Submission on the Financial Market Infrastructures Bill Exposure Draft

29 November 2019

To Cavan O'Connor-Close Manager, Prudential Operational Policy Financial System Policy and Analysis Department Reserve Bank of New Zealand PO Box 2498 Wellington 6140 New Zealand

By email: fmibill@rbnz.govt.nz

From Paul Atmore

paul.atmore@nzfma.org

Dear Cavan

Financial Market Infrastructures Bill: Exposure Draft

1. Introduction

1.1 This is a late submission by the New Zealand Financial Markets Association (the "NZFMA") on the Financial Market Infrastructures Bill (the "Bill"). However, given the potential impact of the Bill on its members (explained below) and the importance of getting consensus on the detail of the Bill from the financial markets industry and its advisers, the NZFMA would like to work with the Reserve Bank of New Zealand ("RBNZ") to ensure the technical detail of the Bill doesn't create any unintended consequences.

1.2 NZFMA apologises for the lateness of this submission which relate primarily to resourcing constraints with it and its members and because it knew it would have a further opportunity to comment when the Bill was referred to a Select Committee. Given the issues with the Bill appear mainly technical, the NZFMA would prefer to be in a position to support the RBNZ at Select Committee on the elements of the Bill affecting it, by working through them beforehand.

1.3 The NZFMA is the professional body for wholesale institutional banking in New Zealand. The NZFMA promotes the efficient operation of the over the counter markets, advocating high professional standards for financial markets organisations and their staff, and represents the interests of members in advocating sensible and proportionate regulation for the wholesale financial markets.

1.4 The NZFMA membership is institutionally based, with members providing a wide range of financial services such as corporate banking, trading in financial instruments and trade finance. Its members all tend to actively trade derivatives – both over the counter and in cleared markets.

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2. Potential Impact of the Bill

2.1 While it does not seem as though NZFMA's members would be directly regulated by the Bill, its members are active in the derivatives market and increasingly clear their derivative trades through clearing houses that typically operate as central counterparties. While the NZFMA notes that the RBNZ does not identify which financial markets infrastructures ("FMI") will be covered by the Bill, the Bill is clearly intended to cover central counterparties and trade repositories. The NZFMA presumes, based on a comment in the paper titled Financial Market Infrastructures Bill: Exposure Draft (the "Summary Paper"), that the RBNZ is likely to consider designating London Clearing House ("LCH") and ASX Clear (Futures) ("ASX")¹ in relation to the central counterparty activities they perform for the New Zealand market. Many of the NZFMA's members use the ASX and LCH as their clearing houses and so are likely to be at least, indirectly, affected by the Bill.

2.2 It is not clear at this stage whether the RBNZ will look to designate a trade repository. However, if it does so it is likely that NZFMA members could also be affected. The NZFMA would be interested in the RBNZ's intentions in relation to trade repository designation (especially as NZFMA members at this stage are only indirectly caught by trade reporting requirements because of their application to entities with off-shore parents).

2.3 The NZFMA believes its members could be impacted by the Bill in two main ways:

(a) in relation to the powers which regulators (RBNZ and Financial Markets Authority ("FMA")) have under the Bill in respect of direct and indirect participants (including through the operator of the FMI); and

(b) the impact the statutory management of a designated clearing system could have on them as participants and, in particular, the potential impact on close out netting and collateral posted to secure obligations under derivatives with central counterparties as a result of Part 4 of the Bill.

3. Timing of the Bill

3.1 The NZFMA has some concerns about the introduction of a new statutory management regime for FMIs which the RBNZ has acknowledged in its Summary Paper² is only an interim approach and may be amended after Phase 2 of the review of the Reserve Bank of New Zealand Act 1989 (the "RBNZ Act") (the "Phase 2 Review") is concluded.

