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New Zealand Securities Commission |
Last Updated: 11 November 2014
Proposal to Declare Certain Foreign Exchange Contracts to
be Futures Contracts Under the Securities Markets Act 1988
24 April
2006
The Securities Commission is an independent statutory body. The Commission is reviewing its policy in relation to the futures regime under the Securities Markets Act 1988, with particular regard to foreign exchange dealing.
We invite comment on the matters raised in this paper. Any comments received will be subject to the Official Information Act 1982. It is the Commission's usual practice to make submissions available on request and where appropriate to draw attention to them in any further paper.
If you would like us to withhold information included in comments on this paper please state this clearly in your response. Any request to withhold information will be considered in accordance with the Official Information Act 1982.
TABLE OF CONTENTS
EXECUTIVE SUMMARY
1.1
The proposals set out in this discussion paper are likely to affect people
who are dealing in certain foreign exchange contracts,
in particular "rolling
spot" foreign exchange transactions. The discussion paper is also likely to be
of interest to securities lawyers.
1.2
The Commission has received requests from market participants for
clarification of whether certain types of financial instruments
are "futures
contracts" as defined in the Securities Markets Act 1988 (the "Securities
Markets Act"). These requests are in respect
of certain foreign exchange
products, known as rolling spot foreign exchange transactions.
1.3
There appears to be real doubt within the futures industry in New Zealand
regarding the application of the definition of "futures
contract" to rolling
spot foreign exchange transactions. The definition is included in the Appendix
to this paper.
1.4
The Commission believes it is necessary to clarify this situation. The
Commission considers it is important for there to be certainty
in the futures
industry as to what constitutes a futures contract for the purposes of the
Securities Markets Act. The Commission
believes it is desirable for instruments
that are used for the same purposes as futures contracts, and that in substance
carry the
same risks and potential rewards as futures contracts, to be treated
as such under the law.
1.5
The Commission proposes to use its specific power under the Securities
Markets Act to declare rolling spot foreign exchange transactions
to be future
contracts.
1.6
The effect of such a declaration will mean that people dealing in these
contracts will need to be authorised to deal in futures contracts
under the
Securities Markets Act. We discuss forms of authorisation that may be
appropriate to this area later in the paper.
1.7
It is important to note that the Commission is not undertaking a general
reform of futures regulation in New Zealand. Such an exercise
is being
undertaken by the Ministry of Economic Development as part of its review of
Financial Products and Providers. This paper
relates to a very specific part of
the futures market about which a number of participants have expressed
uncertainty.
2.
INTRODUCTION
2.1
Dealings in futures contracts are regulated in New Zealand under the
Securities Markets Act. The Securities Commission is the statutory
regulator of
futures dealers under this Act.
2.2
The Securities Markets Act requires people who carry on the business of
dealing in futures contracts to be authorised by the Securities
Commission.
2.3
There are serious penalties under the Securities Markets Act if people deal
in futures contracts without authorisation. Many futures
contracts are also
"securities" in terms of the Securities Act 1978 (the "Securities Act"). For
these reasons it is desirable that
market participants and investors have
certainty about the regulatory treatment of derivative products, so that
appropriate authorisations
or exemptions can be sought where
necessary.
2.4
The Commission has received several requests from market participants for
clarification of whether certain types of financial instruments
are "futures
contracts" under the Securities Markets Act. The statutory definition of
"futures contract" is not entirely clear in
its application to certain
products.
2.5
In particular, as requested by market participants, this paper discusses the
application of the law to certain margined foreign exchange
products known as
rolling spot foreign exchange transactions.
2.6
This paper proposes that the Commission uses its power under the Securities
Markets Act to declare rolling spot foreign exchange transactions
to be future
contracts.
2.7
The Commission welcomes comments from interested parties on its proposal. At
this stage we seek feedback principally on the regulatory
treatment of rolling
spot foreign exchange transactions.
