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Oversight review of NZX 2005 [2006] NZSecCom 5 (26 September 2006)
Last Updated: 11 November 2014
OVERSIGHT REVIEW OF NZX 2005
26 September 2006
CONTENTS
GLOSSARY OF KEY TERMS AND
ABBREVIATIONS
EXECUTIVE SUMMARY
INTRODUCTION
CONFLICT MANAGEMENT
NZX's
position as a registered exchange and public issuer
MARKET SUPERVISION FUNCTION
Arrangements for Market
Supervision
Resources for Market
Supervision Group
Interaction between Market Supervision and the other NZX groups
Responsibility for Market
Supervision
Separation of the Market
Supervision Group
Personnel
Recommendation
ARRANGEMENTS FOR
SUPERVISION OF MARKET PARTICIPANTS
Role of Participant Compliance
Conduct of
market surveillance regarding trading activity
Complaints handling
regarding Market Participants
Onsite inspections and
periodic reporting
Accreditation of Market
Participants
Escalation of issues
Recommendation
ARRANGEMENTS FOR
SUPERVISION OF LISTED ISSUERS
NZXR's focus
Approval of listings and
delistings
Other approvals under the
Listing Rules
Waiver and ruling applications
Timing requirements for
approvals
Surveillance: trading
halts and price enquiries
Inspections and investigations
Disciplinary actions
Records: practices and
procedures
Complaints handling
Education
initiatives regarding the Listing Rules
Supervisory structure
within the NZXR team
Decision-making structure:
divisions
Escalation
Staff management
Recommendations
ARRANGEMENTS FOR RELEASE OF MARKET INFORMATION - LISTED COMPANY
RELATIONS
Recommendation
MARKET OPERATIONS AND
INFRASTRUCTURE
Introduction
Structure and focus
of the Market Operations Group
Core systems
Back-ups
for core systems - continuity and disaster planning
Market outages and disruptions
in 2005
Incident
management and communication with the market
Capacity of core systems
Monitoring and supervision of
systems
Market infrastructure
strategy and planning
Recommendation
DISCIPLINARY ARRANGEMENTS -
NZX DISCIPLINE
Role and functions
Matters considered
Process and decisions
Resources
Reporting
Appeal Panel
Recommendations
SPECIAL
DIVISION - SUPERVISION OF NZX AS A LISTED ISSUER
Conflict management
Jurisdiction and powers
Resources
Communication
Appointed solicitor
Process
Reporting
Recommendations
GOVERNANCE
Monitoring and
oversight of regulatory functions
Board composition
Identical delegations for regulatory responsibilities
to the Head of Regulation and the CEO
Regulatory crisis
response and risk management
Market Operations policy
setting
Board interaction with the
Special Division
Placement of the Market Supervision function within
the NZX organisational structure
Recommendation
CONCLUSION
APPENDIX
Scope of review
Background to review
Process
OVERSIGHT REVIEW OF NZX 2005
GLOSSARY OF KEY TERMS AND ABBREVIATIONS
Annual Regulatory
Report
An annual report required of NZX Discipline under the NZX Discipline
Rules.
Appointed solicitor
NZX Solicitor who acts as a liaison
between NZX and the Special Division.
Austraclear
A system for
securities trades and cash transfers, operated in New Zealand by the Reserve
Bank.
Business Leaders
Staff in the NZX Regulation and Participant
Compliance teams of the Market Supervision Group.
Compliance
Inspectors
NZX staff in the Participant Compliance team.
Conduct
rules
The Participant Rules and Listing Rules of
NZX.
DMA
Direct Market Access - system enabling accredited DMA
firms to trade directly into the New Zealand market.
FASTER
Fully
Automatic Screen Trading and Electronic Registration securities transfer
system.
FSAP
Financial Sector Assessment Programme, conducted by
the International Monetary Fund.
FSS
FASTER Settlement Solution -
transfer system for the real-time settlement of trades.
Futures and
Options Participant
A Futures and Options Firm, Futures and Options
Introducing broker or a Futures and Options Advisor designated by NZX as such
under
the NZX Futures and Options Rules
IOSCO
International
Organization of Securities Commissions
IOSCO Assessment
Methodology
The methods and interpretations approved by IOSCO in 2003 for
assessing implementation of the IOSCO Principles.
IOSCO
Principles
IOSCO's Objectives and Principles of Securities Regulation
(October 2003) which are accepted as the international standards for securities
regulation by the IMF and the World Bank.
LCR
Listed Company
Relations - a team which is part of the NZX Market Supervision
Group.
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.
Listing Subcommittee
A committee of two persons
who may be used by NZX Regulation to review offer documents in assessing listing
applications.
MAP
Market Announcements Platform
Market
Operations Group
Group within NZX that focuses on NZX's trading and systems
infrastructure and technology arrangements.
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 Regulation comprising three teams - NZX Regulation, Participant
Compliance and Listed Company
Relations.
NZSE
New Zealand Stock
Exchange (the former name of NZX)
NZSX
New Zealand Stock
Market
NZX Discipline
A disciplinary body constituted by NZX under
the NZX Discipline Rules.
NZX Discipline Rules
The NZX Discipline
Rules as made by NZX.
NZXR
NZX Regulation- a team within NZX's
Market Supervision Group which focuses on regulation of Listed
Issuers.
NZX
New Zealand Exchange Limited
Participant
Compliance
A team within NZX's Market Supervision Group which focuses on
regulation of Market Participants.
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.
Review period
2005 calendar
year
SMARTS
Securities Markets Automated Research Trading and
Surveillance - the real-time electronic market surveillance system that
generates
alerts indicating unusual trading.
Solicitor's
Handbook
Procedural handbook used by NZX Solicitors in processing
applications and regulating Listed Issuers under the Listing
Rules.
Special Division
The division of NZX Discipline that
exercises the powers and functions of NZX in relation to NZX or a related entity
as a Listed Issuer.
X-Stream
Brand name of NZX's securities
trading system.
OVERSIGHT REVIEW OF NZX 2005
EXECUTIVE SUMMARY
- The
Securities Commission has reviewed NZX's performance of its regulatory functions
as a registered exchange under the Securities
Market Act 1988. This review, the
first oversight review of NZX conducted by the Commission, focussed on NZX's
arrangements in the
2005 calendar year for discharging its obligations.
- We
report on NZX's performance in relation to the following themes:
- conflict
management;
- arrangements
for supervision of Market Participants;
- arrangements
for supervision of Listed Issuers;
- arrangements
for release of market information;
- market
operations and infrastructure;
- disciplinary
arrangements and NZX Discipline;
- supervision
of NZX as a Listed Issuer by the Special Division; and
- governance.
- 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 is good. However, the Commission has made
recommendations for improvements in relation
to a number of areas. These
recommendations are set out below.
- The
Commission has communicated its concerns and recommendations to NZX, NZX
Discipline and the Special Division. Responses from the
parties in regard to the
recommendations and the Commission's views on those responses are also set out
below.
- NZX
has already agreed to take specific action in response to certain
recommendations and has committed to do so by the end of the
2006 calendar year.
If NZX takes these actions within the stated timeframe, the Commission believes
this will properly address those
recommendations.
- In
respect of the remaining recommendations made to NZX, NZX has committed to
reconsider its position and has undertaken to report
back to the Commission by
the end of the 2006 calendar year.
Recommendations
Market Supervision Group (general)
- NZX should
introduce and communicate a formal policy for all Market Supervision staff
concerning identifying and declaring personal
conflicts of
interest.
NZX says that it currently has a policy regarding
conflicts of interest and agrees to set this out in writing.
NZX has committed to do this by the end of this calendar year.
Supervision of Market Participants
- NZX should
take disciplinary action against Market Participants who commit repeat breaches
of the Participant Rules.
While NZX indicated in the course of
our review that it is likely to do this in future, NZX noted that disciplinary
action may not
be the appropriate regulatory tool for dealing with breaches. NZX
Discipline has indicated that it does not consider it appropriate
for all
breaches to be referred to it, in particular less material breaches.
The Commission considers that repeat breaches of the Rules can demonstrate
particular attitudes towards compliance. NZX needs to use
a mechanism to
penalise repeat breaches by Market Participants. Currently, taking a case to NZX
Discipline is the only avenue for
doing this. If NZX is of the view that current
NZX Discipline proceedings may not be appropriate in all cases, we think that
NZX
should consider the sufficiency of the regulatory tools available to it
under the Discipline Rules. The Commission plans to keep
this under review.
NZX will consider this matter again and has undertaken to report back to the
Commission by the end of this calendar year.
Supervision of Listed Issuers
- NZX should
consider enlarging the membership of the Listing Subcommittee to address
potential issues arising from conflicts of interest.
NZX agrees
with this recommendation.
NZX has committed to do this by the end of this calendar year.
- NZX should
ensure that NZX Regulation adheres to its established procedures for timely
appointment of and consultation with division
members, to avoid delays in
addressing applications.
NZX considers that it currently has in
place measures to determine compliance with its timing obligations. However, NZX
will consider
this matter again and has undertaken to report back to the
Commission by the end of this calendar year.
- NZX should
ensure that the delegation of decision-making authority and the accountability
for decisions made by NZX Regulation divisions
are clearly
recorded.
NZX believes that it currently has adequate measures
in place.
The Commission considers that these measures need to be more clearly
communicated to NZX staff.
NZX will consider the matter again and has undertaken to report back to the
Commission by the end of this calendar year.
NZX Discipline
- NZX and NZX
Discipline should together review the administrative support and resource
arrangements in place for NZX Discipline. These
resource arrangements should be
reviewed regularly to ensure that NZX Discipline receives all the resources it
requires to enable
it to continue to carry out its functions
effectively.
NZX has advised that administrative and resource
arrangements are being discussed with NZX Discipline and are close to being
settled.
NZX advises that it proposes to review these arrangements annually.
NZX has committed to do this by the end of this calendar year.
- NZX should
establish a periodic review of NZX Discipline members' fees and consult with NZX
Discipline members on this. The NZX Discipline
Rules should entrench that the
fees for members of NZX Discipline may not be reduced by
NZX.
NZX is willing to entrench the fees so that they may not be
reduced. NZX is willing to review the fees at regular intervals.
NZX has committed to do this by the end of this calendar year.
- NZX
Discipline should publish its Annual Regulatory Report
annually.
NZX agrees with and supports this recommendation.
Special Division
- The Special
Division, as a body, should determine whether the Special Division has
jurisdiction to deal with matters referred to it.
Any delegations from the
Special Division to its Chairman should be formally recorded.
- Given the
important role of the Special Division in respect of NZX's compliance as a
Listed Issuer, the Special Division should take
steps to ensure that it is fully
aware of the powers available to NZX Regulation under the Listing Rules in
respect of other Listed
Issuers, and should exercise those powers as appropriate
in relation to NZX as a Listed Issuer.
- Given NZX's
position as both a Listed Issuer and regulator of all other Listed Issuers
listed on its markets, NZX should set an example
of full compliance with all
lawful directions or requests from the Special Division.
NZX
considers that it is entitled, as is any other issuer, to decline to provide
information sought where NZX does not consider it
relevant or appropriate to
provide such information. NZX considers that NZX should only comply with those
requests or directions
necessary for the Special Division to undertake its
enforcement role (as opposed to the role of considering a waiver or ruling
application)
and within its powers and jurisdiction. NZX is of the view that it
cannot compel production of information by issuers in relation
to waiver
applications.
The Commission considers that in practice NZX does have the power to compel
production of information by otherwise refusing to grant
waivers if relevant
requested information is not provided. We remain of the view that NZX should set
an example of full compliance
with all lawful directions or requests of the
Special Division.
NZX will consider this matter again and has undertaken to report back to the
Commission by the end of this calendar year.
- The Special
Division should discuss its resource requirements with the Board of NZX. The NZX
Board should have a formal guarantee
of funding for the Special Division should
the Special Division need to take NZX to NZX Discipline.
NZX has
advised that it will request a meeting between NZX and the Special Division to
discuss resource requirements and the guarantee
of funding.
NZX has committed to do this by the end of this calendar year.
- NZX and the
Special Division should develop and implement a communication strategy about the
role of the Special Division. Communication
should include publication of
separate contact details for the Special Division.
NZX has
agreed to implement a communication strategy about the role of the Special
Division. NZX considers that the Special Division
should have considerable
involvement with this. The Commission agrees.
NZX has committed to do this by the end of this calendar year.
