Reserve Bank of New Zealand NZClear System

Transcription

1 Reserve Bank of New Zealand NZClear System Assessment of Observance of Principles for Financial Market Infrastructures July 2014 v1.1

2 2 Contents Introduction... 3 Document control... 4 Background on the Principles for Financial Market Infrastructures Executive summary The NZClear service Assessment methodology Summary of major changes since last update Principle-by-principle narrative disclosures Attachment A - FMIs: definition, organisation and function Attachment B - Typical trade on NZClear... 78

3 3 Introduction This is the initial self-assessment for the NZClear system against the Principles for Financial Market Infrastructures. This self-assessment has been prepared by the Financial Services Group (FSG) of the Reserve Bank of New Zealand. FSG is responsible for the operation of NZClear. As noted in Key Consideration 2.2, NZClear is subject to joint regulation by the Financial Markets Authority and the Prudential Supervision Department (PSD) of the Reserve Bank of New Zealand. Arrangements are in place to ensure that FSG and PSD interact with each other on an arm s length basis, including reporting to separate deputy governors of the Reserve Bank. This self-assessment represents the views of FSG and not the views of PSD.

4 4 Document control i. Change history This is the initial self-assessment for the NZClear system against the Principles for Financial Market Infrastructures ii. Related documents Document NZClear System Rules NZClear Operating Guidelines Overview of NZClear Annual Report for NZClear Reserve Bank of New Zealand (Designated Settlement System NZClear) Order 2012 Reference

5 5 Background on the Principles for Financial Market Infrastructures In April 2012, the Bank for International Settlements (BIS) Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organisation of Securities Commissions (IOSCO) published a set of twenty-four principles for financial market infrastructures (FMIs). CPSS-IOSCO define a FMI as a multilateral system used for the purposes of clearing, settling, or recording payments, securities, derivatives or other financial transactions. FMIs include systemically important payment systems, central securities depositories, securities settlement systems, central counterparties and trade repositories. CPSS-IOSCO s new principles replaced the existing standards for FMIs published in Core principles for systemically important payment systems (CPSS, 2001), Recommendations for securities settlement systems (CPSS-IOSCO, 2001) and Recommendations for central counterparties (CPSS-IOSCO, 2004). The new principles are wider in scope than the previous standards incorporating lessons learned from the financial crisis and take into account the experience of implementing the previous standards. CPSS-IOSCO members will strive to adopt the principles by the end of 2012 and put them in to effect as soon as possible. FMIs are expected to observe the standards as soon as possible. CPSS-IOSCO notes that the principles for FMIs are applicable to FMIs operated by central banks as well as those operated by the private sector. A number of the principles, such as legal and governance issues and operational risk, apply to all types of FMIs, whereas some of the principles only apply to particular types of FMIs. A definition of each type of FMI and a guide to the general applicability of principles to FMIs reproduced from Principles for financial market infrastructures, CPSS-IOSCO, April 2012 is provided as Attachment A.

6 6 1. Executive summary The Reserve Bank of New Zealand (RBNZ) operates the NZClear securities settlement system (NZClear). The RBNZ has evaluated the observance of NZClear with each of the principles for financial markets infrastructure developed by CPSS-IOSCO. The table below shows a summary of the RBNZ s assessment. Principles for FMIs NZClear Observed Broadly Observed Partly Observed Not Observed Not Applicable General organisation 1. Legal basis 2. Governance 3. Framework for the comprehensive management of risks Credit and liquidity risk management 4. Credit risk 5. Collateral 6. Margin 7. Liquidity risk Settlement 8. Settlement finality 9. Money Settlements 10. Physical deliveries Central securities depository & exchange-ofvalue settlement systems 11. Central securities depositories 12. Exchange-of-value settlement systems Default management 13. Participant default rules and procedures 14. Segregation and portability General business and operational risk management 15. General business risk 16. Custody and investment risks 17. Operational risks Access 18. Access and participation requirements 19. Tiered participation requirements 20. FMI links Efficiency 21. Efficiency and effectiveness 22. Communication procedures and standards Transparency 23. Disclosure of rules, key procedures and market data 24. Disclosure of market data by trade repositories Nineteen of the twenty-four principles for FMIs are considered to apply to NZClear. It is RBNZ s assessment that NZClear observes eighteen of these principles, with one principle being broadly observed.

