The Large Value Transfer System (LVTS), which is designated as a systemically important payment system (SIPS) by the Bank of Canada (BoC) was assessed by the International Monetary Fund (IMF), and its findings were published in the IMF's 2000 Report on the Observance of Standards and Codes (ROSC). The ROSC concluded that the LVTS was in full compliance with the Committee on Payment and Settlement Systems (CPSS) Core Principles for Systemically Important Payment Systems (CPSIPS). In 2001, the BoC published a self-assessment by C. Goodlet, in which the LVTS was again assessed to be in full compliance with the CPSIPS. The LVTS began operation in February 1999, and is an electronic credit transfer system that provides real-time processing and intraday finality of payments, and guarantees end-of-day settlement. The Canadian Payments Association owns and operates the LVTS. The LVTS is designated for oversight by the BoC under the Payment Clearing and Settlement Act. According to the IMF, the LVTS system is one of the most secure and reliable payment systems in the world, has a well-founded legal basis under all relevant jurisdictions, and has clearly defined procedures for the management of credit and liquidity risks. Most importantly, the LVTS provides prompt final settlement on the day of value, and it is fully capable of ensuring the timely completion of daily settlements in the event of an inability to settle by a participant. The CLS Bank settles foreign exchange transactions and is also designated by the BoC as a SIPS. According to a self assessment by CLS Bank, the system fully observes the CPSS CPSIPS. The other system of systemic importance in Canada is the CDSX, a securities settlement system, which is not under the purview of the CPSS CPSIPS.

General Overview

In its 2006 Financial System Review, the Bank of Canada (BoC) indicates that there are three systems that fall under the jurisdiction of the Payment Clearing and Settlement Act (PCSA) which is an Act designed to oversee clearing and settlement systems that could be operated in a manner that would pose systemic risk to the country. The three systems thus designated are: (1) the Large Value Transfer System (LVTS), which clears and settles large-value payments; (2) CDSX, which clears and settles securities transactions; and (3) the Continuous Linked Settlement (CLS) system, which clears and settles foreign currency transactions. The CDSX is a securities settlement system and therefore does not directly fall under the purview of the Committee on Payment and Settlement Systems' (CPSS) Core Principles for Systemically Important Payment Systems (CPSIPS). Therefore, the systems this report considers in detail are the LVTS and the CLS systems, as they are categorized as systemically important payment system (SIPS) and the CPSIPS apply to them.

The International Monetary Fund (IMF) conducted a Financial Sector Assessment Program (FSAP) of Canada and released its findings on Canada's payment systems in its 2000 Report on the Observance of Standards and Codes (ROSC). The 2000 ROSC assessed the LVTS against the core principles and concluded that the system fully observes all the CPSIPS. A 2003 report on Canada's payment systems by the CPSS alludes to a self-assessment by the BoC which also asserts Canada's full compliance with the CPSIPS. The CLS Bank, in 2007, released the findings of its assessment of the CLS system's compliance with the CPSIPS in which it concluded that the system fully observes all the core principles.

The LVTS was established in 1999 by private sector financial institutions under the auspices of the Canadian Payments Association (CPA). A key factor in the LVTS' success is that the founders were particularly focused on creating the least costly arrangement for processing large-value and time-sensitive payments. As a result, today the system minimizes the amount of collateral necessary to support the use of intra-day credit, while guaranteeing real-time processing, intraday finality of payments and end-of-day settlement. The CPA is the operator of the LVTS, and all laws, regulations and procedures governing LVTS operations are comprehensive, reliable, public and accessible. The PCSA, under which the LVTS is designated and legally based, empowers the BoC to manage all settlement and clearing systems and to limit risks to Canada's financial markets.

The BoC website notes that the LVTS, whose operations are administered by a highly competent and experienced CPA staff, is one of the most secure systems in the world, replete with the reliable SWIFT communication system (to securely transmit payment instructions), extensive contingency plans and a separate emergency back-up site in another part of Canada. Efficiency within LVTS is augmented by the practice of payments being processed individually as they are entered into the LVTS, thus contributing to the LVTS' reputation of never having any cases of payments being jammed in prolonged queues or remaining in queues at the end of the day without being processed. According to the BoC's 2006 Financial Systems Review (hereafter referred to as the 2006 BoC report), the LVTS currently processes approximately 18,000 transactions per day, worth about $145 billion.

