Act 1988. The review covers the 2008 calendar year and
developments up until the date of this report.
The extension of the review
period into 2009 has been encouraged by NZX as it views developments during the
period as of public interest.
28. This review placed particular emphasis on the effectiveness of
NZX’s risk-based approach to supervision of market
participants. The
Commission considered in- depth review and analysis of this specific area would
be valuable.
29. The Terms of Reference for the Commission’s review,
the scope of and the background to the review and the
process that we
followed, are set out in the Appendix to this report.
30. The findings of the review are outlined in seven sections:
• Matters arising from the review of the 2007 year
• NZX’s frontline regulation
• New Zealand Markets Disciplinary Tribunal
• The Special Division of the New Zealand Markets Disciplinary Tribunal
• NZX’s risk-based approach to supervision
• Responsibility for the supervisory function
D. MATTERS ARISING FROM THE REVIEW OF THE 2007 YEAR
31. In its last oversight review report, the Commission required
responses on two matters. NZX has addressed these matters as
follows:
32. The Commission also acknowledges that NZX has recently
abolished the 20 minute waiting period before general release
of the details
of company announcements, a matter which the Commission had commented on in
previous reports.
33. The Commission is satisfied that the matters arising from the
review of the 2007 year have been resolved appropriately.
E. NZX’S FRONTLINE REGULATION
34. Although NZX does not undertake active supervision of the Listing
Rules in the ordinary course, NZX endeavours to minimize
the risk of
non-compliance by issuers. NZX grants waivers and makes rulings which minimize
the risk of non- compliance with the
Listing Rules. Waivers and rulings
recognize that the Listing Rules cannot contemplate every commercial
arrangement.
35. NZX seeks to minimize non-compliance with the Participant
Rules through providing guidance notes, compliance briefings,
compliance
manager forums and on-site inspection reports. NZX also communicates regulatory
guidance through the Securities Industry
Association and the Listed Companies
Association.
36. In April 2009, NZX’s amendments to the Listing Rules for
NZSX, NZDX and NZAX became effective. These amendments
seek to make it easier
for listed companies to raise capital.
37. NZX has adopted and implemented a policy on back-door and reverse
listings which sought to improve the processes by requiring:
(i) the production
of a profile for the post-transaction entity, (ii) director certifications in
respect of the information in the
profile and to certify that all material
information has been disclosed and (iii) a change in fees to align them with
those payable
in respect of a conventional listing. A back-door listing
involves a listed company with little or no active business, a trading
shell,
which acquires an unlisted company which is seeking to become listed. A reverse
listing involves a shell company that lists
on the market with the aim of
identifying a business to acquire.
38. Subsequent to implementing its policy on back door and reverse
listings, NZX issued a revised guidance note to ensure that
sufficient
information was provided to the market about the entities to be listed. In
regard to backdoor and reverse listings on
NZAX during the review period, NZX
required several issuers to provide the required increased disclosure and
certification. We anticipate
that these new requirements will continue to have
positive outcomes for investors.
39. NZX is developing a new system for trade clearing and settlement.
40. NZX informs the Commission that NZX has improved and refined its
frontline regulation processes.
41. The Commission notes that NZX has expanded its commercial
activities to include various information and data services.
42. In 2008-2009 NZX acquired the following businesses:
• A 22% shareholding in Bond Exchange of South Africa (BESA);
• NZX ProFarmer Australia Pty Limited, an agricultural news service;
• Country-Wide Publications Limited, an agricultural publishing service; and
• M-Co, operator of New Zealand’s electricity and gas
markets.
43. In 2008, total NZX Markets operating revenue grew to $29.8
million, a 4% increase over 2007, with $12.3 million
generated from the
NZX Information business, a 17% increase over 2007.
44. The Commission is concerned with the risk of potential conflicts
that might arise between NZX’s regulatory and commercial
functions as NZX
expands its commercial activities. While the Commission is not aware of any
such conflicts at this time, we will
continue to review this issue in our future
oversight review of NZX.
45. NZX has since sold its shareholding in BESA.
G. NEW ZEALAND MARKETS DISCIPLINARY TRIBUNAL
46. The NZMDT, formerly known as NZX Discipline, is an
independent body charged with hearing and determining matters
referred to it by
NZX in regard to the conduct of market participants under the Conduct
Rules.
47. In 2008, NZMDT appointed a new chairman and also established a new
role of executive counsel to NZMDT. The responsibility
of this new role
includes the management of disciplinary matters, drafting of decisions and the
provision of legal advice to NZMDT.