7 7 The RBNZ s assessment methodology is explained in Section 3 of this report. NZClear s approach or method for observing each of the principles is summarized briefly below. General organisation New Zealand law together with the NZClear Rules provides an enforceable legal framework for NZClear activities (principle 1). The RBNZ s governance arrangements with the User Advisory Committee fulfill public interest requirements and promote the interest of NZClear users (principle 2). The RBNZ maintains a high level of security and operational reliability and maintains a formal business continuity plan. RBNZ senior management and the Board review performance. Internal controls are audited by PwC (as agent for the Auditor-General) and external audit reports are published on the RBNZ s website (principle 3). Credit and liquidity risk management NZClear s DVP settlement provides finality. Other than in respect of certain dividend payments and payment arrangements arising under legacy arrangements for a small number of fixed interest securities, RBNZ has no credit exposure to its members. NZClear Rules contain procedures in the event an error occurs including clawback of benefits to which a member is not entitled and loss allocation procedures (principle 4). NZClear does not require collateral to manage its or it participants credit exposure. As a result, principle 5 does not apply. NZClear is not a CCP and does not require a margin system to cover its credit exposure. As a result, principle 6 does not apply. Settlement in NZClear is effected by a Delivery versus Payment process BIS DVP model 1. Where parties to a transaction do not have the same ESAS accountholder act as their Participating ES Accountholder in NZClear, the cash element of all NZClear transactions is settled in central bank funds via the RBNZ s - Exchange Settlement Account System - ESAS (principle 7). Settlement Settlement of securities and associated cash payments occurs between NZClear members on an irrevocable and simultaneous basis. NZClear rules define the timing of settlement finality for transactions. NZClear is a designated settlement system under part 5C of the Reserve Bank of New Zealand Act 1989 which gives statutory backing for the finality of settlements (principle 8). RBNZ, through the provision of Exchange Settlement accounts, facilitates settlement of the cash leg of transactions in central bank funds (principle 9). NZClear is an electronic payment and securities transaction settlement system only. The system does not cater for the physical custody of, or settlement of transactions involving paper securities (principle 10).

8 8 Central securities depositories and exchange-of-value settlement systems All securities settled in NZClear are dematerialised and held in the name of the depository. The depository holds the securities as bare trustee and the NZClear Rules provide for each member having a beneficial ownership in the securities held. NZCSD, as a central depository, holds customer securities on behalf of its participants. Protection of participants assets is provided under Rule 9 (lodgement and holding of securities) of the NZClear Rules and provisions under the Trustee Act 1956 (principle 11). Settlement in NZClear is effected by a Delivery versus Payment ( DVP ) process (principle 12). Default management Settlement in NZClear is DVP. RBNZ as system operator may refuse to act on a member s instructions if it is aware of or believes that a member is in the process of making an application for bankruptcy or liquidation, is in statutory management or receivership, or other specified conditions are evident. NZClear members must notify the RBNZ immediately of any event that may impede the successful settlement of instructions. The RBNZ may expel a member where the member fails to comply with any provision of the rules, is guilty of any misconduct or is likely to apply for bankruptcy or liquidation and may suspend a member pending investigation of the member s non-compliance with the rules or misconduct (principle 13). NZClear is not a Central Counterparty -CCP 1 (principle 14 applies only to CCPs). General business and operational risk management Since NZClear is a central bank-owned system, it has not been assessed against the requirement to hold ring-fenced liquid net assets funded by equity to cover business risk and support a recovery or wind-down plan (Key Considerations ). This recognises central banks inherent ability to supply liquidity to support continuity of operations, should liquidity be required for this purpose. Similarly, NZClear has not been assessed against the requirement to maintain a plan to raise additional equity. Management and internal control systems of NZClear are robust and procedures are continuously improved. Internal controls are audited by PwC as agent for the Auditor-General. On-going internal audit reviews of key operational processes, change control processes, network and access control provide assurance that operational risk is being effectively managed (principle 15). All securities beneficially owned by members and lodged into NZClear are registered in the name of New Zealand Central Securities Depository Limited (NZCSD), which is a whollyowned subsidiary of the RBNZ. NZCSD operates as a bare trustee and is the custodian for securities beneficially owned by members of NZClear (principle 16). The RBNZ s risk management practices identify potential vulnerabilities. The NZClear system is designed for high availability and resiliency. The RBNZ maintains two fully equipped computer operations sites and utilises four separate systems (two at each site) with one system being designated production (primary) at any time and the other three designated as secondary. All three secondary systems are synchronised in real time to the primary 1 A CCP is an entity that interposes itself between counterparties to contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer, and thereby ensuring the performance of every open contract.

