Publications: OVERSIGHT REVIEW OF NZX 2007


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OVERSIGHT REVIEW OF NZX 2007

INTRODUCTION

This is the third oversight review of NZX's performance of its regulatory functions as a registered exchange under the Securities Markets Act 1988 and covers the 2007 calendar year.
The first review of NZX focussed on the activities of NZX more generally. The report provided a general overview of the business and processes of NZX and its regulatory function. The subsequent reviews update progress on issues arising from earlier reviews and focus on specific areas.
In particular, this review focussed on two specific areas: (i) NZX's policies in respect of its continuous disclosure rules and its administration of these policies, including its practices regarding publication of market announcements; and (ii) the impact of NZX's expanding commercial activities on its regulatory function. The Commission considered in-depth review and analysis would be valuable as to these two areas in this review.
NZX has obligations under section 36G of the Securities Markets Act 1988 to secure compliance with its Listing and Business Rules, and to perform any obligations that lie on NZX under those rules.
The Commission has statutory functions to review practices relating to securities and activities on securities markets, and to comment on these. In relation to NZX, performance of these functions requires the Commission to keep under review and comment on NZX's performance of its obligations as a registered exchange.
The Terms of Reference for the Commission's review, the scope of and the background to the review and the process that we followed, are set out in the Appendix to this report.
The report contains five sections with the following headings:
- NZX's frontline regulation
- Policies in respect of continuous disclosure
- Impact of expanding commercial activities on NZX's regulatory function
- The Special Division
- Matters arising from the review of the 2006 year
  1. Conflict management
  2. NZX Discipline
  3. The Special Division
  4. The NZAX market

NZX'S FRONTLINE REGULATION

Although NZX does not undertake active supervision of the Listing Rules, NZX endeavours to minimize the risk of non-compliance by issuers.
NZX also endeavours to minimize the risk of non-compliance by participants with the Participant Rules.
NZX seeks to minimize these risks of non-compliance through providing issuer relations updates, guidance notes on compliance trends, compliance briefings and on-site inspection reports. NZX also communicates regulatory guidance through the Securities Industry Association and the Listed Companies Association.
NZX continues its practice of giving public presentations to potential issuers to promote capital markets. NZX addresses potential issuers about the benefits of listing created by the regulatory regime.
NZX grants waivers and makes rulings which also minimize the risk of non-compliance with the Listing Rules. Waivers and rulings recognise that the Listing Rules cannot contemplate every commercial arrangement.
To ensure that its staff effectively undertakes market supervision, NZX provides staff training on law changes and internal processes.

Market Supervision Changes

The Commission notes several changes to NZX's market supervision processes.
In 2006 NZX moved from annual inspections of Market Participants to a risk-based approach to participant supervision. In 2007 NZX further refined its procedures.
This risk-based approach involves NZX evaluating each Market Participant's compliance with the Rules and making a risk assessment. This assessment includes consideration of governance matters, financial performance, activities, infrastructure and compliance performance of the firm. NZX uses the assessment to determine the risk of a firm's non-compliance with the Rules, so that NZX can establish the appropriate frequency for inspecting the firm.
This risk-based approach enables NZX to allocate its resources in areas where it is most required in that firms with good compliance records will not undergo automatic annual on-site inspections, while firms at high risk of compliance failure would be more closely supervised. This process will not fetter NZX's ability to conduct regulatory visits to participants as NZX deems appropriate. This risk-based regime accords with international standards of supervision.
The Commission will review the effectiveness of the risk-based approach in our future oversight review of NZX.
The Commission notes that in 2006, NZX Participant Rule 17.10 was amended to include self-reporting of breaches by participants to NZX. NZX found no increase in the number of reported breaches during 2006. However, NZX has found that this obligation to self-report breaches has increased the number of matters brought to NZX's attention during 2007.
During 2007, NZX found that some companies which were back-door or reverse listed experienced financial and compliance difficulties. Thus, NZX undertook to review its policies on back-door and reverse listings. A back-door listing involves a listed company with little or no active business, a trading shell, which acquires a private company which seeks to become listed. A reverse listing involves a shell company that lists on the market with the aim of identifying a business to acquire. These listing vehicles provide a means for privately-owned companies to list without the need to meet full listing disclosure requirements and can be less expensive than conventional listings.
NZX has adopted and implemented a policy on back-door and reverse listings which seeks to improve the processes by requiring (i) the production of a profile for the post-transaction entity, (ii) director certifications in respect of the information in the profile and to certify that all material information has been disclosed and (iii) a change in fees to align them with those payable in respect of a conventional listing.
During 2007 NZX employed a new trading platform which has more flexibility in application to a wider range of trading products than did the previous platform. NZX has successfully implemented this new system.
For the reasons stated above, the Commission is satisfied with (i) the processes which NZX uses in considering admission or approval of listed issuers and market participants to its markets and (ii) that NZX is taking appropriate action to minimise the risk of non-compliance by listed issuers and market participants in relation to their obligations under the Listing Rules and Participant Rules.

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