48. NZMDT appointed six additional members in 2008, raised member fees
and improved administrative procedures in regard to documenting
the process for
disciplinary proceedings, providing formal records of its determinations and
selecting division members.
49. The Commission is satisfied that the NZMDT has applied
appropriately its policy guideline in regard to publishing the names
of market
participants in disciplinary actions.
50. The review encountered correspondence between the NZMDT and NZX in
regard to referrals from NZX to the NZMDT.
51. The NZMDT believes that the number of referrals from NZX to the
NZMDT is an issue for the Commission to review in regard
to the performance of
NZX and its regulatory function and its oversight of the markets, rather than an
issue for the NZMDT. The
Commission agrees.
52. The Commission supports the implementation of meetings every four
months between the CEO of NZX and the NZMDT Chairman to
improve communication in
this important regulatory relationship.
53. The Commission further recommends that NZX and the NZMDT establish
a protocol for referrals from NZX to NZMDT to improve
the transparency of their
relationship.
54. The Commission notes that the NZMDT believes that NZX has
liberally resourced the NZMDT.
H. THE SPECIAL DIVISION OF THE NZMDT
55. The Special Division of the NZMDT (Special Division) is an
independent body established under the New Zealand Markets Disciplinary
Tribunal
Rules which regulates NZX as a listed issuer in the same way that NZX regulates
other listed issuers. In 2008, one new
member was appointed to the Special
Division.
56. No significant matters arose concerning the Special Division during
this oversight review.
I. NZX’S RISK-BASED APPROACH TO SUPERVISION
57. This review paid particular attention to NZX’s risk-based
approach to supervision of market participants. The risk-based
approach is
central to NZX’s regulatory methodology and as such, the practical
execution of the approach requires
thorough examination.
58. Under NZX’s risk-based regime, NZX assesses a
participant’s risk of non- compliance with the Participant Rules,
and
would schedule inspections of high risk participants more than once a year and
low risk participants less than once a year.
Risk assessment processes
59. NZX uses three processes by which to supervise participants.
First, NZX reviews the mandated daily, weekly and annual filings
by participants
with NZX, which include daily liquid capital returns. Second, NZX conducts
on-site inspections of participants.
Third, NZX uses participant questionnaires
to make specific requests of participants for data and information.
60. NZX’s process for assessing compliance risk involves
assessing an individual participant’s compliance risk on
both a global and
an individual level.
61. To ensure that supervision is focused on risks affecting the market
environment generally, NZX assesses global risks. Global
risks are relevant to
all participants and include the following: operational processes and
procedures; key person risk (the continuity
of a participant’s senior
management and managing principals);
custody rules and process; new rules; trading (desk-based supervision with
review of trading records for market manipulation); and
margin lending.
62. The framework within which each participant is assessed includes a
review of organisational structure, compliance, business
areas, business risks,
recent compliance activity, and financial processes and procedures.
63. NZX staff develops a risk matrix for each participant against
specific risk factors by: identifying broad areas of risk;
assessing the
magnitude of risk for each area; and determining for each area whether the
supervision should be desk-based or conducted
during an on-site inspection. The
risk matrix is an assessment of the total impact plus the probability of a
participant’s
non-compliance with the Participant Rules. NZX will also
ask a participant to provide its own risk assessment against which NZX
will
compare its risk matrix.
64. To maintain its knowledge of an individual participant’s
business, NZX requires participants to complete periodic
self-assessment
questionnaires. NZX uses the questionnaire responses to define the scope of its
on-site supervision of an individual
participant and to provide guidance and
feedback on generic risk issues.
65. The on-site inspection focuses in-depth on specific risk areas
rather than covering all areas.
66. NZX also conducts desk-based supervision in which NZX reviews a
participant’s daily, weekly and monthly reporting
of its capital positions
to NZX. Participants report to NZX via an on-line system which automatically
generates exception based
reports. These reports show the percentage of
actual liquid capital to prescribed liquid capital and compares client
assets
to client obligations. These participant filings and exception reports are
reviewed by designated NZX compliance staff
with experience in
accounting.
67. Also, NZX compliance staff has contact with a participant’s
key personnel which inform NZX staff of compliance issues.
68. Participant trading on NZX markets is monitored by NZX market
surveillance staff.
69. Based upon the risk assessment, NZX places market
participants into risk categories for supervision purposes.
