This document explains Part 5C of the Reserve Bank of New Zealand Act 1989 and the roles and policies of the Reserve Bank and the Securities Commission in relation to the designation and oversight of designated settlement systems.

Introduction

Settlement systems are at the core of the infrastructure that underpins financial markets and the wider financial system. Having sound and efficient settlement systems is a precondition to maintaining a sound and efficient financial system and instilling investor confidence. For these reasons, the Reserve Bank and the Securities Commission each has an interest in the oversight of settlement systems.

More specifically, Part 5C of the Reserve Bank of New Zealand Act 1989 makes the Reserve Bank and the Securities Commission joint regulators of designated settlement systems.¹ However, it also provides that the Reserve Bank is the sole regulator of designated settlement systems that are declared to be pure payment systems.

Designation under Part 5C is an opt-in regime, with settlement systems needing to apply for designation. This document explains the roles and policies of the Reserve Bank and the Securities Commission in relation to the designation and oversight of designated settlement systems, including background to the matters that the Act allows the joint regulators to take into account in considering an application for designation.

The application process and information that should be submitted with an application for designation are set out in the joint regulators' separate Application Guidelines for Designation under Part 5C of the Reserve Bank of New Zealand Act 1989 (DSS2).

The Reserve Bank's more general payment system oversight role is explained in its Statement of Principles: Payment System Oversight (PS1).

Settlement Systems

A settlement system is defined in the Act as a system or arrangement for effecting settlements or processing settlement instructions, and includes a payment system.² A settlement is defined as the making of payment or the transfer of the title to, or an in interest in, personal property. While these definitions potentially capture the settlement arrangements for a wide range of personal property transfers, the focus of the Reserve Bank and the Securities Commission is on securities settlement systems (including settlement systems for futures and other derivatives) and, in the case of the Reserve Bank, payment systems as well.

Payment and securities settlement systems are a key component of the financial infrastructure. Disruptions in a payment or securities settlement system can have repercussions not only for the market directly served by the system, but for the wider financial system. A payment or securities settlement system may trigger, transmit or amplify shocks across domestic and international financial systems and markets because of:

• The size or nature of the payments or settlements that are processed through the system.
• The aggregate value of the settlements and their importance to the circulation of liquidity within the financial system.
• The number of individuals and institutions who directly or indirectly participate in payment and securities settlement systems or who are otherwise affected by or have an interest in the soundness and efficiency of payment and securities settlement systems.

It is therefore important for investor confidence, the soundness and efficiency of securities markets, and the soundness and efficiency of the financial system as a whole that payment and securities settlement systems operate smoothly and efficiently.

What is a designated settlement system?

A designated settlement system is a settlement system that has been designated under Part 5C of the Act. A settlement system becomes designated by an Order in Council being made, on the recommendation of the joint regulators, declaring that a settlement system is a designated settlement system.

However, it should be noted that while the joint regulators have a role in the designation and ongoing oversight of designated settlement systems, neither the joint regulators nor the Crown are responsible or liable for any losses, damages, costs, or expenses suffered or incurred by or in connection with a designated settlement system.

Benefits of designation to a settlement system

The rules of a designated settlement system relating to the following matters are valid and enforceable despite any enactment or law to the contrary:³

• The basis on which settlement instructions are given or received.
• The basis on which settlement obligations are determined and calculated (either on a gross basis or using netting).
• The basis on which settlements are effected (either on a gross basis or using netting).
• Any action to be taken if a participant in the designated settlement system is unable, or likely to become unable, to meet the participant's obligations to any or all of the following:
  • the specified operator of the designated settlement system,
  • another participant in the designated settlement system, or
  • any other party to those rules.

Designation also gives legislative backing to the finality of settlements effected, netting done, and personal property transferred in accordance with the rules of the system.⁴

This provides a high degree of legal certainty to participants in a designated settlement system that they can rely on the settlements they receive.⁵ In turn, this contributes to the ongoing flow of liquidity in the financial system, the overall soundness and efficiency of the financial system, and the confidence of investors and other market participants.

Designation may also give the operator of a designated settlement system a super-priority in any personal property held to effect a settlement or mitigate a loss relating to the default of a participant.⁶ This is intended to provide a high degree of legal certainty that the particular designated settlement system will have recourse to the property it holds for those purposes. A designated settlement system will only have this benefit if it is specified in the designation Order in Council.

The Joint Regulators of Designated Settlement Systems

Part 5C of the Act makes the Reserve Bank and the Securities Commission joint regulators of designated settlement systems (other than those declared to be pure payment systems). The Reserve Bank alone is the regulator of designated settlement systems that have been declared to be pure payment systems.⁷

The Reserve Bank's purpose is to promote a sound and dynamic monetary and financial system. It must exercise its powers under Part 5C for the purposes of-

• Promoting the maintenance of a sound and efficient financial system.
• Avoiding significant damage to the financial system that could result from the failure of a participant in a settlement system.⁸

The Securities Commission's purpose is to strengthen investor confidence and foster capital investment in New Zealand by promoting the efficiency, integrity, and cost effective regulation of New Zealand's securities markets. It must exercise its powers under Part 5C for the purposes of-

• Promoting the integrity and effectiveness of settlement systems and related markets in New Zealand.
• Enhancing the confidence of investors and other market participants in settlement systems and related markets in New Zealand.⁹

In considering applications for designation, variation, or revocation each of the joint regulators may have regard, or refer, to, and may rely upon, any relevant information, work, or matter held, or produced, by the other joint regulator.¹⁰ This will mean that the joint regulators will work together in their analysis of the various matters they have to consider. The joint regulators will seek to optimise the use of overall regulatory resources in a way that takes into account their respective interests and which makes use of each regulator's comparative advantage and knowledge base.

The joint regulators may also share information obtained under or in connection with Part 5C with each other,¹¹ and each has a statutory obligation to notify the other if it receives an application for designation, variation or revocation, begins a review of a designation, or receives notice of a proposed rule change.¹²

The joint regulators envisage entering into and publishing a Memorandum of Understanding in relation Part 5C of the Act to provide a transparent and readily available record of how the joint regulator framework will operate in practice. Amongst other things, the MoU will establish communication protocols between the joint regulators and between the joint regulators and designated settlement systems (or applicants for designation).