The Financial Markets Authority (FMA) has released its annual review of how effectively the NZX has met its licensed market operator obligations for the period from 1 January to 31 December 2019. NZX's obligations generally relate to its regulatory operations but also cover the operational performance of key functions concerning the operation of the markets.
Findings and areas of focus
Overall, the FMA considered that NZX has demonstrated compliance with its market operator obligations. It noted that there had been an improvement in the quality of NZX Surveillance’s investigative processes and its analysis of possible market misconduct.
However, the FMA also detailed the following areas of focus that it said required further monitoring:
investigations into possible continuous disclosure breaches;
management of surveillance alerts; and
management of market technology issues, including those that have arisen in the current period.
We have set out further detail below on these points, which give some insight into likely priorities for NZX.
Continuous disclosure - NZX Regulation's approach to investigations
The FMA noted that the NZX framework for continuous disclosure, including system functionality, monitoring and enforcement, remains an area of high interest.
During the review period, there was an increase in investigations into issuers, mainly relating to administrative issues. As NZX Regulation explained in its Oversight and Engagement report in March, the increase in the number of administrative issues was attributed to the introduction of the new Listing Rules rather than poorer overall market conduct. Consistent with this, in all other categories there was an overall reduction in the number of investigations. NZX conducted 34 continuous disclosure investigations, of which one investigation resulted in a finding of a breach. No referrals were made to the NZ Markets Disciplinary Tribunal for breaches of continuous disclosure obligations.
The FMA noted that, in each case, NZX Regulation's decision was supported by a record of engagement with issuers and the rationale for the outcome was documented. However, the FMA considered that NZX could increase the depth of its inquiries and promote a more robust process. We expect that issuers should anticipate that NZX will continue to have a strong focus on continuous disclosure matters and that there is a greater likelihood of investigations by NZX in relation to potential continuous disclosure issues.
NZX Surveillance monitors price movements, trading volumes, market releases and other media to ensure that trading on NZX's markets remains fair, orderly and transparent, and does not breach applicable conduct obligations.
The FMA noted that during the review period:
NZX Surveillance handled a significantly increased number of surveillance system alerts;
enhancements were made to the surveillance framework, including a review of some procedures, surveillance system parameters and alerts; and
there was an overall increase in referrals of potential misconduct to the special division and FMA.
The FMA noted that automated trading has become more prevalent on NZX's markets due to an increase in the use of automated trading technology by Direct Market Access clients of Participants. As a result, NZX Regulation focused on algorithmic trading during the review period. While NZX Surveillance identified instances where trading executed by algorithms was deemed not to be operating as optimally as they could, for example because algorithms created for overseas markets had been introduced to New Zealand without appropriate adjustments, it did not identify systematic misuse of algorithms in the market.
Overall, the FMA considered that steps taken by NZX to enhance its surveillance capability have had a positive impact on the effectiveness of the Surveillance team. However, the FMA had concerns about the number of surveillance system alerts generated during the review period, and therefore considers that the calibration and management of surveillance alerts should remain an area of focus.
Technology and systems
In general, during the review period, systems operated well. However, there was a major Trading System incident in November 2019, which resulted in a total market impact and delayed opening of the debt and equities markets. This was corrected on the same day by implementation of a temporary solution (with a permanent solution following a month later). The FMA noted that it was concerned with the duration of this incident and the impact that it may have had on market participant confidence. However, it considers that the NZX took prompt steps to remedy the issue and it was not systemic.
In addition, there were several minor network issues relating to an external network provider, which were resolved on the same day, and further technology disruptions during the COVID-19 lockdown.
Since that time, NZX implemented a number of IT projects and enhancements. However, the FMA is reviewing these issues to examine the cause and overall appropriateness of NZX's response, and they will be commented on in the FMA's next obligations review.
Impact of COVID-19
The FMA noted that the scope of its review was constrained by COVID-19 and the nationwide Alert Level 4 protocols. Market anxieties around COVID-19 resulted in the NZX experiencing record trading activity, significant market volatility, increases in demand for capital, and a need to consider appropriate regulatory relief.
In light of that burden, the FMA felt it inappropriate to divert NZX's resources from responding to these issues in order to conduct a more thorough review process. This meant the FMA was unable to conduct face-to-face meetings, or onsite testing of certain functions at NZX. Notwithstanding those limitations, the FMA still found it was able to provide meaningful comment on NZX's compliance with its obligations.