NZX’s
procedures require that the risk ratings of market participants are
conducted annually and monitored throughout
the year to ensure that changes
to participant risk categories are made appropriately and in a timely
manner. Based upon
the risk categories, NZX’s procedures require NZX to
schedule inspections for the calendar year, with some participants having
inspections more than once per year and others having inspections less than once
per year, but no less frequently than once every
two years.
70. The NZX Board has delegated responsibility for the supervisory
function to both the CEO and the Head of Market Supervision.
The Head of Market
Supervision reports to both the CEO and the NZX Board. NZX compliance team
business
leaders report to the Head of Market Supervision, and the compliance team
members report to the business leaders. The business leaders
decide when
compliance issues should be escalated to the Head of Market Supervision. The
compliance staff regularly provides written
reports highlighting key supervisory
issues to the Head of Supervision, who also regularly provides written reports
to the CEO and
the Board.
71. A participant may apply to NZX for a waiver from compliance with
participant rules. In deciding whether or not to grant
a waiver, NZX will
consider the underlying purpose of the rule and whether or not the underlying
purpose is served if a rule is waived.
72. NZX has delegated the power to declare a participant a
defaulter under the participant rules to the Head
of Market
Supervision, or a compliance team business leader if the Head of Market
Supervision is unavailable. NZX did not
exercise that power in 2008.
73. NZX personnel and resources are assigned to supervisory tasks in
accordance with the risk-based assessment of participants.
74. NZX has its own business continuity plan to ensure its continued
operations if there is a systems failure or major event.
75. NZX also has contingency plans in the event of market or
participant failure which include ensuring the safety of client
assets and
limiting the market impact caused by trade settlement failures.
76. The Commission finds that NZX’s risk-based supervision
programme has an appropriate process for assessing market participants’
risk of non-compliance with the Participant Rules.
On-site inspection
77. NZX staff develops an inspection process overview for each on-site
inspection which gives guidance to participants regarding
the on-site inspection
process and attendant timeframes. The NZX on-site inspection team develop and
use planning memoranda which
outline the specific risk areas in each
participant’s business and the work to be completed in the course of the
inspection.
NZX staff also use a detailed manual for the on-site inspection
which explains the objectives and tests to be used for specific
risk
areas.
78. Using the risk matrix and planning memoranda developed for each
participant, NZX prepares a table showing the areas for
on-site inspections,
areas for desk- based supervision, and number of inspection days anticipated for
each inspection. Also, a visit
planning memorandum is prepared which includes
the participant’s background and the risk areas to be inspected. This
planning
memorandum forms the basis of a checklist of work to be completed
during the on-site inspection.
79. Within the NZX compliance team, a specific person is assigned as
the client relationship manager for each participant.
This person would be
involved with the
onsite inspection, analyse responses to periodic questionnaires and update
the risk matrix for the assigned participant.
80. The compliance team prepares for the on-site inspections by:
reviewing the participant’s files which include correspondence,
applications for waivers and rulings, and data submissions; discussing the
inspection with the participant’s client relationship
manager; reviewing
the responses to periodic questionnaires; reviewing the inspection file from the
previous year; reviewing issues
from the NZX supervisory internal control
checklists; and obtaining a list of the participant’s advisors,
dealers
and settlement officers.
81. In preparing for the on-site inspection, NZX staff will review a
participant’s compliance with the Participant Rules
involving annual
reporting returns, complaints, trading, market making, client assets and capital
adequacy.
82. NZX staff will contact the participant between two weeks and one
month before the proposed inspection date to confirm the
proposed date (there
will be shorter notice for branch office inspections). NZX will then
send a request for information
to the participant reflecting the areas to be
inspected on-site. Approximately one week before the inspection date, NZX
will
email the participant outlining the data and the personnel which the
participant should make available to the NZX inspection team
during the on-site
inspection.
83. NZX will also conduct unscheduled inspections of participants if
there is a breach or suspected breach of participant rules,
such as actual
liquid capital less than prescribed liquid capital, client obligations in excess
of client assets or self- reported
fraud. NZX would conduct these
unscheduled visits in order to determine whether client assets are protected
and whether
there is market risk from the participant’s continued
operations.
84. The actual on-site inspection begins with a meeting between NZX
staff and the participant’s staff at which NZX staff
explain the format of
the inspection. NZX staff and the participant’s staff will also meet at
the conclusion of the inspection,
at which NZX staff will discuss issues
identified during the inspection and may include issues identified during
NZX’s desk-based
and questionnaire reviews.
