Designated settlement systems – questions and answers

A settlement is the making of payment or the transfer of the title to, or an in interest in, personal property.

A settlement system is a system or arrangement for effecting settlements or processing settlement instructions, and includes a payment system. A payment system is used for transferring funds.

While settlement arrangements can exist for a wide range of personal property transfers, the focus of the Reserve Bank and the Securities Commission will be 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.

Designation gives legislative backing to the finality of settlements effected, netting done, and personal property transferred, in accordance with the rules of the designated settlement system. In other words, it provides certainty that trades settled will not ‘unravel’ despite any enactment or law to the contrary. This certainty is particularly important in the event of the insolvency of a settlement system participant.

The Reserve Bank and the Securities Commission will have an on-going role of overseeing designated settlement systems.

By way of background, a key motivation for the previous payment system designation regime was to meet international expectations of legal certainty of settlement in order for the NZ dollar to be included among currencies settled by the Continuous Linked Settlement (CLS) system. CLS is used around the world to settle foreign exchange trades. The use of CLS to settle foreign exchange transactions effectively eliminates foreign exchange settlement risk (the risk associated with the time lags in the paying and receiving of foreign exchange transactions). CLS was designated under the previous payment system designation regime.

The only other payment system designated under the previous regime was the Reserve Bank’s Exchange Settlement Account System (ESAS). ESAS allows individual transactions between financial institutions to be settled electronically in ‘real time’.

An initial impetus for the amending legislation related to NZX’s plans for an exchange for the trading of emissions units and futures products, and its related plans for a new clearing and settlement system. Designation would provide for settlements in that proposed new system to operate with the legal certainties expected by international and domestic participants. The amending legislation allows both settlement and payments systems to seek designation. It does not affect the designation status of CLS and ESAS.

Austraclear is a securities settlement system that can also be used for high value cash transfers. There have been plans to seek designation for Austraclear but these were put ‘on hold’ when it became clear that the designation regime already in place for payment systems was to be extended to security settlement systems; a more complete regime that better fitted the role Austraclear performs.

Applications for designation are to be made to the joint regulators (the Reserve Bank and the Securities Commission). Joint regulators make recommendations to the Minister of Finance and the Minister of Commerce. The legislation sets out the matters that the joint regulators may have regard to when assessing applications. Further details on the planned application process and the proposed policies of joint regulators will be included in a draft policy document which will be released for public consultation shortly. We expect this document to be available by the end of November 2009.

The joint regulators have been working closely together for some time in developing the legislation, developing draft policy and in preliminary engagement with potential designation applicants. Particular details of how the regulators intend to work together will be set out in the draft policy document.

Yes, but this is not new - under the earlier regime the Reserve Bank designated ESAS and its payment oversight work also included oversight of Austraclear. The purpose of the Reserve Bank providing these systems is consistent with its regulatory purpose; i.e. the promotion of a sound and efficient financial system.

Also, under the new regime, if Austraclear NZ is designated it will be regulated by both the Reserve Bank and the Securities Commission as joint regulators.