CLEARING AND SETTLEMENT SYSTEM CONSULTATION MEMORANDUM Depository Rules August 2009
I. INTRODUCTION This Consultation Memorandum accompanies the proposed Depository Rules ( Rules ) and Depository Procedures which NZX have published for public consultation. NZX encourages interested persons to consider the proposed Rules detailed in this Consultation Memorandum. NZX welcomes submissions on any or all of the proposals set out in this paper. As set out in section IV of this Consultation Memorandum, submissions are requested by 2 September 2009. NZX would prefer submissions to be provided in electronic format. Submissions should be addressed to: Robyn Dey NZX Regulation NZX Limited PO Box 2959 WELLINGTON Fax: (04) 473 3181 Email: robyn.dey@nzx.com Those responding to this Consultation Memorandum are asked, as part of their response, to identify specifically the section, rule and paragraph number on which they are commenting. 2 of 8
II. BACKGROUND New Zealand has a settlement system for its capital markets that is unique. Currently Participants take counterparty risk against each other and settle trades bilaterally. The international norm is for a clearing house that acts as a central counterparty to novate, net, clear and settle trades. This central counterparty model allows Participants to easily assess the counterparty risk of a single institution that is regulated by a central government agency. NZX is implementing a clearing and settlement system that aligns with international best practice, in order to promote confidence and participation in NZX s markets. NZX s model comprises a central clearing house (the Clearing House operated by New Zealand Clearing Limited) and securities depository (the Depository operated by New Zealand Depository Limited). These Depository Rules, together with the Depository Procedures, provide the rules in relation to the operation of the Depository, including the rights obligations of the operator of the Depository (New Zealand Depository Limited, known as CDO ) and participants in the Depository House (known as Depository Participants ). These rules are further described below. 3 of 8
III. Proposed new Depository Rules Set out below is a description of each section of the new Depository Rule Book. 1. Section 1: Introduction and General Provisions Section 1 of the Rules is an introductory section, which sets out the purposes of the Depository, the status of the Rules, the process for amendment of the Rules, defined terms and rules of interpretation. As provided for in Rule 1.1, the broad purpose of the Depository is to enable: - electronic custody of admitted product (which will include securities and various forms of carbon credits), - recording of beneficial interests of admitted product, - Depository Participants, who are also Clearing Participants, to discharge delivery obligations for the purposes of the Clearing and Settlement Rules, and - Depository Participants to settle transactions in admitted products. CDO also makes available to Depository Participants various services and facilities in the Depository. These include, but are not limited to, stock lending transactions in admitted products. Rule 1.2 sets out the status of the Rules. The Rules, including any procedures made in accordance with the Rules, are a binding contract between CDO and each Depository Participant. The Rules provide for the basis upon which settlement instructions are given by Depository Participants and CHO to CDO, the basis on which settlements between Depository Participants and CDO are effected, and any action to be taken in relation to a default or prospective default. Rules 1.3 and 1.5 provide for a process for amendment of the Rules, and the effect of amendment of the Rules. Any amendment to the Rules must occur in accordance with the provisions of the RBNZ Act, and therefore the Rules relating to the process for amendment of the Rules should be read in conjunction with the relevant statutory provisions. Rule 1.4 provides for the adoption by CDO of written procedures relating to the operation of the Depository and the activities of CDO and Depository Participants under the Rules. The Procedures are not intended to form part of the Rules. However if a Rule requires compliance with any part of the Procedures, failure to comply with the Procedure is a breach of the Rule. Rule 1.6 provides for defined terms for use in the Rules, as well as rules of interpretation. The terms that are used in the Rules and are not defined in the Depository Rules, but which are defined in the Clearing and Settlement Rules, have a meaning given to those terms in the Clearing and Settlement Rules. That is, where a capitalised term is not defined in Rule 1.6.1, then users of the Rules should refer to the Clearing and Settlement Rules for the definition of the capitalised term. 2. Section 2: Depository Participants Section 2 of the Rules provides for rules relating to eligibility criteria for access to the Depository as a Depository Participant, application procedures and ongoing obligations in relation to the continued status as a Depository Participant. Rules 2.1, 2.2 and 2.3 together provide for the application procedures and eligibility criteria for acceptance of a person by CDO to be a Depository Participant. Only Depository Participants are permitted to access the Depository System and lodge admitted product in the Depository. Rules 2.4 and 2.5 provide for certain generic ongoing obligations in relation to a person s status as a Depository Participant. In particular, each Depository Participant must act as if it were principal in all of its activities with CDO and must, in all cases, be responsible and liable to CDO as if it were principal and not agent. In addition, a Depository Participant must at all times ensure that its directors, personnel, agents and other persons acting on the Depository Participant s behalf comply with the Rules and procedures, any decisions, directions and requirements of CDO under the Rules or Procedures, and undertakings between the Depository Participant and CDO. 4 of 8