85. Although there is a meeting between NZX and participant staff at
the completion of an on-site inspection, it is not until
a draft report is
issued and a participant responds to that draft report that remedial action is
agreed to formally.
86. During the on-site inspection NZX staff will review participant staff
lists, organisational charts, job descriptions, training
records, new employee
induction materials, professional staff licenses, and registers of dealers and
shareholder schedules to ensure
that all staff are accounted for, licensed and
accredited.
87. Also, NZX staff will review the management structure chart,
reporting lines, business continuity and contingency planning,
and lists of
advisors and clients to determine whether a principal broking office is under
direct control of a managing principal.
The staff will also assess
the firm governance, compliance infrastructure and segregation between
roles and duties.
88. To assess a participant’s compliance infrastructure, NZX
staff will review audits of internal processes, system access
records,
compliance manuals, employee security portfolio records, customer reporting and
conflict management policies to ensure that
there is independence of the
compliance manager from operations.
89. NZX staff will test the reliability of a
participant’s reported financials by reconciling back office systems
data to underlying ledger trial balances and daily/monthly returns and
performing calculations to ensure accuracy. The staff also
reviews the
participant’s bank statements and reconciliations to ensure that client
funds have been appropriately attributed
to client ledger accounts.
90. According to its supervision plan, NZX is to issue a draft inspection report within
20 business days of the on-site inspection outlining issues and actions the
participant must take and a timeframe for completion of
action items. If NZX is
not likely to keep to this timeframe, NZX’s policy requires it to
communicate this to the market participant
in advance of the deadline. The
inspection report will contain a section on “Best Practice
Recommendations” which raises
awareness and understanding of industry
developments and standards. The participant is required to respond within 15
business days
of receipt of the draft report to its handling of any breaches,
action items and required timeframes outlined in the draft report.
NZX is to
review the participant’s response and issue the final inspection report
within 10 business days of receipt of the
participant’s response. Also,
participants are required to advise NZX of the implementation of each
recommendation by or before
the due date for completion of the
implementation.
91. NZX’s response to compliance failures includes entry into the
breaches log or into an inspection report. The NZX
staff member initially
handling the matter will bring it to the attention of one of the NZX compliance
team business leaders who
will then discuss it with the other compliance team
business leader and the Head of Market Supervision in making the decision as
to
whether or not to refer the breach to the NZMDT.
92. NZX informs the Commission that NZX’s CEO in his capacity as
dual delegated Head of Market Supervision from the NZX
Board is generally
informed of the referral decisions, but does not generally participate in the
decisions.
93. The Commission finds that NZX’s risk-based supervision
programme has a thorough on-site inspection process.
NZX’s supervision of market participants
94. NZX’s procedures call for NZX to use its risk-based assessment
of market participants to allocate resources for heightened
supervision to areas
in which there is the greatest risk of non-compliance with NZX rules. NZX
inspects high risk firms more frequently
than other firms.
Implementation of the on-site inspection programme
95. For 85% of the inspections conducted during 2008, NZX
issued the draft inspection reports to participants beyond the period of
20
business days or four
weeks after the completion of the on-site inspection, which is the time
period articulated in NZX’s supervisory procedures.
96. The on-site inspections, as part of risk-based supervision, may
reveal conduct which is in breach of the Participant Rules.
NZX’s
notifying participants of these inspection results and requiring
remedial actions assist in ensuring
that participants remain in
compliance with the Participant Rules.
97. The Commission finds that NZX’s risk-based supervision
programme has an appropriate process for assessing market participants’
risk of non-compliance with the Participant Rules and a thorough on-site
inspection process.
98. In 2008, NZX issued most of its draft inspection reports to market
participants beyond the time period outlined in NZX’s
reporting schedule.
The Commission accepts NZX’s position that such timing was caused by
NZX’s necessary and appropriate
reallocation of its regulatory personnel
to manage market risk, under the severe market conditions created by the
global
financial crisis. The Commission also recognizes that during this
period of extraordinarily difficult market conditions, there
was no collapse of
any NZX market participant.
99. While the Commission understands NZX’s position, the
Commission considers that market participants should be able
to expect timely
reports. NZX should resource its supervisory function appropriately so that
feedback can be provided to market participants
in a timely way.
100. As market conditions improve, the Commission anticipates that NZX
will ensure timely delivery of its draft inspection reports
to market
participants.