According to the CLS Bank's 2007 Assessment of Compliance with the Core Principles for Systemically Important Payment System, the CLS system observes al the ten CPSIPS, noting that "a comprehensive and well-established legal framework consisting of contractual provisions, statutes and regulations supports the CLS system" (p. 13). The CLS system is used to settle payment instructions for certain types of underlying financial transactions like foreign exchange and credit derivative contracts in 15 authorized currencies, namely, the Australian dollar, Canadian dollar, Euro, Danish krone, Hong Kong dollar, Japanese yen, New Zealand dollar, Norwegian krone, Singapore dollar, South African rand, South Korean won, Swedish krona, Swiss franc, UK pound sterling, and the US dollar. According to the CLS Bank's 2007 report, "the central banks of these currencies have contributed to the effectiveness of the CLS system by maintaining central bank accounts for CLS Bank and through their efforts in creating a window period during which all their real-time gross settlement systems are open to accommodate the funding necessary for the settlement of payment instructions" (p. 4). The CLS is a payment versus payment system that eliminates settlement risk associated with two currency payment instructions relating to FX transactions. CLS Bank International was established by the private sector as an Edge Corporation under Section 25A of the United States Federal Reserve Act. An Edge Corporation was created by the United States Congress to facilitate international banking transactions. Per the 2007 CLS Bank report, the CLS Bank "is supervised and regulated as a bank by the Federal Reserve. The Federal Reserve also acts as the lead overseer of CLS Bank in a cooperative oversight arrangement with the central banks whose currencies are settled by CLS Bank" (p. 3).

As indicated in its 2006 BoC report, the BoC operates an oversight strategy consisting mainly of setting minimum standards that condition the efforts of designated systems to control risks. In other words, the BoC provides incentives for the operation of risk-free and efficient systemically important clearing and settlement systems. Private sector systems are responsible for designing the most efficient way to meet these conditions. Subsequently, the BoC uses periodical audits to ensure that systems are acting as expected to control risks. Furthermore, as part of the PCSA, the BoC is responsible for reviewing all payment, clearing and settlement systems for potential systemic risks. The PCSA endows the BoC with two main competencies: the power to guarantee settlement within certain systems and the ability to pay interest on special deposits received from participants in certain systems. Under the PCSA, the BoC can review a system if: (1) it consists of three or more participants, including a bank; (2) it settles Canadian dollar payments; and (3) the payments are ultimately settled through BoC accounts.

Other than the LVTS, the Automated Clearing Settlement System (ACSS) is a deferred net settlement system, owned and operated by CPA, through which all payments not processed by the LVTS are handled. The ACSS covers paper-based payments (i.e. checks), small-value electronic payment items (i.e. debit cards and automated banking machine transactions) and pre-authorized debits and credits. In 2002, after a thorough examination, the BoC concluded that the ACSS does not pose systemic risk. As a result of this finding, the ACSS is not currently designated under the PCSA.

The Principles

I. The system should have a well-founded legal basis under all relevant jurisdictions.

FC

According to the 2000 IMF ROSC, Canada fully observes this principle. The CPA is the operator of Canada's LVTS, and all laws, regulations, and procedures governing LVTS operations are comprehensive, reliable, public, and accessible. The LVTS is considered to have a well-founded legal basis according to a 2001 report by Clyde Goodlet. The 2008 IMF report notes that since the LVTS is also a PCSA-designated payment system, "PCSA mandates that settlement of payment obligations on the books of the BoC is final and irrevocable upon entry, and not subject to reversal, set-aside or stay" (p. 6). Per the 2001 Goodlet report, the CPA is incorporated by an Act of Parliament with the power to operate payment systems and to create rules governing such payment systems. The CPA particularly uses bylaws to govern arrangements between LVTS participants. Once passed by the CPA Board of Directors and approved by the federal Cabinet, these bylaws and rules carry the force of law. Canada has advanced laws pertaining to contracts, insolvency and anti-competitive behavior that have general application to individuals, institutions and markets in the economy. Also, there are laws specifically applicable to the LVTS. For instance, the PCSA, under which the LVTS is designated and legally based, empowers the BoC to manage all settlement and clearing systems and to limit risks to Canada's financial markets. The PCSA protects LVTS participants by preventing the creditors of any failed participants from contesting any LVTS rules or the outcomes of the application of these rules. This helps the LVTS achieve the certainty with which it settles in all circumstances. This certainty of settlement subsequently allows LVTS participants to offer their clients intraday unconditional access to funds received through LVTS.