3. Section 3: Depository Accounts Section 3 provides for the opening and maintaining within the Depository of various accounts, for both admitted product and money. Section 3 further provides Rules in relation to the lodgement of admitted product into a product account, the uplift of product from a product account, and the ownership of admitted product in a product account. Rule 3.1 provides that each Depository Participant must have at least one general product account. Further, each Depository Participant that is a Clearing Participant must have a product settlement account. A product settlement account must be used only for the purposes of effecting settlements with CHO in accordance with the Clearing and Settlement Rules. Each Depository Participant that is a Clearing Participant irrevocably authorises CHO to give, and directs CDO to accept and implement, instructions in relation to the settlement through the products settlement accounts of transactions in accordance with the Clearing and Settlement Rules. Rule 3.2 provides for the opening and maintaining of money accounts in the Depository for a Depository Participant. As with product settlement accounts, each Depository Participant that is a Clearing Participant must have a money settlement account. The money settlement account may be used only for the purposes of effecting settlements with CHO in accordance with the Clearing and Settlement Rules. CDO must not credit a money account (other than a payment received from another Depository Participant s money account) unless CDO has confirmed the receipt of a matching amount in either CDO s ESAS account (in the case of NZ dollars) or CDO s relevant account in the Clearing Bank (in the case of foreign currency). Rule 3.5 provides for the lodgement of admitted product in the Depository. This involves the transfer of admitted product into the custody of the Depository. Under the Rules, this must occur in accordance with the form prescribed by Procedure. To lodge admitted product in the Depository, legal title to the admitted product must be transferred to the nominee (New Zealand Depository Nominee Limited). CDO is the managing trustee of the Depository and appoints the nominee as the custodian trustee of the admitted product lodged in the Depository. Rule 3.6 provides that, by lodging admitted product into the Depository, a Depository Participant agrees that the Depository Participant will be treated for the purposes of the Rules as sole beneficial owner of the admitted product. A Depository Participant further agrees it will not assert any proprietary or equitable right in respect of the admitted product other than the absolute beneficial ownership on behalf of the Depository Participant. However, the Rules do provide that a Depository Participant may designate any admitted product held in its product account as being held by it for a particular purpose, in a particular capacity, or in connection with a particular depository instruction or client of the Depository Participant. However, such designation operates solely for the benefit of the Depository Participant and will not constitute notice to CDO or to any other person as to the existence of any limitation on the ability of a Depository Participant to deal with the admitted product. A Depository Participant who has lodged admitted product in the Depository is entitled to all rights incidental to beneficial ownership of the admitted product held in its account, including receipt of distributions and exercise of voting rights. Subject to the Rules, CDO may rely upon, and shall use its reasonable endeavours to act upon, instructions from a Depository Participant in relation to the exercise of voting or other discretionary rights in respect of admitted product held in a product account. However, this does not apply in a product settlement account. CDO or Nominee may refuse to act on any direction given by the Depository Participant in relation to admitted product in the product settlement of the Depository Participant. Rule 3.8 provides for the uplifting of admitted product from the Depository. As with lodgement, uplift of admitted product must occur in the form prescribed by Procedure. To give effect to a request for the uplift of admitted product, CDO will transfer legal title to the admitted product from the name of the nominee into the name of the Depository Participant. The Rules provides for restrictions on when requests for an uplift of admitted product can be made. 5 of 8