2.8
We would also welcome more general comments from market participants
concerning other derivative products that have caused uncertainty
in respect of
their regulatory treatment under New Zealand law. We would be interested to hear
how market participants consider certainty
could best be achieved in this area;
for example whether law reform may be necessary. However, we should note that
the Commission's
declaration power is limited. Any more general law reform will
be a matter for the Government to consider, rather than the
Commission.
2.9
The effect of the Commission's proposed declaration will mean that people
dealing in rolling spot foreign exchange transactions will
be required to obtain
authorisation to deal in futures contracts under the Securities Markets Act.
2.10
In the event that a declaration is made, there will be an appropriate lead-in
period. Accordingly, market participants will not be
required to comply with the
Securities Markets Act overnight. In particular, we would seek to publish a
clear timetable and guidance
for any dealers who would require
authorisation.
2.11
Issues for comment are raised throughout the paper and a list of questions is
included at the end.
3.
Futures regime
3.1
The Securities Markets Act was originally called the Securities Amendment Act
1988. Part III of this Act establishes a regime for
the regulation of dealing in
futures contracts. The law envisaged regulation under a framework involving the
Commission and authorised
futures exchanges. This law was passed because of
concerns that futures contracts were, for the most part, securities in terms of
the Securities Act, but that the Securities Act did not provide an appropriate
mechanism for regulating dealings in futures contracts.
3.2
The Securities Markets Act prohibits dealing in futures contracts by anyone
who is not authorised by the Commission. This makes futures
dealers the only
financial intermediaries who are required by law to seek authorisation from a
regulator to conduct business in New
Zealand (other than the requirement under
the Sharebrokers Act 1908 for sharebrokers to obtain a licence from a District
Court).
3.3
The Securities Markets Act also defines what a "futures contract" is, and
gives the Commission a power to declare that other instruments
are futures
contracts for the purposes of the law.
3.4
The effect of this is that any person who carries on the business of dealing
in futures contracts without being authorised to do so
will face heavy criminal
penalties.
3.5
Until recently, much of the futures dealing in New Zealand was conducted
under the front line regulation of the New Zealand Futures
and Options Exchange
Limited ("NZFOE"), an authorised futures exchange. The NZFOE was a wholly owned
subsidiary of SFE Corporation,
the owner of the Sydney Futures Exchange ("SFE"),
which is also an authorised futures exchange in New Zealand.
3.6
In December 2002 the Commission published a discussion paper about the
regulation of futures dealers, following the decision by the
Sydney Futures
Exchange Limited to close the NZFOE in New Zealand and integrate its futures
markets into the markets operated by
SFE.
3.7
In September 2003 SFE reached an agreement with New Zealand Exchange Limited
("NZX"), New Zealand's only registered stock exchange,
whereby SFE would provide
a trading platform for equity options contracts promoted by NZX, called NZFOX.
At the same time, NZX announced
that it would take on a role as a front line
regulator of futures dealers in New Zealand. The Commission welcomed this move,
which
was in line with the preferences expressed by the great majority of people
who responded to the Commission's discussion paper in
2002.
3.8
The NZX Futures and Options Rules were approved by the Commission in March
2004. These rules provide a framework for dealers to seek
accreditation as NZX
Futures and Options Participants. The Commission has made a class authorisation
which permits any person who
is an NZX Futures and Options Participant to deal
in futures contracts under the terms of the NZX Futures and Options Rules.
3.9
The NZX Futures and Options Rules have their basis in agency trading by intermediaries and are designed primarily for firms dealing in futures contracts that are derived from securities. This means NZX regulation is likely to be most suitable for firms that:
3.10
Dealers whose business activities fit within the scheme of the rules should
seek accreditation from NZX, rather than direct authorisation
by the Commission.
3.11
However, there may be circumstances when the NZX Futures and Options Rules do not provide an appropriate framework for a dealer's business. NZX and the Commission consider that NZX regulation is unlikely to be suitable where the dealer:
3.12
Applicants who believe they come within the categories noted in paragraph
3.11 should approach the Commission directly to seek authorisation.