- The Special
Division should formalise its delegation to the appointed solicitor and should
receive regular reports on work dealt with
by the appointed solicitor under
delegation.
- The Special
Division should have and use the same procedures manuals in respect of NZX's
compliance as a Listed Issuer that are used
by NZX Regulation in respect of all
other Listed Issuers. The Special Division should satisfy itself that the
appointed solicitor
uses the NZX Regulation procedures, including where matters
are delegated to that solicitor.
- The Special
Division should settle internal procedures that it would use, including
procedures for communicating with the market,
in dealing with a serious
compliance matter regarding NZX.
- The Special
Division should formalise its expectation about the referral of data generated
by the SMARTS market surveillance system
concerning NZX's listed securities.
Where alerts from SMARTS are below the threshold set by the Special Division for
referral to
it, the appointed solicitor should regularly advise the Special
Division of the number of such alerts received in the period and
a summary of
any alerts that were not referred.
- To avoid a
situation of conflict for the appointed solicitor, the appointed solicitor
should have no role in matters that raise contentious
issues, including
complaints handling (beyond an initial transmittal of a matter to the Special
Division). The Special Division should
engage external advisers to assist it in
dealing with such matters and be funded to do so. The external advisers should
have access
to NZX's facilities and regulatory precedents and be able to consult
with NZX Regulation.
The Special Division agrees that it would
be appropriate for it to handle such matters without the involvement of the
appointed solicitor
or for the Special Division to engage external counsel if
necessary. In respect of waiver and ruling applications the Special Division
is
of the view that the appointed solicitor should, at the Special Division's
request, be able to provide analysis and comment to
the Special Division on
precedent applications under the Listing Rules.
The Commission considers that in respect of waiver and ruling applications
involving contentious matters the Special Division should
use its external
advisers, and that these advisers should be given access to precedents and other
relevant information.
- NZX should
either formally assure the Special Division that the appointed solicitor will
not perform any corporate advisory work for
NZX or should revisit the use of an
NZX Solicitor for the appointed solicitor role.
NZX and the
Special Division consider that it would be suitable if the appointed solicitor
was not involved in any commercial work
that had Listing Rule content but could
carry out other commercial work.
The Commission does not agree. The appointed solicitor should be free to
carry out other work for NZXR, but we consider that this
person should not
undertake corporate advisory work for NZX.
NZX will consider this matter again and has undertaken to report back to the
Commission by the end of this calendar year.
- The Special
Division should report to NZX Discipline all material findings that it makes.
NZX Discipline should incorporate that information
into its published Annual
Regulatory Report.
NZX notes that the Special Division's
decisions are published in the same way as NZXR decisions and that this
recommendation is unnecessary.
The Commission notes NZX's response but considers that benefit will be
derived by both NZX Discipline and the market if the Special
Division's
activities are included in NZX Discipline's Annual Regulatory Report.
Governance
- Given the
risk of lack of clarity regarding roles in responding to a crisis, the
Commission recommends that responsibilities of the
CEO and Head of Regulation
for exercising delegated powers be reconsidered by the Board of NZX to ensure
that the responsibilities
are clarified.
NZX is of the view that
these responsibilities are sufficiently clear at present, but has agreed to
consider whether any further clarification
is desirable, and to report back to
the Commission by the end of this calendar year.
- The
Commission comments, but does not make specific recommendations, in relation to
NZX's commercial and regulatory conflict management
arrangements, arrangements
for release of market information or market operations and
infrastructure.
OVERSIGHT REVIEW OF NZX 2005
INTRODUCTION
- The
Securities Commission has reviewed NZX's performance of its regulatory functions
as a registered exchange under the Securities
Market Act 1988. This review, the
first oversight review of NZX conducted by the Commission, focussed on NZX's
arrangements in the
2005 calendar year for discharging its obligations.
- NZX
has obligations under section 36G of the Securities Markets Act 1988 to secure
compliance with its listing and business rules,
and to perform any obligations
that lie on NZX under those rules.
- 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 performance
of its obligations as a registered
exchange.
- The
Commission carried out the review under Terms of Reference. The Terms of
Reference, along with the scope of and background to
the review and the process
that we followed, are set out in the Appendix to this report.
- This
review incorporates NZX's progress on the recommendations made to NZX in 2005,
in the Commission's report into Performance by
NZX of its Regulatory Functions
as a Registered Exchange During 2003 and 2004 Prior to the Collapse of Access
Brokerage. NZX has
taken steps to address those recommendations, which concerned
documentation of procedures, record keeping, the roles of supervisors
and the
Board, client funds, and the NZX Fidelity Fund. The Commission notes that
further work is intended by NZX in relation to
policy issues concerning client
funds and the fidelity fund.
- We
report on NZX's performance under the following themes:
- conflict
management;
- arrangements
for supervision of Market Participants;
- arrangements
for supervision of Listed Issuers;
- arrangements
for release of market information;
- market
operations and infrastructure;
- disciplinary
arrangements and NZX Discipline;
- supervision
of NZX as a Listed Issuer by the Special Division; and
- governance.
OVERSIGHT
REVIEW OF NZX 2005
CONFLICT MANAGEMENT
NZX's position as a registered exchange and public issuer
- NZX
is a limited liability company. It is a Listed Issuer: its shares are traded on
the NZSX market. In this respect NZX is both the
frontline regulator of a
securities market and a commercial entity that participates as a regulated
entity on that market. In 2001
the Parliamentary select committee considering
the NZSE demutualisation legislation noted the public interest issues raised by
the
demutualisation of the exchange. 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. Such an inherent conflict within a demutualised exchange
has
been noted in various overseas jurisdictions, and differing approaches have been
taken overseas to manage this conflict.
- We
record that NZX has consistently stated that it does not see its commercial and
regulatory functions as inherently conflicting.
NZX maintains that its success
as a registered exchange, and correspondingly as a commercial entity, largely
depends on its ability
to engender confidence in the regulated markets that it
operates, and that this in turn gives NZX every incentive to maintain high
standards in its regulatory operations. The Commission agrees that these
incentives exist, but does not consider that this means
there is no conflict of
interest. The Commission notes that it is largely the perception of conflicts of
interest that can damage
confidence.
- There
is no doubt that commentators in New Zealand and overseas, and many overseas
exchanges, recognise that a listed exchange company's
dual roles create the
potential for conflicts of interest. The Commission is concerned that the
unwillingness of the NZX Board to
acknowledge that there is an inherent conflict
within any demutualised exchange between commercial and regulatory functions may
preclude
the NZX Board from giving sufficient and necessary consideration to
potential organisational developments within NZX regarding the
regulatory
function.
- The
Board of NZX has told the Commission that whilst it does not consider that such
a conflict in fact exists, NZX and the NZX Board
are aware that the perception
of such a conflict can exist and is held in some quarters. The NZX Board
considers that addressing
this perception is important and it is engaged to
ensure that the perception of such a conflict is addressed, including by keeping
under review its regulatory structures and their position within the
organisation.
- The
Commission in its review has considered the steps that have been taken by NZX to
manage these conflicts. In the Commission's opinion
market confidence is best
served where it can be demonstrated that a registered exchange conducts its
regulatory operations independently
of conflicting commercial objectives.
- The
Commission considers that there is currently in practice effective separation
between NZX's supervisory functions and its corporate
activities, and that the
conflicts of interest between these functions are managed
satisfactorily.
OVERSIGHT REVIEW OF NZX 2005
MARKET SUPERVISION FUNCTION
Arrangements for Market Supervision
- The
Market Supervision Group comprises three teams - NZX Regulation ("NZXR"), Listed
Company Relations ("LCR") and Participant Compliance.
The Group Leader of the
Market Supervision Group is the Head of Regulation. In 2005, the Head of
Regulation and the four other NZX
Group Leaders reported to the
CEO.
- The
focus of the NZXR team is on NZX's Listed Issuers. NZXR supervises the
activities of Listed Issuers in relation to their compliance
with the Listing
Rules.
- During
the review period the NZXR team comprised two Business Leaders and four NZX
Solicitors. The NZXR Business Leaders have responsibilities
for managing the NZX
Solicitors in the NZXR team. Matters tend to be raised with the Business Leaders
in the first instance. Matters
are referred to the Head of Regulation as
necessary. The NZXR team formally reports to the Head of Regulation.
- LCR
is responsible for the accurate and timely release of market information, such
as information submitted by issuers via the Market
Announcement Platform, and
compliance checks of certain information provided by Listed Issuers in relation
to market announcements.
- The
LCR team comprised two Client Relationship Managers and a LCR Team Leader. Any
compliance issues identified by members of the
LCR team are escalated to the LCR
Team Leader in the first instance, and are referred to a NZXR Business Leader as
necessary. Matters
may also be raised with the Head of Regulation by members of
LCR or by the designated Business Leader. The team formally reports
to the Head
of Regulation.
- The
Participant Compliance team supervises the activities of NZX accredited
intermediaries and brokers (Market Participants) in relation
to their compliance
with the NZX Participant Rules, and Futures and Options Participants in relation
to the NZX Futures and Options
Rules.
- During
the review period the Participant Compliance team comprised two Business Leaders
and three Compliance Inspectors. The Business
Leaders have responsibilities for
managing the Compliance Inspectors. Compliance Inspectors raise matters with the
Business Leaders
in the first instance. Matters are referred to the Head of
Regulation as necessary. The Participant Compliance team formally reports
to the
Head of Regulation.
Resources for Market Supervision
Group
- There
is no separate budget or separate financing for NZX's regulatory functions. NZX
Board members expressed the view that any separation
would be unnecessary, and
could be seen as constraining the resources available to this Group. In
practice, we were told, the regulatory
function will be given such resources as
it requires. We were told the Board would expect the Head of Regulation to raise
any resource
constraints with Board members.
- The
Board's impression is shared by executive management. The Head of Regulation
considers that Market Supervision has unlimited access
to financial resources to
discharge its function. The Head of Finance and Strategy prepares high level
projections and budgets for
businesses within NZX, including Market Supervision.
These are discussed with the Head of Regulation. The Head of Regulation has
been
able to talk directly with the CEO about any resource needs. Resources have been
forthcoming.
- Any
resource issues concern human resources. NZX has used secondees or external
legal providers to cover any shortfall in this regard.
The Head of Regulation is
free to make decisions at her discretion regarding external services. There is
no limitation on the budget
for these services. The Head of Regulation was
satisfied that all requests for resources had been met in the review
period.
- Operationally
there is crossover of the personnel that carry out commercial and regulatory
work, in particular the NZX Solicitors
in the NZXR team. There is an expectation
that these solicitors will undertake a certain amount of commercial work for NZX
in addition
to their regulatory activities. NZX's view is that this does not of
itself create a conflict for any solicitor, except in a situation
where a
solicitor might undertake work for the Special Division, as regulator of NZX.
During the review period the NZX Solicitor
appointed to act as the liaison
between NZX and the Special Division did not undertake any commercial work for
NZX.
- The
fact that NZX Solicitors are available to undertake corporate work for NZX has
the potential to cause resource conflicts between
NZX's corporate and regulatory
work. However, in practice it appears to have been clearly communicated to all
NZX Group Leaders that
the first demand on NZX Solicitors' time is their
regulatory work. Sharing of legal resources that have regulatory and commercial
functions is discussed between the Head of Regulation and the Corporate Counsel
(or the Group Leaders). It was evident that NZX's
corporate groups are expected
to contract out legal work if the level of regulatory work would create
competing priorities for NZX
Solicitors. We did not see evidence of material
resource difficulties in the review period caused by the in-house legal resource
being shared between the regulatory and corporate groups.
- The
Commission has previously recorded in its report arising from the collapse of
Access Brokerage that NZX has, since demutualisation,
increased its focus on
market compliance. Our more detailed review has reinforced this observation. It
is our impression that adequate
resources were applied to regulatory functions
in 2005.
Interaction between Market Supervision and the other NZX
groups
- NZX
Solicitors noted interaction with Group Leaders (other than the Head of
Regulation) and the Corporate Counsel in relation to the
commercial aspects of
their work. Some NZX Solicitors were also involved in bringing a regulatory
perspective to the Listings Group,
run by the Head of Market Products, in
relation to potential new listings.
- The
Participant Compliance team's main interactions with other NZX business units
concern IT and systems matters if any systems issues
arise.
- The
LCR team has some interaction with other Group Leaders, particularly in relation
to IT and systems issues, database management,
and NZX's publications for which
LCR generates data. LCR is responsible for running a helpdesk and matters may be
referred from the
helpdesk to other parts of the business for a response. The
LCR Team Leader participates in the Listings Group which focuses on promoting
and attracting listings.
