Publications: OVERSIGHT REVIEW OF NZX 2005


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OVERSIGHT REVIEW OF NZX 2005

GOVERNANCE

Monitoring and oversight of regulatory functions

NZX Board oversight of the NZX regulatory function has improved since the collapse of Access Brokerage in 2004.
A template for periodic separate regulatory reporting at each NZX Board meeting was developed as of November 2005, with significant involvement by the NZX Board in directing the development of this reporting template. Prior to this, the NZX Board received a report on regulatory matters via the CEO Report.
Each NZX Board meeting allows time for direct reporting to the Board by the Head of Regulation. NZX Board members and the Head of Regulation confirm that the working relationship is particularly productive, including open interaction between the Head of Regulation and individual Board members outside of scheduled Board meetings.
NZX Board members believe that with a reasonably small Board (six members including the CEO) the full Board, rather than a committee, should deal with regulatory matters. The Commission agrees that this strategic approach works well for the current NZX Board structure, and that NZX Board members are well-informed and involved regarding regulatory matters.
The NZX Board has set a "risk" threshold (i.e., risk to market integrity of a material nature) for escalation and reporting on regulatory issues to the Board. Functionally this is an appropriate standard and NZX Board members are sensitive to maintaining rigorous standards in this regard.
All NZX Board members are of the view that there are no financial resource constraints on the regulatory function (a view shared by the Head of Regulation), and that from a resource perspective their principal concern would be ensuring that appropriate professionals are available and responsible for regulatory activities. The Head of Regulation was satisfied that all requests for resources had been met in the review period.

Board composition

NZX Board members do consider it beneficial to have a blend of skills and competencies represented on the Board. This desired blend includes awareness of the need for experience regarding regulatory responsibilities.
The Commission believes that, with a small Board requiring members with securities industry experience, the NZX Board should continue to pay particular attention to achieving a Board with a balance of perspectives.

Identical delegations for regulatory responsibilities to the Head of Regulation and the CEO

The NZX Board believes, consistent with the current placement of the Market Supervision function within the NZX organisation, that it is appropriate for both the Head of Regulation and the CEO to have identical delegations for regulatory responsibilities. The Commission notes that these identical delegations organisationally and functionally reflect the NZX Board's belief that there is no inherent conflict between the commercial and regulatory functions of an exchange.
In practice it was clear that the Head of Regulation exercises supervisory authority over regulatory matters. However, we believe that the existence of the identical delegations to the CEO and Head of Regulation potentially blurs who is responsible for exercising the delegations and the circumstances in which the delegation is intended to apply, particularly in crisis situations. We recommend that the Board of NZX reconsider the issue to ensure that the responsibilities are clarified.

Regulatory crisis response and risk management

NZX Board members, except as noted herein, do reflect a focussed awareness of how NZX at all levels would respond to a regulatory crisis. The Commission notes that having two people with the same delegated authority for regulatory responsibilities creates potential for confusion. This may pose a risk to responding most efficiently to a regulatory crisis.

Market Operations policy setting

The NZX Board believes that overall operational performance improved during the review period. The Commission agrees and believes that the NZX Board appropriately communicates to executive management its rigorous performance expectations regarding market infrastructure and holds executive management responsible for meeting these expectations.

Board interaction with the Special Division

The NZX Board believes that NZX should not be treated any differently by the Special Division from any other issuer before NZXR. As to what would happen if NZX had to be taken to NZX Discipline by the Special Division, although there is currently no explicit understanding, the NZX Board would have no difficulty in giving an undertaking as to resources if this was sought by the Special Division and had no difficulty with a guarantee of resources. The NZX Board should give a formal guarantee of funding for the Special Division should the Special Division need to take NZX to NZX Discipline.

Placement of the Market Supervision function within the NZX organisational structure

NZX is the frontline regulator of the securities markets but can organise itself in the way it believes best enables it to fulfil its statutory obligations as a market regulator.
Currently the Head of Regulation reports to the Chief Executive Officer.
NZX Board members are of the view that this present organisational structure meets the needs of the New Zealand securities markets. NZX Board members informed us that the matter is given periodic consideration in light of differing structures in other jurisdictions.
The Commission notes that it is an increasing concern in overseas jurisdictions that an exchange's regulatory function is perceived to be as independent as possible from an exchange's commercial activities. In addition, the increasing evolution to autonomous structures for regulatory functions enables such functions to handle more efficiently the conflicts between the commercial and supervisory interests of an exchange. The Commission acknowledges that at present, in practice, NZX maintains an effective separation between its commercial and regulatory functions.
Nevertheless, the Commission is concerned that the unwillingness of the CEO and other NZX Board members to acknowledge that there is an inherent conflict within any 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 Market Supervision function.

Recommendation

The NZX Board takes an active and appropriate governance role in regard to NZX's performance of its regulatory responsibilities. We make the following recommendation:

Given the risk of lack of clarity regarding roles in responding to a crisis, the Commission recommends that responsibilities of the CEO and Head of Regulation for exercising delegated powers be reconsidered by the Board of NZX to ensure that the responsibilities are clarified.

NZX is of the view that these responsibilities are sufficiently clear at present, but has agreed to consider whether any further clarification is desirable, and to report back to the Commission by the end of this calendar year.

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