4 Enhancing the Safety and Soundness of the Canadian Financial System
The Departmet of Finance (Canada) has released a White Paper, Enhancing the Safety and Soundness of the Canadian Financial System, which, among other things, proposes certain legislative changes to reduce systemic risk in major clearing and settlement systems.
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Initiatives to Reduce Systemic Risk in Major Clearing and Settlement Systems
New Clearing and Settlement Legislation to:
Provide a legislative role for the Bank of Canada to ensure that the design and operation of the major clearing and settlement systems controls systemic risk effectively. Systemic risk is the risk that problems experienced by an institution will spread to others and be destabilizing to the financial system as a whole.
Ensure that clearing and settlement systems contribute to the international competitiveness of Canadian financial institutions.
The Canadian payments system is one of the most efficient paper-based payment systems in the world. Canada is now looking increasingly to electronic payments methods to achieve further gains in efficiency and reductions in risk. The payments system in Canada is operated principally by the financial institutions themselves through the Canadian Payments Associations (CPA).
Clearing and settlement systems are important channels for the interaction of financial institutions and, as such, contribute to the security, efficiency and competitiveness of the financial system as a whole. If clearing and settlement systems are not properly designed, however, they can result in considerable systemic risk – that is, the risk that problems experienced by one financial institution will spread to other financial institutions and be destabilizing to the financial system as a whole. Ensuring that these systems are properly risk proofed, effectively designed, and competetive in terms of the speed and cost with which payments are cleared and settled, will ensure that Canadian financial institutions will be able to compete effectively on a global basis.
Canada is currently the only G-10 country without a system that provides finality of payment on the same day for large value payments. This means that recipients of Canadian payments cannot know for certain that a payment item has been irrevocably processed, or is final, until at least the day after it is submitted in the clearings.
Canadian financial institutions are working through the CPA to develop a Large Value Transfer System (LVTS) to offer intra-day finality of payments for its users. The implemantation of the LVTS will enhance financial system stability by limiting systemic risk. The Bank of Canada and the Department of Finance have participated with industry in the development of this system.
A new system for clearing transactions of government debt securities, known as the Debt Clearing Service (DCS), was implemented by the Canadian Depository for Securities last summer and incorporates risk-containment features accepted by federal and provincial authorities. The DCS currently handles transactions of Government of Canada bonds. Federal government Treasury bills are scheduled to move to the DCS this year. Placing all government debt on this system reduces costs for the government, as issuer, as well as for other participants in the system.
A system for clearing and settling foreign exchange transactions is also being developed by the private sector with the close involvement of the Bank of Canada.
It is proposed that federal legislation be developed to give the Bank of Canada a more explicit role in the oversight of clearing and settlement systems from the point of view of controlling systemic risk. It would build on the Bank of Canada's existing informal role in this area and its role in the settlement of payments obligations between financial institutions. Enhanced powers for the Bank of Canada are consistent with the current focus of central banks around the world on these matters. They are also consistent with the coordination by central banks of efforts to limit the international transmission of risk through clearing and settlement systems. The explicit oversight power would mean that private sector operators of clearing and settlement systems that have potential systemic risk implications would be required to obtain the approval of the Bank of Canada regarding the mechanisms designed to monitor and control these risks.
New clearing and settlement legislation would help ensure that Canada keeps pace with the developing international standards for the design of secure clearing and settlement systems. In some countries, the central bank runs many of these systems. Canada, by contrast, has chosen to leave the development of such systems largly to the private sector. Nevertheless, certain legislative changes are warranted to provide the Bank of Canada with the capacity to participate in these clearing and settlement systems, to provide services to these systems, and to ensure that these systems are operated in a safe and sound manner.
Under proposed legislation, oversight of clearing and settlement of settlement systems by the federal authorities would be exercised by the Bank of Canada with a view to ensuring that appropiate arrangements are in place so that systemic risk is minimized. In particular, clearing and settlement system participants should have both the ability and incentives to recognize and control the risks they face. With respect to the LVTS, for which financial institutions themselves will be posting sufficient collateral to cover the single largest possible default, the Bank of Canada would have the power to guarantee settlement of transactions on the system in the extremely unlikely event that the collateral posted by the institutions is insufficient to cover losses arising from multiple participant failures at the same time. This guarantee means that all evantualities are covered, thus allowing participants in the systems to offer intra-day finality of payment to customers, which will be part of the arrangements. This level of risk containment would meet internationally-agreed-upon standards. These legislative changes would also permit the Bank of Canada to pay interest on deposit liablilities associated with the LVTS, to open deposit accounts for clearing houses and to act as a settlement agent.