9 9 Access system. The location of the production system is alternated between sites on a regular basis (principle 17). Access arrangements are clearly set out in the NZClear Rules. Membership information is published on the RBNZ s website. The RBNZ favourably considers an application for NZClear membership from any institution (domestic or foreign), which, in its opinion is of good standing and has the necessary resources to meet its obligations as a NZClear member (principle 18). The RBNZ recognizes the risk of members of NZClear operating on behalf of other entities. The characteristics of NZClear as a Model 1 DVP securities settlement system largely eliminates settlement risk for the system operator and other users. While RBNZ does not monitor activity of its members undertaken on behalf of others, the RBNZ and members undertake to provide information deemed necessary for the purposes of the NZClear Rules when requested by the RBNZ. Accordingly, our assessment is that NZClear broadly observes principle 19. NZClear has one bilateral link to another FMI. RBNZ is a member of NZCDC Limited s system and uses NZCDC s Legal Title Transfer System to move securities between NZCDC and NZClear. Such movements result in electronic lodges to and uplifts from NZCSD. Efficiency An objective of the RBNZ is to promote the maintenance of a sound and efficient financial system. The RBNZ and NZX (operator of the other major securities settlement system in New Zealand) have a joint objective to ensure that New Zealand s clearing and settlement infrastructure is efficient, sound and responsive to industry needs. A memorandum of understanding supports open market access and interoperability in relation to clearing, settlement and depository activities (principle 21). The RBNZ interacts with members in several ways: a regular newsletter is ed to every member, an annual report on NZClear is published, a User Advisory Committee is elected and meets with RBNZ management four times each year, a customer survey is conducted every year and the results are reported back to the User Advisory Committee and members, and RBNZ management will meet with individual members (and with clients of members) from time to time. The NZClear SWIFT Interface (NSI) is a full application-to-application interface that allows members to enter cash transactions, fixed interest and equity trades automatically into NZClear via SWIFT messages sent over the SWIFT Network, without a user connecting to an NZClear terminal (principle 22). Transparency NZClear rules are considered to be clear and comprehensive and include: membership requirements, arrangements for achieving DVP settlement, members rights and obligations and the RBNZ s rights and obligations. The Rules together with NZClear operating guidelines, additional system information and a detailed schedule of fees are published on the RBNZ s website (principle 23).

10 10 Summary data is published in the NZClear annual report to members which is publicly available on the RBNZ website. This is high level data rather than the data contemplated by principle 24 which is not considered applicable in the context of NZClear.

11 11 2. The NZClear service NZClear is New Zealand s principal high-value securities depository and settlement system operated by the Reserve Bank of New Zealand (RBNZ). It is also used for high value cash transfers, providing real-time irrevocable settlements on a gross basis through the RBNZ s Exchange Settlement Account System (ESAS). Formerly known as the Austraclear New Zealand System, NZClear has been operating in New Zealand since NZClear is a designated settlement system under part 5C of the Reserve Bank of New Zealand Act, The process of obtaining designation included a thorough review of the NZClear Rules by the joint regulators. NZClear became a designated system in There are two major securities settlement systems in New Zealand: NZClear, which clears and settles debt securities and equities among wholesale counterparties; and the NZCDC settlement system which is a central counterparty system that clears and settles listed securities traded on NZX markets and also settles off-exchange trades and certain derivative transactions. A third system, ASX Clear (Futures) - previously Sydney Futures Exchange Clearing (SFE Clearing) - based in Australia, settles New Zealand futures and options products traded on the ASX. The securities market comprises government securities, corporate debt and equity securities and some derivative products. NZClear is an electronic securities settlement system that operates on a delivery-versus-payment (DVP) basis. The system also provides cash payments functionality. The system is classified as BIS DVP model 1 2 i.e. transfer instructions for both securities and funds are settled simultaneously with settlement on a trade-by-trade basis. Securities held on behalf of members of NZClear are registered in the name of New Zealand Central Securities Depository Limited (NZCSD), which is a wholly owned subsidiary of RBNZ. The RBNZ and NZCSD have entered into a Deed of Appointment of Custodian Trustee under which NZCSD has been appointed custodian trustee of the financial instruments registered in its name. RBNZ has undertaken to accept liability for all costs and debts of NZCSD in the event of a claim on NZCSD by a third party. NZClear offers settlement of a wide range of registered securities including registered certificates of deposit, treasury bills, New Zealand government bonds, corporate bonds and equities. Participation in NZClear by members and their bankers (known as Participating ESAS Accountholders ) is governed by the NZClear System Rules. Substantially all direct participants in wholesale financial markets in New Zealand are members of NZClear. 2 See BIS Delivery verses payment in securities settlement systems

