Summary of Submissions on Strengthening Statutory Payment Oversight Powers and Reserve Bank Responses

Summary of Submissions Received on the Consultation on Strengthening Statutory Payment Oversight Powers and the Reserve Bank’s Responses October 2013

SECTION ONE: INTRODUCTION

1. In March 2013, the Reserve Bank of New Zealand (Reserve Bank) released the
   consultation document Strengthening Statutory Payment Oversight Powers1 , which proposed that a formal Recognition Regime for the oversight of systemically important systems in New Zealand be established.
2. The Reserve Bank received sixteen submissions, including four banks, three users,
   three service providers, two payment and settlement systems, two cards schemes, and two industry groups.
3. During May and July 2013 the Reserve Bank conducted a second round of informal
   consultation on a number of key areas that have emerged from the submissions, through both bilateral meetings with stakeholders and two industry forums.
4. Section Two provides a summary of the substantive comments made by submitters
   and interested stakeholders throughout the consultation period, and the Reserve Bank’s responses.
5. Section Three outlines the next steps of the Review.
   SECTION TWO: SUBMISSIONS AND FEEDBACK
6. The consultation paper set out the proposed legislative framework for payment
   systems oversight, which had the following features:

• Systems that are considered to meet a pre-determined set of criteria for systemic
  importance would be formally recognised. This would be based on the CPSS￾IOSCO definition and criteria in Principles for Financial Market Infrastructures2 (PFMIs), and include consideration of size and concentration of financial risks, role of the system and the nature of the transactions processed, degree of substitutability, and interdependencies with other systems or markets;
• Recognised systems would be subject to the joint oversight of the Reserve Bank
  and Financial Markets Authority (FMA), unless they are pure payment systems, in which case the Reserve Bank would be the sole regulator;
• The joint regulators would have a range of oversight powers, including power to
  change rules, power to prescribe obligations and crisis management powers, all of which could be applied to the operator, critical service providers (CSPs) and participants of a recognised system3 ;
• The Recognition Regime would run parallel to the existing Designation Regime.

7. The following provides a summary of submissions in the order of the eight questions
   contained in the consultation document. Subsequent feedback obtained through bilateral meetings and industry forums is also included where appropriate. This is followed by the Reserve Bank’s response to each of the questions. 1 http://www.rbnz.govt.nz/regulation_and_supervision/payment_system_oversight/5195423.pdf 2 http://www.bis.org/publ/cpss101a.pdf 3 Note that for the rest of the document, references to the Reserve Bank exercising proposed oversight powers imply that the joint regulators would act together, in all cases except when the regulated entity is a pure payment system or provides services to a pure payment system

8. Most agreed that the Reserve Bank’s existing oversight powers were light and that
   there was a case for it to strengthen its oversight powers.

9. While the rationale for increasing oversight powers was well understood, a number of
   submitters questioned the need to do so given the lack of market failures. They argued that the New Zealand payment systems had been sound and efficient by international standards and that the self-governance mode had worked well. There were also suggestions that Payments NZ should be formally recognised as a co￾regulator for payment systems oversight. Reserve Bank’s response

10. The Reserve Bank believes that there is a strong case for strengthening the existing
    payment oversight powers. While we agree that the New Zealand payment systems have by and large functioned well in recent years, our objective is to ensure that this continues to be the case. The fact that no previous failures have occurred is, itself, no guarantee that there will be no future failures, and the Reserve Bank is seeking to appropriately position itself to respond to any issues promptly and effectively.

11. One of the key drivers of the Review has been the Reserve Bank’s experience with
    the payments industry in the last decade. Moral suasion has been the only tool the Reserve Bank is able to use for inducing changes, which has not been effective in gaining industry traction to address issues in a timely manner. Strengthening the legislative framework with formal statutory powers would support the Reserve Bank carrying out its function of payment systems oversight more effectively.

12. The self-governance model has been a legacy of how payment systems evolved, and
    has to date remained biased in favour of incumbents, which are largely banks. There is natural tension between these entities’ dual role of referee in owning and operating the payment system, and being participants in it. In addition, new payment instruments and non-bank payment service providers have emerged in the last decade. The Reserve Bank’s focus here is to ensure that there is a level playing field and that non-contestable monopolies and unjustifiable barriers to entry do not exist.