- Of
the personnel in the Market Supervision Group, only the Head of Regulation
reports to and appears before the Board.
Responsibility for
Market Supervision
- NZX
has powers under its Listing Rules and Participant Rules in relation to
administration and enforcement of the Rules. Some of the
enforcement powers have
been delegated by the Board to NZX Discipline. All relevant powers, as they
relate to NZX as a Listed Issuer,
have been delegated to the Special
Division.
- Identical
delegations for administration and enforcement of the Rules have been granted to
the CEO and to the Head of Regulation.
We consider that this detracts from the
separation that has been established between corporate and regulatory
activities.
- The
directors of NZX were strongly of the view that Board delegations for the
exercise of regulatory powers should lie with the CEO
as well as the Head of
Regulation because the Board needs to be able to hold the CEO ultimately
accountable for all aspects of NZX's
performance.
- In
practice it was clear that the Head of Regulation exercises supervisory
authority over regulatory matters. The CEO is consulted
on regulatory matters
from time to time, but the Head of Regulation has no belief that this detracts
from her authority to exercise
the delegated powers. The Head of Regulation
noted that there had been no instances during the review period where the CEO
and Head
of Regulation had disagreed on the approach to be taken on a regulatory
matter. We understand that should this occur on an important
matter, it would be
escalated to the Board. It appears that in practice the CEO is kept informed of
regulatory work, to allow him
to ensure that as CEO he is involved in any
material matters affecting policy or risk.
Separation of the
Market Supervision Group
- Our
review found that NZX has in place physical and procedural information controls
designed to isolate the regulatory work undertaken
by the Market Supervision
Group, in particular NZXR which is responsible for Listing Rule compliance.
- All
NZX personnel work in the same building. While the working environment is open
plan, work areas are divided so that the Market
Supervision Group is separated
from the commercial groups. This area can be locked off from the rest of the
floor. Information in
the regulatory area is understood by commercial personnel
to be confidential.
- We
were advised that there are information controls on the NZX computer system. The
server has a dedicated drive for NZXR personnel,
which is only accessible by
them. Access to electronic files and regulatory databases is also restricted to
NZXR personnel. The Participant
Compliance team has similar controls, and
information about Market Participants can only be accessed by members of that
team and
the Head of Regulation.
- All
staff we spoke to appeared to be aware of the need to maintain separation
between corporate and regulatory work.
- The
treatment of listing applications has highlighted conflicts of interest in
overseas jurisdictions. This has occurred where pressure
has been applied, for
the sake of increasing revenue, to accept lower quality listings. The regulatory
requirements for a listing
on NZX are, consistent with other activities, dealt
with by the NZXR team, quite separately from the corporate side of NZX's
business.
Separation at this stage is assisted by the continuing use of the
Listing Subcommittee, which comprises two persons who are otherwise
independent
of NZX, to review listing documents for compliance with the Listing Rules. We
were told there were occasions on which
Listed Issuers, and in particular
companies that are in the process of listing, have contacted members of the
Market Operations Group
for assistance or support on a regulatory matter. It
seemed to be clearly understood that any such inquiry would be immediately
forwarded
to the appropriate regulatory
personnel.
Personnel
- As
an entity exercising regulatory authority it is important that NZX's processes
for dealing with potential conflicts of interest
on the part of individuals are
clear and consistently applied.
- At
a staff level, management of conflicts of interest is important, in particular
for NZX Solicitors who have authority to take decisions
(in divisions of 3
solicitors) on various applications made by Listed Issuers. NZX Solicitors were
aware that they should declare
conflicts of interest. However, NZX does not have
any formal written policy about identification and disclosure of personal
conflicts
by its Market Supervision staff. We were told that it is the
responsibility of the Lead Solicitor on any matter to ensure that no
member of a
division has an interest in the matter. NZX Solicitors were of the view that
interests should be declared to the Head
of Regulation or to the relevant
Business Leader, who can determine whether or not an interest is such as to
preclude participation
in any matter. Participant Compliance team members appear
to have a similar understanding but it was not clear that a specific expectation
had been communicated to them regarding disclosure of conflicts of interest. We
recommend that NZX introduce and communicate to all
Market Supervision staff a
formal policy about disclosure of conflicts of interest so that all Market
Supervision staff have a consistent
understanding of NZX's expectations about
conflicts disclosure. NZX has a policy regarding trading by its officers and
employees
in the securities of any NZX Listed
Issuer.
Recommendation
- We
recommend that:
NZX introduce and communicate a formal policy for all
Market Supervision staff concerning identifying and declaring personal conflicts
of interest.
NZX says that it currently has a policy regarding
conflicts of interest and agrees to set this out in writing.
NZX has
committed to do this by the end of this calendar year.
OVERSIGHT REVIEW OF NZX 2005
ARRANGEMENTS FOR SUPERVISION OF MARKET PARTICIPANTS
Role of Participant Compliance
- Participant
Compliance performs the following functions in relation to supervision of Market
Participants and Futures and Options
Participants:
- Review
of daily, monthly and annual financial returns submitted by Market Participants,
Futures and Options Firms, and Futures and
Options Introducing Brokers;
- Review
of Internal Control Checklists, which contain confirmation from Market
Participants of their compliance with various Participant
Rules;
- Onsite
reviews of Market Participants' compliance with the Participant Rules and
Futures and Options Participants' compliance with
the Futures and Options
Rules;
- Review
and investigation of complaints received from investors relating to the
activities of Market Participants that may be referred
to NZX Discipline;
- Review
of trading in the shares of Listed Issuers to identify possible breaches of NZX
Rules and securities laws; and
- Reviewing
applications from entities and individuals seeking accreditation by
NZX.
Conduct of market surveillance regarding trading
activity
- The
Participant Compliance team has the primary responsibility for reviewing the
alerts received from SMARTS, the real-time market
surveillance system. Members
of NZXR also have access to SMARTS.
- The
SMARTS system maintains an audit trail of the alert and the person who has
reviewed the alert. A review of a sample of alerts
indicated that alerts were
regularly reviewed by members of the Participant Compliance team.
Complaints handling regarding Market Participants
- NZX
has a complaints manual detailing processes for handling complaints. Participant
Compliance team members advised that they use
the processes set out in the
manual to deal with complaints. The files evidenced that the complaints
procedure was followed. All
members of the Participant Compliance team handle
complaints. Complaints handling is overseen by a Business Leader and the Head of
Regulation.
- Where
complaints raise substantive issues and lead on to referral to NZX Discipline,
the Participant Compliance team prepares the
Statement of Case which commences
the discipline process.
Onsite inspections and periodic
reporting
- The
findings of the inspection and working papers relating to inspections of Market
Participants were well documented. Findings of
inspections were generally
observed to be communicated to Market Participants within the timeframes
determined by internal NZX policies.
Copies of inspection reports were sent to
the Commission at the time.
- There
was regular communication with Market Participants for correcting the breaches
and shortcomings observed in the course of inspection.
The inspection files
contained well-documented records of regular follow-up correspondence with
respective Market Participants.
- Some
delays in relation to internally determined timeframes were observed in the
submission of monthly reports to the Head of Regulation.
- Some
repeat breaches of Participant Rules, observed in inspection reports selected
for sample review, did not result in these breaches
being referred for
disciplinary action. We understand from discussions with members of the
Participant Compliance team that the approach
is to provide guidance and advice
to the Market Participants and to try to change their behaviour rather than
initiate immediate
disciplinary action.
- The
Head of Regulation noted in terms of NZX's approach to participant compliance
that it may be a matter of selecting the right regulatory
tool to deploy in any
given situation. In the course of its inspection programme, NZX focuses on
education rather than discipline
but depending on the circumstances would bring
disciplinary actions as well. The Head of Regulation indicated that the focus on
education
may change now that NZX has inspected every Market Participant.
Material received from NZX Discipline shows that several broker compliance
matters have been referred to it. We recommend that NZX take disciplinary action
against Market Participants who commit repeat breaches
of the Participant
Rules.
Accreditation of Market Participants
- Market
Participants are required to be accredited by NZX under the Participant Rules.
The Participant Compliance team processes accreditation
applications. NZX seeks
to ensure that only fit and proper entities are designated as NZX Participants.
In the course of the NZX
Sponsor application process, the application is put to
a panel of senior NZX staff (comprising the Head of Regulation, the Group
Leader
- Market Products and the CEO) for review. The files showed that the panel makes
comments on the applicant's appropriateness
for accreditation. This panel
approval process was used for each of the files that we reviewed. The panel's
decision was then confirmed
to the applicant. Other Market Participant
applications are approved by the Head of Regulation following review and
recommendation
by Participant Compliance staff.
Escalation of
issues
- The
Participant Compliance Business Leaders report to the Head of Regulation from
on-site inspections if there are significant issues.
The Head of Regulation has
been involved in reviewing five inspection reports during 2005. Her focus is on
the findings and recommendations,
and the timeframes for issues to be remedied.
The Head of Regulation also takes into consideration whether the report is
raising
issues that she needs to bring to the attention of the CEO or Board. A
similar approach is taken for escalating significant issues
observed in other
areas of participant compliance work.
- Where
repeat breaches occur within a firm there may be increased intervention by NZX.
The Head of Regulation always expects to be
made aware of situations where a
client funds account is in overdraft, liquid capital thresholds have been
breached, or "cultural"
issues noted at a firm. This expectation has been
communicated to the Participant Compliance Business Leaders.
Recommendation
- NZX
has adequate processes in place for supervision of Market Participants and
Futures and Options Participants under the Participant
Rules and the Futures and
Options Rules and uses its processes consistently. We make the following
recommendation:
NZX ensures that, now the "education process" with
Market Participants is complete (through the inspection process), NZX takes
disciplinary
action against Market Participants who commit repeat breaches of
the Participant Rules.
While NZX indicated in the course of our
review that it is likely to do this in future, NZX noted that disciplinary
action may not
be the appropriate regulatory tool for dealing with breaches. NZX
Discipline has indicated that it does not consider it appropriate
for all
breaches to be referred to it, in particular less material breaches.
The
Commission considers that repeat breaches of the Rules can demonstrate
particular attitudes towards compliance. NZX needs to use
a mechanism to
penalise repeat breaches by Market Participants. Currently, taking a case to NZX
Discipline is the only avenue for
doing this. If NZX is of the view that current
NZX Discipline proceedings may not be appropriate in all cases we think that NZX
should
consider the sufficiency of the regulatory tools available to it under
the Discipline Rules. We plan to keep this under review.
NZX will
consider this matter again and has undertaken to report back to the Commission
by the end of this calendar year.
OVERSIGHT REVIEW
OF NZX 2005
ARRANGEMENTS FOR SUPERVISION OF LISTED ISSUERS
NZXR's focus
- NZXR
focuses on applications made under the Listing Rules received from Listed
Issuers. NZXR also supports the LCR team, prepares
matters for NZX Discipline,
provides support to the Special Division (as required) and monitors the
regulatory environment and effectiveness
of the Listing Rules. Members of the
NZXR team also undertake corporate legal work for NZX, including preparing
applications to the
Special Division on behalf of NZX as a Listed Issuer.
- NZXR
works in divisions of three solicitors for considering most matters. Generally
this process seems to work well, and ensures that
decisions are well-canvassed
and that a mix of experience and viewpoints are taken into account. We noted
that the division process
appeared to create certain timing difficulties in some
instances. We comment further on the division process below.
- NZXR
does not initiate investigations regarding compliance with the Listing Rules,
absent complaints, and observed or suspected non-compliance.
While the
Participant Compliance team actively monitors the market, through a programme of
inspections and the SMARTS technology,
the NZXR work is reactive. Solicitors are
approached by issuers or third parties in respect of matters which require their
attention,
such as document approvals required by the Listing Rules or
applications for waivers from the requirements of the Listing Rules.
This is
consistent with the approach taken by other exchanges.
Approval
of listings and delistings
- NZX
Solicitors have access to a comprehensive listing manual which is intended to
provide guidance to the solicitors on the listing
process. It was evident from
file reviews that the NZX Solicitors were following the processes and checklists
contained in the manual.
The Market Products Group has a role in promoting and
attracting listings, but once a listing application is received by NZXR, the
Market Products Group has no involvement in the processing of that
application.
- As
with all NZXR work, an application for listing is assigned to a Lead Solicitor.