J. RESPONSIBILITY FOR THE SUPERVISORY FUNCTION
101. The NZX Conflicts Management Policy approved in January 2008
contemplates that the dual role of market operator and supervisor
may lead to a
conflict or perception of a conflict between regulatory and commercial function,
because commercial interests have
the objective to maximize value for
shareholders and the obligation as a market operator is to utilise resources to
supervise its
market.
102. Accordingly, the policy requires that commercial interests should
not be allowed to influence supervisory decision
making; that
supervisory activity and information is to be quarantined from commercial
activity, and that supervisory activity
and decision making must be consistent
and transparent.
103. The NZX Board has responsibility for both the commercial and regulatory sides of
NZX’s business.
104. The Board operates subject to a regulatory charter which outlines
that the Board and CEO have a dual accountability for commercial
and supervisory
operations.
105. Pursuant to this charter, the Board must ensure that strategy of the
business will not diminish the high integrity reputation
of the capital
markets; that no
commercial interests will be permitted to unduly influence supervisory
strategy or decision-making; that supervisory activity will
be performed in a
consistent and transparent manner; and that supervisory activity will be
resourced to an appropriate level.
106. The Board has made a joint delegation in respect of regulatory
activity to the CEO and the Head of Supervision. The Head
of Supervision
undertakes the day-to-day management of the supervisory function and the CEO
must retain accountability for the supervisory
function.
107. To ensure that the Board is properly informed of supervisory
activity and that no undue influence may be brought to bear
upon the supervisory
activity undertaken by the Head of Supervision and her team, the Head of
Supervision presents a regulatory paper
to the Board at each of its regular
meetings. The report addresses key supervisory activity, inappropriate
behaviour of any commercial
staff seeking to influence supervisory decision
making or strategy, any breach of conflict management protocols, and, until
November
2008, adequacy of resourcing.
108. The Head of Supervision may and does report to the Board without the
presence of the CEO. The Head of Supervision also may
escalate a supervisory or
potential conflict issue to the Board where a difference has arisen and cannot
be resolved between the
Head of Supervision and the CEO.
109. Supervisory decision making and information is quarantined from the
commercial side and all core supervisory functions are
undertaken by a separate
regulatory division.
110. Specifically, the CEO is bound by a regulatory code of conduct in
that the CEO may not inappropriately use his power to influence
or direct the
outcome of a supervisory matter for reasons that are not relevant to the
supervisory issue.
111. The International Organization of Securities Commissions (IOSCO),
Objectives and Principles of Securities Regulation (February
2008) outline
principles relating to a regulator which include that “[t]he regulator
should be operationally independent and
accountable in the exercise of its
functions and powers” and that “[t]he regulator should have adequate
powers, proper
resources and the capacity to perform its functions and exercise
its powers.” These IOSCO Principles specifically recommend
that
“[t]he regulator should be operationally independent from external
political or commercial interference in the exercise
of its functions and powers
and accountable in the use of its powers and resources.”
112. The assessment methodology for the IOSCO Principles notes that while
all exchanges should have procedures in place to address
conflicts of interest,
there may be more concern for conflicts of interest, or the appropriate use of
self- regulatory resources,
in the case of for-profit, demutualised markets.
One concern is that such an exchange would seek to cut its regulatory activities
or standards in order to boost returns for its shareholders.
113. While NZX continues to manage appropriately the conflicts of
interest between its commercial and regulatory functions, this
dual delegation
remains of concern to
the Commission. While this delegation is in place, there remains a potential
for conflict to exist.
114. Demutalised exchanges around the world have taken different
approaches to ensure separation of regulatory and commercial
functions. While
models differ, a consistent standard is that the head of regulation is
completely autonomous from any other executive
function. The NZX has proffered
the view that the dual delegation has worked in practise and no commercial
concerns have affected
the regulatory exercise of the delegation.
115. During the period under review the CEO, under the direction of a
committee of the NZX Board, exercised fully on occasion
the delegation
as Head of Supervision. The Commission considers that the function was
competently discharged, and no conflict
was evident in the discharge of that
function.
116. However the Commission considers that the dual delegation is
inadvisable. In the Commission’s view the issue which
required the
exercise of the delegation could have been resolved by the retaining of external
counsel or an expert, who could have
independently reported to the Board,
thereby retaining the separation of the commercial and regulatory functions. The
NZX disagrees
with this perspective but does agree that the process of obtaining
a regulatory outcome is important as well as the outcome itself.