13. Payments NZ, owned by eight banks that currently participate in the payments
    systems directly, is a payment scheme company that devises and administers the framework of rules and procedures for four clearing streams. As an advocate for its members, it promotes integrity and stability of the rules and standards for interchange and settling payments, and one of its objectives is to introduce open access to those payment streams over time. This contrasts with the Reserve Bank’s mandate set by Parliament, which is to promote the maintenance of soundness and efficiency of financial systems. As Payments NZ is owned by participants in, and advocates for, the industry that is being regulated the Reserve Bank does not consider it appropriate that Payments NZ should be positioned as a co-regulator for payment systems oversight.

14. Payments NZ has contributed to the advancement of a number of industry-led
    projects since its inception in 2010. The Reserve Bank has worked, and will continue to work, closely with Payments NZ on those areas that fall within Payments NZ’s responsibilities as an operator of four clearing streams. Question 1: Do you agree with the gaps and issues identified and the conclusion reached? Are there any other factors that the Reserve Bank should be taking into account – if yes, please provide more details.

15. There have been mixed responses to the proposed definition of “systems”. While
    submitters generally agreed with adopting a broad definition, there were concerns on how the proposed powers could be applied to “systems”, which were not legal entities. Some submitters suggested alignment with international terminology – i.e. adopting the term “financial market infrastructure” (FMI), which the PFMIs defines as “multilateral system among participating institutions, including the operator of the system, used for the purposes of clearing, settling or recording payments, securities, derivatives or other financial transactions”.

16. Others questioned the intended scope of “systems4
    ”, in particular, whether CSPs and participants of a system should be included. It was argued that CSPs were fundamentally different in nature from a system, and should be treated differently. A couple of submitters noted that system participants are already governed by system rules, therefore should not be subject to increased oversight. Reserve Bank’s response

17. On balance, the Reserve Bank agrees that there is merit in adopting the international
    terminology “FMI”, rather than retaining the use of “system”. FMIs are a broad set of entities that typically include payment systems, securities settlement systems, central securities depositories, central counterparties and trade repositories.

18. One previous concern with adopting the term FMI was that it excluded CSPs. The
    Reserve Bank acknowledges submitters’ comments that an FMI uses CSPs to deliver its services, but CSPs themselves are not part of an FMI. Under the PFMIs, CSPs are required to meet expectations in the areas of risk management, technology management, security management, resilience and communication with users. The assessment of a CSP is quite likely to differ from that of an FMI.

19. A CSP, in this context, refers to a related party or third party that provides an FMI
    infrastructure services that are critical to the sound and effective provision of the FMI’s core functions. CSPs generally include providers of IT infrastructure, messaging services, data processing, and switching, but do not include ancillary or utility providers such as telecommunications or electricity providers.

20. While CSPs are not part of an FMI, they play a critical role in ensuring the reliability
    of services and effectiveness of risk management of an FMI, as the operational reliability of an FMI may well be dependent on the continuous and adequate functioning of its CSPs. The Reserve Bank, therefore, considers it important that the proposed Recognition Regime would cover CSPs, so it could establish expectations for an FMI’s CSPs in order to support its oversight of the FMI.

21. An alternative is to impose requirements on CSPs via contractual arrangements
    between the FMI and its CSP. This would be a simpler approach that allows the Reserve Bank to retain some influence by requiring that the FMI provide for certain prescribed matters in contracts with any service providers that the Reserve Bank specifies. However, the indirect nature would mean that the Reserve Bank might not have any crisis management powers, a core area we believe must be retained. This approach is therefore not favoured by the Reserve Bank. 4 It was proposed that the scope included system rules or arrangements, system operators, participants, infrastructure providers, governance structures and payment instruments. Question 2: Do you agree with the proposed definition of “systems”? If not, please provide more details. Alternatively, do you think the term “FMI” should be adopted, if so, why?

22. The Reserve Bank also agrees with submitters’ comments that participants should
    not be included in the definition of an FMI. As participants are required to comply with the FMI’s rules, they would not need to be subject to direct oversight of the Reserve Bank. Participants would, however, continue to be subject to the information gathering power under Section 156C of the Reserve Bank Act 1989 (the Act).

23. We also note that the majority of proposed powers would be exercisable to FMIs and
    CSPs that are legal entities, and operators of FMIs when the FMIs are systems.

24. Most submitters were comfortable with the proposed criteria for systemic importance
    as they were drawn from the international principles.

25. Some noted that the criteria should reflect New Zealand domestic conditions. In
    particular, a few submitters suggested broadening the criteria to include FMIs that might not be considered systemic, but were important to the New Zealand payment system. They noted that some of these systems were used by many sectors in the real economy and formed an integral part of commerce and financial activities, so their soundness and efficiency were also important.

26. On the other hand, a couple of submitters supported the focus on systemic important
    FMIs only.
    Reserve Bank’s response

27. The Reserve Bank’s original proposal in the consultation document had been
    focusing only on systemically important FMIs, based on a relatively narrow interpretation of its mandates on soundness and efficiency.