The Lead Solicitor then works in tandem with the
Listing Subcommittee to assess
the application and make a decision. Divisions are not used to consider listing
applications. NZX's
process of using the Listing Subcommittee to consider
listing applications is derived from the previous NZSE mutual structure. It
is
not a requirement of the Listing Rules. The Lead Solicitor and the Subcommittee
correspond at length about the issues raised in
any particular matter. The
Subcommittee's focus is on the financial information disclosed in offer
documents.
- The
Subcommittee has two members. In the event of a conflict, the conflicted member
stands down and the Subcommittee is reduced to
one member. We recommend that NZX
consider enlarging the membership of the Listing Subcommittee to address
conflicts.
- On
one occasion we found the Listing Subcommittee recommended that a draft offer
document submitted with a listing application should
include information that
would have been in breach of the securities laws. Although the Listing
Subcommittee's focus is on the financial
information included in offer documents
we would expect the Listing Subcommittee to be aware of the securities law
requirements.
We note that the Companies Office also reviews offer documents
from a statutory perspective, although NZX and the Companies Office
do not have
any formal liaison. In interviews, NZX told us that where it discovered an offer
document was in breach of Securities
Act requirements, it would communicate its
concerns to the issuer in the first instance, and would likely also refer the
breach to
the Companies Office. In its comments on the report NZX said that it
would communicate its concerns to the issuer and may refer the
matter to the
Companies Office or to the Securities Commission. The Commission expects all
unresolved breaches to be referred.
- Delisting
applications were considerably less complicated. It appears that delisting
applications are dealt with by a Lead Solicitor
working alone. For issuers who
had a listing in another jurisdiction the primary concern was that any
outstanding obligations were
settled by the issuer so that delisting could
proceed. NZX was also concerned that communications were undertaken with
security holders
so that they were informed of their position. NZX advised in
submissions that it would be likely to require shareholders' resolutions
where a
company that did not have a secondary listing with another exchange wanted to
delist.
Other approvals under the Listing Rules
- NZXR
reviews and approves a range of other documents under the Listing Rules,
including:
- Waiver
and ruling applications;
- Approvals
of persons to prepare Appraisal Reports;
- Notices
of Meetings; and
- Approval
of the independent solicitor to prepare an opinion on an issuer's constitution.
- NZX
has a Solicitor's Handbook which contains checklists and guidelines for these
matters. It appears from the files reviewed that
during the review period NZXR
staff followed these checklists and guidelines consistently.
Waiver and ruling applications
- Processing
of waiver and ruling applications for Listed Issuers followed a consistent
process. The Solicitor's Handbook contains a
guide to waivers and rulings which
sets out the steps of an application for the solicitors. The decisions appeared
consistent with
those made on similar facts.
- Waiver
and ruling applications are dealt with by the division process. NZXR solicitors
reviewed the applications and identified issues
for follow-up with other members
of the division, with Business Leaders, and with the applicant. Once a draft
decision had been prepared,
there was input from the division in terms of
proof-reading and content.
- Where
waiver and ruling applications were made in respect of several Listing Rules,
the NZXR solicitors considered the application
in respect of each Rule. There
was good use of precedents. Many of the published decisions did not refer to the
precedents searched.
NZX Solicitors advised that NZXR always considers the
position of shareholders in considering applications more generally. Statements
about the effect on shareholders were in fairly standard form across the
decisions we examined. Decisions and conditions appeared
consistent across
applications.
- File
reviews indicated that NZXR would consider past compliance issues when
determining applications, although each application is
determined on a case by
case basis.
- Applications
for waivers and rulings that involve Listing Rule 10.1.1 (continuous disclosure
of material information) were dealt with
differently to other waiver and ruling
applications due to different statutory requirements. A Business Leader dealt
with these applications
in consultation with the Head of Regulation. This
process reflects the experience of the Business Leaders in dealing with this
type
of application. In some particularly complex applications, external
advisers were consulted. In these cases, the Business Leader
would consult with
the external adviser and Head of Regulation. In the case of one waiver
application dealing with Listing Rule 10.1.1,
there was active involvement from
the CEO. This application was made in the context of an IPO.
- It
appeared that there were several Listing Rules where a significant number of
issuers sought waivers. NZX noted that it had identified
that the market had
missed the fact of the new obligation for the nomination period for directors,
and this had led to widespread
non-compliance. To remedy the situation, NZX took
positive steps to educate the market, including making announcements and writing
to issuers to remind them of the new obligation. NZX has advised that it
monitors waivers and rulings and incorporates these into
the rule review
process.
Timing requirements for approvals
- An
area of concern was timing in processing applications. Under the Listing Rules,
certain documents requiring approval by NZX, and
waiver and ruling applications,
are to be submitted to NZX at least 10 days before the document is to take
effect or a determination
is sought. Waivers and rulings can also be sought on
an urgent basis. When this occurs, the matter must be dealt with within 10
working
days and urgency rates apply. The Commission acknowledges that the
quality of applications and information provided by applicants
can have an
effect on timing. File reviews indicated some delays in addressing applications,
with some issuers expressing concerns
about this, although in most cases the 10
day timeframe was met. This appears partly to be a side-effect of the division
process,
as the Lead Solicitor must wait for feedback from other division
members. At times this slows down the process. We recommend that
more attention
be paid to this. File reviews also indicated issues about applications made
under urgency which were not dealt with
in the expected timeframe. In some cases
this caused problems for the issuers, and in one instance led to NZX making
representations
to the issuer that it would not find an issuer in breach on the
basis that NZX had not fully considered the application.
Surveillance: trading halts and price enquiries
- There
are two types of trading halts: issuer-requested and NZX-initiated. File reviews
evidenced that these did not require much action
by NZX. Where trading halts
were requested, the LCR team actioned them promptly.
- Price
enquiries arise when SMARTS generates an alert that there has been unusual
trading activity, either in the price of the securities
being traded, or in the
volume. Unusual trading activity may suggest insider trading and may raise
questions as to whether the issuer
is complying with its continuous disclosure
obligations. Where alerts generated by SMARTS warrant further enquiry, a
Business Leader
will action a price enquiry in conjunction with a member of the
Participant Compliance team. A form letter is sent to the issuer,
setting out
the concern and asking for confirmation that the issuer is complying with Rule
10.1.1. NZX normally releases its letter
and the response to the market. NZX
also provides information to the Commission under the Securities Markets
Act.
Inspections and investigations
- NZX
has powers to obtain information by exercising its powers of inspection. The
Solicitor's Handbook refers to the inspection power
in a short note on
investigation processes.
- File
reviews indicated that in some cases, issuers were not forthcoming with
documents. NZXR has a range of enforcement tools which
it is willing to consider
and has indicated it is willing to use its powers of inspection to obtain
required documents.
- NZXR
is able to contract resources, and in the case of suspected breaches, this may
be an option in order to determine whether a breach
has occurred. This external
adviser is managed by the Lead Solicitor on a matter. In some cases the NZX
would also refer matters
to the Commission. NZXR did note that the extent to
which it investigated a matter would need to be determined in terms of the
outcomes
that would likely be achieved.
- On
occasion, when NZXR referred breaches to NZX Discipline, some issuers involved
expressed their unhappiness with the referral directly
to NZXR. We note that
NZXR did not make any changes to their approach, despite potential risks to
listings, but followed the procedures
that NZXR had identified as appropriate.
Disciplinary actions
- The
Solicitor's Handbook contains a brief note about the NZX Discipline process. It
does not contain further specific guidance in
relation to disciplinary
processes. The matters giving rise to disciplinary actions varied throughout the
review period. NZXR followed
the same general process in respect of each
matter.
- The
Statement of Case and Notice of Referral to NZX Discipline were drafted by the
Lead Solicitor in consultation with the Business
Leaders and the Head of
Regulation. An external adviser was also used during the review period. The
Statements of Case and Notices
of Referral followed a standard format and
attached relevant documentation.
- There
was evidence that NZXR was under considerable pressure at times, both from
complainants and issuers. NZXR corresponded in a
measured way and did not yield
to demands from these parties. NZXR was clearly following a process and
attempting to ensure that
disciplinary matters were dealt with in a considered
fashion. The Lead Solicitor sought input from external advisers when drafting
responses on these types of matters.
- There
was some variance between the views of NZXR and NZX Discipline regarding the
penalties handed down by NZX Discipline for breaches
of the Listing Rules versus
the penalties recommended by NZXR. Executive management noted disagreement with
some decisions handed
down by NZX Discipline but considered this indicated that
the process of having NZX Discipline act as the disciplinary body was effective
and showed that NZX Discipline was acting independently. Both NZXR and NZX
Discipline have regard to the published NZX Discipline
Penalty Bands Guidance
Note in recommending and setting penalties. The Commission has no comments about
consistency in relation to
the penalties imposed by NZX Discipline, although we
note there have not been a sufficient number of NZX Discipline decisions to
identify any clear trend.
Records: practices and
procedures
- File
reviews indicated that NZXR's files appear to be comprehensive, well maintained
and clearly identified. It was clear from the
files reviewed what process NZXR
had undertaken in respect of each application. The NZXR team makes use of a file
closing form, which
indicates the names of the members of the division, the Rule
which the file related to, and the time spent on the matter, as well
as other
information such as whether an external adviser was engaged.
- NZX
also has a Legal Reference System, which is essentially a database of all NZXR
decisions and includes key items of correspondence
and application documents.
NZX Solicitors use this information to assess the precedent value of decisions.
We understand that every
decision is summarised for the Legal Reference System,
although the summary may be brief for straightforward
matters.
Complaints handling
- NZXR
maintains a complaints log. This contains a copy of all complaints received and
a summary of the responses to those complaints.
NZXR uses the complaints manual
to process complaints. In the complaints process, NZXR essentially acts as a
go-between for the parties.
NZX indicated that it would assess whether
complaints were frivolous or without substance before entering into the extended
complaints
process.
- Where
complaints are made in respect of NZX's compliance as a Listed Issuer, the
complaints procedures manual makes it clear the complaint
should be referred to
the Special Division. The Special Division did not receive any complaints about
NZX's, or its related parties,
own compliance with the Listing Rules during the
review period.
- If
a complaint concerns NZX as a regulator and market operator, NZXR will respond
directly to the complainant.
Education
initiatives regarding the Listing Rules
- The
Business Leaders have involvement in seminar presentations about the Listing
Rules. They also provide assistance to issuers on
an individual basis regarding
clarification of the Rules as requested. One NZX Solicitor who focussed more on
the AX Market work
undertook a similar role in terms of working with the AX
issuers to provide information and clarification as
necessary.
Supervisory structure within the NZXR
team
- The
NZX Solicitors report to two Business Leaders, who in turn report to the Head of
Regulation. The NZXR team has a clear reporting
and supervisory structure, and
in the review period staff undertook their roles within that structure. Business
Leaders have responsibilities
for work allocation to the NZX Solicitors with the
assistance of the Head of Regulation. Members of the NZXR team were clear that
they would raise any workload issues with the Business Leaders or the Head of
Regulation.
Decision-making structure:
divisions
- Work
is allocated to a Lead Solicitor who conducts the initial review of an
application matter and records their initial comments.
The Lead Solicitor asks
for volunteers from the NZXR team to form a division. A division is usually made
up of three NZX Solicitors,
and may contain a Business Leader or the Head of
Regulation, depending on the complexity of the issue. Division members give
feedback
to the Lead Solicitor through circulation of marked-up draft documents.
Meetings are convened if the matter is more complex. Generally
the NZXR division
process appeared to have worked well in the review period.
- Although
no deadlocked divisions were experienced during the review period, all NZXR
staff stated that the proper procedure would
be to escalate the matter and seek
the opinion of a Business Leader or the Head of Regulation.
- The
Lead Solicitor is responsible for timing and procedural matters relating to an
application. However, it appears unclear to NZXR
staff where accountability lies
for the decision made by a division, that is, whether accountability lies with
the Lead Solicitor,
the division as a whole or the Head of Regulation. We think
that this should be clarified. It is also unclear whether the delegation
to
divisions to decide matters has been formally recorded. We recommend that NZX
clarify these matters for the NZXR
staff.
Escalation
- All
NZX Solicitors were clear that if they were unsure how to deal with a matter or
needed assistance that the appropriate person
to escalate it to was their
Business Leader in the first instance, and following that, the Head of
Regulation. Business Leaders were
clear that they should escalate matters to the
Head of Regulation when they needed further assistance or if they considered the
Head
of Regulation should be made aware of a situation. NZX Solicitors have
discretion to deal with issuers or other parties themselves,
up until the point
they consider escalation is appropriate.