With respect to the scope of the proposed legislation, it would be framed to establish federal oversight, through the Bank of Canada, of all clearing and settlement systems that are sources of systemic risk in the payments system. In practical terms, federal involvement would be limited to clearing and settlement systems where the potential exposures have very large dollar values and where financial institutions are participants. The legislation would be directed at the clearing arrangements and not at the underlying transactions. Thus, clearing and settlement systems for foreign exchange or securities could come under the legislation – if warranted by systemic risk concerns and with respect to these concerns – without implying federal regulation of these markets.
Finally, a key component of this initiative would be to give statutory recognition to 'netting arrangements' in payment and other clearing and settlement systems and in certain types of financial instruments. In the context of these systems, netting refers to the process by which participants in a system can offset amounts owed to them by other participants against their obligations to others to arrive at a net obligation. Netting can dramatically reduce the credit exposures of participants and make the settlement of obligations more efficient. Confirming that netting arrangements are legally valid ( and unassailable in a liquidation or restructuring) is essential to securing the benefits of netting.
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PAYMENT CLEARING AND SETTLEMENT ACT
SCHEDULE
(Section 162)
An Act respecting the regulation of systems for the clearing and settlement of payment obligations
Whereas Parliament recognizes that the stability of the financial system in Canada and the maintenance of efficient financial markets are important to the health and strength of the national economy;
Whereas systems established for the clearing and settlement of payment obligations among financial institutions are an essential element of the financial system in Canada and must be properly designed and operated in order to control risk to the financial system in Canada and contribute to its stability;
Whereas the Bank of Canada, in promoting the economic and financial welfare of Canada, takes actions to promote the efficiency and stability of the Canadian financial system, including providing the means of settlement of Canadian dollar payments, acting as lender of last resort and, in consultation with other central banks, developing and implementing standards and practices to recognize and manage risk associated with systems for clearing and settling payment obligations;
And whereas Parliament recognizes that it is desirable and in the national interest to provide for the supervision and regulation of such clearing and settlement systems in order to control risk to the financial system in Canada and promote its efficiency and stability;
NOW, THEREFORE, Her Majesty, by and with the advice and consent of the Senate and House of Commons of Canada, enacts as follows:
SHORT TITLE
1. This Act may be cited as the Payment Clearing and Settlement Act.
INTERPRETATION
2. In this Act,
Bank means the Bank of Canada;
central counter-party means a corporation, association, partnership, agency or other entity in a clearing and settlement system with whom all participant's payment rights and obligations are netted to produce a single amount owing as between each participant and the central counter-party;
clearing and settlement system means a system or arrangement for the clearing or settlement of payment obligations or payment messages in which
- (A)
there are at least three participants, at least one which is a bank,
- (B)
clearing or settlement is all or partly in Canadian dollars, and
- (C)
the payment obligations that arise from clearing within the system or arrangement are ultimately settled through adjustments to the account or accounts of one or more of the participants at the Bank
and, for greater certainty, includes a system or arrangement for the clearing or settlement of securities transactions, foreign exchange transactions or other transactions where the system or arrangement also clears or settles payment obligations arising from those transactions;
clearing house means a corporation, association, partnership, agency or other entity that provides clearing or settlement services for a clearing and settlement system, but does not include a stock exchange or the Bank;
Minister means the Minister of Finance;
participant means a member of a clearing house or a party to an arrangement that establishes a clearing and settlement system;
systemic risk means the risk that the inability of a participant to meet its obligations in a clearing and settlement system as they become due or a disruption to a clearing and settlement system could, through the transmittal of financial problems through the system, cause
- (A)
other participants in the clearing and settlement system to be unable to meet their obligations as they become due,
- (B)
financial institutions in other parts of the Canadian financial system to be unable to meet their obligations as they become due, or
- (C)
the clearing and settlement system's clearing house or the clearing house of another clearing and settlement system within the Canadian financial system to be unable to meet its obligations as they become due.
PART I
CLEARING AND SETTLEMENT SYSTEM REGULATION
Designated Clearing and Settlement Systems
3. In this part, designated clearing and settlement system means a clearing and settlement system designated under subsection 4(1).
4. (1) Where the Governor of the Bank is of the opinion that a clearing and settlement system may be operated in such a manner as to pose a systemic risk, the Governor may, if the Minister is of the opinion that it is in the public interest to do so, designate the clearing and settlement system as a clearing and settlement system that is subject to this Part.