28. After careful consideration of the pros and cons of widening the legislative scope and
    engaging further with stakeholders, the Reserve Bank has come to the view that the original scope should be broadened to include those FMIs that have system-wide importance, and that such FMIs should be brought under the proposed Regime.

29. System-wide important FMIs are those that may appear to present a low level of
    systemic risk, yet a disruption or failure of their operation could nevertheless affect public confidence in the payment system or financial system of New Zealand, and may affect many users. Their inefficient operation may also distort financial activity.

30. In our view, the FMIs that are likely to come under this category are those that
    provide the processing, clearing and settling of general purpose payment instruments such as credit transfers, direct debits, payment cards and cheques, which together make up 99 per cent of retail payments by volume. These general purpose payments are transactions made to and from business, consumers and governments, who use them for a broad array of purposes such as paying bills, suppliers, salaries, dividends, benefits, and collection of taxes and fines.

31. The main objectives for including these types of FMIs within the strengthened
    oversight framework are:
    Question 3: Do you agree with adopting the CPSS/IOSCO definition of “systemically important systems”? If not, please provide more details. Are there any additional factors that the Reserve Bank should take into account when making an assessment of the systemic importance of a system? If so, what are those factors?

• Maintaining public confidence in the payment system or financial system;
• Minimising the negative impact on the public and business interests that
  would result from deficiency in design or disruption to their operations; and
• Minimising the distortion to financial activity or market structure from their
  inefficient operation.

32. In seeking to strengthen its oversight on system-wide FMIs, the Reserve Bank
    intends to adopt a risk-based approach which reflects its consideration of the different types of risks that distinguish system-wide important FMIs from systemically important FMIs. The focus and intensity of its oversight approach would therefore be likely to differ accordingly.

33. All submissions that expressed a view were supportive of the co-regulatory model put
    forward. A few commented on the need for a formal Memorandum of Understanding (MOU) in place between the Reserve Bank and FMA, and that there should be clarity as to which regulator would be the primary regulator under various circumstances. Some also called for a MOU between the Reserve Bank and Commerce Commission, on efficiency matters.

34. A couple of submitters also queried how the Reserve Bank manages the perceived
    conflict of interest for the FMIs that it operates.
    Reserve Bank’s response

35. Assuming the Government accepts the recommendation on establishing a
    Recognition Regime, the Reserve Bank plans to establish a formal MOU with the FMA, similar to the one under the current Designation Regime. We may also look to establish a MOU with the Commerce Commission – see our response to Question 7.

36. We do not agree there is a need to separately identify the primary regulator under a
    co-regulatory arrangement, given that in the case of payment systems and their CSPs, the Reserve Bank would be the sole regulator. However, we acknowledge there could be some benefits in having a clear division of responsibilities for other types of FMIs, and this could be addressed as part of the MOU process.

37. We acknowledge submitters’ concern on the perceived conflict of interest between
    the Reserve Bank’s oversight and operator functions. This issue exists under the Designation Regime - both ESAS and NZClear are designated, so both are operated and regulated by the Reserve Bank. Under the proposed Recognition Regime, the Reserve Bank would continue to manage the potential conflict via organisational separation and transparency of policy application, including the application of consistent requirements on all systems, separate reporting lines, and in the case of NZClear, the joint regulatory arrangements with the FMA. We plan to consult on a draft policy on managing conflicts of interests as part of the updated Statement of Principles: Payment System Oversight (PS1)5 . 5 http://www.rbnz.govt.nz/regulation_and_supervision/payment_system_oversight/1911038.html Question 4: Do you agree with the proposed co-regulatory model? If not, how should oversight responsibility be shared between the Reserve Bank and the FMA?

38. There was a reasonable level of support for the Reserve Bank to obtain the proposed
    oversight powers, especially those related to crisis management. There were more mixed views on the proposed ability to impose governance requirements.

39. A number of submitters expressed a common desire for more clarity in the following
    areas:

• Which proposed powers would be exercised against whom;
• The precise statutory purposes, grounds and limits for each proposed powers;
• Types of governance requirements that may be imposed;
• What statutory arrangements would be in place to ensure that the Reserve
  Bank is transparent in its regulatory role; and
• How the Reserve Bank would apply the proposed powers to global systems
  that are under cooperative oversight arrangements.

