Publications: OVERSIGHT REVIEW OF NZX 2005


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OVERSIGHT REVIEW OF NZX 2005

MARKET OPERATIONS AND INFRASTRUCTURE

Introduction

To be an effective market operator, NZX needs appropriate infrastructure arrangements to operate that market. The market, through the technology that NZX uses, must operate effectively and have integrity. There must be procedures to ensure that the market operates smoothly and to manage any outages and disasters that may arise.
The Commission has not reviewed the particular systems technology that NZX has chosen to implement. This is a matter for NZX to decide. However, the Commission has reviewed the market infrastructure, development and maintenance, backups and disaster planning to assess whether the market is functioning effectively. While there were a number of outages in the review period, we have concluded that the market operated effectively.

Structure and focus of the Market Operations Group

The Market Operations Group's activities include the following:
1. IT Strategy - looking at the future state of NZX's core market systems;
2. Operations and Trading - maintaining the operability of the FASTER trading and FASTER clearing and settlement environment, network infrastructure and connectivity;
3. Development - enhancements and development for the FASTER Settlement Solution; and
4. Conformance and Sales - connecting new Participants, accreditation of systems, training and support for FASTER.
There are four Business Leaders within the Market Operations Group. Each meets with his or her team weekly. The Business Leaders meet with the Head of Operations individually each week. Interaction is otherwise on an as-needed basis. The Head of Market Operations (also referred to as the Chief Operating Officer) meets weekly with the CEO or otherwise as-needed.

Core systems

NZX has individual core systems for trading and settlement: the FASTER trading system, based on the X-Stream trading system, and the FASTER Settlement Solution (FSS). FASTER is the Fully Automatic Screen Trading and Electronic Registration securities transfer system.
Together, the combined system (the NZX system) facilitates execution and settlement of NZX market transactions and manages Participants' unsettled obligations.

Back-ups for core systems - continuity and disaster planning

The trading platform system and the clearing and settlement system both exist in Auckland and Wellington and are mirrored. There is a fail-safe in place to switch between the nodes if needed. The systems are redundant from a disaster recovery perspective. The two data centres operate in 'lock-step' mode. If one site fails the other will take over and no transaction is lost.
NZX runs two external disaster recovery exercises on a six-monthly basis. The fail-safe is tested in the six-monthly disaster recovery test. The disaster recovery test also involves Market Participants to check that they can switch from Auckland to Wellington or vice versa. Within approximately one hour trading can be migrated from Auckland to Wellington.
The last disaster recovery exercise was carried out in March 2006 and prior to that October 2005. The disaster recovery exercise raised small issues that were incorporated into operational checks. NZX sent the results of the disaster recovery exercise to all Market Participants.
NZX has a Hewlett Packard package that monitors the core market infrastructure platforms. The systems are housed in Telecom's "trader support high availability centres" in Auckland and Wellington. There are environmental controls in place.
Network connections always face some risk of failure. There is no full network provider other than Telecom.

Market outages and disruptions in 2005

NZX closed the market on three occasions during 2005 due to Telecom network faults or firewall faults for a total of 460 minutes. Of that time, 370 minutes' closure was due to two general Telecom network faults and 90 minutes was due to a firewall failure at NZX. All Telecom customers were affected by the Telecom network faults.
There were two instances where a trading system fault closed the market. The whole market was closed for 35 minutes. The debt market only was closed for 110 minutes for trading in debt securities.
NZX also experienced some FASTER settlement incidents during the review period, mainly loss of connectivity to registries. Some of these connectivity faults were intermittent but recurring during 2005. The market was closed for trading in one registry's securities for 105 minutes.
The whole market operated without fault for 99.67% of total market operating hours. This figure excludes outages caused by the general Telecom network faults.
The share market operated without fault for 99.78% of total market operating hours. This figure excludes outages cause by the general Telecom network faults.
During 2005, the London Stock Exchange (LSE) did not experience any outages of its SETS and SETSmm trading platforms. The New York Stock Exchange (NYSE) experienced market outages totalling 4 minutes of trading time. The Australian Stock Exchange (ASX) has a benchmark of 99.8% systems availability. In 2004/2005 all of ASX's critical systems exceeded this benchmark.

Incident management and communication with the market

NZX has a formal incident management procedure for system disruptions. Systems are categorised in terms of their criticality to market function. The response to incidents is managed against procedures established for each system category. Incident management reports are stored in a register.
The communication and reporting procedures for an incident are outlined in the procedure. The procedure outlines to stakeholders the communication processes that NZX will use to notify Market Participants and Data Distributors of issues that may lead to the suspension of trading or impact on key systems.
The procedure includes the processes NZX will use to communicate about failures. This relies in part on text messaging. NZX has identified that the text message service had not worked very well for technical reasons. NZX is working with its user groups to identify the most effective avenues for communication.
The first real trial of the incident management procedure was in December 2005 when a software bug caused the debt market to cease operating. NZX received positive comments about how it communicated the explanation of the outage. It also appears that NZX followed its published procedures.

Capacity of core systems

NZX considers the NZX system to be mature and stable. It has been operational for a number of years and progressively developed to meet market and user requirements and demand. The trading system is currently running at less than 20% of capacity. The system can be reconfigured to allow more trades if near-capacity is reached.

Monitoring and supervision of systems

Staff expertise and training

The Market Operations Group comprises experienced individuals who are knowledgeable about the operation of New Zealand's securities markets as well as specific software and technologies. NZX considers that little training is required in terms of technical knowledge for the people in this Group. There is a focus on the development of individuals, given evolving technologies and technical trends that NZX needs to stay abreast of. The Information Technology team has attended international courses on such matters.