(2) The Governor of the Bank shall, in writing, notify a designated clearing and settlement system's clearing house of the designation and shall cause a copy of the designation to be published in the Canada Gazette.
Agreements
5. The Bank may enter into an agreement with a clearing house or a participant, or both, in respect of
- (A)
netting arrangements;
- (B)
risk-sharing and risk-control mechanisms;
- (C)
certainty of settlement and finality of payment;
- (D)
the nature of financial arrangements among participants;
- (E)
the operational systems and financial soundness of the clearing house; and
- (F)
such other matters pertaining to systemic risk as may be agreed on by the parties to the agreement.
Directives
6. (1) Where the Governor of the Bank is of the opinion that
- (A)
a clearing house for a designated clearing and settlement system is engaging in or is about to engage in any act, omission or course of conduct,
- (B)
a participant is engaging in or is about to engage in any act, omission or course of conduct with respect to its participation in the designated clearing and settlement system, or
- (C)
the designated clearing and settlement system is operating or is about to operate in a way
that results or is likely to result in systemic risk being inadequately controlled, the Govenor may issue a directive in writing to the clearing house requiring it, within such time as the Governor considers necessary and may specify in the directive, to
- (D)
cease or refrain from engaging in the act, omission or course of conduct or have the participants cease or refrain from engaging in the act, omission or course of conduct, and
- (E)
perform such acts or have the participants perform such acts as in the opinion of the Governor are necessary to remedy the situation.
(2) Where the Governor of the Bank has formed an opinion under subsection (1) that systemic risk is being inadequately controlled and
- (A)
the clearing house fails to comply with a directive that has been issued to it under that subsection,
- (B)
the designated clearing and settlement system does not have a clearing house located in Canada, or
- (C)
in the opinion of the Governor,
- (I)
the systemic risk is being inadequately controlled due to an act, omission or course of conduct by a participant with respect to its participation in the designated clearing and settlement system, and
- (II)
the act, omission or course of conduct is not subject to the by-laws, agreements, rules, procedures, guides or other documentation governing the designated clearing and settlement system,
- (I)
the Governor may issue a directive in writing to the participants requiring them, within such time as the Governor considers necessary and may specify in the directive, to
- (D)
cease or refrain from engaging in certain acts, omissions or courses of conduct with respect to their participation in the designated clearing and settlement system, and
- (E)
perform such acts with respect to their participation as the Governor considers necessary to remedy the situation.
(3) For greater certainty, a directive under this section may not be made in respect of
- (A)
the capital adequacy of a participant;
- (B)
the management of its investments;
- (C)
its corporate governance;
- (D)
its relations with customers who are not themselves participants in the designated clearing and settlement system;
- (E)
its ownership structure; or
- (F)
any other matter that is not directly related to its participation in the designated clearing and settlement system.
(4) Subject to the approval of the Minister, a directive, if it so provides, applies to a designated clearing and settlement system that is established by or under a statute.
Bank Powers
7. The Bank may do all or any of the following things in relation to a designated clearing and settlement system and its clearing house:
- (A)
provide a secured or unsecured guarantee of settlement by participants;
- (B)
make liquidity loans to the clearing house and the central counter-party; and
- (C)
act as the central counter-party to the participants.
Settlement Provisions
8. (1) Notwithstanding anything in any statute or other law of Canada or a province,
- (A)
the settlement rules of a designated clearing and settlement system are valid and are binding on the clearing house, the participants, a central counter-party and the Bank and any action may be taken or payment made in accordance with the settlement rules;
- (B)
the obligation of a participant, a clearing house or a central counter-party to make payment to a participant and the right of a participant, a clearing house or a central counter-party to receive payment from a participant, a clearing house or a central counter-party shall be netted and a net settlement or close-out amount shall be determined in accordance with the settlement rules, if they so provide; and
- (C)
where the settlement rules of a designated clearing and settlement system provide that the settlement of a payment obligation through an entry to or a payment out of an account of a participant, a clearing house or a central counter-party at the Bank is final and irrevocable, the entry or payment shall not be required to be reversed, repaid or set aside.
(2) An entry to or a payment out of the account of a participant, a clearing house or a central counter-party at the Bank to settle a payment obligations in a designated clearing and settlement system shall not be the subject of any provision or order that operates as a stay of that activity.