4. Section 4: Depository Transactions Section 4 provides for the giving by the Depository Participant of instructions to CDO to transfer beneficial ownership of admitted product within the Depository, and to transfer money from the money account of a Depository Participant to the money account of another Depository Participant within the Depository. Rule 4.1 provides that CDO must execute instructions by making the appropriate debits and credits to the product account and/or money account of the Depository Participants specified in the instruction, provided that there is sufficient product or money (as the case may be) in the accounts of the Depository Participant when aggregated with all other instructions relating to that admitted product and money given by the Depository Participant. Rule 4.3 provides that settlements are final and may not in any circumstances be reversed or avoided after an amount is credited or debited a money account, or admitted products are accredited to or debited from a product account. Rule 4.5 provides for the recording of the security interest of another Depository Participant who was a secured party in specified admitted product held in an account of that Depository Participant (other than a product settlement account). Rules 4.6 and 4.7 provide for the passing of information held by CDO to Depository Participants relating to a corporate action in respect of admitted product, and the passing on of information in relation to the persons recorded in the Depository as the beneficial owner of the admitted product. Rule 4.7 provides for the passing through to the Depository Participant s money account of any distribution in the form of money received by the Nominee in respect of an admitted product in the Depository. Where the Nominee receives any additional admitted product as the result of a corporate action, CDO will record the relevant Depository Participant s interest in that additional admitted product by crediting the relevant product account of the Depository Participant. Rule 4.9 provides that CDO must give notice to a Depository Participant in the event that CDO makes an error which results in the Depository Participant receiving money, admitted product or other property to which the Depository Participant is not entitled. Rule 4.9 further provides that CDO may specify steps that must be taken by the Depository Participant in order to return the benefit it has received to the person entitled to receive the benefit. However, any correcting action must not derogate from the irrevocable settlement of a Depository Transaction. 5. Section 5: Stock Lending Section 5 provides Rules in relation to lending transactions in an admitted product. Only Depository Participants who are also Clearing Participants may undertake lending transactions in relation to an admitted product held in the Depository. Rule 5.1 provides that a Depository Participant may identify an admitted product which is available for lending in accordance with the Rules. Rule 5.2 provides for a lending transaction to be initiated by a Depository Participant giving notice that it wishes to borrow an admitted product. Alternatively, CHO may also give notice that it proposes to borrow admitted product under the Clearing and Settlement Rules to remedy a settlement failure. On receipt of a borrowing request, CDO will randomly select a lender from the Depository Participants who have indicated they have sufficient specified admitted product available for lending. CDO may identify one or more Depository Participants to satisfy a borrowing request. Each lending transaction is undertaken on the terms set out in Rule 5.4, which provides for the delivery of admitted product, warranties given by the lender and the borrower, and the payment by the borrower to the lender of the borrowing fee. 6. Section 6: CDO Powers Section 6 of the Rules provides for various general powers of CDO in relation to the approval of classes of property that may be lodged in the Depository. Section 6 further provides for provisions for complaints and investigations undertaken by CDO, CDO s powers to give waivers or rulings, set fees and undertake actions in response to a state of emergency. 6 of 8
Rule 6.2 provides that CDO may approve a class of property as admitted product that may be lodged in the Depository. CDO may subsequently withdraw its approval, and may also require as a condition of approval conditions it considers appropriate having regard to the integrity, reliability and efficiency of the Depository. The approval of a class of admitted product will be automatically suspended upon the commencement of liquidation of an issuer of that admitted product. Rules 6.3, 6.4 and 6.5 relate to the receipt and consideration by CDO from any person of a complaint about CDO, CDO s operation of the Depository, the nominee, a Depository Participant or a Depository Participant s directors, personnel or agent s depository activities. Under Rule 6.4, CDO may exercise various powers of investigation for the purposes of ascertaining whether a Depository Participant is complying, or has complied with the Depository Rules or the Rules or requirements of any person with whom CDO has a reciprocal regulatory arrangement. These powers of investigation include requiring any Depository Participant to produce for inspection documents or records, requiring the Depository Participant (or any of its directors, personnel, agent or other persons within the control of the Depository Participant) to answer questions, provide explanations and/or give evidence as may be required by CDO. Rule 6.5 provides that information obtained pursuant to these powers of investigation may be disclosed in various limited circumstances, otherwise CDO must take all reasonable measures to protect any information obtained by CDO pursuant to the powers of investigation from any unauthorised use or disclosure. Depository Participants may request information obtained by CDO under the powers of investigation not be disclosed to specified persons. Rule 6.6 provides for a general power for CDO to waive all or any part of the Rules and for CDO to make rulings as to the interpretation of the Rules. CDO may make rulings and grant waivers on such terms and conditions as CDO thinks fit. Rule 