12 12 NZClear allows members to: 1. hold their debt and equity securities in their securities accounts within the system, with the securities held for members at the relevant securities registries in the name of NZCSD. 2. record cash transactions in cash accounts which are provided to members by their relevant clearing bank. 3. record in members securities accounts and cash accounts, the settlement of sales and purchases of securities transactions and cash transfers in accordance with members instructions. The Rules provide that once a transaction is settled, the settlement is irrevocable. 4. give instructions to the RBNZ to deal with securities. This includes lodging securities into the system, uplifting securities from the system and issuing instructions to effect corporate actions relevant to the securities. Corporate actions include receiving interest and dividend revenue from securities and the processing of a range of other entitlements associated with ownership of securities, such as rights issues, bonus issues, takeover offers, dividend reinvestment plans, stock conversions and other like events. 5. use a function known as FINEWISS to create and issue fixed interest securities. Members who use this service enter into a FINEWISS Registry Agreement with the RBNZ. Under that arrangement, the RBNZ is the registrar for the relevant securities and uses the NZClear system for that purpose, with NZCSD being the sole registered holder of those securities. Members submit instructions to NZClear via electronic means, primarily via one or more of a dedicated telecommunications network, via the internet or via the SWIFT system. In all cases NZClear has security features in place designed to ensure that access is authorised and instructions received are authenticated. In the case of corporate actions, processing involves giving instructions either through NZClear, or in the case of more complex events, through manual communications. NZClear is owned and operated by RBNZ and, since it is not operated as a separate legal entity, the management and operation of NZClear fall under the governance structure of RBNZ, and are therefore subject to its normal oversight, decision-making and audit processes. Day-to-day operations, liaison with participants, and the ongoing development of NZClear are delegated to the RBNZ s Financial Services Group (FSG). FSG is headed by the RBNZ s Chief Financial Officer, and day-to-day business support is provided by the Payment and Settlement Services Team within FSG. FSG reports on the operation of NZClear to the Deputy Governor and Head of Operations. The RBNZ s Knowledge Services Group (KSG) supports the computer and telecommunications network and related security features utilised by the system. The RBNZ s Risk Assessment and Assurance Department provides on-going review of NZClear s risk management framework. The RBNZ Board and its Audit Committee also contribute to the regular review of risk management practices. Software support, software development and operational support services are provided by a third party service provider - Datacom Systems (Wellington) Limited (Datacom). The internal controls of NZClear are audited each year by PricewaterhouseCoopers ( PwC ), as required by the NZClear Rules, who act on behalf of the RBNZ s external auditor, the Auditor- General. The scope of this audit includes the controls performed by Datacom.

13 13 A User Advisory Committee, elected by members, ensures that NZClear members have an opportunity to contribute to the long term effectiveness and viability of NZClear, and that the RBNZ is aware of, and takes into account, the views of members concerning the strategy and operation of NZClear and approval and oversight of the rules by the joint regulators. Key NZClear statistics: June 2014 Average daily transaction volumes 1,242 Average daily transaction values NZ$ 8.3 billion Value of equities held in custody Value of fixed interest securities held in custody Number of members 121 NZ$ 28.5 billion NZ$159.2 billion

14 14 3. Assessment methodology The assessment of NZClear s observance with the principles for FMIs contained in this report is based on the assessment methodology published by CPSS-IOSCO 3. This assessment methodology is built on the gravity and urgency to remedy any issues of concern such as a risk management flaw, a deficiency or a lack of transparency or effectiveness that needs to be addressed. An explanation for the ratings applied in the assessment is shown in the table below. Rating Observed Broadly observed Partly observed Not observed Not applicable Definition The FMI observes the principle. Any identified gaps and shortcomings are not issues of concern and are minor, manageable, and of a nature that the FMI could consider taking up in the normal course of its business. The FMI broadly observes the principle. One or more issues of concern have been identified that the FMI is encouraged to address and follow up to better manage risks or improve operations. The FMI should pursue such improvements in a defined timeline. The FMI partly observes the principle. The assessment has identified one or more issues of concern that could become serious if not addressed in a timely manner. The FMI should accord a high priority to address these issues. The FMI does not observe the principle. The assessment has identified one or more serious issues of concern that warrant immediate action. Therefore, the FMI must accord the highest priority to address these issues in a timely manner. The principle does not pertain to the type of FMI being assessed because of the particular legal, institutional, structural, or other characteristics of the FMI. 3 Assessment methodology for the principles for FMIs and the responsibilities of authorities, Consultative report, April 2012

15 15 For the purpose of assessing NZClear s observance of the principles for FMIs, NZClear is considered to provide the function of the following types of FMIs: payment systems (PSs); central securities depositories (CSDs); and securities settlements systems (SSSs). A definition of each type of FMI and a guide to the general applicability of each principle to each type of FMI is provided as Attachment A. Nineteen of the twenty-four principles for FMIs apply to NZClear. The five principles not applicable to NZClear are: Principle 5: Collateral - NZClear does not require collateral to manage its or it participants credit exposure Principle 6: Margin - NZClear is not a CCP and does not require a margin system to cover its credit exposure Principle 10 Physical Deliveries: NZClear does not deliver physical securities Principle 14: Segregation and portability - applicable only for CCPs Principle 24: Disclosure of market data by trade repositories is not applicable because NZClear is not a trade repository and so the only disclosures made are in respect of high level turnover statistics. Principle 19 Tiered participation requirements is considered to be broadly observed.

16 16 4. Summary of major changes since last update This is the RBNZ s first self-assessment of NZClear s observance of the principles for FMIs.

