Vol. 151, No. 51 — December 23, 2017

By-law Amending the Canadian Payments Association By-law No. 3 — Payment Items and Automated Clearing Settlement System

Statutory authority

Canadian Payments Act

Sponsoring department

Department of Finance

REGULATORY IMPACT ANALYSIS STATEMENT

(This statement is not part of the By-law.)

Issues

Amendments to the Canadian Payments Association By-law No. 3 — Payment Items and Automated Clearing Settlement System (ACSS By-law) under the Canadian Payments Act are proposed to address developments impacting Canada’s core payment systems, namely the recent designation of the Automated Clearing Settlement System (ACSS) as a Prominent Payment System by the Governor of the Bank of Canada.

Background

Payments Canada is a statutory body with a mandate to establish and operate national systems for the exchange, clearing, and settlement of payments between banks, credit unions, and other Payments Canada members. Payments Canada operates the Large Value Transfer System and the ACSS. The ACSS is a deferred net settlement system that clears retail payments, including paper-based payment items such as cheques, pre-authorized debits and credits, as well as smaller-value electronic payment items, such as debit card or automated banking machine transactions. Currently, 12 financial institutions participate in the ACSS as either direct or group clearers.

The Governor of the Bank of Canada designated the ACSS as a Prominent Payment System on May 2, 2016. This designation reflects the fact that the ACSS has been deemed to have the potential to pose payments system risk, that is, the risk that a disruption to or a failure of a clearing and settlement system could cause a significant adverse effect on economic activity in Canada.

The designation brings the ACSS under the formal oversight of the Bank of Canada, thereby requiring Payments Canada to meet the Bank of Canada’s Risk-Management Standards for Prominent Payment Systems (the Standards). The Standards are based on the CPMI-IOSCO (see footnote 1) Principles for financial market infrastructures (PFMIs), reflecting the different risks posed by Prominent Payment Systems compared to systems designated as systemically important. Payments Canada performed an initial self-assessment of the ACSS against the Standards. The self-assessment took into account the characteristics and design of the ACSS and Payments Canada as an organization, including the statutory framework in which it operates.

The largest gap uncovered through the self-assessment process was related to credit risk requirements. The Standard on credit risk requires a Prominent Payment System to maintain sufficient financial resources to cover its credit exposure arising from the default of the participant and its affiliates that would generate the largest aggregate credit exposures for the Prominent Payment System, in extreme but plausible market conditions. This Standard requires the ACSS to maintain collateral that can be used to effect settlement on the day of default.

Currently, the ACSS is a deferred net settlement system with no collateral requirements. In the unlikely event of a default, direct clearers who have an exposure to the defaulter on the day of the default are required to make an additional contribution in order to effect the settlement of the defaulter’s obligation. There are currently no assurances that direct clearers will have available resources to draw upon under short timelines. This arrangement does not meet the Standard on credit risk, which requires a Prominent Payment System to maintain collateral ex ante to cover the largest credit exposure.

Payments Canada is currently engaged in a multi-year project to modernize and update Canada’s large payment systems. While the ACSS will be replaced and updated as part of this initiative, Payments Canada has developed an interim credit risk model for the ACSS until such time as the ACSS is replaced. The ACSS interim credit risk model requires direct and group clearers participating in the ACSS to pledge collateral ex ante and sets out loss allocation arrangements in the event of default. Implementation of the interim credit risk model requires amendments to the ACSS By-law to articulate the obligations of direct and group clearers, which will be accompanied by rules made under section 19 of the Canadian Payments Act.

Objectives

The objectives of the proposed amendments are to provide well-founded, clear, transparent, and enforceable legal basis for the ACSS interim credit risk model.

Description

The amendments impose a new requirement for direct and group clearers participating in the ACSS to pledge collateral to the Bank of Canada for purposes of same-day settlement of clearing balances in the event of a participant’s default. The collateral pledged to the Bank of Canada by all direct and group clearers participating in the ACSS will make up the ACSS “collateral pool.” The amendments also articulate direct and group clearer’s responsibility to contribute to the loss-sharing arrangement in the event that a clearer defaults.

Collateral pool and pledging of collateral

The proposed amendments articulate a requirement for Payments Canada to calculate, and periodically recalculate, the size of the collateral pool in accordance with Payments Canada’s rules. While the conditions surrounding this calculation will be set out in the rules, the Bank of Canada credit risk Standard requires the single largest credit exposure to be fully covered by collateral with a high degree of confidence.

