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Designated settlement systems – questions and answers

1. What is a settlement system?

  • A settlement is the making of payment or the transfer of the title to, or an 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 Financial Markets Authority[1] is on securities settlement systems (including settlement systems for futures and other derivatives) and, in the case of the Reserve Bank, payment systems as well.

2. Why are settlement systems important?

  • 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.

3. What does designation achieve?

  • 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 Financial Markets Authority have an on-going role in overseeing designated settlement systems.

4. How can a settlement system be designated?

  • Applications for designation are to be made to the joint regulators (the Reserve Bank and the Financial Markets Authority). 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.
  • The policy document “The Designation and Oversight of Designated Settlement Systems” (DSS1) (PDF 128KB) explains the roles and policies of the Reserve Bank and the Financial Markets Authority. This document was finalised in March 2010 and updated in July 2011 to account for the establishment of the Financial Markets Authority.
  • Designation under Part 5C of the Act is an opt-in regime, with settlement systems needing to apply for designation. The application process and information that should be submitted with an application for designation are set out in this document: Application Guidelines for Designation under Part 5C of the Reserve Bank of New Zealand Act 1989 (DSS2) (PDF 53KB). This document was finalised in April 2010 and updated in July 2011 to account for the establishment of the Financial Markets Authority.

5. How do the Reserve Bank and the Financial Markets Authority work together?

  • The joint regulators have worked closely together for some time in developing the legislation, developing policy and in engaging with potential designation applicants. Details of how the regulators intend to work together are set out in the policy document.

6. With the designation of NZ Clear, does this mean that the Reserve Bank regulates its own system (NZ Clear)?

  • Yes, but this is not new - the Reserve Bank-owned Exchange Settlement Account System (ESAS) was designated in 2004. The Bank’s payment oversight work has also previously included oversight of NZ Clear. The potential conflict between these two roles is managed within the Bank by having the roles carried out by different departments with separate reporting lines. 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, as a designated settlement system, NZ Clear is regulated by both the Reserve Bank and the Financial Markets Authority as joint regulators.

7. What other designated settlement systems exist?

[1] The Financial Markets Authority was established on 1 May 2011. The Financial Markets Authority took over the functions of the now disestablished Securities Commission including those relating to designated settlement systems.