117. The current legislation makes no provision for resolution of these
differing perspectives between NZX and the Commission. This
may be a matter that
the Government may wish to consider in the review of the regulatory landscape
under the Securities Act review
later this year.
K. CONCLUSION
118. The Commission’s overall conclusion from this review is that
NZX is satisfying its obligation to operate its markets
in accordance with its
Conduct Rules and the requirements of the Securities Markets Act 1988.
Specifically, the Commission has found
as follows:
Matters arising from the review of the 2007 year
119. The Commission is satisfied that NZX has resolved all issues that arose from the
2007 review.
NZX’s frontline regulation
120. The Commission is satisfied with NZX’s frontline regulation
processes.
121. NZX informs the Commission that NZX has improved and refined its
frontline regulation processes.
Relationship of NZX’s expanding commercial activities to its
regulatory function
122. As the NZX expands its commercial activities, the Commission has
concerns that there is a risk of potential conflicts arising
between NZX’s
commercial and regulatory functions.
New Zealand Markets Disciplinary Tribunal (NZMDT)
123. The Commission is satisfied with the NZMDT’s execution of its
function as an independent disciplinary body dealing
with matters referred by
NZX.
124. The review encountered correspondence between the NZMDT and NZX in
regard to referrals from NZX to the NZMDT.
125. The NZMDT believes that the number of referrals from NZX to the
NZMDT is an issue for the Commission to review in regard
to the performance of
NZX and its regulatory function and its oversight of the markets, rather than an
issue for the NZMDT. The
Commission agrees.
126. The Commission supports the implementation of meetings every four
months between the CEO of NZX and the NZMDT Chairman to
improve communication in
this important regulatory relationship.
127. The Commission further recommends that NZX and the NZMDT establish a
protocol for referrals from NZX to NZMDT to improve
the transparency of their
relationship.
128. The Commission notes that the NZMDT believes that NZX has
liberally resourced the NZMDT.
The Special Division of the New Zealand Markets Disciplinary
Tribunal
129. The Commission is satisfied with the NZMDT’s execution of its
function as an independent regulator of NZX as a listed
issuer.
NZX’s risk-based approach to supervision
130. In this review, the Commission placed particular emphasise on
NZX’s risk-based supervision approach. The Commission
finds that this
approach provides an appropriate process for assessing market
participants’ risk of non-compliance with the
Participant Rules and a
thorough on-site inspection process.
131. NZX issued most of its draft inspection reports to market
participants beyond the time period outlined in its 2008
reporting
schedule. While the Commission accepts NZX’s position that these
delays were caused by NZX’s necessary
and appropriate reallocation of
its regulatory personnel to manage extraordinary market risk during the
period, the Commission
considers that market participants should be able to
expect timely reports.
132. The Commission recommends that NZX should resource its supervisory
function appropriately so that feedback can be provided
to market participants
in a timely way.
133. The Commission also recognizes that during this period of
extraordinarily difficult market conditions there was no collapse
of any NZX
market participant. This is a positive endorsement of NZX’s
performance as a supervisor of market
participants.
Responsibility for the supervisory function
134. The Commission has concerns relating to the dual delegation of
responsibility for the supervisory function at NZX and the
risk that this will
create conflicts of interest that have the potential to compromise regulatory
effectiveness.
135. While there is no evidence that any conflict has caused regulatory
activity to be compromised by commercial pressures during
the period covered by
this review, the Commission considers any structure that imbeds ongoing
potential for conflict of interest
as inadvisable.
APPENDIX
Glossary of key terms and abbreviations
Conduct Rules The Participant Rules and Listing Rules of NZX.
Issuer Any entity
which is or has been listed on the NZSX, NZAX or the NZDX.
Listing Rules Rules made by NZX
that govern the conduct of Issuers listed on NZX’s markets, approved as
Listing Rules under the Securities
Markets Act 1988.
Market Participant An organisation accredited
by NZX to participate in the markets that NZX operates.
Market Supervision Group A group within NZX led by
the Head of Market Supervision comprising two teams – Issuer and
Participant Compliance.
NZAX New Zealand Alternative Stock Market.
NZSX New Zealand Stock Market.
New Zealand Markets
Disciplinary Tribunal A disciplinary body
constituted by NZX under the NZX Discipline Rules (formerly called NZX
Discipline).
New Zealand Markets
Disciplinary Tribunal Rules The New Zealand Markets
Disciplinary Tribunal Rules as made by NZX.
