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

4.

FORMS OF COMMISSION REGULATION

4.1

If the Commission makes a declaration as proposed in this paper, people dealing in the relevant contracts will need to seek authorisation as futures dealers (unless they are already authorised).

4.2

Before granting any authorisation, the Commission will need to be satisfied that there is an adequate regulatory framework upon which the authorisation can be based.

4.3

The Commission will generally consider as part of any application to become an authorised futures dealer whether the entity is subject to any existing regulation; for example, whether they are prudentially regulated or licensed in another jurisdiction.

4.4

We believe that for wholesale participants this recognition of, and reliance on, existing credible regulation to determine whether an entity is a 'fit and proper person' to deal in futures contracts is a sensible approach. Adopting this approach, as the Commission has done in the past, has the advantage of reducing compliance costs associated with different regulatory regimes for the dealer involved.

4.5

In circumstances where an entity is not subject to existing regulation, any authorisation application will require an assessment of whether the entity is a 'fit and proper person'. In this regard, the "compliance reporter model" of authorisation referred to in paragraph 4.12 is likely to be relevant.

 

Wholesale investors

4.6

The Commission has traditionally based its regulation of futures dealing on whether the participants involved are wholesale or retail investors. Unlike the Securities Act, the Securities Markets Act does not contain any differentiation between futures dealers that deal exclusively on behalf of wholesale, rather than retail, clients.

4.7

However, we consider that people who deal exclusively for wholesale clients, such as large institutions, should be subject to a lower level of regulation on the basis that the need for public investor protection is lower when only wholesale clients are involved.

4.8

Generally the conditions of wholesale authorisations aim to ensure that any counterparty to a futures contract is a person that might be assumed to have either a sufficient level of assets or a sufficient knowledge of the futures industry to be excluded from general concerns about futures trading with retail investors. We would usually consider that such a person can be presumed to be 'sophisticated' and more able to look after their own interests.

4.9

The Authorised Futures Dealers Notice 2006 sets out a definition of "wholesale client" that is likely to serve as a precedent. This notice limits the dealer's clients to any person who is:

1. a person who controls at least $10 million; or
2. a trustee of a trust or a funds manager, acting in that capacity, who has under that person's control, as trustee or funds manager, net assets of at least $10 million; or
3. a person who is authorised to carry on the business of dealing in futures contracts under the Act; or
4. a person authorised in another jurisdiction by the competent authority of that jurisdiction to deal in futures contracts; or
5. Her Majesty the Queen in right of New Zealand, a Crown entity named in the Crown Entities Act 2004, or a State enterprise named in the First or Second Schedule to the State-Owned Enterprises Act 1986 (each as amended from time to time); or
6. a person who is a statutory corporation or a registered bank; or
7. a person whose principal business is the investment of money or who, in the course of and for the purposes of their business, habitually invests money; or
8. a person who is a related body corporate of any of the persons mentioned in (a) to (g) above.

4.10

The Commission has also granted a number of authorisations to professional funds managers who deal in futures contracts on behalf of wholesale clients as part of their funds management business.

Retail investors

4.11

Depending on the circumstances, we have authorised dealers that propose to deal in futures contracts on behalf of retail investors by way of two different approaches.

4.12

In circumstances involving 'traditional' futures dealers (that is, people acting as intermediaries), authorisation has involved a combination of client funds reporting, supervision, ongoing monitoring and disclosure; namely a "compliance reporter model" of authorisation. The compliance reporter model was discussed in the Commission's discussion paper in 2002.

4.13

This model requires disclosure of certain information to clients about the dealer and the futures contracts in which they deal, and requires the dealer to have appointed an independent "compliance reporter", who must be a qualified auditor, to review compliance with the firm's compliance manuals and undertake 6-monthly on-site inspections. An example of such an authorisation is the Authorised Futures Dealers Notice (No. 3) 2005.

4.14

Where the futures dealer is a party to the futures contract, we have often considered it more appropriate to treat the dealer as if they were an issuer under the Securities Act, with the focus of the authorisation on the disclosure to be given to potential investors. In this type of situation we would envisage that product disclosure along the lines of a New Zealand investment statement or an Australian product disclosure statement for Australian companies may be suitable. An example of this is the Authorised Futures Dealers Notice (No. 4) 2004. The terms of this authorisation require the dealer to provide detailed disclosure under an Australian product disclosure statement, similar to the sort of disclosure that would be required for an offer of securities under the Securities Act.