Monitoring of systems and change management

A series of procedures is carried out at the start of each day to make sure that everyone is connecting to the trading platform and that the registries are connecting. These "start of day" procedures are run by the Information Technology Operations team. The NZX network has diagnostic equipment to provide notification if a link is down and SMS texting that is automatically generated if there is a network failure.
NZX considers that it has a network design now that works very well and the design that it wants. NZX focuses on ongoing monitoring of the infrastructure environment. We queried how NZX benchmarks the performance of its IT systems. Each system has a classification according to its contribution to the IT framework. Standards are set against these around availability, reliability and access, and achievement of the standards is monitored by the Operations Group.
NZX has change-control guidelines to analyse any systems changes that may be required. Changes are tested in a test environment and there is a further test process before any change goes live. Changes are also managed through the communication channels.
The network is provided by Telecom. The Head of Market Operations advised us that NZX retains a critical level of involvement but it is Telecom's infrastructure and Telecom's design engineers who work on it. NZX has a package that maps the Telecom network, showing all Participants and where they are connected. There is ongoing monitoring of this and work has been carried out to ensure that each Market Participant has a separate connection and that there is no sharing of lines, so that if a connection goes down multiple Participants would not be affected.

Market Participant connection and accreditation

The Participant Rules do not mandate the way in which a Market Participant connects to the NZX network. NZX has given recommendations as to how it believes Market Participants should connect and that they should provide for an alternative connection if one is lost.
There are formal accreditation procedures and tests to be met before there is sign-off and recognition that a Participant is accredited. The system needs to be tested to ensure that it can interface with the NZX system. NZX requires the Participant to have fully developed and tested its system within the NZX test environment before applying to NZX for conformance. NZX produces information setting out the standard requirements for conformance.
Following initial accreditation and conformance testing, the Participant Compliance team looks at the way the Participant firm's back office systems are connecting during the inspection process.

Training for Participant users of the NZX systems

Training requirements for the Participants that use the trading system are set out in a practice note and information document. Determinations regarding the competence of the candidate in operating the system are made by the Operations and Development section of the Market Operations Group. Determinations on competence regarding the Participant Rules are made by Participant Compliance.
All FASTER dealers using the trading system undertake training with an NZX Trainer. Training is undertaken in a test environment. The feedback on the "train the trainer" system, introduced in December 2005, is that it is effective. Where the applicant fails the test, the competence of the NZX Trainer may be questioned. We understand this has not been an issue.
A trading participant is responsible and liable for all trading messages sent to the trading system. Each FASTER dealer has its own user ID and password to access the system. Access to systems is reviewed on inspection. Each firm that uses Direct Market Access ("DMA") facilities must have filters in place to ensure that any order entered via DMA does not cause the firm to breach any Participant Rules.
The inspection process reviews client order/trade records to review error records. Participants and their employees who frequently commit dealing errors are liable for suspension from operating the trading system. No Participants or any Participants' employees were suspended from operating the trading system in the review period.

Market infrastructure strategy and planning

External user groups provide feedback

NZX communicates with a number of external user groups in the areas of clearing and settlement, technology, and the securities industry more generally. User groups have given feedback that there is overall satisfaction with the trading, clearing and settlement platform. Where issues were raised by the user groups, NZX has taken steps to address those concerns.

Internal groups assess needs

NZX has a number of committees and groups comprised of NZX staff which focus on IT-related issues. In particular we note the IT Governance Committee. The responsibilities of the Committee are to have input into the technology strategy, to approve the resulting technology 12 month plan, prioritisation, and investment decisions. Essentially it provides oversight for NZX information technology, infrastructure and applications. The Head of Market Operations chairs the Committee.

Enterprise Risk Management Group

The Head of Market Operations heads the Enterprise Risk Management Group (also called the Internal Risk Committee). The Committee considers risks to both NZX as a listed entity and NZX as the market operator.
The Enterprise Risk Management Group is charged with monitoring NZX's risk profile. We are advised that it uses international standards to categorise risks - operational, financial, strategic, environmental and external. These are fed through to the Audit and Risk Committee of the NZX Board and to the full Board if considered necessary. In terms of Market Operations, the Group looks at operational risks arising from the core trading platform and infrastructure.

Resources

The IT Leadership Team identifies major maintenance requirements 12 months in advance for approval. Any new development expenditure requires a business case.
The Market Operations Group did not request or require any urgent investment in 2005. There were no major projects or investments that were deferred due to lack of resources. No major requests for resources had been declined. The majority of large investments were made in 2004 and early 2005.
The Market Operations Group considers that it is sufficiently resourced to carry out its functions. There is longevity in terms of the experience of the Group and specialist knowledge. A business case would be made if there were larger capital expenditure requirements.
The only area in 2005 where the Market Operations Group identified that it needed further resourcing regards the future clearing and settlement structure. This was identified in the corporate strategy and has been discussed by NZX. NZX does not consider the dual functioning of FSS and Austraclear (a transfer system for the real-time settlement of trades) to be efficient. NZX has recruited a resource from overseas who will be leading work to specifically investigate and recommend an approach to the clearing and settlement structure. This is an area where the Market Operations Group would have faced constraints without additional expertise.

Reporting to the Board

Relevant updates on market operations are presented to the Board in a report by the CEO. The Head of Market Operations does not present reports to the Board in the normal course. He may attend Board meetings if there is a paper that he has prepared or to support a paper prepared by the Market Operations Group.

Recommendation

NZX has adequate service levels and adequate systems and processes for back-ups and continuity planning. We make no recommendation in respect of the Market Operations Group.

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