The
Commission is able to grant individual authorisations on such terms and
conditions as are appropriate to the case.
3.13
All authorised futures dealers are also subject to the Futures Industry
(Client Funds) Regulations 1990, which prescribe rules regarding
the operation
of clients' funds and require these to be kept separate from those of the
dealer. These rules seek to protect clients'
money and property in cases where
the dealer becomes insolvent.
Securities regime
3.14
Most futures contracts are also likely to be "securities" under the
Securities Act. A futures contract by its nature will give a party
a right to be
paid money in certain circumstances. This makes it likely that a futures
contract will fall within the broad definition
of "debt security" in the
Securities Act. Other types of futures contracts may be viewed as participatory
securities or, in the case
of equity options, as equity securities.
3.15
The Commission, and many in the industry, are of the view that most futures
contracts could be subject to both securities regulation
and futures contract
regulation. This raises a serious doubt as to which legislative framework should
apply to such products. The
application of two regulatory regimes to a product
increases costs for market participants without appreciably benefiting the
market
or investors.
3.16
The Commission has addressed this by granting an exemption from the
Securities Act for authorised futures contracts: the Securities
Act (Authorised
Futures Contracts) Exemption Notice 2002. The notice unconditionally exempts
persons who deal in authorised futures
contracts from the trustee, statutory
supervisor, prospectus and investment statement requirements of the Securities
Act and all
of the Securities Regulations 1983 (except regulation 8 - misleading
information) in respect of any authorised futures contract.
3.17
This exemption was enacted to provide certainty of regulatory treatment for
futures contracts that are securities for the purposes
of the Securities Act, as
was the entire body of futures legislation. The Securities Markets Act is
generally viewed as being the
regulatory framework that more sensibly fits
futures contracts.
3.18
Unlike many jurisdictions, New Zealand has no general regulation for
derivative products, other than that provided for futures contracts
under the
Securities Markets Act. We understand that regulation of derivatives will be
considered by the Government as part of its
review of securities
law.
3.19
Because derivatives are synthetic products that derive their value from the
value of an underlying commodity or instrument, the disclosure
and other
regulatory requirements that are suitable for these products are often different
from those for more conventional securities.
The Commission has addressed this,
in respect of various types of products, either by a tailored exemption under
the Securities Act
or by authorisation of the issuer under the Securities
Markets Act, subject to terms and conditions.
3.20
We believe rolling spot foreign exchange transactions are closer to futures
contracts in substance, and should, therefore, be regulated
under the Securities
Markets Act. However, people dealing as principals in rolling spot foreign
exchange transactions could be subject
to the requirements to register a
prospectus and have a trustee on the basis that the contracts may be debt
securities under the
Securities Act.
3.21
This paper proposes that the Commission should declare rolling spot foreign
exchange transactions to be futures contracts. Any declaration
would have the
advantage of exempting dealers in any contracts that were the subject of a
declaration from regulation under the Securities
Act, as the Securities Act
(Authorised Futures Contracts) Exemption Notice 2002 would be
applicable.
4.
FORMS OF COMMISSION REGULATION
4.1
If the Commission makes a declaration as proposed in this paper, people
dealing in the relevant contracts will need to seek authorisation
as futures
dealers (unless they are already authorised).
4.2
Before granting any authorisation, the Commission will need to be satisfied
that there is an adequate regulatory framework upon which
the authorisation can
be based.
4.3
The Commission will generally consider as part of any application to become
an authorised futures dealer whether the entity is subject
to any existing
regulation; for example, whether they are prudentially regulated or licensed in
another jurisdiction.
4.4
We believe that for wholesale participants this recognition of, and reliance
on, existing credible regulation to determine whether
an entity is a 'fit and
proper person' to deal in futures contracts is a sensible approach. Adopting
this approach, as the Commission
has done in the past, has the advantage of
reducing compliance costs associated with different regulatory regimes for the
dealer
involved.