17 17 5. Principle-by-principle narrative disclosures This section of the report contains detailed narrative disclosure for each principle for FMIs. The disclosure for each principle is intended to provide a narrative response for each applicable key consideration in sufficient detail and context to enable the reader to understand NZClear s approach or method for observing the principles. Principle 1: Legal basis An FMI should have a well-founded, clear, transparent, and enforceable legal basis for each material aspect of its activities in all relevant jurisdictions. Assessment: NZClear observes principle 1. Key Considerations KC1.1: The legal basis should provide a high degree of certainty for each material aspect of an FMI s activities in all relevant jurisdictions. NZClear is an electronic securities depository and settlement system owned and operated by the Reserve Bank of New Zealand (RBNZ). The Reserve Bank of New Zealand Act 1989 (the Act) gives the RBNZ the authority to operate the NZClear system. In addition to effecting transfer of securities between participants on a DVP basis and effecting settlement of cash payments between participants, the NZClear system includes: the central securities depository operated by New Zealand Central Securities Depository Limited (NZCSD); the performance of the custodian trustee role by NZCSD; and a system for the transfer of legal title to securities, including by electronic means. Securities held on behalf of members of the NZClear system are registered in the name of NZCSD, which is a wholly owned subsidiary of RBNZ. RBNZ and NZCSD have entered into a Deed of Appointment of Custodian Trustee under which NZCSD has been appointed custodian trustee of the financial instruments registered in its name. RBNZ has undertaken to accept liability for all costs and debts of NZCSD in the event of a claim on NZCSD by a third party. A well-established legal framework is in place. The laws governing the settlement of securities transactions within NZClear include the Reserve Bank of New Zealand Act, Companies Act, Trustee Act, Securities Act, Securities Markets Act and Securities Transfer Act. The key legal basis for the NZClear system is provided by the NZClear System Rules, which establish a complete, reliable and enforceable contract governed by New Zealand law. The rights

18 18 and interests of NZClear, its participants and the system operator are defined in the NZClear Rules. Under NZClear rules (Rule 11.9) settlements are final and irrevocable. Legal certainty of the settlement and finality arrangements is reinforced by the status of NZClear as a designated settlement system under part 5C of the Reserve Bank of New Zealand Act. NZCSD, as a central depository, holds customer securities on behalf of its participants. Protection of participants assets is provided under Rule 9 (lodgement and holdings of securities) of the NZClear Rules and provisions under the Trustee Act Where a NZClear participant is a custodian and holds assets in a sub-account in NZClear, the contractual arrangements between NZClear participants who are custodians and their clients lie outside the scope of NZClear rules. The electronic transfer of securities is regulated under the Securities Transfer Act This Act provides for the transfer of securities on-register by electronic means where the transfer system has been approved. NZClear has been approved by the Minister of Finance to operate an electronic interface to securities registries. Each NZClear participant, both local and offshore, is bound by the NZClear Rules and operating guidelines. The rules are governed by the laws of New Zealand and subject to the jurisdiction of the Courts of New Zealand. The system operates in New Zealand, any conduct in relation to the system occurs in New Zealand. All settlements take place in New Zealand. KC1.2: An FMI should have rules, procedures, and contracts that are clear, understandable, and consistent with relevant laws and regulations. The key legal basis for the NZClear system is provided by the NZClear System Rules, which establish a complete reliable and enforceable contract governed by New Zealand law. The NZClear System Rules are considered to be clear and comprehensive, and include:- NZClear membership requirements arrangements for achieving DVP settlement members rights and obligations, and the system operator s rights and obligations. Administrative and operating processes for NZClear are set out in the NZClear Operating Guidelines. The NZClear System Rules and NZClear Operating Guidelines are considered to be clear and consistent with relevant law and regulations. The Rules, Operating Guidelines and additional system information are available on the RBNZ website 4. The Rules were last updated in March NZClear is a Designated Settlement System under the Reserve Bank of New Zealand Act. Designation gives legislative backing to the finality of settlements effected in accordance with the rules of the system. 4 See

19 19 KC1.3: An FMI should be able to articulate the legal basis for its activities to relevant authorities, participants, and, where relevant, participants customers, in a clear and understandable way. NZClear is operated in New Zealand by the Reserve Bank of New Zealand. The rights and obligations of members to each other and the rights and obligations of the RBNZ as operator of the system are governed by a mutual contract entered into by all members. The NZClear Rules and Operating Guidelines are supplemented with explanatory material which is published on RBNZ s website to facilitate understanding by participants and prospective participants of the risks they face through participation in the system. Publicly available material includes high-level descriptions of NZClear operations and settlement process, the NZClear system (including test system), business continuity arrangements, classes of NZClear participant, technical documentation and fees and charges. There is a clear process for changing NZClear Rules and Operating Guidelines. Legal advice is sought in respect of all rule changes. Proposed rule changes are subject to a consultation with members and are submitted informally to the joint regulators for advice of any regulatory concerns. Formal submission of a proposed rule change is made to joint regulators which triggers a 21-working day period which provides the joint regulators with the opportunity to decline the proposed rule change. KC1.4: An FMI should have rules, procedures, and contracts that are enforceable in all relevant jurisdictions. There should be a high degree of certainty that actions taken by the FMI under such rules and procedures will not be voided, reversed, or subject to stays. Although participants of NZClear include entities which are incorporated in foreign countries, the rules are governed by New Zealand law and require that all participants submit to the exclusive jurisdiction of New Zealand courts. RBNZ has received legal advice confirming that the NZClear System Rules represent enforceable obligations under the laws of New Zealand. Legal advice provided to the RBNZ is there should not be any situation where a foreign law judgement could affect the operation of the system. From 2012, all NZClear members whose country of incorporation is outside New Zealand have been required to provide a legal opinion which is satisfactory to RBNZ and which provides the RBNZ with a suitable degree of assurance that the NZClear System Rules will be valid and binding on the participant under the laws of country in which the participant is incorporated. KC1.5: An FMI conducting business in multiple jurisdictions should identify and mitigate the risks arising from any potential conflict of laws across jurisdictions. The NZClear system operates in New Zealand. Although participants of NZClear include entities which are incorporated in foreign countries, the rules are governed by New Zealand law and require that all participants submit to the exclusive jurisdiction of New Zealand courts. RBNZs analysis of potential conflict of law across jurisdictions has identified no material legal risk.