NZX NZX Limited.
Participant Rules Rules made by NZX
that govern the conduct of business on securities markets operated by NZX
and persons authorised to undertake
trading activities on those markets,
approved as Business Rules under the Securities Markets Act 1988.
Special Division The division of the
New Zealand Markets Disciplinary Tribunal that exercises the powers and
functions of NZX in relation to
NZX or a related entity as a Listed
Issuer.
Scope of review
1. Section 36G of the Securities Markets Act 1988 says that NZX must
operate each of its securities markets in accordance
with approved rules for
that market. The Conduct Rules include Listing Rules, and Business Rules that
govern the conduct of persons
authorised to undertake trading activities on the
market.
2. NZX’s obligations under section 36G are to secure compliance
with its Listing and Business Rules, and to perform
any obligations that lie on
NZX under those rules. To do this, NZX has established a Market Supervision
Group with responsibilities
for discharging NZX’s regulatory function. The
New Zealand Markets Disciplinary Tribunal Rules establish a dedicated body,
the
New Zealand Markets Disciplinary Tribunal, to determine questions of
non-compliance with the Listing or Business Rules. Decisions
can be appealed to
the Appeal Panel. An independent body, the Special Division of the New Zealand
Markets Disciplinary Tribunal,
exercises the powers and functions of NZX in
relation to NZX as a Listed Issuer and its related entities.
3. The Commission has statutory functions to review practices
relating to securities and activities on securities markets,
and to comment on
these. In relation to NZX, performance of these functions requires the
Commission to keep under review and comment
on NZX’s obligations as a
registered exchange. The oversight review was conducted under sections 10(b),
10(c) and 10(caa) of
the Securities Act 1978.
4. The Commission’s Terms of Reference for the review were:
The Securities Commission (“the Commission”) is conducting
an oversight review of NZX Limited (“NZX”)
under sections 10(b),
10(c) and 10(caa) of the Securities Act 1978. The purpose is to review
NZX’s performance of its co- regulatory
function, in particular its
obligations under section 36G of the Securities Markets Act 1988 and, in
respect of futures
and options dealers, NZX’s regulation of dealers under
its Futures and Options Participant Rules.
In particular, the Commission will review the following aspect of
NZX’s activities:
(a) the effectiveness of NZX’s risk-based approach to supervision of
market participants by ensuring that:
(i) NZX has adequate processes and procedures in place
to appropriately make an assessment of a market participant’s
risk of
non-compliance with NZX rules;
(ii) NZX is making appropriate risk-based assessments of NZX market
participants;
(iii) NZX is applying its risk-based assessments by properly allocating
its resources to provide heightened supervision to areas
in which there is the
greatest risk of non-compliance with NZX rules; and
(iv) NZX is appropriately supervising market participants.
The review may also consider any issues arising in the course of the review
in respect of the following areas:
(a) supervision of market participants and enforcement of the Participant
Rules;
(b) supervision of listed issuers and enforcement of the Listing
Rules;
(c) allocation of human, technological and financial resources as it
affects performance of the regulatory functions of NZX;
(d) internal practices and procedures associated with investigations,
price enquiries, complaints-handling and referrals;
(e) discipline practices, procedures and resources;
(f) arrangements for market infrastructure development and maintenance; (g) Special Division practices, procedures and resources;
(h) corporate governance arrangements, including board composition,
policy setting, crisis response and oversight of executive
management, with
reference to regulatory standards relating to governance of demutualised
exchanges under IOSCO and other international
principles; and
(i) the impact, if any, of NZX’s expanding commercial
activities on its regulatory function.
The Commission’s review will consider the progress made by NZX (up to
the date of the Commission’s report on this
oversight review) in
addressing matters arising as set out in its report dated 20 June 2008.
AND accordingly, will obtain, consider and utilise information for the purposes of any recommendation, report or comment the Commission may decide to make under sections 10(b), 10(c) or 10(caa) of the Securities Act
1978 in relation to the above matters.
SUBJECT to the Commission’s discretion to amend these Terms of
Reference as it may consider fit. December 2008
Background to review
5. In 2002 the Securities Markets and Institutions Bill
created a co-regulatory regime for registered exchanges. NZX is the only
registered exchange in New Zealand. Under the co-regulatory
regime it is
intended that the Commission monitors the performance of NZX’s statutory
responsibilities.