4.5
In circumstances where an entity is not subject to existing regulation, any
authorisation application will require an assessment of
whether the entity is a
'fit and proper person'. In this regard, the "compliance reporter model" of
authorisation referred to in
paragraph 4.12 is likely to be
relevant.
Wholesale investors
4.6
The Commission has traditionally based its regulation of futures dealing on
whether the participants involved are wholesale or retail
investors. Unlike the
Securities Act, the Securities Markets Act does not contain any differentiation
between futures dealers that
deal exclusively on behalf of wholesale, rather
than retail, clients.
4.7
However, we consider that people who deal exclusively for wholesale
clients, such as large institutions, should be subject to a lower level of
regulation on the basis that the need for public investor
protection is lower
when only wholesale clients are involved.
4.8
Generally the conditions of wholesale authorisations aim to ensure that any
counterparty to a futures contract is a person that might
be assumed to have
either a sufficient level of assets or a sufficient knowledge of the futures
industry to be excluded from general
concerns about futures trading with retail
investors. We would usually consider that such a person can be presumed to be
'sophisticated'
and more able to look after their own interests.
4.9
The Authorised Futures Dealers Notice 2006 sets out a definition of "wholesale client" that is likely to serve as a precedent. This notice limits the dealer's clients to any person who is:
4.10
The Commission has also granted a number of authorisations to professional funds managers who deal in futures contracts on behalf of wholesale clients as part of their funds management business.
Retail investors
4.11
Depending on the circumstances, we have authorised dealers that propose to
deal in futures contracts on behalf of retail investors by way of two
different approaches.
4.12
In circumstances involving 'traditional' futures dealers (that is, people
acting as intermediaries), authorisation has involved a
combination of client
funds reporting, supervision, ongoing monitoring and disclosure; namely a
"compliance reporter model" of authorisation.
The compliance reporter model was
discussed in the Commission's discussion paper in 2002.
4.13
This model requires disclosure of certain information to clients about the
dealer and the futures contracts in which they deal, and
requires the dealer to
have appointed an independent "compliance reporter", who must be a qualified
auditor, to review compliance
with the firm's compliance manuals and undertake
6-monthly on-site inspections. An example of such an authorisation is the
Authorised
Futures Dealers Notice (No. 3) 2005.
4.14
Where the futures dealer is a party to the futures contract, we have often
considered it more appropriate to treat the dealer as if
they were an issuer
under the Securities Act, with the focus of the authorisation on the disclosure
to be given to potential investors.
In this type of situation we would envisage
that product disclosure along the lines of a New Zealand investment statement or
an Australian
product disclosure statement for Australian companies may be
suitable. An example of this is the Authorised Futures Dealers Notice
(No. 4)
2004. The terms of this authorisation require the dealer to provide detailed
disclosure under an Australian product disclosure
statement, similar to the sort
of disclosure that would be required for an offer of securities under the
Securities Act.
5.
DECLARATION POWER
5.1
The Commission considers it is important for there to be certainty in the
futures industry as to what constitutes a futures contract
for the purposes of
the Securities Markets Act. The enquiries we have received regarding aspects of
the futures regime and, in particular,
the regulation of foreign exchange
dealing, leads us to believe that clarification may be needed. We seek comment
on how such clarification
could best be achieved.
5.2
Under section 37(7) of the Securities Markets Act the Commission may, by notice in the Gazette, declare:
to be agreements to which
the Securities Markets Act applies; i.e. futures contracts.
5.3
This declaration power is also recognised in the definition of futures
contract in sections 37(1)(e) and (f).
5.4
It is important to recognise, however, that the Commission's power to make
declarations is quite specific. The Commission's power
does not extend to
declaring that an agreement, or a class of agreements, is not a futures
contract; or that any act or conduct does not constitute dealing in a
futures contract. The usefulness of the Commission's declaration power to
clarify the scope of the definition
of futures contract may be limited in this
regard. For example, it would not be open to the Commission to exclude spot
foreign exchange
transactions from the definition of futures
contract.
