Reserve Bank and FMA release framework on financial market infrastructure regulation

Today the Reserve Bank of New Zealand (reserve bank) and Financial Markets Authority (FMA) published their final version together framework to assess the systemic importance of financial market infrastructures (MFI). This followed consultation with industry and stakeholders and was accompanied by the publication of a their responses to the submissions received and the submissions themselves.

The Financial Markets Infrastructure Act 2021 (the Act) was adopted by Parliament in mid-2021. After an ongoing transition period, during which important implementation issues need to be worked out, it will replace and expand the payment and settlement systems oversight regimes under the Bank of New Zealand reserve. Our analysis of the law after its adoption can be found on our website.

By law, the Reserve Bank and the FMA are generally jointly responsible for regulating MFIs.

Who needs to read it? Why?

The framework will be of interest to all financial institutions and businesses that operate or participate in capital markets in New Zealand.

Even for those who were subject to surveillance before the law, this is still a significant development, and those who were not will face very different treatment. The framework’s details on how the law will be applied in practice will help them understand how their businesses will be affected.

What does it cover?

FMIs are the essential systems that underpin the financial system, enabling the clearing, settlement, or recording of payments, personal property (or transactions involving them), or other transactions within the financial system. Because of this role, their disruption or failure could have a significant negative impact on, and threaten the stability or confidence in, the whole (or a significant part) of the financial system.

Under the Act, “designated MFIs” are subject to stricter regulation, while for other MFIs (and their participants), regulatory powers are more limited (mainly in collection and monitoring information). A systemically important FMI will be the primary basis on which designations will be made.

Under the Act, an FMI is systemically important if either (or both):

  • the disruption of the FMI’s activities could cause problems for one or more participants (direct or indirect) of the FMI; and or
  • problems with one or more participants (direct or indirect) of the FMI could, because of the transactions or other interconnections within the framework of the FMI between them, cause problems for one or more other participants,

that would threaten the stability or confidence in the whole or a significant part of the financial system.

The framework provides guidance on the quantitative and qualitative factors that the Reserve Bank and FMA will consider in determining whether an FMI would meet this definition and be systemically important. The law defines these factors (which align with international best practices in regulating MFIs) as follows:

  • the size of the MFI (with respect to its New Zealand operations) and its number of direct and indirect participants, which may include an estimate of future growth;
  • the types of people who are direct and indirect participants of the MFI (such as other MFIs, registered banks, and/or large corporations);
  • the nature and scope of activities within the scope of the FMI, including the interconnection (direct or indirect) of the FMI with other FMIs or other activities within the financial system and direct or indirect participants between them within the framework of the MFI;
  • the manner and extent of financial risk concentration within the MFI; and
  • whether another FMI could quickly and efficiently take over the operations of an FMI in the event of a disruption, in order to mitigate the effects.

The framework also provides details on how each of these factors could be assessed against specific types of FMIs (such as payment systems, central counterparties, and securities settlement systems).

Assessing an MFI as systemically important is largely a matter of judgment and regulatory discretion for the Reserve Bank and FMA. The diversity of MFIs means that a more prescriptive approach or one based on scores or thresholds is not appropriate. This assessment should be made on a case-by-case basis.

Our point of view

We continue to welcome this more comprehensive regulatory regime as it brings New Zealand more in line with international best practice. The transparency and explanation that this framework provides as to how it works will help affected entities navigate the new regime.

Although the law and this framework do not appear to address the cryptocurrency space, it seems plausible to us that the underlying infrastructure of a cryptocurrency system could be an IMF, as a “multilateral system clearing, settlement or recording of…payments”. The comments that have been made on the diversity of MFIs seem to support this proposition.

It may take some time before a cryptocurrency system is used enough to be a systemically important MFI. However, it will be important for operators in this space to remain aware of this regime, as if they were to fall into this category, their regulatory obligations could expand significantly.

And then ?

The next step for the Reserve Bank and the FMA will be to consult on an exposure draft of the standards. The planned 18-month transition period would end towards the end of this year, but it is not yet known when the order in council that will put much of the law into force will be published.

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