Equipped with a comprehensive and well-established legal framework consisting of contractual provisions, statutes and regulations, the CLS system observes Principle I, according to the 2007 CLS Bank report. Also, the contractual provisions clearly define the rights and obligations of each CLS system participant and the statutes and regulations in each CLS Bank jurisdiction provide participants with a solid degree of legal assurance for the finality of settlement.

II. The system's rules and procedures should enable participants to have a clear understanding of the system’s impact on each of the financial risks they incur through participation in it.

FC

As noted in the 2000 IMF ROSC, which reviewed Canada's observance of the CPSIPS, Canada has fully observed Principle II regarding the understanding of financial risks. The IMF report notes that the LVTS bylaws and the related rules created by the CPA provide participants a clear understanding of the risks involved when partaking in the LVTS system. The 2007 CLS Bank self-assessment notes that the CLS system also observes Principle II, adding that the CLS rules and procedures are clear thus enabling participants to be cognizant of the potential financial risks involved in participating in the CLS system.

III. The system should have clearly defined procedures for the management of credit risks and liquidity risks, which specify the respective responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those risks.

FC

Per the 2000 IMF ROSC, Canada fully observes Principle III regarding the management of financial risks. The IMF report notes that the very structure of the system provides participants the incentives to contain and manage these risks. For instance, the payment system is conducted in real-time with message-by-message processing. This means that each payment message must pass a risk-control test before being approved. To further shield the system from risk, LVTS bylaws allow participants to decide whether or not they would like to give intra-day credit to other participants, If yes, LVTS bylaws create strong incentives to hedge this exposure carefully by requiring that participants collateralize the largest intra-day credit position that they grant each day. This process is further buttressed by the fact that collateral used to support intra-day credit is pledged directly to the central bank, guaranteeing immediate access to liquidity if needed. Participants uninterested in receiving intra-day credit from other participants may continue to partake in the system by pledging their own assets. Finally, according to the 2001 Goodlet report, the CPA determines whether prospective participants are technically capable of meeting LVTS requirements. The CLS system also observes Principle III, according to the 2007 CLS Bank report. The CLS Bank manages all credit and liquidity risks to participants in the CLS system through a comprehensive set of analytical and operational tools.

IV. The system should provide prompt final settlement on the day of value, preferably during the day and at a minimum at the end of the day. (Systems should seek to exceed the minima included in this Core Principle.)

FC

According to the 2000 IMF ROSC Canada fully observes Principle IV regarding prompt final settlement. The 2001 Goodlet report notes that the LVTS meets the minimum standard because it provides final settlement, which is the time of debiting and crediting of participants' accounts at the Bank of Canada to settle their net positions, at the end of each day between 18:30 and 20:00. According to the same report, the LVTS also meets the more difficult best practice standard of "intraday receiver finality." In other words, once a payment message is accepted by the system, it is certain to settle, and those participants expecting to receive funds over the system will certainly receive at the time expected. This is possible because, regardless of what else happens, the aforementioned risk-control tools guarantee that net LVTS positions will be settled on the books of the BoC. The 2007 CLS Bank report states that the CLS system observes Principle IV, adding that, within the CLS system, final settlement and funding occurs every business day during overlapping RTGS opening hours.

V. A system in which multilateral netting takes place should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single settlement obligation. (Systems should seek to exceed the minima included in this Core Principle.)