5.5
There is likewise no power to exempt people from any part of the futures
dealing regime. The Commission also cannot make any declaration
that would have
the effect of including the contracts listed in section 37(2) of the Securities
Markets Act within the definition
of futures contract.
5.6
The Commission has previously made declarations under section 37(7) mainly
'for the avoidance of doubt' when uncertainty exists over
the appropriate
treatment of derivative products, especially some equity options.
5.7
Other circumstances that may warrant the use of the Commission's declaration power include:
5.8
The Commission's declaration power must, like any discretionary power, be
used in a manner that is consistent with the purpose of
the Act under which the
power is used. The Commission cannot use its power to effectively override the
Securities Markets Act or
to declare agreements to be futures contracts where
this would be plainly inconsistent with the intention of the law.
6.
FOREIGN EXCHANGE CONTRACTS - PROPOSED DECLARATION
6.1
When the futures dealing laws in the Securities Markets Act were introduced,
all foreign exchange dealing was subject to regulation
under the Reserve Bank of
New Zealand Act 1964 and the Exchange Control Regulations 1985. Only an
authorised foreign exchange dealer
or a registered bank could carry out foreign
exchange transactions. As a consequence of this, section 37(2) of the Securities
Markets
Act originally excluded foreign exchange and interest rate swaps and
forward contracts from the definition of futures contract where
these were
carried out by any authorised foreign exchange dealer or registered
bank.
6.2
There are no longer any authorised foreign exchange dealers. As noted above,
foreign exchange and interest rate swap and forward agreements
are still
excluded from the definition of "futures contract" where a registered bank is a
party to the agreement. This covers the
majority of foreign exchange dealings in
New Zealand.
6.3
Recently there have been a number of companies established in New Zealand
that offer a variety of foreign exchange trading services.
Most of these are
simple exchange services, and do not raise any questions in terms of the futures
dealing regime. A small number,
however, offer dealing services in margined
forward exchange rate contracts and foreign currency forward contracts that may
be futures
contracts under the Securities Markets Act. A few of these businesses
have obtained authorisations as futures dealers. Most have
not. The reason for
this appears to be a real doubt as to the application of the definition of
"futures contract" to the foreign
exchange contracts offered by these
businesses.
6.4
The Commission has been informed that some firms are being advised by lawyers
that their business does not require authorisation.
Others have been advised
differently. In some cases the application of the law to foreign exchange
products turns on the legal form
of the agreements used by the dealer, rather
than the substance of the transaction.
6.5
The effect of this is that some industry participants have sought and been
granted authorisations to deal in futures contracts, with
attendant oversight
and protections for their clients and associated costs for the firms, while
others trade unregulated.
6.6
It is desirable for there to be certainty in the market concerning the scope
and effect of regulation. It is also desirable for instruments
that are used for
the same purposes as futures contracts, and that in substance carry the same
risks and potential rewards as futures
contracts, to be treated as such under
the law, so that there is consistency in regulation.
Spot contracts and forward contracts
6.7
Conventionally, over-the-counter (that is, non-exchange traded) foreign
exchange contracts can, with some variations, be divided into
spot contracts and
forward contracts.
6.8
A spot contract is, in its simple form, not a futures contract. It is an
agreement under which a person purchases an amount of a foreign
currency at the
exchange rate that applies at the time (or on the day) of the agreement (the
"spot" price). The person takes delivery
of the currency. This is, in essence,
the simple purchase of an amount of foreign currency.
6.9
A forward foreign exchange rate contract is an agreement to purchase an
amount of foreign currency at a fixed exchange rate on a future
date. Forward
foreign exchange rate contracts are commonly used by exporters and importers to
hedge against movements in currency
values.
