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Proposal to Declare Certain Foreign Exchange Contracts to be Futures Contracts Under the Securities Markets Act 1988

1.: 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.

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