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OVERSIGHT REVIEW OF NZX 2005

CONFLICT MANAGEMENT

NZX's position as a registered exchange and public issuer

15. NZX is a limited liability company. It is a Listed Issuer: its shares are traded on the NZSX market. In this respect NZX is both the frontline regulator of a securities market and a commercial entity that participates as a regulated entity on that market. In 2001 the Parliamentary select committee considering the NZSE demutualisation legislation noted the public interest issues raised by the demutualisation of the exchange. The assessment methodology for the IOSCO Principles notes that while all exchanges should have procedures in place to address conflicts of interest, there may be more concern for conflicts of interest, or the appropriate use of self-regulatory resources, in the case of for-profit, demutualised markets. One concern is that such an exchange would seek to cut its regulatory activities or standards in order to boost returns for its shareholders. Such an inherent conflict within a demutualised exchange has been noted in various overseas jurisdictions, and differing approaches have been taken overseas to manage this conflict.
16. We record that NZX has consistently stated that it does not see its commercial and regulatory functions as inherently conflicting. NZX maintains that its success as a registered exchange, and correspondingly as a commercial entity, largely depends on its ability to engender confidence in the regulated markets that it operates, and that this in turn gives NZX every incentive to maintain high standards in its regulatory operations. The Commission agrees that these incentives exist, but does not consider that this means there is no conflict of interest. The Commission notes that it is largely the perception of conflicts of interest that can damage confidence.
17. There is no doubt that commentators in New Zealand and overseas, and many overseas exchanges, recognise that a listed exchange company's dual roles create the potential for conflicts of interest. The Commission is concerned that the unwillingness of the NZX Board to acknowledge that there is an inherent conflict within any demutualised exchange between commercial and regulatory functions may preclude the NZX Board from giving sufficient and necessary consideration to potential organisational developments within NZX regarding the regulatory function.
18. The Board of NZX has told the Commission that whilst it does not consider that such a conflict in fact exists, NZX and the NZX Board are aware that the perception of such a conflict can exist and is held in some quarters. The NZX Board considers that addressing this perception is important and it is engaged to ensure that the perception of such a conflict is addressed, including by keeping under review its regulatory structures and their position within the organisation.
19. The Commission in its review has considered the steps that have been taken by NZX to manage these conflicts. In the Commission's opinion market confidence is best served where it can be demonstrated that a registered exchange conducts its regulatory operations independently of conflicting commercial objectives.
20. The Commission considers that there is currently in practice effective separation between NZX's supervisory functions and its corporate activities, and that the conflicts of interest between these functions are managed satisfactorily.