6.10
It is common market practice for currency acquired under a spot contract to be delivered up to two days after the execution of the contract. However, future delivery alone does not, under New Zealand law, make an agreement a futures contract. An agreement is only a futures contract if one of the following applies:
6.11
In either of the above cases, it must be contemplated that the contract
between the two parties can be satisfied by means other than
actual delivery of
the foreign currency. Generally spot contracts can be settled only by delivery
of the currencies concerned. This
is also the case for some, but not all,
forward exchange rate contracts. Where this is the case, we do not think that
the contract
is a futures contract, nor do we consider there is in substance a
contract that should be regulated, in terms of the policy of the
Securities
Markets Act, as a futures contract.
6.12
However, where a contract for a commodity (including foreign exchange) has
any forward delivery element (even intra-day) and where
it is understood that
the contract can be settled rather than delivered, we consider this will be a
futures contract under paragraph
(a) of the definition in the Securities Markets
Act. Our understanding of paragraph (a) of the definition is that it does not
capture
a contract which can only be settled by actual delivery. If
delivery is not the only way the contract can be settled, then the agreement
will be a futures
contract.
6.13
Where a contract does not contemplate delivery of the commodity at all, but
sets out obligations for one party to pay the other depending
on the value of
the commodity on a future date compared to the value or price agreed at the time
of the contract, this is likely
to be a futures contract under paragraph (b) of
the definition in the Securities Markets Act.
Rolling spot contracts
6.14
While we think the law is sufficiently clear in its application to simple
spot and forward contracts, we are aware that there are
some instruments, the
use of which is growing in New Zealand, about which there is less certainty. The
main contract of this type
of which we are aware is called a rolling spot. A
rolling spot contract may sometimes be referred to as a margined foreign
exchange
contract. We understand them to be essentially the same
thing.
6.15
A rolling spot contract is, most commonly, a leveraged contract under which
the return or cost to each party depends on the value
at the end of the day of a
named currency, compared to its value at the beginning of the day. The actual
amount of foreign currency
underlying the contract is not deliverable. Instead,
the contract is valued on a daily basis and, depending on the movement of the
currencies concerned, each party is either debited or credited a sum of money.
The contract is valued and renewed on a daily basis
until closed, and the
client's account is either debited or credited each day. The position is closed
by the client taking a notional
opposite position for the same quantity of the
same currency.
6.16
In practice, dealers offering these products take both initial and ongoing
margins from clients to cover potential exposures as exchange
rates move
throughout the life of the rolling spot contract.
6.17
Most enquiries the Commission has received about the application of the law
to foreign exchange products have concerned rolling spot
contracts. In substance
these contracts are non-deliverable forward contracts of indeterminate duration.
In legal form, however,
they are intra-day contracts that are renewed
daily.
6.18
It seems that the form of rolling spot contracts highlights a gap in the
current definition of "futures contract". Paragraph (a) of
the definition only
applies where the contract is able to be delivered and where the contract
value is determined according to the value of a commodity at a specified
future time. It may be said that the settlement value of a rolling spot contract
is to be determined according to the value of the
currency at a specified future
time (being the market price at the close of the day), but it does not appear
that these contracts
are in form contracts for the delivery of a
currency.
6.19
It would appear to be more likely that paragraph (b) of the definition of
"futures contract" would fit rolling spot contracts. This
paragraph says that an
agreement is a futures contract if the obligations of the parties are to be
determined by whether or not at
a future date the value of a commodity is higher
or lower than a value agreed upon at the time the agreement was made. In form,
however,
the payment obligations under a rolling spot are determined according
to the value of a currency at the end of the same day on which
the contract was
made. The definition applies only where a future "date" is involved.
6.20
On the other hand, if the positions are effectively held open indefinitely in
spot foreign exchange transactions by being continuously
rolled over, this
rollover could arguably be viewed as introducing a future date. However, the
form of these agreements does not
in this respect accord with the economic
substance.
Regulation of rolling spot contracts overseas
6.21
It appears that the appropriate regulatory treatment of rolling spot
contracts has caused similar difficulties in overseas jurisdictions.
6.22
In the United States the issue was addressed in late 2004 by the Court of
Appeals for the Seventh Circuit, in the case of CFTC v Zelener1. The case looked
at whether rolling spot contracts and similar speculative transactions in
foreign currency were "contracts of sale
of a commodity for future delivery"
under the US Commodity Exchange Act and, therefore, within the regulatory
authority of the US
Commodity Futures Trading Commission ("CFTC").