20 20 Principle 2: Governance An FMI should have governance arrangements that are clear and transparent, promote the safety and efficiency of the FMI, and support the stability of the broader financial system, other relevant public interest considerations, and the objectives of relevant stakeholders. Assessment: NZClear observes principle 2. Key Considerations KC2.1: An FMI should have objectives that place a high priority on the safety and efficiency of the FMI and explicitly support financial stability and other relevant public interest considerations. NZClear is operated by the RBNZ. The RBNZ has a statutory responsibility to promote the maintenance of a sound and efficient financial system and RBNZ s objective is to operate NZClear to achieve outcomes which are consistent with that statutory responsibility. The RBNZ s high level objective in providing the NZClear and ESAS services is to ensure that payments system infrastructure services support the smooth functioning of the economy, by being designed and operated so that domestic and international standards of resilience and reliability are met, users needs are met and services are delivered efficiently and priced appropriately, the business structure and technology enable delivery of innovation and growth, and governance arrangements are consistent with the regulatory framework, stakeholder needs and the public interest. NZClear is designed to ensure that high value securities settlements and certain high value payments can be effected in a way which eliminates settlement risk and provides finality in a safe and efficient manner. RBNZ recognises NZClear is an integral part of New Zealand s payment infrastructure and in providing the NZClear service, the RBNZ places significant emphasis on the ensuring appropriate arrangements are in place to govern the system and ensure that risks are managed. Reflecting the critical importance of the NZClear system, RBNZ aims to operate NZClear at an extremely high standard of availability and resilience. From time to time, RBNZ undertakes reviews to ensure that settlement services provided by RBNZ (including NZClear) continue to evolve to meet the changing needs of the broader payment system. If there are any material changes proposed to NZClear, or if there are any emerging industry issues or developments which impact or potentially impact RBNZ s ability to meet the high level objectives for NZClear, these matters will be discussed with RBNZ payments policy personnel, joint regulators and industry stakeholders including direct and indirect participants in NZClear. The NZClear Rules make provision for a User Advisory Committee to be elected to represent members and provide feedback to RBNZ as system operator and input to significant proposals for material aspects of providing the service including proposed capital expenditure and fee changes. The User Advisory Committee ensures that members have an opportunity to contribute to decisions which are critical to the long-term effectiveness of NZClear and to ensure that the RBNZ is aware of and takes into account the views of members concerning the strategy, efficiency and effectiveness of NZClear.

21 21 Each year the RBNZ must prepare a plan and objectives for NZClear for the year ahead. Members have the opportunity to comment on the proposed plan before it is finalised. For each year ended 30 June, RBNZ prepares an Annual Report for the RBNZ as a whole including an assessment of its performance as operator of both NZClear and ESAS. Additionally, an annual report is prepared for the NZClear system which reports on performance against the plan and objectives that had been set for that year. The annual report for NZClear is discussed by the User Advisory Committee. The annual reports for RBNZ and NZClear are available on the RBNZ website. KC2.2: An FMI should have documented governance arrangements that provide clear and direct lines of responsibility and accountability. These arrangements should be disclosed to owners, relevant authorities, participants, and, at a more general level, the public. NZClear is owned and operated by RBNZ and, since it is not operated as a separate legal entity, the management and operation of NZClear fall under the governance structure of RBNZ, and are therefore subject to its normal oversight, decision-making and audit processes. As an independent central bank and statutory body, RBNZ is ultimately accountable to Parliament. The Governor and senior officials of the RBNZ appear before Parliament s Finance and Expenditure Select Committee to report on matters under RBNZ s responsibility. The RBNZ s Board s primary function is to monitor the performance of the Governor and the RBNZ on behalf of the Minister of Finance. The RBNZ Board has delegated oversight of internal and external audit responsibilities to the Board Audit Committee. The Board Audit Committee reviews external audit reports on NZClear s operations and monitors progress in implementing recommendations made as a result of internal and external audits. In accordance with the provisions of the Reserve Bank of New Zealand Act 1989, the Governor is responsible for the management of the RBNZ, and is therefore ultimately responsible for the operation of NZClear. Day-to-day operations, liaison with participants, and the ongoing development of NZClear are delegated to the RBNZ s Financial Services Group (FSG). FSG is headed by the Chief Financial Officer of the RBNZ who is responsible for overseeing the management of NZClear and NZCSD, reporting to the Deputy Governor/Head of Operations and, in turn, the Governor of the RBNZ whose performance is monitored by the RBNZ s Board of Directors. NZClear is a designated settlement system under part 5C of the Reserve Bank of New Zealand Act As a designated settlement system, NZClear is subject to conditions of designation outlined in the Reserve Bank of New Zealand (Designated Settlement System NZClear) Order 2012 and NZClear is subject to regulation jointly by the RBNZ s Prudential Supervision Department and also the Financial Markets Authority. Arrangements are in place to ensure that the Prudential Supervision Department and Financial Services Group interact with each other on an arm s length basis, including reporting to separate deputy governors of RBNZ. The RBNZ publishes an annual Statement of Intent (SOI) and an Annual Report, which report on the RBNZ s governance, objectives, strategies key performance indicators and performance. The RBNZ also publishes a NZClear annual report which reports on governance, risk management and performance of RBNZ with respect to the operation of NZClear. The RBNZ s SOI and Annual Report and the NZClear annual report are published on the RBNZ website. These documents include clear explanations of the governance arrangements for RBNZ.