6. In 2003 the International Monetary Fund conducted a
Financial Sector Assessment Programme (FSAP) review
of New Zealand. The FSAP
measured New Zealand’s framework of securities regulation and its
operation against the Objectives
and Principles of Securities Regulation
(October 2003) published by IOSCO. The IOSCO principles include
principles
for self-regulatory organizations and are accepted as the
international standards for securities regulation by the International
Monetary
Fund and the World Bank.
7. One of the recommendations in the FSAP report was that the
Commission develop a formalised oversight plan for regulated
exchanges,
providing for risk assessment criteria and periodic inspections that take into
account best practices for self- regulatory
organisations and exchanges. It
recommended that there should be public disclosure summarising the objectives of
the oversight plan
and of the key findings of such reviews. The Government
response noted that the Commission had decided to develop a formal oversight
plan for regulated exchanges and had informed NZX.
8. Demutualisation and listing of stock exchanges has
been an emerging phenomenon overseas in the past decade.
In all cases we
have seen, regulatory structures have been put in place accompanying such moves,
reflecting the core importance
of stock exchanges to countries’ capital
markets and broader economies. In New Zealand these regulatory structures
include
an ownership cap, regulatory review of exchange rules, and oversight by
the Commission. Different approaches have been taken in
various jurisdictions
overseas. The approach taken in New Zealand was settled after consideration of
international models existing
at the time, and the particular circumstances of
the New Zealand markets. It has not been a part of this review to reconsider
these
arrangements.
9. However, as encouraged by the FSAP review, we have looked to the
emerging high-level standards in overseas jurisdictions
to gain an insight into
best practices for exchanges. We have taken into account the report of the FSAP
inspectors, the IOSCO Objectives
and Principles of Securities Regulation
(October 2003), and the methodology used for assessing compliance with these
standards, in
particular the principles applying to self-regulatory
organisations.
10. The Commission has also looked to the legal obligations of
exchanges in similar jurisdictions to gain an understanding of
the expectations
that overseas investors in particular are likely to have for the conduct of a
registered exchange. While there
are differences in the approaches taken by
each jurisdiction, there are a number of standards that can be taken from an
overall assessment
of the IOSCO Principles and overseas law and practice. These
suggest that a stock exchange should:
(a) meet and maintain adequate standards of integrity and fitness to operate a market;
(b) develop rules for the conduct of listed issuers and market participants; (c) develop and operate fair procedures for the enforcement of its rules; (d) conduct a fair, orderly, informed, and efficient market;
(e) maintain effective trading, clearing, and settlement systems;
(f) have adequate capacity to carry out its regulatory functions and enforce its rules; and
(g) have procedures in place to manage conflicts of interest.
11. Development of rules is addressed in New Zealand under the
statutory approval and disallowance process for conduct rules.
The IOSCO
Principles also address competition issues, which are outside the remit of the
Securities Commission. The remaining matters
have been addressed in this
review.
12. The oversight review conducted this year is the fourth oversight review of NZX
conducted by the Commission. The review focussed on the 2008 calendar
year.
Process
13. The Commission requested information from NZX under section 36ZK of
the Securities Markets Act. Section 36ZK says that a
registered exchange must
give the Commission (or any person authorised by the Commission) information,
assistance, and access to
the exchange’s facilities if the Commission
reasonably requests it to carry out its functions.
14. The Commission sent questionnaires to NZX, the New Zealand
Markets Disciplinary Tribunal and the Special Division
seeking information the
Commission considered necessary to effectively evaluate NZX’s performance
of its regulatory functions.
The questionnaires covered the areas identified in
the Terms of Reference.
15. The Commission requested copies of any procedures manuals
and process documents that evidenced NZX’s policies
and procedures for
each of the areas covered by the questionnaires. Where written procedures and
policies were not available, we
requested written explanations and information
from NZX in response to each specific information request.
16. NZX provided information in response to the questionnaires,
including procedures manuals and process documents where relevant.
Questions
relating to the New Zealand Markets Disciplinary Tribunal and the Special
Division were answered by the Chairs of those
bodies.
17. Commission staff selected and reviewed a sample of NZX’s
files across a range of regulatory activities.
18. Commission staff conducted interviews with NZX personnel and Board
members and market participants. Commission staff also
interviewed the Chairman
of the New Zealand Markets Disciplinary Tribunal and the Chairman of the
Special
Division. Thirteen interviews were conducted and the interviews were
recorded. Affected parties made submissions and appeared before
the
Commission.
19. Confidentiality and privacy orders were in place throughout the review.
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