6.23
The Court of Appeals found that these contracts were not futures contracts.
It did not consider that an absence of delivery was critical
under US
law.
6.24
The Court held that the transactions involved in the case were, in form, spot
sales for delivery within 48 hours as opposed to "contracts
of sale of a
commodity for future delivery". In the Court's view, the rolling-over of the
transactions and the consequent increased
gain or loss over a longer period of
time did not make the transactions future contracts.
6.25
Following this decision, we understand a legislative change has been proposed in the US. This would broadly include as a futures contract any agreement, contract or transaction in foreign currency that is offered, or entered into, on a leveraged or margined basis, or financed by the offeror, the counterparty, or a person acting in concert with the offeror or counterparty on a similar basis; but would not include:
6.26
There are similarities between the US Commodity Exchange Act and the relevant provisions of the Securities Markets Act, but there are also important differences that we think make it unsafe to place too much weight on decisions by US Courts for assistance in determining the appropriate regulatory treatment in New Zealand. For example:
6.27
United Kingdom financial services legislation treats rolling spot foreign
exchange contracts as futures. It does this by expressly
including rolling spot
contracts in the definition of "futures" under the financial services
legislation. This supports our view
that rolling spot contracts are in substance
the same as futures contracts, but is not helpful in determining whether they
are legally
futures contracts under New Zealand law.
6.28
In Australia we understand rolling spot foreign exchange contracts are
regulated by the Australian Securities and Investments Commission
as a financial
product under the Corporations Act 2001.
Proposed declaration
6.29
Trading in rolling spot foreign exchange transactions is likely to involve
the same risks, and have the same economic result, as trading
in standard
non-deliverable forward foreign exchange contracts.
6.30
If the rollover of a spot foreign exchange transaction could be viewed as
introducing a future date 'in substance', a party's gains
or losses would depend
on price movements in the future. On the other hand, section 37(1)(b) does
appear to require that 'in form'
the contracts must involve a future "date"
rather than being effectively intra-day like spot foreign exchange transactions.
This
appears to be one of the key differences between rolling spot foreign
exchange transactions and standard futures contracts.
6.31
Nevertheless, it is relevant to bear in mind the policy reason behind the New
Zealand law: that the speculative nature of futures
contracts, and the manner in
which they are traded, appears to require particular regulation. From the
perspective of investors,
it appears that the need for protection is the same in
relation to a rolling spot foreign exchange transaction as a standard futures
contract. This is particularly so given the practice of calling for margins to
support exposures in these contracts. If these agreements
are futures contracts,
margin payments should be held in separate client funds accounts under the
Futures Industry (Client Funds)
Regulations. If the agreements are not futures
contracts, there is no requirement for this protection to be afforded to client
funds,
including margin payments.
6.32
We consider a rolling spot foreign exchange transaction shares sufficient
similarities with a futures contract so that it should be
regulated under the
Securities Markets Act, despite the form of the contract being intra-day. In our
view, because the economic substance
of a rolling spot foreign exchange
transaction and, accordingly, the issues involved for investors, are essentially
the same as that
of a standard non-deliverable forward foreign exchange
contract, we believe rolling spot foreign exchange transactions should be
regulated as futures contracts.
6.33
The Commission proposes to use its declaration power to declare rolling spot
foreign exchange transactions to be futures contracts.
We believe such a
declaration would be consistent with the policy of the Securities Markets
Act.
6.34
For discussion, it appears to us that wording similar to the US proposal
mentioned in paragraph 6.25 may be appropriate to clarify
the situation in New
Zealand as well.
7.
OTHER OPTIONS FOR CLARIFICATION
Law reform
7.1
We would be interested to hear other suggestions about the best way to
clarify aspects of the futures regime and, in particular, the
regulation of
foreign exchange dealing.
