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OVERSIGHT REVIEW OF NZX 2005

MARKET SUPERVISION FUNCTION

Arrangements for Market Supervision

21. The Market Supervision Group comprises three teams - NZX Regulation ("NZXR"), Listed Company Relations ("LCR") and Participant Compliance. The Group Leader of the Market Supervision Group is the Head of Regulation. In 2005, the Head of Regulation and the four other NZX Group Leaders reported to the CEO.

22. The focus of the NZXR team is on NZX's Listed Issuers. NZXR supervises the activities of Listed Issuers in relation to their compliance with the Listing Rules.
23. During the review period the NZXR team comprised two Business Leaders and four NZX Solicitors. The NZXR Business Leaders have responsibilities for managing the NZX Solicitors in the NZXR team. Matters tend to be raised with the Business Leaders in the first instance. Matters are referred to the Head of Regulation as necessary. The NZXR team formally reports to the Head of Regulation.
24. LCR is responsible for the accurate and timely release of market information, such as information submitted by issuers via the Market Announcement Platform, and compliance checks of certain information provided by Listed Issuers in relation to market announcements.
25. The LCR team comprised two Client Relationship Managers and a LCR Team Leader. Any compliance issues identified by members of the LCR team are escalated to the LCR Team Leader in the first instance, and are referred to a NZXR Business Leader as necessary. Matters may also be raised with the Head of Regulation by members of LCR or by the designated Business Leader. The team formally reports to the Head of Regulation.
26. The Participant Compliance team supervises the activities of NZX accredited intermediaries and brokers (Market Participants) in relation to their compliance with the NZX Participant Rules, and Futures and Options Participants in relation to the NZX Futures and Options Rules.
27. During the review period the Participant Compliance team comprised two Business Leaders and three Compliance Inspectors. The Business Leaders have responsibilities for managing the Compliance Inspectors. Compliance Inspectors raise matters with the Business Leaders in the first instance. Matters are referred to the Head of Regulation as necessary. The Participant Compliance team formally reports to the Head of Regulation.

Resources for Market Supervision Group

28. There is no separate budget or separate financing for NZX's regulatory functions. NZX Board members expressed the view that any separation would be unnecessary, and could be seen as constraining the resources available to this Group. In practice, we were told, the regulatory function will be given such resources as it requires. We were told the Board would expect the Head of Regulation to raise any resource constraints with Board members.
29. The Board's impression is shared by executive management. The Head of Regulation considers that Market Supervision has unlimited access to financial resources to discharge its function. The Head of Finance and Strategy prepares high level projections and budgets for businesses within NZX, including Market Supervision. These are discussed with the Head of Regulation. The Head of Regulation has been able to talk directly with the CEO about any resource needs. Resources have been forthcoming.
30. Any resource issues concern human resources. NZX has used secondees or external legal providers to cover any shortfall in this regard. The Head of Regulation is free to make decisions at her discretion regarding external services. There is no limitation on the budget for these services. The Head of Regulation was satisfied that all requests for resources had been met in the review period.
31. Operationally there is crossover of the personnel that carry out commercial and regulatory work, in particular the NZX Solicitors in the NZXR team. There is an expectation that these solicitors will undertake a certain amount of commercial work for NZX in addition to their regulatory activities. NZX's view is that this does not of itself create a conflict for any solicitor, except in a situation where a solicitor might undertake work for the Special Division, as regulator of NZX. During the review period the NZX Solicitor appointed to act as the liaison between NZX and the Special Division did not undertake any commercial work for NZX.
32. The fact that NZX Solicitors are available to undertake corporate work for NZX has the potential to cause resource conflicts between NZX's corporate and regulatory work. However, in practice it appears to have been clearly communicated to all NZX Group Leaders that the first demand on NZX Solicitors' time is their regulatory work. Sharing of legal resources that have regulatory and commercial functions is discussed between the Head of Regulation and the Corporate Counsel (or the Group Leaders). It was evident that NZX's corporate groups are expected to contract out legal work if the level of regulatory work would create competing priorities for NZX Solicitors. We did not see evidence of material resource difficulties in the review period caused by the in-house legal resource being shared between the regulatory and corporate groups.
33. The Commission has previously recorded in its report arising from the collapse of Access Brokerage that NZX has, since demutualisation, increased its focus on market compliance. Our more detailed review has reinforced this observation. It is our impression that adequate resources were applied to regulatory functions in 2005.

