Bell Gully Submission on the Financial Market Infrastructures Bill Exposure Draft

BELL GULLY

Reserve Bank of New Zealand 2 The Terrace Wellington

By e-mail: fmibill@rbnz.govt.nz

FROM: David Craig DDI: +64 4 915 6839 MOBILE: +64 21 674 851 EMAIL: david.craig@bellgully.com MATTER NO. 403-1129 DATE: 20 September 2019

Submission on exposure draft of the Financial Market Infrastructures Bill

This letter contains Bell Gully's submission on the exposure draft of the Financial Market Infrastructures Bill (the Bill) published by the Reserve Bank on 1 August.

Bell Gully has a significant practice in the area the Bill seeks to regulate. We act for six of the nine FMIs that have been identified by the Reserve Bank as being potentially systemically important. However, the submissions in this letter represent the views of Bell Gully only. Other than in relation to our submission on sections 113 and 116 of the Bill, which we have discussed with the International Swaps and Derivatives Association, Inc., we have not discussed these submissions with any of our clients.

We appreciate that policy decisions have already been made on the overall structure of the new regulatory regime. Therefore, as you requested, our submissions focus on more technical matters. Our submissions are set out in the table attached to this letter.

We would be happy to discuss our submissions with you if that would be helpful.

Yours sincerely

[Signature]

David Craig Partner

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Section number	Heading	Comment	Drafting suggestion (if any)
5	Interpretation ("Insolvency event")	Given that companies and corporations cannot be admitted to the no-asset procedure, the reference in paragraph (d) to "or in the jurisdiction under whose law P is incorporated or otherwise established" is inappropriate.	Replace those words with "or elsewhere".
5	Interpretation ("Insolvency manager")	It seems the intention is that an "insolvency event" can only occur in relation to an operator or a participant. Therefore, there can only be an "insolvency manager" in relation to an operator or a participant. Paragraphs (e) and (f) of the definition expressly contemplate this. But paragraphs (a) – (d) are more generic, as is the definition of "insolvency event".	For the sake of consistency, replace the references to "operator or participant" in paragraphs (e) and (f) with "a person". ("Paragraph (f) may require other wording, given it already refers to a (different) "person".)
5	Interpretation ("participant")	Given this is a key term in the Bill, and although it is not strictly necessary given the current drafting, it would be good to expressly state that "indirect participants" are not "participants".	Insert a new paragraph (c) to read "excludes an indirect participant".
5	Interpretation ("participant default")	An important part of many FMI's rules deals with what happens following an indirect participant (or 'client') default. That part of the rules should have the protection in section 54(2)(e).	There should be a separate (but similar) definition of "indirect participant default", and the words "or indirect participant default" should be added at the end of section 54(e). While it is a considerably lesser issue, those same words could be added at the end of section 13(2)(c).
28	Content and publication of designation notice	Section 28(2)(e) contemplates the possibility that a designated FMI may not have the benefit of the statutory protections in subpart 5 of Part 3. It is inconceivable that an FMI would opt in and not seek to have this benefit. And it should not be possible for the regulator to call in an FMI (and subject it to this regime) and not confer on it this benefit. That is, this benefit should be an automatic consequence of designation.	Section 28(2)(e) should be deleted (and with it section 53).

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Section number	Heading	Comment	Drafting suggestion (if any)
54	Designated FMI's rules relating to settlements, etc, are valid and enforceable	The Bill has five separate phrases indicating the supremacy of its rules: <br> 1. "despite any enactment or rule of law to the contrary" (sections 54(1), 55(2) and 56(2)); <br> 2. "despite anything to the contrary in any enactment, rule of law, constitution, deed, or agreement" (section 59(4)); <br> 3. "in contravention of an enactment, an instrument, a confidence, a trust, or any other rule of law or equity" (section 79(1)); <br> 4. "despite any enactment, rule of law, or the terms of the constitution of the operator" (section 83(2)); and <br> 5. "despite anything to the contrary in/in contravention of] any enactment, instrument, or other rule of law or equity" (sections 100(2) and (3) and 113(1)). <br> We don't see the need for all of these. Our view is that the broadest formulation in section 59(4) should apply in all cases.	The broadest formulation should be inserted into each of those other sections (perhaps with the addition of "or equity" after "rule of law").
55(3)	Settlements must not be reversed, etc	In your cover note (¶ 33), you ask whether the 24 hour period in section 55(3) should be extended in certain circumstances, and whether this is just an issue for central counterparties clearing derivatives. We expect that industry participants will be able to speak to these questions more authoritatively than we can. But our experience has been that the 24 hour cut-off rule is a concern for not just central counterparties (e.g., it is a concern for payment systems also). This is particularly so where the operator is located in a time zone that, in effect, significantly shortens the cut-off time. <br> But there is no doubt this issue is the most acute for central counterparties, who may face weeks after the occurrence of an insolvency event before all resulting "settlements" (e.g., close out,	See adjacent column.