3.2 Given the importance of exceptions in the statutory management regime for collateral and netting arrangements and the need to update New Zealand legal opinions when this changes, the NZFMA has a preference for the RBNZ to defer the passing of the Bill until the Phase 2 Review has concluded.³ That way there will only need to be one update of the New Zealand law opinion and more importantly the statutory management provisions will

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¹ Financial Market Infrastructures Bill: Exposure Draft August 2019, page 10. ² Financial Market Infrastructures Bill: Exposure Draft August 2019, page 14. ³ Although on initial analysis of the Bill the NZFMA does not believe the work to update the opinions should be extensive.

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have the benefit of the thorough review of the other statutory management regimes which we understand is being undertaken as part of the Phase 2 Review.

3.3 Notwithstanding the NZFMA's preference for the Bill to be deferred and aligned with the conclusions of the Phase 2 Review as it relates to statutory management, the NZFMA does acknowledge the significant work that has been undertaken in designing the statutory management regime for FMIs, to ensure consistency with existing regimes. In particular, the NZFMA acknowledges the challenge in aligning the statutory management provisions of the Bill with the work which was happening virtually contemporaneously in finalising the detail of the Financial Markets (Derivatives Margin and Benchmarking Reform) Amendment Act 2019 which did contain a number of relevant provisions which were being reviewed even after the Select Committee process.

3.4 It is clear to the NZFMA that significant work has been undertaken by the RBNZ, in particular, in designing the provisions of the FMI legislation relating to central counterparties. While the NZFMA has some mainly high level comments on the Bill, its strong preference would be to organise a workshop between it, its advisors, its members and the officials responsible for drafting the Bill (and potentially also affected central counterparties) to better understand the detailed and significant work that has gone into the Bill and to test the thinking through those workshops. The NZFMA believes it and its members have a similar interest to the RBNZ in ensuring any statutory management regime for FMIs is robust without undermining the level of legal certainty the global financial markets require in the derivatives market (including the cleared derivatives market).

3.5 The NZFMA makes the following high level comments on the Bill.

4. Powers

4.1 NZFMA believes that its members will be indirectly impacted by the Bill because they will almost certainly fall within the definition of either:

(a) participant; or

(b) indirect participant.

As such, its members will be obliged to provide the regulator with certain information if required. These powers appear consistent with those which already exist over participants in designated settlement systems – although now extend to indirect participants. NZFMA presumes this is to capture entities operating through clearing brokers.

4.2 While keen to understand the kinds of information that the regulator may seek (particularly from those who are only indirect participants) NZFMA's members are satisfied that there are appropriate checks and balances in relation to the power to require information.

4.3 The NZFMA notes that much of the detail of how FMIs will be regulated appears likely to be undertaken through the setting of standards. Those standards have the potential to significantly impact NZFMA's members as participants (particularly, for example, contingency plans and standards relating to various types of risk which will no doubt be applied to participants). The NZFMA notes that there is an obligation on the regulator to

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consult the persons that the regulator considers will be substantially affected by the issue of the proposed standards. The NZFMA and its members assume that this will include NZFMA members and they will be consulted in relation to standards imposed on clearing systems and, if designated, trade repositories.

4.4 The NZFMA members do however also note that the regulators have the power to give directions to an FMI operator requiring it to make rule changes. This will invariably affect direct and indirect participants bound by those rules. The NZFMA believe that before that power is exercised there should at least be some requirement to consult with the direct and indirect participants who could be affected in the same way the regulators must before imposing standards (or indeed a statutory manager must before taking action affecting direct or indirect participants).

4.5 The NZFMA also notes that there is no obligation on the regulators to consult when an operator of an FMI is to be designated. Given the significant impact designating a clearing house or trade repository could have on participants and indirect participants, the NZFMA believes the regulators should notify them as well as the operator of a proposal to designate an FMI and also give them an opportunity to submit.

5. Statutory Management

5.1 The NZFMA reiterates its earlier comment that it is apparent that significant work has been undertaken in trying to align statutory management provisions in the Corporations (Investigation and Management) Act 1989 ("CIMA"), the RBNZ Act and the Bill. However, NZFMA is concerned that New Zealand will now have three statutory management regimes all with slightly different objectives and subtle differences. It, therefore, welcomes the review of statutory management regimes (which have not been substantively reviewed for 30 years) being undertaken in the Phase 2 Review which it assumes will also consider the extent of differences between regimes if necessary.