The proposed amendments to the ACSS By-law also articulate the requirement for direct and group clearers to pledge collateral to the pool, in an amount, time and manner to be specified in the rules. Once a direct clearer has pledged collateral, that direct clearer may not use that collateral for any purpose other than for the purpose of securing an advance from the Bank of Canada to enable settlement. The proposed amendments also specify the conditions under which the Bank of Canada may release excess collateral to a direct or group clearer, and specify that the collateral pool pledge is subject to valuation by the Bank of Canada at the time the pledge is made.

Default

In the event of default by a direct or group clearer, if the value of the defaulter’s collateral is not enough to obtain an advance from the Bank of Canada to cover the shortfall, the surviving direct and group clearers must cover a portion of the default by making a default contribution in an amount determined by a formula to be set out in the rules. The rules will specify that the default contribution will be calculated based on the value each surviving direct clearer’s credit exposure to the defaulter on the day of default.

In the event that the default contributions described above are not sufficient to cover the shortfall, the proposed amendments provide that the surviving direct clearers, and the Bank of Canada, must make an additional contribution to cover the remaining shortfall, so that the default is fully covered. The amount of the additional contribution for surviving and direct clearers will be determined in accordance with the rules. The proposed amendments also specify that, once the default and additional contributions from surviving direct clearers have covered the default shortfall, the Bank of Canada shall effect settlement. The proposed amendments provide that the total amount of default contributions is limited to the value of the collateral that each surviving direct or group clearer has apportioned to the collateral pool.

Default in following ACSS cycles

An additional amendment to the Canadian Payments Association by-law is proposed to provide that a direct or group clearer will also be in default if it is not able to satisfy its collateral requirement. The effect of this new ground for default is that, even if the ACSS collateral pledged by the direct clearer is sufficient to obtain an advance from the Bank of Canada for the settlement of one cycle, it will be in default if it cannot make the required collateral pool pledge for the subsequent ACSS cycle.

The proposed amendments also specify that a defaulting direct or group clearer is required to reimburse other direct and group clearers in the amount of its default and additional contributions, plus interest.

“One-for-One” Rule

There are no “One-for-One” Rule implications of the amendments.

Small business lens

The small business lens does not apply, as the amendments do not impose costs on small businesses. All direct and group clearers who will be required to pledge collateral to the ACSS are large financial institutions.

Consultation

Representatives of direct clearers and the Bank of Canada participated with Payments Canada in a Risk Working Group that was established to review the requirements regarding the pledging of collateral and develop the proposed loss-sharing arrangement and settlement model. The working group met on multiple occasions to develop and finalize the approach. Payments Canada then published a consultation paper, inviting members’ feedback on the proposed ACSS interim credit risk model. The comments and concerns that were received were summarized and addressed in a follow-up communication with two management advisory committees and the Risk Working Group, and are reflected in the proposed amendments.

Rationale

The proposed amendments are needed to provide a sound legal basis for the ACSS interim credit risk model, which will enhance the safety and soundness of Canadian payments system by effecting same-day settlement of the ACSS in the unlikely event of default by a direct or group clearer. Given that the ACSS has been designated as a Prominent Payment System, the proposed amendments to implement the interim credit risk model are also required to meet the Bank of Canada’s Risk-Management Standards for Prominent Payment Systems, based on the CPMI-IOSCO Principles for financial market infrastructures (PFMIs).

Contact

Stephanie Mould
Senior Legal Counsel and Principal, Compliance
Payments Canada
Constitution Square, Tower II
350 Albert Street, Suite 800
Ottawa, Ontario
K1R 1A4
Email: smould@payments.ca

PROPOSED REGULATORY TEXT

Notice is given that the Board of Directors of the Canadian Payments Association, pursuant to subsection 18(1) (see footnote a) of the Canadian Payments Act (see footnote b), proposes to make the annexed By-law Amending the Canadian Payments Association By-law No. 3 — Payment Items and Automated Clearing Settlement System.

Interested persons may make representations concerning the proposed By-law within 30 days after the date of publication of this notice. All such representations must cite the Canada Gazette, Part I, and the date of publication of this notice, and be addressed to Hugues Vaillancourt, Director, Payments Policy, Financial Sector Policy Branch, Department of Finance, 90 Elgin Street, Ottawa, Ontario K1A 0G5 (tel.: 613-369-4123).