40. Some submitters also argued that the Reserve Bank should not obtain payment
    oversight powers that were designed for banks, non-bank deposit takers and insurance sectors – especially when there had been no market failure in the sector. Reserve Bank’s response
41. The Reserve Bank acknowledges that the consultation document’s focus was on the
    high level legislative framework, and lacked details on the scope and grounds of the various proposed powers.
42. In response to industry request for more detail, in early August the Reserve Bank
    issued a discussion policy paper Oversight of Financial Market Infrastructures – Definitions, Criteria and Scope of Proposed Powers, which expanded on the various components of the proposed Recognition Regime, including the criteria and process for recognition, grounds and scope of the proposed powers etc. It was targeted at those stakeholders that the Reserve Bank had engaged with throughout this Review. The Reserve Bank is currently analysing feedback from interested stakeholders. As the paper’s focus was on the details of the proposed framework, it would feed into the Reserve Bank’s consideration on the draft legislation, which would be consulted assuming it receives Cabinet’s approval of the legislative framework.
43. As mentioned earlier in this paper, most of the proposed new powers are intended to
    be applied to FMIs and CSPs that are legal entities, and operators of FMIs if the FMIs are systems. The main exception is the existing information gathering power under Section156C of the Act, which has a wider application, including to FMI participants.
44. Generally speaking, the proposed powers to request independent reports and onsite
    inspections are intended to be reserve powers, to be used when there is a potential breach of a requirement for an FMI to provide information, or reasonable grounds to Question 5: Are there any powers that are proposed in this paper not appropriate in your view? If yes, please explain which one(s) and why. Are there any other powers should the Reserve Bank seek and why?

believe the FMI has provided incorrect or misleading information, or reasonable concerns about the way the FMI was being operated.
45. The Reserve Bank is committed to effective consultation and cooperation with other
central banks and regulatory authorities in its oversight of recognised FMIs that have a global presence. Before exercising the power to prescribe obligations, the Reserve Bank would consider the existence of any international co-operative oversight arrangements. The Reserve Bank must also consider avoiding duplication of requirements, minimising compliance costs and maintaining competitive neutrality. There would be a requirement for consultation with affected parties before an obligation is imposed. Similarly, there would be a consultation requirement for any rule changes or new rules proposed by the Reserve Bank.
46. Direction powers would have a high threshold, such as ministerial consent, before
being used. The circumstances for issuing a direction include likely or actual insolvency, the affairs of the FMI being conducted in a manner prejudicial to the soundness of the financial system, the operator acting fraudulently or recklessly, or the operator being involved in serious or repeated breaches of its obligations.
47. The proposed powers are generic oversight powers and do bear resemblance to
other sectors that the Reserve Bank regulates. This does not mean that the Reserve Bank would use a one-size-fits-all approach. The Reserve Bank intends to apply appropriate powers proportionate to the circumstances and entities it oversees. The generic powers represent a common approach to identifying issues and inducing changes - they are consistent with the powers overseas regulators have for their oversight of this sector, and well aligned to the responsibilities for regulatory authorities set out in the PFMIs.
48. There has been overwhelming support for separating the proposed Recognition
Regime from the Designation Regime.
Reserve Bank’s response
49. The Reserve Bank recommends that a Recognition Regime be established for the
oversight of FMIs and CSPs, and that it be run parallel to the Designation Regime.
50. Most submitters have commented on the efficiency considerations. The majority
agreed that efficiency matters should be considered as part of Reserve Bank’s oversight of the sector. Areas highlighted were fair and open access, clear and transparent governance and prompt and efficient processing of payments. There were also suggestions that the Reserve Bank set up a MOU with the Commerce Commission, for efficiency related areas of overlapped interests. Question 6: Do you agree that separating the two regimes would represent a better framework overall? Please provide more details to your answer. Do you have any comments about how these two regimes would work? Question 7: Do you agree with the efficiency considerations discussed in this paper? If not, please explain why. Are there any other efficiency-related areas that you consider the Reserve Bank should look into? If so, please provide further details on those areas.

51. Some submitters have cautioned that the interpretation of efficiency should not go
    too far, and the Reserve Bank should refrain from intervening in price regulation or consumer protection. Commercial issues should also be left to the market. Reserve Bank’s response
52. Since 2001, the Reserve Bank has been raising access and governance issues with
    the industry. The Reserve Bank has been actively involved in an industry project called Access and Governance, which had two key objectives:

• In terms of access, the Reserve Bank was interested in seeing objective and
  publicly disclosed criteria for participation, which permit fair and open access, especially access being possible for non-banks; and
• In terms of governance, the Reserve Bank was interested in seeing
  governance arrangements that were effective, accountable and transparent with respect to payment systems’ owners and users, and which took into account the public interest.

