OVERSIGHT REVIEW OF NZX 2007

IMPACT OF EXPANDING COMMERCIAL ACTIVITIES ON NZX'S REGULATORY FUNCTION

67. The Commission notes that NZX has expanded its commercial activities to include various information and data services. NZX is seeking approval in Australia to operate an ECN (electronic communication network) which operates as a trade-matching system. While we do not review NZX's commercial activities, we are concerned with the risk of potential conflicts that might arise between its regulatory and commercial functions as NZX expands its commercial activities.
68. While we are not aware of any such conflicts at this time, we will continue to review this issue in our future oversight review of NZX.

THE SPECIAL DIVISION

69. The Special Division is an independent body established under the NZX Discipline Rules which regulates NZX as a listed issuer in the same way that NZX regulates other listed issuers.
70. Under the Listing Rules, issuers must seek the approval of NZX for an issuer's notice of shareholder meetings. In this approval process, NZX determines whether the notice of meeting sufficiently discloses to shareholders the issues to be addressed at the meeting.
71. For matters involving NZX as an issuer, the Special Division has the role which NZX has with other issuers. Thus, for an NZX notice of meeting, NZX must seek the approval of the Special Division.
72. One issue which arose in the course of this review was that the Special Division, in the context of an NZX notice of special meeting application regarding the CEO share scheme, reviewed the merits of the CEO scheme rather than limiting its review to whether there was sufficient disclosure regarding the CEO scheme for shareholder consideration.
73. The role of the Special Division in granting approval for this notice of special meeting application was to determine whether the scheme was sufficiently disclosed in the notice and the accompanying appraisal report to enable shareholders to understand the effects of the scheme. While it was appropriate for the Special Division to ask NZX questions about the scheme to determine if it was sufficiently disclosed, the Special Division's review appeared to reflect a merit based assessment of the elements of the scheme.
74. The Commission is of the view that had the Special Division merely required the basis of the remuneration to be explained clearly to shareholders and had examined the details of the basis of the remuneration for that purpose, the Special Division would have remained within its remit. However, it went further. Based on correspondence the Commission has seen, it is the Commission's view that the Special Division made an assessment of the merits of the scheme.
75. A merit based review is not within the remit of the Special Division. The Commission believes that in this instance the Special Division exceeded the scope of its role under the Listing Rules.
76. The Commission will continue to review the Special Division's exercise of its role in our future oversight reviews.

MATTERS ARISING FROM THE REVIEW OF THE 2006 YEAR

77. The Commission raised a number of matters (as set out below in bold type) in the course of the 2006 review. We report on the progress on these matters made by NZX, NZX Discipline and the Special Division.

Conflict management

• NZX should ensure that the Board is provided with relevant and up-to-date information on conflict management in relation to for-profit exchanges and that this information is subject to regular discussion at Board meetings.
• NZX should ensure that the practical measures used to ensure the practical separation between its commercial and regulatory functions have reference to the information in relation to for-profit exchanges the Board receives on conflict management.

78. NZX is aware that some parties, including the Commission, perceive that NZX is subject to conflict between its commercial and regulatory functions and the risks that arise from such conflict. The Commission is satisfied that NZX has taken satisfactory practical measures to address this issue. We will continue to review this issue in our future oversight review of NZX.
79. NZX believes that it is fundamental to its commercial success that it maintains a sound regulatory scheme to ensure market integrity. The NZX Board has adopted a conflict management policy and procedure which has been implemented. The overall principles are that, for commercial success, the market must operate in a fair way; the perception of conflict must be managed; commercial issues must not be allowed to influence supervisory decision making; supervisory activity and information must be quarantined from commercial activity; supervision is conducted by a separate regulatory division which is subject to a personal conflicts policy; the Board receives regulatory briefings from the Head of Market Supervision; and that supervisory activity must be consistent and transparent. The policy includes procedures for identifying the specific types of conflict and managing the balance between the regulatory and commercial interests.

NZX Discipline

• NZX Discipline should ensure that, when determining the procedure to apply to a proceeding before it, it treats all parties evenly.

80. This recommendation has been followed.

• NZX Discipline should be seen to be transparent in exercising its discretion whether to publish decisions which identify Market Participants who have breached the Participant Rules. Where a Market Participant's details are not published, NZX Discipline should disclose its reasons for withholding this information.

81. NZX Discipline has adopted a policy guideline on the naming of market participants, which sets out the criteria for NZX Discipline to use in its determination of whether to publish the name of a market participant subject to adjudication by NZX Discipline. Since the policy implementation in September 2007, there have been only two completed matters involving market participants, and in one of those matters NZX Discipline exercised its discretion to publish the name of the market participant. The Commission is satisfied that NZX Discipline's policy guideline has addressed the Commission's recommendation and the Commission will continue to review the application of the policy guideline in our future oversight reviews.

• NZX and NZX Discipline should review the NZX Discipline Rules in order to give NZX Discipline input into its own Rules, and amendments arising from this review should be included in the amendments which are presently being considered by NZX Discipline.

82. NZX Discipline and NZX are currently working collaboratively on the amendments to the Discipline Rules. The Commission expects that the amended rules will be implemented by December 2008.

• NZX Discipline should review its resource requirements and structure, and communicate its needs to NZX, so that delays in dealing with non-urgent work are minimised or removed.

83. NZX Discipline has reviewed its resource requirements for administrative support and structure and has communicated its needs to NZX. NZX is supportive of NZX Discipline's requirements.

• NZX should provide more information about the role, membership and mandate of NZX Discipline on its website. In particular, the contact details for NZX Discipline should be included on the NZX website.

84. The Commission is satisfied that the NZX website has the appropriate information about NZX Discipline.

The Special Division

• NZX should increase the amount of information it provides about the Special Division and make it easier to find. In particular, the contact details for the Special Division should be included on the 'Contacts' and 'Supervision of NZX' pages of the NZX website.

85. The Commission is satisfied that the NZX website has the appropriate information about the Special Division.

The NZAX Market

86. Following a review of the NZAX market in 2006, several changes to this market were implemented in late 2006 in relation to tick size (the increment by which a security price is increased or decreased) and trading hours.
87. A further change was implemented on 19 March 2007 which was the removal of the anonymous call auction. The anonymous call auction allowed participants to submit bids anonymously prior to the opening of the market. However, this function was not being used. Also in March 2007, the NZAX Listing Rules were changed to align more closely with the structure of the NZSX Listing Rules.
88. As a result of these changes, NZX updated the staff materials, trained the staff on the changes to the NZAX rules and updated its website to reflect the rule changes.
89. The Commission is satisfied with the changes made to the NZAX market and the educational initiatives in regard to these changes.