Ottawa, December 13, 2017

Eileen Mercier
President of the Board of Directors of the
Canadian Payments Association

By-law Amending the Canadian Payments Association By-law No. 3 — Payment Items and Automated Clearing Settlement System

Amendments

1 Section 1 of the Canadian Payments Association By-law No. 3 — Payment Items and Automated Clearing Settlement System (see footnote 2) is amended by adding the following in alphabetical order:

pledge means a grant to the Bank of Canada of a security in collateral to guarantee an advance of funds that the Bank of Canada may make for the purposes described in section 34.1 and includes a grant of a security in which the Bank of Canada does not take possession of the collateral. (nantissement)

2 Paragraph 26(b) of the By-law is replaced by the following:

3 The By-law is amended by adding the following after section 34:

Pledging Collateral

Calculation of necessary collateral

34.1 (1) The Association shall calculate, in accordance with the rules, the required amount of the ACSS collateral pool and the amount of each direct clearer and group clearer’s collateral pool pledge. The Association shall periodically recalculate these amounts, in accordance with the rules.

Pledging collateral

(2) Each direct clearer and group clearer shall pledge collateral to the Bank of Canada, in an amount determined by the Association in accordance with the rules, within the time and in the manner set out in the rules. If the amount of the collateral pool pledge increases as a result of a recalculation under subsection (1), the direct clearer or group clearer shall pledge the recalculated amount, within the time and manner set out in the rules.

Valuation by Bank of Canada

(3) Any collateral pledged by a direct clearer or group clearer for ACSS purposes is subject to valuation by the Bank of Canada at the time the pledge is made.

Insufficient collateral

(4) If, on valuation of the collateral by the Bank of Canada, the value assigned by the Bank of Canada to the collateral pledged is less than the amount that is required to be pledged, the direct clearer or group clearer shall pledge additional collateral.

Exceeding collateral

(5) If the value of the direct clearer or group clearer’s collateral pledge exceeds the amount that is required to be pledged, the direct clearer or group clearer shall, on request for a release made to the Bank of Canada, obtain a release of the excess collateral from the pledge.

Restricted purpose

34.2 A direct clearer or group clearer shall not use the collateral pledged under subsection 34.1(2) for any purpose other than securing an advance from the Bank of Canada to enable settlement under section 50.

4 Section 50 of the By-law is replaced by the following:

Settlement

50 (1) Subject to subsection (2), once the clearing balances have been established by the ACSS and corrected, if necessary, the Bank of Canada shall effect settlement by making the appropriate debit or credit entry into each direct clearer’s or group clearer’s settlement account.

Default

(2) In the case of a default by a direct clearer or group clearer under paragraph 53(1)(a), the Bank of Canada shall only effect settlement once the contributions by the other direct clearers, group clearers or the Bank of Canada have been made under subsection 57(2) or 57.01(2).

5 Section 53 of the By-law is replaced by the following:

Default of direct clearer or group clearer

53 (1) A direct clearer or group clearer is in default for the purposes of this By-law if

Notice

(2) The Bank of Canada shall immediately notify the President of a default and, in the case of a default under paragraph (1)(a), of the amount of the shortfall. The President shall then notify all other direct clearers and group clearers of the default.

6 Section 57 of the By-law is replaced by the following:

Allocation of shortfall

57 (1) Subject to subsection (3), upon receiving notice from the Bank of Canada of a default by a direct clearer or group clearer under paragraph 53(1)(a) and of the amount of the shortfall, the Association shall allocate the shortfall between the direct clearers and group clearers that are not in default by calculating, in accordance with the rules, the default contribution to be made by each of them.

Default contribution

(2) The direct clearers and group clearers that are not in default shall make a default contribution to the settlement account of the direct clearer or group clearer in default in the amount determined under subsection (1) within the time and in the manner specified by the rules.

Limit of contribution

(3) The total amount of default contributions under subsection (2) from the direct clearers and group clearers that are not in default shall not exceed the amount of the ACSS collateral pool calculated in subsection 34.1(1), less the amount pledged as collateral by the defaulting direct clearer or group clearer.

Calculation of additional contribution

57.01 (1) In the event that the default contributions made under section 57 are not sufficient to enable the Bank of Canada to effect settlement, the Association shall calculate, in accordance with the rules, an additional contribution to be made by direct clearers and group clearers that are not in default and by the Bank of Canada to effect settlement.

Additional contribution

(2) The direct clearers and group clearers that are not in default and the Bank of Canada shall make a contribution to the account of the direct clearer or group clearer in default in the amount determined under subsection (1) within the time and in the manner specified in the rules.

Reimbursement with interest

57.02 A direct clearer or group clearer shall reimburse each direct clearer, group clearer, or the Bank of Canada for any amount received as a contribution under subsection 57(2) or 57.01(2), plus interest at the rate specified in the rules, and those amounts constitute a debt that survives irrespective of the status of the defaulting direct clearer or group clearer.

Coming into Force

7 This By-law comes into force on the day on which it is registered.

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