Staff
management
- All
NZX Solicitors and one Business Leader were required to undertake both
regulatory and commercial work during the review period.
Job descriptions for
the relevant staff indicate that the targeted division between regulatory
functions and commercial activities
was between 20% to 50% allocation to
commercial work. This was broadly in line with the amount reported by the NZX
Solicitors and
Business Leaders. The NZXR team was clear that regulatory work
took precedence at all times, and in the event of a time conflict,
commercial
work would be de-prioritised or dealt with externally. If such a conflict arose
it would be escalated to the Head of Regulation
to discuss with the Corporate
Counsel in terms of managing the shared legal resource.
- NZXR
staff received mainly on-the-job training during the review period. All NZXR
staff reported that they had received induction
training and NZX also conducted
regular internal seminars for its staff, involving external advisers and
experts. NZXR staff are
also encouraged at their annual and interim performance
reviews to actively seek external training. Staff take up these opportunities
as
appropriate.
Recommendations
- NZXR
has adequate processes in place for supervision of Listed Issuers under the
Listing Rules and uses its processes consistently.
We make the following
recommendations.
- NZX
should consider enlarging the membership of the Listing Subcommittee to address
potential issues arising from any conflicts of
interest.
NZX agrees with this recommendation.
NZX has committed to do this by the end of this calendar year.
- NZX
should ensure that NZXR adheres to its established procedures for timely
appointment of and consultation with division members,
to avoid delays in
addressing applications.
NZX considers that it currently has in
place measures to determine compliance with its timing obligations. However, NZX
will consider
this matter again and has undertaken to report back to the
Commission by the end of this calendar year.
- NZX
should ensure that NZXR clearly records the delegation of decision-making
authority and the accountability for decisions made
by NZXR
divisions.
NZX believes that it currently has adequate measures
in place.
The Commission considers that these measures need to be more
clearly communicated to NZX staff.
NZX will consider this matter again
and has undertaken to report back to the Commission by the end of this calendar
year.
ARRANGEMENTS FOR RELEASE OF MARKET INFORMATION - LISTED
COMPANY RELATIONS
- The
LCR team members have a systems-based role. A core focus is the accurate and
timely release of market information, the administration
of the Market
Announcement Platform (MAP), and associated administrative activities and
systems checks. LCR staff use an extensive
procedures manual to assist them in
their work. LCR staff work closely as a team.
- It
appears from the review that the LCR team has a clear and comprehensive
understanding of its role and that its activities are carried
out to a
satisfactory standard.
Recommendation
- We
make no recommendation in relation to
LCR.
OVERSIGHT REVIEW OF NZX 2005
MARKET OPERATIONS AND INFRASTRUCTURE
Introduction
- To
be an effective market operator, NZX needs appropriate infrastructure
arrangements to operate that market. The market, through
the technology that NZX
uses, must operate effectively and have integrity. There must be procedures to
ensure that the market operates
smoothly and to manage any outages and disasters
that may arise.
- The
Commission has not reviewed the particular systems technology that NZX has
chosen to implement. This is a matter for NZX to decide.
However, the Commission
has reviewed the market infrastructure, development and maintenance, backups and
disaster planning to assess
whether the market is functioning effectively. While
there were a number of outages in the review period, we have concluded that
the
market operated effectively.
Structure and focus of the Market
Operations Group
- The
Market Operations Group's activities include the following:
- IT
Strategy - looking at the future state of NZX's core market systems;
- Operations
and Trading - maintaining the operability of the FASTER trading and FASTER
clearing and settlement environment, network infrastructure and
connectivity;
- Development
- enhancements and development for the FASTER Settlement Solution;
and
- Conformance
and Sales - connecting new Participants, accreditation of systems, training
and support for FASTER.
- There
are four Business Leaders within the Market Operations Group. Each meets with
his or her team weekly. The Business Leaders meet
with the Head of Operations
individually each week. Interaction is otherwise on an as-needed basis. The Head
of Market Operations
(also referred to as the Chief Operating Officer) meets
weekly with the CEO or otherwise as-needed.
Core systems
- NZX
has individual core systems for trading and settlement: the FASTER trading
system, based on the X-Stream trading system, and the
FASTER Settlement Solution
(FSS). FASTER is the Fully Automatic Screen Trading and Electronic Registration
securities transfer system.
- Together,
the combined system (the NZX system) facilitates execution and settlement of NZX
market transactions and manages Participants'
unsettled
obligations.
Back-ups for core systems - continuity and disaster
planning
- The
trading platform system and the clearing and settlement system both exist in
Auckland and Wellington and are mirrored. There is
a fail-safe in place to
switch between the nodes if needed. The systems are redundant from a disaster
recovery perspective. The two
data centres operate in 'lock-step' mode. If one
site fails the other will take over and no transaction is lost.
- NZX
runs two external disaster recovery exercises on a six-monthly basis. The
fail-safe is tested in the six-monthly disaster recovery
test. The disaster
recovery test also involves Market Participants to check that they can switch
from Auckland to Wellington or vice
versa. Within approximately one hour trading
can be migrated from Auckland to Wellington.
- The
last disaster recovery exercise was carried out in March 2006 and prior to that
October 2005. The disaster recovery exercise raised
small issues that were
incorporated into operational checks. NZX sent the results of the disaster
recovery exercise to all Market
Participants.
- NZX
has a Hewlett Packard package that monitors the core market infrastructure
platforms. The systems are housed in Telecom's "trader
support high availability
centres" in Auckland and Wellington. There are environmental controls in
place.
- Network
connections always face some risk of failure. There is no full network provider
other than Telecom.
Market outages and disruptions in
2005
- NZX
closed the market on three occasions during 2005 due to Telecom network faults
or firewall faults for a total of 460 minutes.
Of that time, 370 minutes'
closure was due to two general Telecom network faults and 90 minutes was due to
a firewall failure at
NZX. All Telecom customers were affected by the Telecom
network faults.
- There
were two instances where a trading system fault closed the market. The whole
market was closed for 35 minutes. The debt market
only was closed for 110
minutes for trading in debt securities.
- NZX
also experienced some FASTER settlement incidents during the review period,
mainly loss of connectivity to registries. Some of
these connectivity faults
were intermittent but recurring during 2005. The market was closed for trading
in one registry's securities
for 105 minutes.
- The
whole market operated without fault for 99.67% of total market operating hours.
This figure excludes outages caused by the general
Telecom network faults.
- The
share market operated without fault for 99.78% of total market operating hours.
This figure excludes outages cause by the general
Telecom network faults.
- During
2005, the London Stock Exchange (LSE) did not experience any outages of its SETS
and SETSmm trading platforms. The New York
Stock Exchange (NYSE) experienced
market outages totalling 4 minutes of trading time. The Australian Stock
Exchange (ASX) has a benchmark
of 99.8% systems availability. In 2004/2005 all
of ASX's critical systems exceeded this benchmark.
Incident
management and communication with the market
- NZX
has a formal incident management procedure for system disruptions. Systems are
categorised in terms of their criticality to market
function. The response to
incidents is managed against procedures established for each system category.
Incident management reports
are stored in a register.
- The
communication and reporting procedures for an incident are outlined in the
procedure. The procedure outlines to stakeholders the
communication processes
that NZX will use to notify Market Participants and Data Distributors of issues
that may lead to the suspension
of trading or impact on key systems.
- The
procedure includes the processes NZX will use to communicate about failures.
This relies in part on text messaging. NZX has identified
that the text message
service had not worked very well for technical reasons. NZX is working with its
user groups to identify the
most effective avenues for communication.
- The
first real trial of the incident management procedure was in December 2005 when
a software bug caused the debt market to cease
operating. NZX received positive
comments about how it communicated the explanation of the outage. It also
appears that NZX followed
its published procedures.
Capacity of
core systems
- NZX
considers the NZX system to be mature and stable. It has been operational for a
number of years and progressively developed to
meet market and user requirements
and demand. The trading system is currently running at less than 20% of
capacity. The system can
be reconfigured to allow more trades if near-capacity
is reached.
Monitoring and supervision of systems
Staff expertise and training
- The
Market Operations Group comprises experienced individuals who are knowledgeable
about the operation of New Zealand's securities
markets as well as specific
software and technologies. NZX considers that little training is required in
terms of technical knowledge
for the people in this Group. There is a focus on
the development of individuals, given evolving technologies and technical trends
that NZX needs to stay abreast of. The Information Technology team has attended
international courses on such matters.
Monitoring of systems
and change management
- A
series of procedures is carried out at the start of each day to make sure that
everyone is connecting to the trading platform and
that the registries are
connecting. These "start of day" procedures are run by the Information
Technology Operations team. The NZX
network has diagnostic equipment to provide
notification if a link is down and SMS texting that is automatically generated
if there
is a network failure.
- NZX
considers that it has a network design now that works very well and the design
that it wants. NZX focuses on ongoing monitoring
of the infrastructure
environment. We queried how NZX benchmarks the performance of its IT systems.
Each system has a classification
according to its contribution to the IT
framework. Standards are set against these around availability, reliability and
access, and
achievement of the standards is monitored by the Operations Group.
- NZX
has change-control guidelines to analyse any systems changes that may be
required. Changes are tested in a test environment and
there is a further test
process before any change goes live. Changes are also managed through the
communication channels.
- The
network is provided by Telecom. The Head of Market Operations advised us that
NZX retains a critical level of involvement but
it is Telecom's infrastructure
and Telecom's design engineers who work on it. NZX has a package that maps the
Telecom network, showing
all Participants and where they are connected. There is
ongoing monitoring of this and work has been carried out to ensure that each
Market Participant has a separate connection and that there is no sharing of
lines, so that if a connection goes down multiple Participants
would not be
affected.
Market Participant connection and accreditation
- The
Participant Rules do not mandate the way in which a Market Participant connects
to the NZX network. NZX has given recommendations
as to how it believes Market
Participants should connect and that they should provide for an alternative
connection if one is lost.
- There
are formal accreditation procedures and tests to be met before there is sign-off
and recognition that a Participant is accredited.
The system needs to be tested
to ensure that it can interface with the NZX system. NZX requires the
Participant to have fully developed
and tested its system within the NZX test
environment before applying to NZX for conformance. NZX produces information
setting out
the standard requirements for conformance.
- Following
initial accreditation and conformance testing, the Participant Compliance team
looks at the way the Participant firm's back
office systems are connecting
during the inspection process.
Training for Participant users
of the NZX systems
- Training
requirements for the Participants that use the trading system are set out in a
practice note and information document. Determinations
regarding the competence
of the candidate in operating the system are made by the Operations and
Development section of the Market
Operations Group. Determinations on competence
regarding the Participant Rules are made by Participant Compliance.
- All
FASTER dealers using the trading system undertake training with an NZX Trainer.
Training is undertaken in a test environment.
The feedback on the "train the
trainer" system, introduced in December 2005, is that it is effective. Where the
applicant fails the
test, the competence of the NZX Trainer may be questioned.
We understand this has not been an issue.
- A
trading participant is responsible and liable for all trading messages sent to
the trading system. Each FASTER dealer has its own
user ID and password to
access the system. Access to systems is reviewed on inspection. Each firm that
uses Direct Market Access
("DMA") facilities must have filters in place to
ensure that any order entered via DMA does not cause the firm to breach any
Participant
Rules.
- The
inspection process reviews client order/trade records to review error records.
Participants and their employees who frequently
commit dealing errors are liable
for suspension from operating the trading system. No Participants or any
Participants' employees
were suspended from operating the trading system in the
review period.
Market infrastructure strategy and
planning
External user groups provide feedback
- NZX
communicates with a number of external user groups in the areas of clearing and
settlement, technology, and the securities industry
more generally. User groups
have given feedback that there is overall satisfaction with the trading,
clearing and settlement platform.
Where issues were raised by the user groups,
NZX has taken steps to address those concerns.
Internal groups
assess needs
- NZX
has a number of committees and groups comprised of NZX staff which focus on
IT-related issues. In particular we note the IT Governance
Committee. The
responsibilities of the Committee are to have input into the technology
strategy, to approve the resulting technology
12 month plan, prioritisation, and
investment decisions. Essentially it provides oversight for NZX information
technology, infrastructure
and applications. The Head of Market Operations
chairs the Committee.