7.2
The Government is reviewing the law regarding financial products and
providers. As part of this review it will, we understand, be
examining the
appropriate treatment of derivative products. It is unlikely that any
legislative changes from this review will occur
before 2008. This paper raises
issues that we consider might be usefully clarified in the interim.
7.3
We query whether industry participants consider it would be preferable for
the questions raised in this paper to be dealt with in
that review, rather than
by the Commission and, if so, why.
7.4
We recognise that the Commission's declaration power is limited. Any
necessary law reform will be a matter for the Government to consider,
rather
than the Commission.
8.
SUMMARY / TIMING
8.1
The Commission has received requests from market participants for
clarification of whether rolling spot foreign exchange transactions
are "futures
contracts" under the Securities Markets Act.
8.2
The Commission appreciates that regulation of derivatives will be considered
by the Government as part of its review of securities
laws. However, the
Commission believes it is necessary to clarify the situation in the interim.
8.3
The Commission proposes to use its power under the Securities Markets Act to
declare rolling spot foreign exchange transactions to
be future
contracts.
8.4
The effect of the Commission's proposed declaration will mean that people
dealing in these products will be required to obtain authorisation
to deal in
futures contracts under the Securities Markets Act.
8.5
In the event that any declaration is made, the Commission intends there to be
an appropriate lead-in period.
8.6
We welcome submissions from all participants in the futures industry on
whether it would be effective and appropriate to clarify the
application of the
Securities Markets Act by way of the Commission making a declaration. We would
also be interested in comments
on the proposed approach for any such
declaration, if this is considered to be an appropriate step for the Commission
to take.
8.7
The Commission welcomes comments from interested parties on the following:
8.8
We also welcome comments on any other relevant issues relating to the futures regime under the Securities Markets Act. Comments should be sent to the Commission by 5pm Friday 2 June 2006.
Postal: Securities Commission
Email: meredith.pearson@seccom.govt.nz
PO
Box 1179
WELLINGTON
Attn: Meredith Pearson
Facsimile: (04) 472
8076
Securities Markets Act - Definition of Futures Contract
Section 37(1) of the Securities Markets Act defines the term "futures contract", as follows:
"futures contract" means-
(a)
an agreement under which one party agrees to deliver to another party at a
specified future time a specified commodity or a quantity
of a specified
commodity at a price which is fixed when the agreement is made but under which
it is contemplated or understood that
the obligations of the parties may be
satisfied by means other than actual delivery:
(b)
an agreement under which each party has either:
depending on whether at a future date the value or
price of a specified commodity calculated in a manner specified by, or in
accordance
with, the agreement is greater or less than the value or price agreed
upon by the parties when the agreement was made:
(c)
an agreement under which each party has either:
depending on whether at a future date the value or
level of a specified index calculated in a manner specified by, or in accordance
with, the agreement is greater or less than the value or level agreed upon by
the parties when the agreement was made:
(d)
an option or right to assume, at a specified price or value, or within a
specified period, or by a specified date, rights and obligations
under an
agreement of a kind described in a preceding paragraph:
(e)
an agreement, option or right which is declared by the Commission, in
accordance with this section, to be an agreement, option or
right to which this
Part of this Act applies:
(f)
an agreement, option or right which is of a class of agreements, options or rights declared by the Commission, in accordance with this section, to be a class to which this Part of this Act applies.
This definition applies to contracts whether they are traded on an exchange or not.
Certain agreements or contracts are excluded from this definition by section
37(2) of the Securities Markets Act. These are:
(a)
a currency swap agreement to which a registered bank is a
party:
(b)
an interest rate swap agreement to which a registered bank is a
party:
(c)
a forward exchange rate agreement to which a registered bank is a
party:
(d)
a forward interest rate agreement to which a registered bank is a party.
An agreement or option that is described in the definition of "futures
contract" is a futures contract whether or not it:
(a)
has any other effect; or
(b)
contains any other provisions; or
(c)
is capable of being varied or discharged before the time fixed for performance.
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