(3) The rights and remedies of a participant, a clearing house, a central counter-party or the Bank in respect of collateral pledged to it as security for a payment or the performance of an obligation incurred in a designated clearing and settlement system shall not be the subject of any stay provision or order affecting the ability of creditors to exercise rights and remedies with respect to the collateral.
(4) Notwithstanding that all or part of the administration or operation of a designated clearing and settlement system is conducted outside Canada or that its settlement rules are governed by the laws of a foreign jurisdiction, where in any judicial proceedings in Canada a court determines that the rights and obligations of any person arising out of or in connection with the operation of the designated clearing and settlement system are governed in whole or in part by Canadian law, the provisions of this section shall be applied to the extent that the Canadian law applies in determining those rights and obligations.
(5) In this section, settlement rules means the rules, however established, that provide the basis on which payment obligations are calculated, netted or settled and includes rules for the taking of action in the event that a participant is unable or likely to become unable to meet its obligations to the clearing house, a central counter-party or the other participants.
Notices and Information
9. (1) Every clearing house shall, in respect of its designated clearing and settlement system, provide the Bank with reasonable notice in advance of any change to be made by the clearing house that is of a significant nature in relation to the designated clearing and settlement system and, without limiting the generality of the foregoing, the notice shall be provided in respect of any change affecting
- (A)
the constating documents and by-laws of the clearing house;
- (B)
the operation of the designated clearing and settlement system; or
- (C)
the by-laws, agreements, rules, procedures, guides or other documentation governing the designated clearing and settlement system.
(2) Every clearing house shall, forthwith after it makes any other changes in relation to the designated clearing and settlement system, provide the Bank with written notice of the change and, without limiting the generality of the foregoing, the notice shall be provided in respect of any change affecting
- (A)
the composition of a board of directors of the clearing house due to resignation or otherwise; or
- (B)
the appointed auditor of the clearing house.
(3) Every clearing house shall, in respect of its designated clearing and settlement system, provide the Bank with such information, at such times and in such form as the Bank may in writing require.
Audits and Inspections
10. (1) The Bank may, for the purpose of carrying out its functions under this Act, conduct audits and inspections of a clearing house, and every clearing house shall, as required, Assist the Bank to the extent necessary to enable the Bank to carry out an audit or inspection.
(2) For the purpose of obtaining evidence under oath in relation to an audit or inspection under subsection (1), the Bank has all the powers of a person appointed as a commisioner under the Part II of the Inquiries Act.
Cost of Regulation
11. (1) The Bank may annually impose a fee on a clearing house in respect of the cost to the Bank for that year of the administration of this Act in respect of the designated clearing and settlement system of the clearing house.
(2) A fee imposed under subsection (1) constitutes a debt due to the Bank and may be recovered as such in any court of competent jurisdiction.
PART II
GENERAL
Bank Powers
12. The Bank may do all or any of the following things in relation to a clearing and settlement system and its clearing house:
- (A)
be a participant and participate in the loss-sharing mechanism;
- (B)
act as a custodian of finacial assets or act as a settlement agent, or both; and
- (C)
notwithstanding section 23 of the Bank of Canada Act, accept and pay interest on deposits from the clearing house, a participant, or the central counter-party.
Netting Agreements
13. (1) Notwithstanding anything in any law relating to bankruptcy or insolvency or any order of a court made pursuant to an administration of a reorganization, arrangement or receivership involving insolvency, a financial institution that is a party to a netting agreement may terminate the agreement and determine a net termination value or net settlement amount in accordance with the provisions of the agreement and the party entitled to the net termination value or settlement amount shall be a creditor of the party owing the net termination value or net settlement amount for that value or amount.
(2) In subsection (1),
financial institution means
- (A)
a financial institution within the meaning of section 2 of the Trust and Loan Companies Act,
- (B)
such other entity or entity within a class of intities engaged primarily in the business of providing financial services as may be designated by order of the Governor in Council to be a financial institution for the purposes of this section, or
- (C)
a trustee, manager or administrator of a pension fund maintained to provide benefits under a pension plan registered under the Income Tax Act;
net termination value means the net amount obtained after setting off or otherwise netting the obligations between the parties to a netting agreement in accordance with its provisions;
netting agreement means an agreement between two or more financial institutions that is
- (A)
an eligible financial contract within the meaning of section 22.1 of the Winding-up and Restructuring Act, or
- (B)
an agreement that provides for the netting or set-off of present or future obligations to make payments against the present or future rights to receive payments.