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Section number	Heading	Comment	Drafting suggestion (if any)
		auction, loss allocation, realisation and application of security, porting) have occurred. <br> If the 24 hour period is to be extended, and we submit it should be, there are two approaches the Bill could take. <br> 1. The first approach is to have different rules for different types of FMI: a long (say, 30 days) or indefinite¹ protection period that applies to central counterparties, and a shorter (say, 48 hours) protection period that applies to all other FMIs. <br> 2. The second approach is to have the same rule apply to all FMI types. That same rule should apply the long or indefinite protection period we mention above. <br> We prefer the simplicity of the single rule approach in 2 above. However, if there are compelling policy reasons why this protection period needs to be tightly constrained, the first approach may be an appropriate compromise.
78	Directions to operator	A direction notice should not require an operator of an overseas FMI to act, or not act, if that would result in it breaching an overseas standard, or a law in its home jurisdiction. This should be the case even though the pre-condition in section 77(1)(b) applies. An operator cannot be placed in the situation where a direction given to it under the Bill would breach its home jurisdiction laws/overseas standards. While such a breach may well also result in a breach under the FMI's rules (and so be covered by section 78(4)), that will not necessarily be the case.	A new section 78[4A] should be added to read as follows: "A direction notice may not require the operator of an overseas FMI to act, or not act, if that would result in the operator breaching an overseas standard, or a law in its home jurisdiction."

¹ Part 5 of the Payment Systems and Netting Act 1998 (Cth) is an example of equivalent law that offers indefinite protection.

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Section number	Heading	Comment	Drafting suggestion (if any)
79(1)	Giving and complying with direction does not place person in contravention etc	This provision has equivalents that apply in the context of: <br> 1. the effect of a new operating scheme (section 100(3)); and <br> 2. the making of a statutory management order (section 113(1)). <br> However, those two other provisions state that they do not apply where the FMI's rules specify otherwise. The same should apply in section 79.	The opening words of section 79(1) should read "Unless the rules of the FMI specify otherwise, the giving ..."
88	Statutory management of operator whose home jurisdiction is not New Zealand	In addition to stating (as sub-section (1) does) that the FMI's rules "continue to apply" in a statutory management, there should be an express acknowledgement that the protection in section 54 also continues.	The words "in New Zealand" should be added after "business undertakings".
95(1)	Application of FMI's rules	In recognition of the limitation in section 88, the power of a statutory manager to disapply the rules of an FMI should only extend to the New Zealand business of the operator.	The words "section 54 continues to apply in respect of those rules." should be added after "apply," in section 95(1).
95(3)	Application of FMI's rules	In recognition of the limitation in section 88, the power of a statutory manager to disapply the rules of an FMI should only extend to the New Zealand business of the operator.	A new section 95(6) should be added to read as follows: "Subsection (3) only applies in the statutory management of an operator of an overseas FMI to the extent that the FMI's rules relate to the operator's property, rights, assets, and liabilities of its New Zealand business or, if the operator has business undertakings in New Zealand unrelated to the FMI, that part of its New Zealand business that relates to the FMI." (Alternatively, given that this concept of 'the New Zealand business' of an overseas operator