Enterprise Risk Management
Group
- The
Head of Market Operations heads the Enterprise Risk Management Group (also
called the Internal Risk Committee). The Committee
considers risks to both NZX
as a listed entity and NZX as the market operator.
- The
Enterprise Risk Management Group is charged with monitoring NZX's risk profile.
We are advised that it uses international standards
to categorise risks -
operational, financial, strategic, environmental and external. These are fed
through to the Audit and Risk
Committee of the NZX Board and to the full Board
if considered necessary. In terms of Market Operations, the Group looks at
operational
risks arising from the core trading platform and
infrastructure.
Resources
- The
IT Leadership Team identifies major maintenance requirements 12 months in
advance for approval. Any new development expenditure
requires a business case.
- The
Market Operations Group did not request or require any urgent investment in
2005. There were no major projects or investments
that were deferred due to lack
of resources. No major requests for resources had been declined. The majority of
large investments
were made in 2004 and early 2005.
- The
Market Operations Group considers that it is sufficiently resourced to carry out
its functions. There is longevity in terms of
the experience of the Group and
specialist knowledge. A business case would be made if there were larger capital
expenditure requirements.
- The
only area in 2005 where the Market Operations Group identified that it needed
further resourcing regards the future clearing and
settlement structure. This
was identified in the corporate strategy and has been discussed by NZX. NZX does
not consider the dual
functioning of FSS and Austraclear (a transfer system for
the real-time settlement of trades) to be efficient. NZX has recruited
a
resource from overseas who will be leading work to specifically investigate and
recommend an approach to the clearing and settlement
structure. This is an area
where the Market Operations Group would have faced constraints without
additional expertise.
Reporting to the Board
- Relevant
updates on market operations are presented to the Board in a report by the CEO.
The Head of Market Operations does not present
reports to the Board in the
normal course. He may attend Board meetings if there is a paper that he has
prepared or to support a
paper prepared by the Market Operations
Group.
Recommendation
- NZX
has adequate service levels and adequate systems and processes for back-ups and
continuity planning. We make no recommendation
in respect of the Market
Operations Group.
OVERSIGHT REVIEW OF NZX 2005
DISCIPLINARY ARRANGEMENTS - NZX DISCIPLINE
Role and functions
- While
maintaining governance authority in a single Board, NZX has created a separate
entity, NZX Discipline, to adjudicate on alleged
breaches of the NZX Listing
Rules and Participant Rules. This was done in 2004. The decision to separate
this function was a positive
step in terms of managing potential conflicts of
interest (both corporate and personal) for Board members.
- NZX
Discipline is constituted by the NZX Discipline Rules, which form part of the
conduct rules of the NZX under the Securities Markets
Act. These Rules also set
out the procedures of NZX Discipline. NZX Discipline is dependent on NZX for
resources. Both NZX Discipline
and the Special Division carry out functions
under delegation from NZX. Their functions form part of NZX's obligations. While
NZX
Discipline and the Special Division operate separately from NZX and set
their own policies and processes, NZX remains responsible
for these bodies
because they perform functions for which NZX is responsible under the Securities
Markets Act.
- NZX
Discipline has procedures set out in the Discipline Rules for dealing with
conflicts of interest on the part of any of its members.
No member of NZX
Discipline who has a conflict of interest in respect of a case can consider that
matter.
- In
brief, NZX Discipline acts as a tribunal, hearing cases that are referred to it
by NZXR. There are separate procedures for summary
and full hearings. NZX
Discipline has powers to impose penalties including private reprimands, public
censures, suspension or cancellation
of listing, suspension or revocation of a
Market Participant's designation, monetary penalties, and restitution. NZX
Discipline can
also consider and determine a referral of any waiver or ruling
decision of NZX under the Listing or Participant Rules where the decision
is
referred to it by the applicant. A determination of NZX Discipline on any matter
is binding on NZX in its exercise of its powers
to grant waivers or
rulings.
- NZX
Discipline has both independent members and representatives of NZX. Board
Members, the CEO, Corporate Counsel, and NZXR personnel
are ineligible for
appointment. The NZX Board has resolved to remove NZX appointees from NZX
Discipline. This will be effected in
upcoming changes to the NZX Discipline
Rules.
Matters considered
- The
Commission received copies of all decisions taken by NZX Discipline in the
review period, and a copy of the report of NZX Discipline
for the two years from
its inception in May 2004.
- In
the review period, NZX Discipline considered 12 matters. These comprised four
matters under the Listing Rules, seven under the
Participant Rules, and one
referral of a waiver decision.
- The
Chairman of NZX Discipline noted that from May 2005 there was a marked increase
in its activities. This had increased the demands
on the members and Chairman of
NZX Discipline.
- The
Chairman of NZX Discipline spoke very highly of the members of the disciplinary
body, describing their contribution in the review
period as "outstanding". He
reported that members of NZXR have conducted their activities in a professional
manner, and have been
supportive of the role undertaken by NZX Discipline. The
Chairman of NZX Discipline reported that the concept of NZX Discipline is
working well.
Process and decisions
- The
procedures for NZX Discipline are set out in the Discipline Rules. The Chairman
of NZX Discipline reports that during its early
stages it worked to "bed-in" its
processes. The Chairman has sought to be involved in most hearings to provide
consistency and continuity.
- The
majority of NZX Discipline decisions have been published, consistent with the
presumption in favour of publication set out in
the Discipline Rules. The
Chairman remarked that some decisions were not published where the breaches
concerned were relatively minor,
because of a concern that this would harm
confidence in NZX Participants generally. In these cases, notice of the NZX
Discipline
decision was given to all Market Participants, without naming the
firm concerned.
- There
is evidence in the cases heard to date of differences of views between NZX in
its submissions and NZX Discipline decisions.
It seems clear that NZX Discipline
takes care to maintain operational independence from NZX.
- No
cases taken to NZX Discipline were settled in the review period. However the
Chairman of NZX Discipline noted that the requirement
for NZX Discipline
approval of a settlement was an important element of the settlement process. The
Commission agrees.
- There
were instances in the review period of uncertainty about procedure, affecting a
review of a waiver application and the preliminary
steps for a disciplinary
hearing. The latter case also showed some uncertainty as to the extent to which
the Chairman of NZX Discipline
can give binding procedural directions
preliminary to hearings. The Commission thinks this should be clarified.
However, such issues
are not surprising given the relatively short period for
which the Discipline Rules have been in force. We note that NZX has recently
announced a review of the Discipline Rules, which should provide a useful
opportunity to make improvements based on experience to
date.
Resources
- NZX
Discipline comprises part-time members. It has no secretariat or premises
provided by NZX. Hearings to date have been held, at
NZX Discipline's election,
in premises supplied by NZX Discipline members. The Chairman's personal computer
and recording equipment
has been used. NZX has supplied teleconference
equipment. NZX has advised that premises would be made available to NZX
Discipline
should it wish to use them.
- The
Chairman of NZX Discipline noted that he had not asked for further resources
during the period. He was confident that these would
be supplied if sought. We
were told that it would be helpful if some further administrative support could
be supplied by NZX. The
Chairman has carried out the administrative work himself
to date, and has not billed NZX for this time. NZX advised that it was not
aware
of this and has discussed this with the Chairman.
- It
became clear to us that the current success of NZX Discipline's operations is
largely due to the goodwill and dedication of the
Chairman and other members.
NZX Discipline has to date coped with its workload, although this has placed
significant demands on the
time of the Chairman, who acknowledged that this
might not have been possible had he been in private practice at the time. File
reviews
showed that NZXR had expressed concern about the timeliness of the
publication of one decision which had been delivered to NZX and
the respondent
but where publication was delayed.
- We
are of the view that NZX and NZX Discipline should together review
administrative support and other resourcing arrangements, and
these matters
should be reviewed on a regular basis. We stress that NZX Discipline has
operated very well in the review period, but
we record also that this appears to
be largely dependent on the willingness of the individuals involved to go to
significant lengths
to ensure the success of the organisation.
- Members'
fees are set by NZX. NZX and NZX Discipline consulted on this. The fees have not
been reviewed since NZX Discipline was established.
There is no provision in the
Discipline Rules for review of these fees. Given the dependence of NZX
Discipline on NZX for its resources,
and the importance of continuing to attract
high quality members, we think it would be appropriate for NZX to establish a
periodic
review of NZX Discipline members' fees and to consult with NZX
Discipline members on this. NZX has said that it is willing to review
the fees
regularly. It may also be appropriate, as is the case for judicial officers, to
entrench in the Discipline Rules that NZX
may not reduce the level of NZX
Discipline fees.
Reporting
- Most
NZX Discipline decisions are published. Where they are not, it is clear that NZX
Discipline members have recorded their decision,
including the reasons for not
publishing.
- Under
the Discipline Rules, NZX Discipline is required to provide an annual report to
NZX on its operations. This report is required
to state, among other things,
whether NZX Discipline received sufficient resources in the year to date.
- We
note that no annual report was provided by NZX Discipline to NZX in the review
period. The report made in April 2006 covered the
first two years of operations.
The Chairman of NZX Discipline commented to us that although assistance was
offered by NZX during
2005, this was not taken up by NZX Discipline. NZX
Discipline intends to make use of available assistance in future. The Commission
recommends NZX and NZX Discipline discuss this further, with a view to ensuring
that NZX Discipline receives all the resources it
requires to enable it to
continue to carry out its functions effectively. The Commission recommends that
NZX Discipline publish its
report annually.
Appeal Panel
- Under
the NZX Discipline Rules, decisions of NZX Discipline can be appealed to an
Appeal Panel. Other than as set out in the NZX Discipline
Rules, the Appeal
Panel determines its own processes for hearing and determining appeals. This
Panel has been established and has
met, but has not yet had to consider an
appeal. Accordingly we do not comment on it further, other than to note our view
that we
expect NZX to publish information about the Appeal Panel, including
contact details required for lodging an appeal.
Recommendations
- NZX
Discipline as an organisation has effectively carried out its function in the
review period but there are certain gaps in resources
and administration. The
Commission makes the following recommendations:
- NZX
and NZX Discipline should together review the administrative support and
resource arrangements in place for NZX Discipline. These
resource arrangements
should be reviewed regularly to ensure that NZX Discipline receives all the
resources it requires to enable
it to continue to carry out its functions
effectively.
NZX has advised that administrative and
resource arrangements are being discussed with NZX Discipline and are close to
being settled.
NZX advises that it proposes to review these arrangements
annually.
NZX has committed to do this by the end of this calendar year.
- NZX
should establish a periodic review of NZX Discipline members' fees and consult
with NZX Discipline members on this. The NZX Discipline
Rules should entrench
that the fees for members of NZX Discipline may not be reduced by
NZX.
NZX is willing to entrench the fees so that they may not be
reduced. NZX is willing to review the fees regularly.
NZX has committed
to do this by the end of this calendar year.
- NZX
Discipline should publish its Annual Regulatory Report
annually.
NZX agrees with and supports this recommendation.
OVERSIGHT REVIEW OF NZX 2005
SPECIAL DIVISION - SUPERVISION OF NZX AS A LISTED ISSUER
Conflict management
- As
a Listed Issuer, NZX must comply with the Listing Rules. This requires it, like
other issuers, to make certain applications and
potentially be subject to
disciplinary proceedings before NZX Discipline. To deal with the obvious
conflict that arises for NZX in
these situations, it has formed a Special
Division of NZX Discipline. The Special Division is an independent body. It
deals with
regulatory matters concerning NZX as a Listed Issuer and its related
entities.
- The
Special Division plays a vital role given NZX's dual functions as a market
regulator and commercial listed entity. The Special
Division is integral to
conflict management and the integrity of the NZX structure. The oversight review
showed that the system of
using the Special Division was working effectively and
seemed to achieve separation between NZX's commercial and regulatory functions.
We are satisfied that the Special Division adequately carried out its function
in the 2005 review period.
Jurisdiction and powers
- The
Special Division is established under the NZX Discipline Rules. The Special
Division is empowered under the NZX Discipline Rules
to "stand in the shoes" and
exercise the powers and functions of NZXR in respect of NZX as a Listed Issuer
that NZXR exercises in
respect of other issuers listed on NZX's markets. The
Chairman of the Special Division confirmed its understanding of the role. Given
the key role that the Special Division plays in NZX's conflict management, we
expect it to assert its jurisdiction clearly and actively.