FC

The 2000 IMF ROSC concluded that Canada fully observes Principle V regarding settlement in multilateral netting system. The IMF report notes that bilateral and multilateral limits help control the exposures that any one participant can incur within LVTS, and the single largest exposure created by any one participant is fully collateralized by the participants. In case there is more than one failing participant within the same LVTS business day, the BoC guarantees settlement for the entire system but not before collateral pledged by private sector participants is exhausted. The CLS system observes Principle V because it features a sufficient risk design to facilitate efficient final payment, ensuring that the CLS Bank can fulfill its post-settlement pay-out obligations "even if the Settlement Member with the largest Pay-In requirement in a single currency is unable to satisfy this funding requirement" (p. 40).

VI. Assets used for settlement should preferably be a claim on the central bank; where other assets are used, they should carry little or no credit risk and little or no liquidity risk.

FC

As noted in the IMF's 2000 ROSC Canada fully observes Principle VI regarding the use of settlement assets. According to the 2001 Goodlet report, the LVTS uses claims drawn on the BoC to settle net payment obligations to participants partaking in the system. The report also notes that the risk-proof nature of the LVTS guarantees that a sufficient balance is available at the central bank for settlement purposes at all times and under all circumstances. Per the 2007 CLS Bank report, the CLS system observes Principle VI. While each settlement member is exposed to credit and liquidity risks tied to funds due from the CLS Bank, the risks are very limited because the CLS system design features thorough algorithms to guarantee the efficient deployment of central bank funds on an intraday basis.

VII. The system should ensure a high degree of security and operational reliability and should have contingency arrangements for timely completion of daily processing.

FC

According to the 2000 IMF ROSC, Canada fully observes Principle VII regarding security and operational reliability. As noted in Goodlet's 2001 report, the LVTS, whose operations are administered by a highly competent and experienced CPA staff, is one of the most secure systems in the world, replete with a reliable SWIFT communication system (to securely transmit payment instructions) and controls to ensure only authorized users can gain access to LVTS. To further ensure a high degree of operational reliability, the LVTS operates a secondary operations site in a separate location within Canada, where backup processing capacity is often tested. Furthermore, the BoC has extensive contingency plans, which are designed to control a thorough list of operational risks and are examined annually by an independent auditing firm. To further bolster the system, the BoC has numerous standby emergency committees created to promptly contain any operational crisis in the LVTS or any of its associated systems, such as the Debt Clearing Service (DCS), which is used by LVTS participants to pledge collateral to the BoC. It is important to note that the DCS recovery time to return the systems to full operations following a disaster at the primary site has been reduced to two hours just like in LVTS. Equipped with a high degree of operational reliability and a resilient technical architecture, the CLS system observes Principle VII as noted in 2007 CLS Bank report. Furthermore, the CLS Bank has effective contingency operations, which are regularly tested.

VIII. The system should provide a means of making payments which is practical for its users and efficient for the economy.

FC

The 2000 IMF ROSC noted that Canada fully observes Principle VIII regarding efficiency. According to the 2001 Goodlet report, there are no indications of system inefficiencies, and the system has the capacity to handle significant growth in payment volumes. Efficiency is augmented by the practice of payments being processed individually as entered into the LVTS, thus contributing to the LVTS' solid reputation of never having any cases of payments being jammed in prolonged queues or remaining in queues at the end of the day without being processed. The 2000 IMF ROSC states that, even if the risks are minute, there are still risks involved in the BoC's guarantee of the payment system. The BoC asserted to the IMF that, in its opinion, there was little relative cost to the risk that the guarantee would be used when compared to the cost to system participants of a requirement to pledge more collateral in order to cover failure by multiple participants. This the BoC deems such a guarantee to be a public good. The CLS Bank's 2007 report states that the CLS system also observes Principle VIII, adding that "the CLS system operates efficiently, providing high-quality, practical services to Members" (p. 48).

IX. The system should have objective and publicly disclosed criteria for participation, which permit fair and open access.