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Section number	Heading	Comment	Drafting suggestion (if any)
			is already used in section 88, perhaps the term could be defined and then used in sections 88 and 95.)
113(2)	Statutory management does not place any person in contravention of enactment, etc	The appointment of a statutory manager to a counterparty is a standard, and important, event of default in derivatives documentation such as the ISDA Master Agreement. Section 42(7)(b)(i) of the Corporations (Investigation and Management) Act 1989 (the CIMA) currently preserves the effectiveness of such a statutory management termination trigger. <br> Section 113(2) of the Bill, in effect, upholds the enforceability of such a provision in the statutory management of an FMI operator, but only where the operator is a central counterparty. While central counterparty FMIs are, no doubt, the most significant type of FMI that will enter into derivatives, other FMIs could also do so. Their counterparties should not be prevented from closing out their trades if the FMI/operator is made subject to statutory management.	The reference to "section 116" in section 113(2) should be amended to refer to "section 116(1)(a) and (b)".
116	Certain rights relating to derivatives exercised after stay	It is essential to the derivatives industry that the effect of this new subpart 4 be clearly understood. In particular: <br> 1. As currently drafted, subsection (2) states that section 42 of the CIMA (as applied by section 102 of the Bill) does not limit or prevent the exercise of "the right" (i.e., the right specified in subsection (1)) if the right is exercised after the specified time. The use of the words "limit or prevent" means that anything not already prohibited by section 42 of CIMA is unaffected by the Bill. <br> However, we had understood the intention of the Bill to be something different. Specifically, we had understood the intention to be that the exercise of certain derivatives-related rights (in particular, to close-out net and to enforce security) would be	See adjacent column.

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Section number	Heading	Comment	Drafting suggestion (if any)
		stayed, for a period, regardless whether that is currently permitted under the CIMA. In this regard, we note that: <br> (i) the exercise of termination rights is generally considered not to be prohibited by section 42(1) of CIMA; and <br> (ii) the exercise of netting and secured creditor rights is generally considered to be prohibited by section 42(1) of CIMA. But section 42(7) and (8) allow for the exercise of these rights in certain circumstances. <br> If we have misunderstood what this part of the Bill is intended to achieve, we would welcome the chance to talk this through with the Reserve Bank. Conversely, if our understanding is correct, clause 116 should be amended to broaden the current stay in section 42 of the CIMA as it applies to a designated FMI that is a central counterparty. However, if such an amendment is made, it should also state it does not affect the application of section 42 to a designated FMI that is not a central counterparty. <br> 2. The inter-relation between the Bill and the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Act 2019 (the Derivatives Margin Act) should be clear.² We appreciate that the Bill pre-dates the enactment of the Derivatives Margin Act, and so this inter-relation could not have been previously provided for in the Bill. But the Bill will now need to describe how it affects the new section 42(9) of the CIMA (as inserted by section 16 of the Derivatives Margin Act).

² The potential for crossover between the Bill and the Derivatives Margin Act arises because "specified operators" under the Bill are "qualifying counterparties" for the purposes of the Derivatives Margin Act.

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Section number	Heading	Comment	Drafting suggestion (if any)
N/A	Transitional arrangements	Presumably, the effect would be that section 42(9) applies in the statutory management of an operator of a designated FMI in the unlikely event that this statutory management occurs under the CIMA.³ However, in the more likely event that this statutory management occurs under the Bill, the position would be as we suggest in 1 above. <br> In your cover note (¶ 48 - 53), you ask whether settlement systems currently designated should be automatically deemed to be designated under the Bill, or whether they should be re-designated (either because they opt in or because they are called in). We agree with the Reserve Bank's view that, given the new issues introduced by the Bill, these FMIs should be re-designated. However, given their status under the existing regime, the re-designation should be a considerably more streamlined process than for an FMI not currently designated. <br> You also asked whether the proposed transitional arrangements provide sufficient certainty that the relevant statutory protections will be continuous. Our view is those arrangements do provide that certainty. However, the question that follows is whether a currently designated FMI will have sufficient notice that this continuity is assured. In other words, it will be important for the FMI to know well in advance of the transition date whether it will be re-designated. FMIs may comment on what is an acceptable period of notice. But we would not expect it to be less than 30 days.

³ We note that the FMA would need to consult with the Reserve Bank before initiating statutory management for a designated FMI under the CIMA: Schedule 2, Part 1 of the Bill.