- The
objective of the Special Division under the NZX Discipline Rules is to foster
market confidence that the Listing Rules, NZX Participant
Rules and NZX
Discipline Rules are applied in respect of NZX, or a related entity, in an
impartial and independent manner.
- The
Special Division operates independently of NZX. It comprises four independent
members approved by the Securities Commission. Special
Division members must
have no conflicts of interest as regards NZX. The role of Chairman of the
Special Division is separate from
the Chairman of NZX Discipline. In the 2005
review period the Special Division dealt with a total of nine matters. These
included
document approvals, a waiver application and a continuous disclosure
matter. The Special Division did not deal with any complaints
about NZX as a
Listed Issuer.
- The
Special Division's jurisdiction to deal with a matter is in the first instance
seen as a matter for the Chairman to determine.
In the review period there were
no formal written delegations by the Special Division to the Chairman of the
Special Division in
relation to jurisdictional matters. If the Chairman is to
have authority to determine whether matters are referred to the Special
Division
we think that the delegation from the Special Division should be formally
recorded. However, given the importance of the
Special Division's role, we
consider it preferable that determination of the Special Division's jurisdiction
to deal with matters
be assessed by the Special Division, rather than any one
member.
- In
2005 NZXR sought information from NZX on behalf of the Special Division
regarding the CEO's remuneration. The information related
to an application for
a waiver. NZX declined to provide the Special Division with the requested
documentation. The Chairman of NZX
was clear that NZXR would simply demand any
information it sought from issuers. NZX advised in its submissions that it
considers
it does not have powers to compel disclosure of information. In the
context of a waiver application, NZX advises that it may instead
consider
whether, in the absence of the information sought, it has sufficient information
to make a decision. If not, NZX advised
that it will decline to grant a waiver.
We consider that in practice NZX does have the power to compel production of
information
by otherwise refusing to grant waivers where relevant and requested
information is not provided.
- The
Special Division believes it pursued the matter and obtained sufficient
information by other means. The Special Division was satisfied
that it had
managed to obtain an assurance from NZX in relation to the information that it
sought and granted the waiver. The Special
Division exercises the powers of NZXR
in respect of NZX as a Listed Issuer. The Special Division should be aware of
these powers
and exercise them as appropriate. NZX should comply fully with all
lawful requests and directions from the Special Division. We do
not consider it
was appropriate for NZX to refuse access to the requested documentation.
- The
Special Division's view is that NZX is not bound to a higher standard under the
Listing Rules than any other Listed Issuer. Nor
is there a lesser standard for
NZX. However, the Special Division encourages NZX to set a higher standard of
disclosure and compliance
as a matter of practice and has provided comment to
NZX about this.
Resources
- The
Special Division is dependent on NZX for resources. The Special Division
considered that it was adequately resourced in 2005 to
carry out its function.
The level of resource is established on an as-needed basis. The Special Division
has access to independent
counsel and experts. The Special Division invoices NZX
and is paid. The Special Division did not request additional resources in
2005.
While resource needs have not yet been tested, we think the Special Division
should give critical thought to its likely and
contingent resource needs. We
expect the Special Division to discuss its resource requirements with the Board
of NZX.
- The
Special Division has not considered with particularity what would happen in
terms of process and resources if the Special Division
were to take a case
against NZX to NZX Discipline. Security of funding in advance of initiating such
an action has not been discussed
between the Special Division and NZX. The NZX
Board informed the Commission that it would guarantee funding for the Special
Division
should such a situation arise. The Commission considers it appropriate
that a guarantee of advance funding for such an action be
formalised between the
Special Division and the Board of NZX.
Communication
- The
first point of contact for external correspondence with the Special Division is
NZX. This includes confidential complaints about
NZX as an issuer that are sent
to the attention of the Special Division. No separate contact details for the
Special Division are
made publicly available. The Special Division sees benefit
in separate contact details being published. We recommend this be done.
The
Board of NZX agrees that communication about the existence and role of the
Special Division needs to improve. Market feedback
received by NZX suggests that
the role of the Special Division is not well understood. NZX intends to develop
a communication strategy
in this area. We support the development and timely
implementation of a communications strategy concerning the Special Division,
including capacity for complaints to be addressed directly to the Special
Division rather than through NZX staff.
Appointed
solicitor
- An
NZX Solicitor is appointed to act as the liaison between NZX as a Listed Issuer
and the Special Division. Most matters are referred
to the Special Division by
NZX via the appointed solicitor. The Special Division advised that the appointed
solicitor is not to make
recommendations to the Special Division. On occasion in
2005 the appointed solicitor did make recommendations. NZX advised that it
had
not been told that the appointed solicitor was not to make recommendations and
no concerns were expressed by the Special Division
about the solicitor's
performance during the year. The appointed solicitor provides the Special
Division with relevant information
and documents and is the main "pivot point"
between NZX and the Special Division. This process appeared to function
efficiently during
the review period, although it seems there were differing
views about the role of the appointed solicitor.
- Special
Division members may at times initiate matters based on market knowledge. The
Special Division itself does not monitor the
trading activity of NZX. The
Special Division relies on the appointed solicitor to report unusual trading
information generated by
the SMARTS surveillance system.
- In
the 2005 review period the appointed solicitor, as nominated by the Head of
Regulation, did not perform any commercial work for
NZX. The Special Division
considers it of key importance that the appointed solicitor be independent of
the commercial activities
of NZX. The Chairman of the Special Division advised
that he had sought and received an assurance from the Head of Regulation that
the currently appointed solicitor would not perform any NZX commercial work that
would require the Special Division's involvement.
In submissions, NZX and the
Special Division were of the view that it would be suitable if the solicitor was
not involved in commercial
work that had Listing Rule content but could carry
out other commercial work.
- In
the Commission's view, any corporate advisory work undertaken by an employee of
NZX in relation to NZX's own business as a Listed
Issuer has the potential to
raise a conflict of interest for the employee concerned where that person also
provides advisory services
to the Special Division. The appointed solicitor
should be free to carry out other work for NZXR, but we consider that this
person
should not undertake corporate advisory work for NZX. In the Commission's
view, either an assurance to this effect should be settled
between NZX and the
Special Division, or NZX should revisit the use of an NZX Solicitor for the
appointed solicitor role.
- Even
with an assurance that the appointed solicitor will not carry out corporate work
for NZX, we think that the conflict for the
appointed solicitor as an employee
of NZX is potentially acute. In dealing with more contentious issues such as
complaints handling,
or matters where there is disagreement between the Special
Division and NZX, or any potential Listing Rule breaches or disciplinary
matters, we think that there is a serious risk that an appointed solicitor would
be placed in an unreasonable position of conflict
as the "pivot point" between
the Special Division and his or her employer, NZX.
- We
consider that the appointed solicitor should have no role in such matters
(beyond any initial transmittal of a matter to the Special
Division). The
Special Division should engage external advisers to assist it in dealing with
these matters, including accessing NZX's
facilities and regulatory precedents
and consulting as needed with NZXR. We consider that in respect of any waiver
and ruling applications
that raise contentious matters, the Special Division
should also use external advisers rather than the appointed solicitor.
- We
acknowledge that the appointed solicitor is likely to continue to have a role in
relation to SMARTS surveillance and the referral
of alerts as the Special
Division does not have access to this system. We think that the Special Division
should formalise its expectation
about the referral of data generated by the
SMARTS market surveillance system concerning NZX's listed securities. Where
alerts from
SMARTS are below the threshold set by the Special Division for
referral to it, the appointed solicitor should regularly advise the
Special
Division of the number of alerts received in the period and a summary of any
alerts that were not referred.
- The
Special Division has delegated administration of compliance checks of
advertisements and amendments to trust deeds to the appointed
solicitor. Under
the NZX Discipline Rules the Special Division is not permitted to delegate
certain key functions, such as the cancellation
or suspension of the quotation
of NZX securities, and the power to make rulings and give waivers. The Special
Division advised that
it had retained all substantive listing rule compliance.
File reviews evidenced this. The Special Division expects to be advised
by the
appointed solicitor if there are particular issues with matters dealt with under
delegation. The Special Division does not
otherwise expect to receive reports
from the appointed solicitor on matters dealt with under delegation. There needs
to be a complete
record of the Special Division's business and appropriate
periodic review of the delegation. We recommend that all matters dealt
with by
the appointed solicitor under delegation be recorded and reported on to the
Special Division regularly.
Process
- The
NZX Corporate Counsel, or an NZX Solicitor acting in a commercial capacity,
prepares applications for referral to the Special
Division. As noted above, the
Chairman of the Special Division determines whether the particular matter can be
dealt with by the
Chairman of the Special Division or should be referred to a
division of Special Division members. If a division of members is required
the
Chairman determines the composition of the division. There is no written
conflicts disclosure policy for Special Division members,
however the Special
Division has received external advice in relation to independence and avoidance
of conflicts of interest. Conflicted
members are expected to disclose the
conflict and remove themselves from consideration of the matter.
- The
appointed solicitor provides NZX's applications and supporting material to the
Special Division, accompanied by the appointed
solicitor's comments and views on
the application. The appointed solicitor also refers the Special Division to
precedents. The Special
Division's practice is that NZX is bound by the
precedents and policy that NZXR sets for other issuers.
- File
reviews evidenced that Special Division members were actively engaged in matters
referred to them. The Special Division made
it clear that it required receipt
from the appointed solicitor of all relevant documentation associated with
applications. Comments
were exchanged between Special Division members.
Responses and decisions were conveyed to NZX through the appointed solicitor.
- The
Chairman of the Special Division has a copy of a procedures handbook used by
NZXR, however the Special Division does not make
use of procedural material such
as handbooks and checklists that NZX uses in respect of other issuers. The
Chairman of the Special
Division advised that the Special Division relies on the
appointed solicitor to use the correct procedures. If NZXR operates in a
certain
way then the Special Division considers its procedures should be the same. We
expect the Special Division to formally communicate
its expectations to the
appointed solicitor. The Special Division should have and use the same
procedures manuals in respect of NZX's
compliance as a Listed Issuer that are
used by NZXR in respect of other Listed Issuers. The Special Division should not
rely on the
appointed solicitor to use the NZXR procedures. We also suggest that
the Special Division consider the internal procedures that it
would use
(including procedures for communicating with the market) if it were in the
situation where it needed to pursue a serious
compliance matter regarding
NZX.
Reporting
- The
Special Division reported on its work to the Annual Meeting of NZX Discipline in
2005. We think that the Special Division should
report to NZX Discipline all
material findings that it makes. We think that NZX Discipline should incorporate
that information into
its Annual Regulatory Report. There is no particular
reporting process for the Special Division to comment to NZX on the Special
Division's view of NZX's compliance as a Listed Issuer. However, the Special
Division may note concerns or issues in its communications
with
NZX.
Recommendations
- The
Special Division operated adequately during the review period, however the
Special Division has not yet been tested in a significant
matter. In light of
the substantive and procedural issues identified, including NZX's refusal to
provide requested information, we
have reservations as to how the Special
Division would deal with a contentious situation with NZX. We make the following
recommendations:
- The
Special Division, as a body, should determine whether the Special Division has
jurisdiction to deal with matters referred to it.
Any delegations from the
Special Division to its Chairman should be formally recorded.
- Given
the important role of the Special Division in respect of NZX's compliance as a
Listed Issuer, the Special Division should take
steps to ensure that it is fully
aware of the powers available to NZXR under the Listing Rules in respect of
other Listed Issuers,
and should exercise those powers as appropriate in
relation to NZX as a Listed Issuer.
- Given
NZX's position as both a Listed Issuer and regulator of all other Listed Issuers
listed on its markets, NZX should set an example
by full compliance with all
lawful directions or requests from the Special Division.
NZX
considers that it is entitled, as is any other issuer, to decline to provide
information sought where NZX does not consider it
relevant or appropriate to
provide such information. NZX considers that NZX should only comply with those
requests or directions
necessary for the Special Division to undertake its
enforcement role (as opposed to the role of considering a waiver or ruling
application)
and within its powers and jurisdiction. NZX is of the view that it
cannot compel production of information by issuers in relation
to waiver
applications.
The Commission considers that in practice NZX does have
the power to compel production of information by otherwise refusing to grant
waivers if relevant requested information is not provided. We remain of the view
that NZX should set an example of full compliance
with all lawful directions or
requests of the Special Division.
NZX will consider the matter again and
has undertaken to report back to the Commission by the end of this calendar
year.
- The
Special Division should discuss its resource requirements with the Board of NZX.