FC

According to the 2000 IMF ROSC, Canada fully observes Principle IX regarding access criteria. The 2001 Goodlet report attributes this assessment to the full declaration of criteria (for becoming a direct participant in the LVTS) in the LVTS bylaw. Better yet, according to the LVTS bylaw, all CPA members are permitted to participate in LVTS, and there are no restrictions on the value or volume of payments processed by a direct participant. Also pertaining to access criteria, the report notes that all CPA members unwilling to be direct LVTS participants may still make payments through the LVTS by using the services of a direct participant. The Goodlet report notes that if there are legal issues originating from the location of a foreign bank, restrictions will be placed on their ability to be direct LVTS participants. Also, current Canadian law stipulates that foreign banks operating within the LVTS do so through their Canadian subsidiaries, since the latter are incorporated under and subject to all Canadian laws, including the PCSA. Foreign banks could be eligible to be direct LVTS participants through their branches so long as they can assure the BoC that their involvement would not undermine LVTS efforts to control risks, such as the use of netting and collateral. According to the 2007 CLS Bank report, the CLS system observes Principle IX. The criteria for participation by CLS system's members are objective and publicly disclosed. Also, access to the CLS system is open to all institutions either directly to members or indirectly to customers of members.

X. The system's governance arrangements should be effective, accountable and transparent.

FC

As noted by the IMF in its 2000 ROSC, Canada fully observes Principle X regarding effective, accountable and transparent governance. According to the 2001 Goodlet report, the LVTS is owned and operated by the CPA, and the CPA is governed by an Act of Parliament, which clearly and publicly lists LVTS membership criteria, the composition of the board of directors and public-disclosure requirements, amongst other requirements. The plans and objectives of the CPA Board, which is specifically tasked with the day-to-day operation of the LVTS, are fully documented, and all progress is assessed and publicized. Furthermore, all major decisions are made after thorough public consultation with interested parties (i.e. the Cabinet must approve all bylaws), and final decisions are promptly publicized. While separate committees containing direct participants like the BoC exists to manage numerous operational challenges, the LVTS does not have separate governance arrangements. Also, the 2001 IMF ROSC notes that since the BoC has placed the LVTS under PCSA jurisdiction, the central bank is the overseer of Canada's payment system. The 2007 CLS Bank report concludes that the CLS system observes Principle X, noting that the bank's governance structure is effective, accountable and transparent.

A. The central bank should define clearly its payment system objectives and should disclose publicly its role and major policies with respect to systemically important payment systems.

FC

According to information provided the BoC website, the PCSA mandates the BoC to perform oversight of payments and other clearing and settlement systems in Canada for the ultimate purpose of controlling systemic risks. In addition to these regulatory responsibilities, the BoC performs a plethora of other important duties, such as settling the positions among LVTS participants and lending funds overnight to any institution that is unable to meet its LVTS obligations on any given day (i.e. providing liquidity). It is important to note that, unlike central banks in many other countries, the BoC itself does not own or manage the country's major payment systems, even though the BoC does have a natural interest in the smooth operation of the systems for numerous reasons. For example, the smooth running of the LVTS directly impacts the BoC's overarching goal to ensure a sound financial system in Canada and its goal to participate in international groups that monitor payment system risks. Also, an unsound payment system can undermine the BoC's efforts to adequately install Canada's monetary policy, and can also create major liquidity and credit risks for LVTS participants. Furthermore, the Canadian Payment Association, which operates Canada's national payment systems, would be ineffective without its strong links to the BoC.

As noted in the 2003 CPSS "Payment Systems in Canada" report, the PCSA mandates the CPA to "establish by-laws, rules and standards regarding the operation and governance of its systems" (p. 53). Furthermore, these LVTS by-laws cover all functions of the LVTS, and are publicly available. These by-laws form the basis on which the CPA oversees daily LVTS operations and compliance with transaction rules. Finally, according to the CPSS report, the CPA and PCSA gives the BoC Governor and the Minister of Finance most of their regulatory powers with respect to CPA rules and by-laws. According to the BoC, the PCSA also provides the BoC with powers to provide a guarantee of settlement to designated systems and the ability to pay interest on special deposits accepted from the participants in systems. The BoC also publishes a guideline outlining its approach to carrying out its oversight responsibilities. Ultimately the outcome of these oversight activities is published in its Annual Report and numerous papers. The BoC also disseminates such information through speeches by senior officials of the Bank and through public media, such as The Canada Gazette, which is used to formally announce systems designated as subject to the Bank's oversight. Lastly, the BoC is mandated by law to consult with interested parties (like the Canadian Cabinet) about its oversight activities.