5.2 The NZFMA believes because of the importance of the derivatives market on financial stability the statutory management regime in the Bill should more closely follow the statutory regime in the RBNZ Act rather than CIMA. This, by and large, appears to be the case.

5.3 Also given the importance of the financial markets to financial stability, the NZFMA believes that there should be a single regulator responsible for recommending and supervising statutory management under the Bill and that the most appropriate regulator to do that is the RBNZ. This is because the financial infrastructure is much more important to either the soundness and efficiency or financial stability of the economy (noting the likely change of the objectives of the RBNZ to financial stability) than it is to the operation of fair and efficient markets. The NZFMA also believes that there should only be one regime that could apply to FMIs and it should be the one that is in the Bill. FMIs should be expressly excluded from statutory management under CIMA. This is because the objectives in the Bill are more relevant to FMIs than the CIMA objectives. Most importantly there should only be one regulator responsible for recovery and resolution of FMIs that clear and settle derivatives, and that should be the prudential regulator.

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5.4 While it is clear that the statutory management regime has been carefully thought through the NZFMA is interested in:

(a) reasons for expanding the right to enforce security beyond the "default time" not just for statutory management, but also where an operator has been given a direction. In particular, why is this change needed for the cleared derivatives market (when it is not for the over the counter market);

(b) the reason for the exclusion of subpart 20 of part 15A of the Companies Act 1993 (relating to voluntary administration) to netting under a designated system. This seems to have been added to the provisions moved from the RBNZ Act.⁴ Ostensibly this seems sensible but NZFMA would be interested in the policy background;

(c) the background to the provisions in sections 97, 98 and 99 and 100 that give a statutory manager the right to create a new operator scheme. In particular, NZFMA notes the RBNZ Act includes a provision enabling assets of a branch of a bank to be transferred by a statutory manager to a newly incorporated company. Given LCH and ASX are likely only to operate as branches in New Zealand, has consideration been given to including a similar power for FMI statutory management or does the RBNZ consider sections 97 and 200 enable this?

(d) discussing with the RBNZ whether 24 hours is sufficient time for a clearing house to complete settlement with a failed participant and then suspend them (the question asked in your Summary Paper (at page 101). NZFMA's initial view is that this period should be able to be extended using the same criteria set out in clause 116 of the Bill when making that decision – as you have suggested; and

(e) the reason for the inclusion of the power for a statutory manager to decide rules of a designed clearing system should not apply (clause 95(3)). This seem to undermine the certainty that clauses 54 and 55 are intended to provide and could have impacts on the legal certainty required for transactions undertaken through clearing houses.

6. As a policy decision for both statutory management under the RBNZ Act and under the Bill, NZFMA believes consideration should be given to reinstating the indemnity for a statutory manager (which is found in CIMA) to give more certainty to those in the financial markets dealing with a failed FMI (noting section 112(2) also expressly removes liability for obligations incurred by a statutory manager on behalf of an operator). The NZFMA is concerned that without some form of indemnity or guarantee for the operator of an FMI that it may simply not be able to continue operations after it is placed in statutory management (because no counterparty will deal with it because of the credit risk). For bank statutory management NZFMA notes that a Crown guarantee (effectively) is required for a failed bank to continue in the payment system⁵ and for statutory management using the Open Bank Resolution Policy.

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⁴ RBNZ Act, section 156U. ⁵ Under the Payments NZ rules.

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7. Conclusion

While the NZFMA apologises for the lateness of this submission it does believe there is value in a workshop to test the detailed thinking that has clearly gone into the Bill, rather than risk having this happen at the Select Committee stage. It hopes it is not too late to organise that.

Yours sincerely

[Signature]

Paul Atmore Chief Executive Officer