The NZX Board should have a formal guarantee
of funding for the Special Division
should the Special Division need to take NZX to NZX Discipline.
NZX has advised that it will request a meeting between NZX
and the Special Division to discuss resource requirements and the guarantee
of
funding.
NZX has committed to do this by the end of this calendar
year.
- NZX
and the Special Division should develop and implement a communication strategy
about the role of the Special Division. Communication
should include publication
of separate contact details for the Special Division.
NZX has
agreed to implement a communication strategy about the role of the Special
Division. NZX considers that the Special Division
should have considerable
involvement with this. The Commission agrees.
NZX has committed to do
this by the end of this calendar year.
- The
Special Division should formalise its delegation to the appointed solicitor and
should receive regular reports on work dealt with
by the appointed solicitor
under delegation.
- The
Special Division should have and use the same procedures manuals in respect of
NZX's compliance as a Listed Issuer that are used
by NZXR in respect of all
other Listed Issuers. The Special Division should satisfy itself that the
appointed solicitor uses the
NZXR procedures, including where matters are
delegated to that solicitor.
- The
Special Division should settle internal procedures that it would use, including
procedures for communicating with the market in
dealing with a serious
compliance matter regarding NZX.
- The
Special Division should formalise its expectation about the referral of data
generated by the SMARTS market surveillance system
concerning NZX's listed
securities. Where alerts from SMARTS are below the threshold set by the Special
Division for referral to
it, the appointed solicitor should regularly advise the
Special Division of the number of such alerts received in the period and
a
summary of any alerts that were not referred.
- To
avoid a situation of conflict for the appointed solicitor, the appointed
solicitor should have no role in matters that raise contentious
issues,
including complaints handling (beyond an initial transmittal of a matter to the
Special Division). The Special Division should
engage external advisers to
assist it in dealing with such matters and be funded to do so. The external
advisers should have access
to NZX's facilities and regulatory precedents and be
able to consult with NZXR.
The Special Division agrees that
it would be appropriate for it to handle such matters without the involvement of
the appointed solicitor
or for the Special Division to engage external counsel
if necessary. In respect of waiver and ruling applications the Special Division
is of the view that the appointed solicitor should, at the Special Division's
request, be able to provide analysis and comment to
the Special Division on
precedent applications under the Listing Rules.
The Commission considers
that in respect of waiver and ruling applications involving contentious matters
the Special Division should
use its external advisers, and that these advisers
should be given access to precedents and other relevant information.
- NZX
should either formally assure the Special Division that the appointed solicitor
will not perform any corporate advisory work for
NZX or should revisit the use
of an NZX Solicitor for the appointed solicitor role.
NZX and
the Special Division consider that it would be suitable if the appointed
solicitor was not involved in any commercial work
that had Listing Rule content
but could carry out other commercial work.
The Commission does not
agree. The appointed solicitor should be free to carry out other work for NZXR,
but we consider that this
person should not undertake corporate advisory work
for NZX.
NZX will consider this matter again and has undertaken to
report back to the Commission by the end of this calendar
year.
- The
Special Division should report to NZX Discipline all material findings that it
makes. NZX Discipline should incorporate that information
into its published
Annual Regulatory Report.
NZX notes that the Special
Division's decisions are published in the same way as NZXR decisions and that
this recommendation is unnecessary.
The Commission notes NZX's response
but considers that benefit will be derived by both NZX Discipline and the market
if the Special
Division's activities are included in NZX Discipline's Annual
Regulatory Report.
OVERSIGHT REVIEW OF
NZX 2005
GOVERNANCE
Monitoring and oversight of regulatory functions
- NZX
Board oversight of the NZX regulatory function has improved since the collapse
of Access Brokerage in 2004.
- A
template for periodic separate regulatory reporting at each NZX Board meeting
was developed as of November 2005, with significant
involvement by the NZX Board
in directing the development of this reporting template. Prior to this, the NZX
Board received a report
on regulatory matters via the CEO Report.
- Each
NZX Board meeting allows time for direct reporting to the Board by the Head of
Regulation. NZX Board members and the Head of
Regulation confirm that the
working relationship is particularly productive, including open interaction
between the Head of Regulation
and individual Board members outside of scheduled
Board meetings.
- NZX
Board members believe that with a reasonably small Board (six members including
the CEO) the full Board, rather than a committee,
should deal with regulatory
matters. The Commission agrees that this strategic approach works well for the
current NZX Board structure,
and that NZX Board members are well-informed and
involved regarding regulatory matters.
- The
NZX Board has set a "risk" threshold (i.e., risk to market integrity of a
material nature) for escalation and reporting on regulatory
issues to the Board.
Functionally this is an appropriate standard and NZX Board members are sensitive
to maintaining rigorous standards
in this regard.
- All
NZX Board members are of the view that there are no financial resource
constraints on the regulatory function (a view shared by
the Head of
Regulation), and that from a resource perspective their principal concern would
be ensuring that appropriate professionals
are available and responsible for
regulatory activities. The Head of Regulation was satisfied that all requests
for resources had
been met in the review
period.
Board composition
- NZX
Board members do consider it beneficial to have a blend of skills and
competencies represented on the Board. This desired blend
includes awareness of
the need for experience regarding regulatory responsibilities.
- The
Commission believes that, with a small Board requiring members with securities
industry experience, the NZX Board should continue
to pay particular attention
to achieving a Board with a balance of
perspectives.
Identical delegations for
regulatory responsibilities to the Head of Regulation and the CEO
- The
NZX Board believes, consistent with the current placement of the Market
Supervision function within the NZX organisation, that
it is appropriate for
both the Head of Regulation and the CEO to have identical delegations for
regulatory responsibilities. The
Commission notes that these identical
delegations organisationally and functionally reflect the NZX Board's belief
that there is
no inherent conflict between the commercial and regulatory
functions of an exchange.
- In
practice it was clear that the Head of Regulation exercises supervisory
authority over regulatory matters. However, we believe
that the existence of the
identical delegations to the CEO and Head of Regulation potentially blurs who is
responsible for exercising
the delegations and the circumstances in which the
delegation is intended to apply, particularly in crisis situations. We recommend
that the Board of NZX reconsider the issue to ensure that the responsibilities
are clarified.
Regulatory crisis response and
risk management
- NZX
Board members, except as noted herein, do reflect a focussed awareness of how
NZX at all levels would respond to a regulatory
crisis. The Commission notes
that having two people with the same delegated authority for regulatory
responsibilities creates potential
for confusion. This may pose a risk to
responding most efficiently to a regulatory crisis.
Market Operations policy setting
- The
NZX Board believes that overall operational performance improved during the
review period. The Commission agrees and believes
that the NZX Board
appropriately communicates to executive management its rigorous performance
expectations regarding market infrastructure
and holds executive management
responsible for meeting these expectations.
Board
interaction with the Special Division
- The
NZX Board believes that NZX should not be treated any differently by the Special
Division from any other issuer before NZXR. As
to what would happen if NZX had
to be taken to NZX Discipline by the Special Division, although there is
currently no explicit understanding,
the NZX Board would have no difficulty in
giving an undertaking as to resources if this was sought by the Special Division
and had
no difficulty with a guarantee of resources. The NZX Board should give a
formal guarantee of funding for the Special Division should
the Special Division
need to take NZX to NZX Discipline.
Placement of
the Market Supervision function within the NZX organisational structure
- NZX
is the frontline regulator of the securities markets but can organise itself in
the way it believes best enables it to fulfil
its statutory obligations as a
market regulator.
- Currently
the Head of Regulation reports to the Chief Executive Officer.
- NZX
Board members are of the view that this present organisational structure meets
the needs of the New Zealand securities markets.
NZX Board members informed us
that the matter is given periodic consideration in light of differing structures
in other jurisdictions.
- The
Commission notes that it is an increasing concern in overseas jurisdictions that
an exchange's regulatory function is perceived
to be as independent as possible
from an exchange's commercial activities. In addition, the increasing evolution
to autonomous structures
for regulatory functions enables such functions to
handle more efficiently the conflicts between the commercial and supervisory
interests
of an exchange. The Commission acknowledges that at present, in
practice, NZX maintains an effective separation between its commercial
and
regulatory functions.
- Nevertheless,
the Commission is concerned that the unwillingness of the CEO and other NZX
Board members to acknowledge that there
is an inherent conflict within any
exchange between commercial and regulatory functions may preclude the NZX Board
from giving sufficient
and necessary consideration to potential organisational
developments within NZX regarding the Market Supervision
function.
Recommendation
- The
NZX Board takes an active and appropriate governance role in regard to NZX's
performance of its regulatory responsibilities. We
make the following
recommendation:
Given the risk of lack of clarity regarding roles in
responding to a crisis, the Commission recommends that responsibilities of the
CEO and Head of Regulation for exercising delegated powers be reconsidered by
the Board of NZX to ensure that the responsibilities
are clarified.
NZX is of the view that these responsibilities are sufficiently clear at
present, but has agreed to consider whether any further clarification
is
desirable, and to report back to the Commission by the end of this calendar
year.
OVERSIGHT REVIEW OF NZX 2005
CONCLUSION
- Our
overall conclusion is that NZX is satisfying its obligation to operate its
markets in accordance with its conduct rules.
- The
conduct of an oversight review of NZX by the Commission will be an annual
process. This first oversight review has focussed on
NZX's performance of its
obligations during the 2005 calendar year from an overall perspective. It is
expected that future oversight
reviews may address particular areas in greater
depth. The concerns and recommendations that we have recorded as a result of
this
review, NZX's actions and response to these recommendations, and relevant
intervening matters, will be reviewed next
year.
APPENDIX
Scope of review
- 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.
- 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 NZX Discipline
Rules establish a dedicated body, NZX Discipline, 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 NZX
Discipline,
exercises the powers and functions of NZX in relation to NZX as a Listed Issuer
and its related entities.
- 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.
- The
Commission's Terms of Reference for the review were:
The Securities
Commission ("the Commission") is conducting an oversight review of New Zealand
Exchange 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 aspects
of NZX's activities:
- supervision
of market participants and enforcement of the Participant Rules;
- supervision
of listed issuers and enforcement of the Listing
Rules;
- allocation
of human, technological and financial resources as it affects performance of the
regulatory functions of NZX;
- internal
practices and procedures associated with investigations, price enquiries,
complaints-handling and referrals;
- discipline
practices, procedures and resources;
- arrangements
for market infrastructure development and maintenance;
- Special
Division practices, procedures and resources; and
- 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
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.
March 2006
Background to review
- 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.
- 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 published by the International
Organization of Securities Commissions. The IOSCO Principles include principles
for self-regulatory
organisations.
- 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.
- 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.
- 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, and the
methodology used for assessing compliance with these standards, in particular
the principles applying to self-regulatory
organisations.
- We
have 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:
- meet
and maintain adequate standards of integrity and fitness to operate a
market;
- develop
rules for the conduct of listed issuers and market
participants;
- develop
and operate fair procedures for the enforcement of its
rules;
- conduct
a fair, orderly, informed, and efficient market;
- maintain
effective trading, clearing, and settlement systems;
- have
adequate capacity to carry out its regulatory functions and enforce its rules;
and
- have
procedures in place to manage conflicts of interest.
- 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.
- The
oversight review conducted this year is the first oversight review of NZX
conducted by the Commission. The review focussed on
the 2005 calendar
year.
Process
- 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.
- The
Commission sent questionnaires to NZX, NZX Discipline, the Special Division and
the Appeal Panel seeking information the Commission
considered necessary to
effectively evaluate NZX's performance of its regulatory functions. The
questionnaires covered the eight
areas identified in the Terms of
Reference.
- We
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.
- A
significant amount of information was provided by NZX in response to the
questionnaires. NZX also provided a number of procedures
manuals and process
documents to us. Questions relating to NZX Discipline, the Special Division and
the Appeal Panel were answered
by the Chairs of those bodies.
- The
information provided in response to the questionnaires enabled us to gain a
fuller understanding of the business of NZX, and the
procedures and processes
that NZX uses to discharge its regulatory functions.
- Commission
staff selected and reviewed a sample of NZX's files across a range of regulatory
activities.
- Commission
staff conducted interviews with NZX personnel and Board members. Commission
staff also interviewed the Chairman of NZX
Discipline and the Chairman of the
Special Division. A total of 29 interviews were conducted.
- Confidentiality
and privacy orders were in place throughout the review. NZX personnel and Board
members were represented by counsel
during the interviews and the interviews
were recorded.
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