B. The central bank should ensure that the systems it operates comply with the Core Principles.

FC

As noted by the IMF in its 2000 ROSC, the Canadian LVTS system complies with all the CPSIPS. According to the 2003 CPSS report, the BoC has sufficiently broad oversight ability in line with international standards. As noted in its 2006 Financial Systems Review, the BoC ensures that the systems it operates comply with the Core Principles by operating a thorough oversight strategy consisting mainly of setting minimum standards that condition the efforts of designated systems to control risks. In other words, the BoC basically provides incentives for the operation of risk-free and efficient systemically important clearing and settlement systems. Private sector systems are responsible for designing the most efficient way to meet these conditions. Subsequently, the BoC uses periodical audits to ensure that systems are acting as expected to control risks. Furthermore, as part of the PCSA, the BoC is responsible for reviewing all payment, clearing and settlement systems for potential systemic risks.

C. The central bank should oversee compliance with the Core Principles by systems it does not operate and it should have the ability to carry out this oversight.

FC

According to the 2003 CPSS report, the BoC has sufficiently broad oversight ability in line with international standards. The PCSA plays a key role in defining the BoC's oversight reach by determining which systems are eligible for BoC oversight, outlining the criteria by which systems are selected to be subject to BoC oversight, and also by apportioning the powers to effectively carry out such oversight.

As noted in the 2001 Goodlet report, the ultimate function of the BoC's oversight efforts is to reduce and adequately control systemic risks. Therefore, most importantly, the PCSA mandates the BoC to exercise oversight not only over systemically important payments systems, but also over other clearing and settlement systems that are capable of posing systemic risks, such as a clearing and settlement system for securities or foreign exchange. According to the 2003 CPSS report, under the PCSA, the BoC can review a system if: (1) it consists of three or more participants, including a bank; (2) it settles Canadian dollar payments; and (3) the payments are ultimately settled through BoC accounts. This is the case, regardless of whether or not the BoC operates the system.

D. The central bank, in promoting payment system safety and efficiency through the Core Principles, should cooperate with other central banks and with any other relevant domestic or foreign authorities.

FC

The Goodlet 2001 report discloses that the BoC established the Financial Institutions Supervisory Committee (FISC) in 1987 to facilitate co-operation with other relevant domestic and foreign authorities. Composed of the Superintendent of Financial Institutions (the chairperson), the Deputy Minister of Finance, the Chairman of the Canada Deposit Insurance Corporation and the Governor of the BoC, the main function of the FISC is to encourage the exchange of information on topics concerning the supervision of financial institutions, particularly developments pertaining to systemically important clearing and settlement systems.

According to its 2006 Financial System Review, an important part of the BoC's oversight process is the signing of Memoranda of Understanding (MoUs) with operators of major domestic clearing and settlement systems, the CPA and CDS. The MoUs outline the duties and responsibilities of both participating parties under the PSCA. According to the BoC's 2006 report, "they address such topics as the Bank's exercise of its oversight responsibilities and powers, as laid out in the PCSA, confidentiality of information, time frames for review of significant system changes, and the use of minimum standards" (p. 33). A major example was the signing of an MoU between the BoC and the CPA concerning LVTS oversight in November 2006. Reflective of the overall co-operative nature of the BoC's oversight process, the MoU further clarified the relationship between the BoC and the CPA, thus also advancing the oversight process. A significant aspect of the MoU is that the CPA will henceforth give advance written notice upon any significant change to the LVTS bylaws or rules. This is done to give the BoC ample time to ascertain if the proposed changes raise any concerns about systemic risk.