Reserve Bank and FMA release framework on Financial Market Infrastructures regulation
Today the Reserve Bank of New Zealand (Reserve Bank) and Financial Markets Authority (FMA) together released their finalised framework for assessing the systemic importance of Financial Market Infrastructures (FMIs). This followed consultation with the industry and stakeholders, and was accompanied by publication of their responses to submissions received and the submissions themselves.
The Financial Market Infrastructure Act 2021 (the Act) was passed by Parliament in mid-2021. After an ongoing transitional period, in which important implementation matters are to be developed, it will replace and expand the payment systems and settlement systems oversight regimes under the Reserve Bank of New Zealand Act 1989. Our discussion of the Act following its passage can be found on our website.
Under the Act, the Reserve Bank and FMA are, in general, jointly responsible for regulating FMIs.
Who needs to read it? Why?
The framework will be of interest to all financial institutions and businesses that operate or participate in financial markets in New Zealand.
Even for those that were subject to oversight prior to the Act, this is still a significant development, and those that were not will encounter greatly different treatment. The framework’s details on how the Act will be operated in practice will assist them in understanding how their businesses will be impacted.
What does it cover?
FMIs are the critical systems underpinning the financial system, allowing the clearing, settling, or recording of payments, personal property (or transactions involving it), or other transactions within the financial system to take place. Because of this role, their disruption or failure could have a significant adverse impact on, and threaten the stability of, or confidence in, the whole (or a significant part) of the financial system.
Under the Act, “designated FMIs” are subject to greater regulation, while in respect of other FMIs (and their participants) there are more limited regulator powers (primarily around information gathering and monitoring). An FMI being systemically important will be the primary basis on which designations are made.
Under the Act, an FMI is systemically important if either (or both):
- disruption to activities under the FMI 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, due to the transactions or other interconnections under the FMI between them, cause problems for one or more other participants,
that would threaten the stability of, 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 when assessing whether an FMI would meet this definition and be of systemic importance. The Act defines these factors (which align with international best practices for regulating FMIs) as:
- the size of the FMI (in respect of its activities in New Zealand), and its number of direct and indirect participants, which can include estimated future growth;
- the types of persons who are direct and indirect participants of the FMI (such as other FMIs, registered banks, and/or large corporates);
- the nature and scope of the activities under the FMI, including the interconnectedness (direct or indirect) of the FMI with other FMIs or other activities within the financial system and of direct or indirect participants with each other under the FMI;
- the way in, and extent to, which financial risks are concentrated within the FMI; and
- whether another FMI could promptly and effectively take over activities under an FMI were they to be disrupted, to mitigate the impacts of such.
The framework also sets out some detail on how each of these factors could be assessed in relation to specific kinds of FMIs (such as payment systems, central counterparties, and securities settlement systems).
Assessment of an FMI as systemically important is very much a matter of judgement and regulatory discretion for the Reserve Bank and FMA. The diversity of FMIs means a more prescriptive or score- or threshold-based approach is not appropriate. This assessment will need to be carried out on a case-by-case basis.
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 for how it will operate will assist affected entities in navigating the new regime.
While the Act 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 FMI, as a “multilateral system for the clearing, settling, or recording of…payments”. The comments that have been made about the diversity of FMIs seems to support this proposition.
It may be some time before a cryptocurrency system is used widely enough to constitute a systemically-important FMI. However, it will be important that operators in this space remain conscious of this regime, as if they did come to fall within this category their regulatory obligations could expand substantially.
The next step for the Reserve Bank and FMA will be consulting on an exposure draft of standards. The intended 18-month transitional period would conclude around the end of this year, but it is not yet known when the Order in Council that will bring much of the Act into effect will be issued.
If you have any questions in relation to the framework, the Act, or financial markets regulation more generally, or are considering how this may affect your business, please contact one of our experts.