New Zealand: a step in the right direction

A new draft version of New Zealand’s Financial Markets Conduct Bill was published for consultation in August. The bill provides greater clarity than the previous draft and removes uncertainty – but some further tweaks are needed, says Cindy Leiw of Isda

New Zealand’s Ministry of Economic Development (Med) released the latest version of the Financial Markets Conduct Bill for consultation in August – a 400-page draft bill that seeks to bring various pieces of legislation together, such as the Securities Act, Securities Markets Act and Superannuation Schemes Act, to name a few.

The legislative proposal will lead to some potentially significant changes for derivatives market participants, with parts of the sector falling under the regulatory spotlight for the first time. However, the new regime will create much-needed clarity in certain areas of the derivatives market. This article focuses on the impact this draft may have on derivatives participants.

Derivatives, financial products and the FMA

The latest proposal is applicable to ‘financial products’, which have been defined as (a) a debt security; (b) an equity security; (c) a managed investment product; or (d) a derivative.

The latest proposal differs from the 2010 Med-issued draft bill, which defined derivatives based on International Accounting Standard 39. This accounting definition excludes collective investment schemes, equity and debt. The International Swaps and Derivatives Association and its members submitted a response at the time, highlighting the departure of the derivatives definition from a predominantly form-based approach (under which a list of specified products and a catch-all category exists) to a substance-based approach (under which products are deemed to be derivatives if they have certain specified features, regardless of their form). Isda argued that the definition should include an element of the form-based approach, given the vagaries of the specified criteria, the diversity in product types, and the need for certainty of categorisation.

This issue has been resolved in the current draft bill. Derivatives are now defined using a hybrid of a form-based approach and a substance-based approach, similar to the equivalent definition in section 761D of the Corporations Act 2001 (Australia). However, the Australian definition expressly carves out spot transactions, while the proposed New Zealand definition does not.

While the proposed definition is a substantial improvement over the 2010 version, it requires a little more work. For example, the definition says the product needs to be “recurrently entered into in the financial markets”. This may be difficult to achieve, as one would not know how often a product will trade on day one. It also infers some sort of retrospective classification may occur if the product becomes regularly traded some time after day one. In addition, the definition would capture an intangible product that is not a financial instrument, such as a forward sale on intellectual property, which is probably not the intent of the definition.

Meanwhile, the Financial Markets Authority (FMA), New Zealand’s financial regulator, has the ability to make certain declarations concerning the classification of a financial product. For example, the FMA may at its discretion declare that a security is a financial product of a particular kind. It also has the power to declare such classification with retrospective effect – which could be operationally difficult and onerous for derivatives participants to implement. If the FMA was to apply an extensive list of published principles/factors (over and above the economic substance of the relevant financial product) when making a declaration, derivatives participants would have greater certainty that the classification/re-classification of a financial product would not be conducted lightly.

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New Zealand: a step in the right direction