53. While this project has drawn to a close, the Reserve Bank continues to engage with
    relevant stakeholders and monitor developments and any evidence that significant barriers to entry exist.
54. Other aspects of efficiency are also relevant. In the PFMIs, efficiency refers generally
    to the use of resources by FMIs and their participants in performing their functions. Efficient FMIs contribute to well-functioning financial markets, whereas an FMI that operates inefficiently may distort financial activity and the market structure, affecting not only the financial and other risks of its participants, but also the risks of its participants’ customers and end users. These distortions may lead to lower aggregate levels of efficiency and soundness, as well as increased risks within the broader financial system. For example, if an FMI is inefficient, a participant may choose to use an alternate arrangement that poses increased risks to the financial system and the broader economy.
55. Building on the current interpretation of efficiency in PS1, the Reserve Bank believes
    that its oversight framework should continue to reflect its efficiency objectives, in broadly the following aspects:

• Ensuring an FMI is efficient and reliable, and is effective in meeting the
  requirements of its participants and the market it serves.
  This means
  1) The operation of the FMI, such as its clearing and settlement
  arrangements, its operating structure, its delivery systems and technologies, its individual services and products efficiently and reliably meet the needs of its participants and the market it serves
  2) The FMI is reliable and resilient, and has clear goals and objectives that
  are measurable and achievable, such as in the areas of minimum service levels, risks management expectations, and business priorities; and
  3) The FMI has established processes and metrics to regularly evaluate its
  effectiveness and efficiency

• Ensuring clear and transparent governance in an FMI, which provides the
  proper incentives for its board and management to pursue objectives that are in the interest of its stakeholders and that support relevant public interest. This means
  1) The FMI has clear objectives that place a high priority on the soundness
  and efficiency of the FMI
  2) The FMI has put in place formal governance arrangements that support
  the FMI’s design, rules, overall strategy and major decisions appropriately reflect the legitimate interests of its direct and indirect participants and other relevant stakeholders

• Ensuring fair and open access with no unwarranted barriers to entry, and
  fostering competition
  This means that an FMI should have objective, risk-based, and publicly disclosed criteria for participation, which permit fair and open access. Competition can be an important mechanism for promoting efficiency. Where there is effective competition and participants have meaningful choices between FMIs, such competition may help to ensure that FMIs are efficient.

56. These specific aspects represent a more detailed interpretation of the Reserve
    Bank’s efficiency mandate. They are consistent with the focus of PFMIs and how the Reserve Bank has progressed payment system efficiency matters in the past.
57. Adopting a more explicit interpretation of efficiency in the Reserve Bank’s oversight
    approach would likely require more cooperation and engagement with the Commerce Commission, who enforces the Commerce Act 1986. That Act prohibits anti￾competitive behaviour and structure in markets. The FMA also contributes to financial system efficiency by enforcing clear and transparent rules for financial market conduct.
58. While these areas would not be the Reserve Bank’s focus, there could be overlapped
    interests in some cases, and consequently the Reserve Bank plans to engage more closely with these agencies as part of its FMI oversight, and may look to establish MOUs to provide a framework for dealing with efficiency issues.
59. There was strong support for the Reserve Bank to establish a list of all payment and
    settlement systems.
    Reserve Bank’s response
60. In the first instance, the Reserve Bank plans to investigate further with the Ministry of
    Business, Innovation and Employment (MBIE) the use of the existing Financial Services Providers (FSP) Register. Dependent on whether a joint solution with MBIE could be found, the Reserve Bank may look to set up a separate register for FMIs and CSPs in due course. Question 8: What are the pros and cons for the Reserve Bank to maintain a list of all the payment and settlement systems in New Zealand? Are you supportive of the Reserve Bank having such a list? If not, please provide detailed comments.

SECTION THREE: PROCESS FROM HERE
61. We would like to thank all stakeholders that have been involved throughout the
consultation process. We have received a lot of constructive and useful feedback, which has helped us recalibrate and refine the original proposal that was consulted in March this year.
62. We are now working through comments received from the targeted consultation
document Oversight of Financial Market Infrastructures – Definitions, Criteria and Scope of Proposed Power, which will directly feed into a Cabinet paper on the Reserve Bank’s preferred policy position on payment oversight framework. Assuming Cabinet approval is obtained, we plan to release an exposure draft for consultation. This is expected to be in the first half of 2014.
63. As mentioned earlier in this paper, we also plan to consult publicly an updated PS1 in
the first half of 2014. This document will outline the Reserve Bank’s proposed oversight objectives, focuses and approach, including how it plans to adopt the PFMIs.