Proposal to Declare Certain Derivative Contracts to be Futures Contracts Under the Securities Markets Act 1988

A Discussion Paper

2. INTRODUCTION

2.1

Dealings in futures contracts are regulated in New Zealand under the Securities Markets Act. The Securities Commission is the statutory regulator of futures dealers under this Act.

2.2

The Securities Markets Act requires people who carry on the business of dealing in futures contracts to be authorised by the Securities Commission.

2.3

There are serious penalties under the Securities Markets Act if people deal in futures contracts without authorisation. Many futures contracts are also "securities" in terms of the Securities Act 1978 (the "Securities Act"). For these reasons it is desirable that market participants and investors have certainty about the regulatory treatment of derivative products, so that appropriate authorisations or exemptions can be sought where necessary.

2.4

The Commission often receives requests from market participants for clarification of whether certain types of financial instruments are "futures contracts" under the Securities Markets Act. The statutory definition of "futures contract" is not entirely clear in its application to certain products.

2.5

In particular, as requested by market participants, this paper discusses the application of the law to certain derivative contracts known as contracts for difference ("CFDs") in respect of shares or other securities.

2.6

A CFD is a derivative contract in which an investor can receive the economic benefits of holding an underlying commodity or instrument without having equitable or legal title to that commodity or instrument. The price of the CFD is derived from the underlying commodity or instrument and the counterparties to the CFD agree to settle the difference between the acquisition and disposal price in cash. Therefore, there is no delivery of the underlying commodity or instrument.

2.7

This paper proposes that the Commission uses its power under the Securities Markets Act to declare CFDs in respect of shares or other securities to be futures contracts. The Commission welcomes comments from interested parties on its proposal.

2.8

However, we should note that the Commission's declaration power is limited. Any more general law reform will be a matter for the Government to consider, rather than the Commission.

2.9

The effect of the Commission's proposed declaration will mean that people dealing in CFDs in respect of shares or other securities will be required to obtain authorisation to deal in futures contracts under the Securities Markets Act.

2.10

Issues for comment are raised throughout the paper and a list of questions is included at the end.