6.7 provides for the imposition from time to time by CDO of fees, levies and other charges as CDO thinks fit. These will be published by way of Procedure. Rule 6.8 provides for various actions that may be taken by CDO if CDO determines that a state of emergency exists or is developing. These actions include making state of emergency rules, suspending Depository facilities or services, taking any action, or directing a Depository Participant to take action which CDO considers appropriate, taking action in the name of and at the expense of a Depository Participant, and any other actions that may be inconsistent with the Rules. Where CDO has taken an action under the emergency powers provisions of Rule 6.8.1, no person bound by the Rules shall be liable for failure to comply with the Rules or Procedures (other than the Depository Participant s warranties or a state of emergency rule) where compliance has been delayed, interfered with, curtailed or prevented by CDO exercising emergency powers. 7. Section 7: Default and Termination Section 7 provides for rules relating to the occurrence of a default event with a Depository Participant, including the exercise of default remedies. This section also provides for rules relating to the suspension, resignation and termination of a Depository Participant s participation in the Depository. 8. Section 8: Transfer of Legal Title to Securities Section 8 provides for rules in relation to the electronic transfer of legal title to securities that are admitted product. The Designated Settlement System, including the Clearing House and the Depository, is intended to provide a mechanism for the transfer of legal title to securities without the need for execution of documents in paper format. This continues the functionality provided under the current FASTER system. Parliament is currently considering proposed amendments to the Reserve Bank of New Zealand Act 1989 ( RBNZ Act ), which among other things will establish a new opt-in regulatory regime for clearing and settlement systems in New Zealand. If the amendments to the RBNZ Act are passed by Parliament, NZX intends to make an application for the Clearing House and the Depository to be a Designated Settlement System for the purposes of the RBNZ Act. 7 of 8
If the clearing and settlement system comes into operation before its designation under the RBNZ Act, the part of the FASTER system used to transfer legal title will remain in use. Transitional provisions will need to be included into the Rules to provide for this. Legal title to securities may only be transferred electronically through the legal title transfer system within the clearing and settlement system if the issuer of the securities has entered into a Securities Transfer Services Agreement with CDO, under which the issuer agrees to the use of the legal title transfer system to transfer legal title to the issuer s securities by electronic means. Rule 8.2 provides that a Depository Participant may apply to CDO to be a Legal Title Transfer Depository Participant and access the legal title transfer system if it satisfies certain criteria set out in Rule 8.2. Rule 8.3 sets out the range of electronic transfers of legal title to securities that may be effected by either a Legal Title Transfer Depository Participant or CDO in accordance with the Rules. Broadly, these are transfers for the purposes of the transfer of legal title between a Legal Title Transfer Depository Participant and its client, and between a Legal Title Transfer Depository Participant and the nominee (for the purposes of lodging and uplifting securities in the Depository). Rules 8.6 to 8.10 provide for the mechanism for effecting the various forms of electronic transfer. Such electronic transfers are initiated by sending an electronic message through the legal title transfer system. Rules 8.13 and 8.14 provides for general obligations of Legal Title Transfer Depository Participants. These include rules in relation to the maintenance of a transfer account and an owned account on the securities register of each Issuer in respect of which the Legal Title Transfer Depository Participant or CDO gives effect to legal title transfer of securities under the Rules. These Rules also provide for obligations in relation to the authorisation and validity of instructions to transfer legal title to securities through the legal title transfer system, and the receipt and storage of a client s FIN or Authorisation Code. 9. Section 9: Miscellaneous Section 9 provides for miscellaneous matters, including the liability of CDO, an indemnity in favour of CDO, the provision of services by CDO, the giving of notices in accordance with the Rules, and various other general provisions relating to contract management and interpretation and operation of the Rules. Under Rule 9.1, CDO s liability to any person for any breach, act or omission whatsoever is limited to losses resulting from fraud by CDO (excluding indirect and consequential damages, loss of profits, good will, reputation or opportunity). CDO s aggregate liability for any one event is capped at NZ$5 million. IV. TIMETABLE The table below sets out the anticipated timetable for this review of the Rules. Action Consultation Memorandum for new Rules to be released for public consultation NZX to receive and consider submissions made in response to the Consultation Memorandum NZX to submit rules to the joint regulators (the Reserve Bank and the Securities Commission) in accordance with section 156Y of the Reserve Bank of New Zealand Act 1989 Anticipated date 12 August 2009 2 September 2009 1 October 2009 8 of 8