Information Requirements
14. (1) Where the Governor of the Bank has reasonable grounds to believe that a system or arrangement exists for the clearing and settlement of payment obligations or payment messages but the Bank requires further information in order to determine whether the system or arrangement is a clearing and settlement system, the Governor may, with the agreement of the Minister, request a person who is a party to the system or arrangement to provide the Bank with such information and documents regarding the system or arrangement as the Bank may require to make the determination.
(2) Every person to whom a request is directed under subsection (1) shall comply with the request.
(3) Every clearing house shall, in respect of its clearing and settlement system, provide the Bank with such information and documents as the Bank may from time to time require to enable the Bank to determine whether the clearing and settlement system poses a systemic risk and, without limiting the generality of the foregoing, the clearing house shall, in respect of the clearing and settlement system, provide the Bank with
- (A)
the names of its participants;
- (B)
copies of its constating documents, by-laws, resolutions, agreements, rules, procedures and other documents governing its establishment and operation;
- (C)
the names of its directors, committee members and auditors;
- (D)
copies of its reports, statements or other documents that are required to be filed with any government agency or regulatory body; and
- (E)
copies of its financial statements.
Enforcements
15. If a clearing house or a participant fails to comply with a provision of this Act or a directive issued to it by the Governor of the Bank in connection with any matter under this Act, or a person to whom a request refferred to in subsection 14(1) is directed fails to comply with the request, the Bank or the Governor may apply to a superior court for an order directing the clearing house, participant or person, as the case may be, to comply with the provision, directive or request and, on the application, the court may so order and make any further order it thinks fit.
16. Every person who, without reasonable cause, contravenes any provision of this Act is guilty of an offence and
- (A)
in the case of a natural person, liable on summary conviction to a fine not exceeding $100,000 or to imprisonment for a term not exceeding twelve months, or to both; or
- (B)
in the case of any other entity, liable on summary conviction to a fine not exceeding $500,000.
Guidelines
17. The Governor of the Bank or the Bank may issue guidelines in respect of any matter relating to the administration or enforcement of this Act.
Disclosure of Information
18. (1) Information and documents obtained under this Act are confidential and shall be treated accordingly.
(2) Nothing in subsection (1) prevents the Bank from disclosing any information or documents
- (A)
to any government agency or regulatory body charged with the regulation of financial institutions, within the meaning of section 2 of the Trust and Loan Companies Act, for purposes related to that regulation, and
- (B)
to the Deputy Minister of Finance or any other officer of the Department of Finance authorized in writing by the Deputy Minister of Finance or to the Chairperson of the Canada Deposit Insurance Corporation or any officer of that Corporation authorized in writing by the Chairperson.
if the Bank is satisfied that the information or documents will be treated as confidential by the agency, body or person to whom they are disclosed.
Designations and Directives
19. A designation under the subsection 4(1) or a directive issued under this Act is not a statutory instrument for the purposes of the Statutory Instruments Act.
Liability
20. No action lies against Her Majesty, the Minister, the Bank, any officer or employee of the Bank or any person acting under the direction of the Governor of the Bank for anything done or omitted to be done in good faith in the administration or discharge of any powers or duties that under this Act are intended or authorized to be executed or performed.
Judicial Review
21. On an application for judicial review under the Federal Court Act of any designation under subsection 4(1) or of any directive issued under this Act, no stay of the designation or directive shall be granted pending the final disposition of the application.
Participants
22. (1) Where a clearing and settlement system does not have a clearing house located in Canada, the Canadian participants
- (A)
shall comply with the obligations imposed under this Act on a clearing house in respect of a clearing and settlement system, and
- (B)
have all the rights conferred by this Act on a clearing house in respect of a clearing and settlement system.
in the same manner and to the same extent as if the Canadian participants were the clearing house on which those obligations and rights are imposed or conferred and, for that purpose, any action that the Bank may take in respect of a clearing house may only be taken in respect of the Canadian participants.
(2) Where a clearing house fails to comply with the obligations imposed on it under this Act in respect of its clearing and settlement system or otherwise contravenes this Act, the participants jointly and severally shall comply with those obligations or are liable for the contravention in the same manner and to the same extent as if the participants were the clearing house on which the obligations are imposed or that committed the contravention.
(3) In subsection (1), a participant is Canadian if the participant is incorporated or formed under an enactment of Canada or a province.
23. A participant is not required to provide information to the Bank under this Act concerning another participant of a clearing and settlement system if that information is not available to all the participants.
Published under authority of the Speaker of the House of Commons
Available from Canada Communication Group – Publishing, Public Works and Government Services Canada, Ottawa, Canada K1A 0S9