Interaction between Market Supervision and the other NZX groups

34. NZX Solicitors noted interaction with Group Leaders (other than the Head of Regulation) and the Corporate Counsel in relation to the commercial aspects of their work. Some NZX Solicitors were also involved in bringing a regulatory perspective to the Listings Group, run by the Head of Market Products, in relation to potential new listings.
35. The Participant Compliance team's main interactions with other NZX business units concern IT and systems matters if any systems issues arise.
36. The LCR team has some interaction with other Group Leaders, particularly in relation to IT and systems issues, database management, and NZX's publications for which LCR generates data. LCR is responsible for running a helpdesk and matters may be referred from the helpdesk to other parts of the business for a response. The LCR Team Leader participates in the Listings Group which focuses on promoting and attracting listings.
37. Of the personnel in the Market Supervision Group, only the Head of Regulation reports to and appears before the Board.

Responsibility for Market Supervision

38. NZX has powers under its Listing Rules and Participant Rules in relation to administration and enforcement of the Rules. Some of the enforcement powers have been delegated by the Board to NZX Discipline. All relevant powers, as they relate to NZX as a Listed Issuer, have been delegated to the Special Division.
39. Identical delegations for administration and enforcement of the Rules have been granted to the CEO and to the Head of Regulation. We consider that this detracts from the separation that has been established between corporate and regulatory activities.
40. The directors of NZX were strongly of the view that Board delegations for the exercise of regulatory powers should lie with the CEO as well as the Head of Regulation because the Board needs to be able to hold the CEO ultimately accountable for all aspects of NZX's performance.
41. In practice it was clear that the Head of Regulation exercises supervisory authority over regulatory matters. The CEO is consulted on regulatory matters from time to time, but the Head of Regulation has no belief that this detracts from her authority to exercise the delegated powers. The Head of Regulation noted that there had been no instances during the review period where the CEO and Head of Regulation had disagreed on the approach to be taken on a regulatory matter. We understand that should this occur on an important matter, it would be escalated to the Board. It appears that in practice the CEO is kept informed of regulatory work, to allow him to ensure that as CEO he is involved in any material matters affecting policy or risk.

Separation of the Market Supervision Group

42. Our review found that NZX has in place physical and procedural information controls designed to isolate the regulatory work undertaken by the Market Supervision Group, in particular NZXR which is responsible for Listing Rule compliance.
43. All NZX personnel work in the same building. While the working environment is open plan, work areas are divided so that the Market Supervision Group is separated from the commercial groups. This area can be locked off from the rest of the floor. Information in the regulatory area is understood by commercial personnel to be confidential.
44. We were advised that there are information controls on the NZX computer system. The server has a dedicated drive for NZXR personnel, which is only accessible by them. Access to electronic files and regulatory databases is also restricted to NZXR personnel. The Participant Compliance team has similar controls, and information about Market Participants can only be accessed by members of that team and the Head of Regulation.
45. All staff we spoke to appeared to be aware of the need to maintain separation between corporate and regulatory work.
46. The treatment of listing applications has highlighted conflicts of interest in overseas jurisdictions. This has occurred where pressure has been applied, for the sake of increasing revenue, to accept lower quality listings. The regulatory requirements for a listing on NZX are, consistent with other activities, dealt with by the NZXR team, quite separately from the corporate side of NZX's business. Separation at this stage is assisted by the continuing use of the Listing Subcommittee, which comprises two persons who are otherwise independent of NZX, to review listing documents for compliance with the Listing Rules. We were told there were occasions on which Listed Issuers, and in particular companies that are in the process of listing, have contacted members of the Market Operations Group for assistance or support on a regulatory matter. It seemed to be clearly understood that any such inquiry would be immediately forwarded to the appropriate regulatory personnel.

Personnel

47. As an entity exercising regulatory authority it is important that NZX's processes for dealing with potential conflicts of interest on the part of individuals are clear and consistently applied.
48. At a staff level, management of conflicts of interest is important, in particular for NZX Solicitors who have authority to take decisions (in divisions of 3 solicitors) on various applications made by Listed Issuers. NZX Solicitors were aware that they should declare conflicts of interest. However, NZX does not have any formal written policy about identification and disclosure of personal conflicts by its Market Supervision staff. We were told that it is the responsibility of the Lead Solicitor on any matter to ensure that no member of a division has an interest in the matter. NZX Solicitors were of the view that interests should be declared to the Head of Regulation or to the relevant Business Leader, who can determine whether or not an interest is such as to preclude participation in any matter. Participant Compliance team members appear to have a similar understanding but it was not clear that a specific expectation had been communicated to them regarding disclosure of conflicts of interest. We recommend that NZX introduce and communicate to all Market Supervision staff a formal policy about disclosure of conflicts of interest so that all Market Supervision staff have a consistent understanding of NZX's expectations about conflicts disclosure. NZX has a policy regarding trading by its officers and employees in the securities of any NZX Listed Issuer.

Recommendation

49. We recommend that:
    
    NZX introduce and communicate a formal policy for all Market Supervision staff concerning identifying and declaring personal conflicts of interest.
    
    NZX says that it currently has a policy regarding conflicts of interest and agrees to set this out in writing.
    
    NZX has committed to do this by the end of this calendar year.