22 22 KC2.3: The roles and responsibilities of an FMI s board of directors (or equivalent) should be clearly specified, and there should be documented procedures for its functioning, including procedures to identify, address, and manage member conflicts of interest. The board should review both its overall performance and the performance of its individual board members regularly. The RBNZ has a board of directors. The Board s primary function is to monitor the performance of the Governor and the RBNZ on behalf of the Minister of Finance. The RBNZ s board is appointed in terms of sections of the Reserve Bank of New Zealand Act. The Minister of Finance appoints the non-executive directors to the Board (section 54 and 56). In making appointments of directors, the Minister has regard to the person s knowledge, skill and experience, and the likelihood of any conflict between the interests of the RBNZ and any interests the person has or represents. In addition, section 58 of the Reserve Bank of New Zealand Act contains provisions to ensure directors are of good standing. Protocols are in place for managing any actual or perceived conflicts of interest which may arise for members of the RBNZ s Board. As described in Key Consideration 2.2, the Governor is ultimately responsible for management of the RBNZ, including the operation of NZClear. Responsibility for day-to-day operation of NZClear is delegated to Financial Services Group. Staff roles and responsibilities are set out in position descriptions. The RBNZ has a performance assessment process for all staff and management. For NZClear management, annual objectives and goals are established for NZClear s performance and development. Performance against these objectives and goals is monitored throughout the year. All staff are subject to a RBNZ Code of Conduct which requires all employees to carry out their duties with integrity and in a non-partisan manner. All employees must also comply with RBNZ s conflicts of interest policy. As described in Key Consideration 2.2, arrangements are in place to ensure that the Prudential Supervision Department and Financial Services Group interact with each other on an arm s length basis. KC2.4: The board should contain suitable members with the appropriate skills and incentives to fulfill its multiple roles. This typically requires the inclusion of non-executive board member(s). In practice, the individuals appointed to the RBNZ board typically have proven skills and experience in finance, accounting, business and/or public policy. Consideration is given to the existing mix of skills and experience on the Board and the fit of suitable new directors at the time of each new appointment. Details of all directors, including other directorships and employment, are published in RBNZ s Annual Report and on each appointment. The RBNZ board comprises not less than five and not more than seven non-executive members. The NZClear User Advisory Committee comprises up to seven members elected by NZClear members excluding the RBNZ that represent the various industries of NZClear participants (i.e. banking, broking, and custodian). In accordance with the provisions of the Reserve Bank of New Zealand Act, the Governor is appointed by the Minister of Finance on the recommendation of the RBNZ s Board. Appointments of Deputy Governors are made by the Board on the recommendation of the Governor. Since NZClear is owned by the RBNZ, and is not operated as a separate legal entity, the skills and qualifications of the Governor are determined in accordance with the RBNZ s broader responsibilities.

23 23 The RBNZ has human resources policies in place to help ensure that staff have the appropriate skills and incentives to fulfil their roles. These policies are described in Key Consideration 2.5. KC2.5: The roles and responsibilities of management should be clearly specified. An FMI s management should have the appropriate experience, a mix of skills, and the integrity necessary to discharge their responsibilities for the operation and risk management of the FMI. The RBNZ s Financial Services Group (FSG) is responsible for the administration of the business aspects of the NZClear system. FSG is headed by the RBNZ s Chief Financial Officer and day-to-day business operations are undertaken by the Payment and Settlement Services Team within FSG. RBNZ staff and management are appointed with regard to their skills to manage the development and operation of NZClear and associated depository. The roles and responsibilities of management and staff responsible for day-to-day operation of NZClear are clearly documented in position descriptions. RBNZ s senior management responsible for the operation and oversight of NZClear system have significant experience within the financial services industry. RBNZ has human resources policies in place to ensure that management positions are filled with employees with the appropriate skills, incentives, experience and integrity to perform their duties. RBNZ has a formal performance management programme, which sets out the expectations of employees, and ensures that timely feedback is provided. Recruitment and selection at RBNZ is based on the suitability of an applicant to carry out the specific requirements of the position to be filled, having regard to the applicant s: ability to perform the duties; relevant experience; relevant training and qualifications; and willingness to meet any particular requirement specified in the job description. RBNZ staff are subject to the Code of Conduct and Conflict of Interest policies. RBNZ aims to offer remuneration packages that attract employees able to perform their duties to a high standard. External advice is obtained to ensure that remuneration policies are consistent with market practice. KC2.6: The board should establish a clear, documented risk-management framework that includes the FMI s risk-tolerance policy, assigns responsibilities and accountability for risk decisions, and addresses decision making in crises and emergencies. Governance arrangements should ensure that the risk-management and internal control functions have sufficient authority, independence, resources, and access to the board. The RBNZ views risk management as an integral part of the general management task and the responsibility of day-to-day management, which in the case of NZClear rests with the Financial Services Group. The RBNZ s Risk Assessment and Assurance Department is responsible for providing advice on and monitoring of the RBNZ s risk management frameworks. The internal audit role also resides in this department. The Head of the Risk Assessment and Assurance Department reports to the Deputy Governor and Head of Operations, and also has direct access to both the Governor and Chair of the Board Audit Committee. The Board and its Audit Committee also contribute to the review of the RBNZ s risk management processes and oversight of its internal and external audit functions.

24 24 The RBNZ operates an Enterprise-wide Risk Management framework and this applies to all RBNZ risks including those which arise in operating NZClear. The Enterprise-wide Risk Management Framework identifies the existence of risks, controls which mitigate the risks and defines the extent of residual risk. Each risk is classified depending on the RBNZ s assessment of its potential severity and the probability that the relevant risk event will occur. The combined assessment of severity and probability results in risks being classified as high, medium or low. The Enterprise-wide Risk Management framework is updated each quarter and discussed by the RBNZ s Senior Management Group. It is reviewed by the RBNZ s board annually. Individual departments within RBNZ are responsible for: identifying business-specific risks; applying controls; maintaining risk-management systems; reporting on the effectiveness of risk controls; and implementing enhancements and taking remedial action as appropriate. Financial Services Group has established a documented risk management framework for NZClear which details tolerance for risk, and assigns responsibilities and accountability for management of risk. NZClear is primarily exposed to operational risks. These risks are identified by assessing the system and processes using risk matrices to identify potential vulnerabilities. To minimise risks, appropriate internal controls systems and procedures are developed and continuously improved on. The assessment is an on-going NZClear management responsibility. In addition, a comprehensive business continuity plan is maintained and key elements are either invoked (for example swapping production sites) or are regularly tested. This plan includes decision making authority and processes related to emergencies. The internal controls of NZClear are audited by PricewaterhouseCoopers (PwC) who act on behalf of the RBNZ s external auditor, the Auditor-General. PwC s audit reports are addressed to the Governor and reports are reviewed by the Audit Committee of the Board with external auditors, RBNZ governors and management in attendance. The PwC audit opinion is published on the RBNZ s website. The RBNZ s internal audit team also performs an annual audit of the NZClear system including an annual review of the relevant information technology environment. KC2.7: The board should ensure that the FMI s design, rules, overall strategy, and major decisions reflect appropriately the legitimate interests of its direct and indirect participants and other relevant stakeholders. Major decisions should be clearly disclosed to relevant stakeholders and, where there is a broad market impact, the public. RBNZ s governance arrangements ensure accountability and transparency to NZClear participants and other relevant parties. The NZClear Rules require that before a rule change is promulgated by the RBNZ as system operator, members must be provided a reasonable opportunity to comment in respect of a proposed rule change. RBNZ determines the period and process for such consultation but is not required to consult with members where, in the RBNZ s reasonable opinion, the rule change is required to be

25 25 effected urgently to mitigate a potential threat to the system. Also, joint regulators have a 21- working day period to disallow rule changes proposed by the RBNZ. The system s participants can influence decision making through the User Advisory Committee and direct representation to the RBNZ. This forum reviews the RBNZ s performance as system operator and considers future plans. The RBNZ ensures that it consults with members, particularly with respect to major initiatives, before important decisions are made. If there are any material changes proposed to NZClear, or if there are any emerging industry issues or developments which impact or potentially impact RBNZ s ability to meet the high level objectives for NZClear, these matters will be discussed with RBNZ payments policy personnel, joint regulators and industry stakeholders including direct and indirect participants in NZClear. Key system information including legal, operational access and pricing is publically disclosed on the RBNZ website as are User Advisory Committee minutes, external audit reports and user group presentations and minutes.