Financial System

• Large Value Transfer System (LVTS)
• Automated Clearing Settlement System (ACSS)

Designed and built by the Canadian Payments Association (CPA), the LVTS began full operations on 4 February 1999. The LVTS is a real-time, electronic wire transfer system that processes large-value or time-critical payments quickly and continuously throughout the day. It provides LVTS participants and their customers with the certainty that once a payment message has passed the system's risk-control tests, the transaction will settle on the books of the Bank of Canada on the same day, regardless of what happens to any of the participants subsequently.

The LVTS plays a particularly important role in the settlement of Canadian-dollar payment obligations arising from securities and foreign exchange transactions. The LVTS has been designated under the Payment Clearing and Settlement Act and thus is subject to Bank of Canada oversight.

More about the LVTS:

Direct participants

Risk-control mechanisms

Tranche 1 and Tranche 2 payments

LVTS daily operating schedule

The core principles and their application to the LVTS

LVTS participants

The Canadian Payments Association sets out the requirements financial institutions must meet to be direct participants in the LVTS. An institution must:

• be a member of the CPA
• use the SWIFT telecommunications network
• have adequate backup capability for its LVTS operations
• have a settlement account at the Bank of Canada
• enter into agreements relating to taking loans from the central bank and to pledging the appropriate collateral. Indirect access to the LVTS is provided by LVTS participants to their customers, which include other financial institutions as well as commercial and government entities.

The LVTS forms the core of the national payments system. The LVTS substantially reduces systemic risk and allows Canada to meet the best international practices for handling large-value payments. The risk-control structure of the LVTS is composed of the following elements:

• Individual payment messages are subject to risk-control tests in real-time.
• The net amount that each participating financial institution is permitted to owe is subject to bilateral and multilateral limits.
• At the beginning of each day, the participants pledge to the Bank of Canada appropriate collateral security with a value sufficient to cover the largest single permitted net debit position from a single participant, thus providing sufficient collateral to make available the necessary liquidity to settle the system even in the event that one of the participants defaults.
• The Bank of Canada also guarantees settlement of the system in the extremely unlikely circumstance that more than one participant fails during the LVTS operating day. The guarantee will only be called on in the event of an unanticipated failure of more than one participant on the same day during LVTS operating hours, with the failing participants in a net owing position vis-à-vis the system, and if the amount owed by the failing participants exceeds the value of collateral that has been pledged to the Bank of Canada.

These four elements provide the participants with certainty of settlement of those payments that pass the risk-control tests. In turn, this permits the institutions to offer intraday finality of payment to their customers.

Tranche 1 and Tranche 2 payments

When sending an LVTS payment, the sending participant has a choice between two types of payment: Tranche 1 and Tranche 2. Each tranche has its corresponding risk-control limit. A participant can send a Tranche 1 payment as long as its net owing position as a result of all Tranche 1 payments sent by it is no greater than the amount of collateral that the institution has pledged to the Bank of Canada for Tranche 1 activity. If the participant should default in the course of that day, this collateral would be used to cover any net negative position in this category of payment. For this reason, Tranche 1 payments are known as the "defaulter-pays" type within the LVTS.

Under Tranche 2, each participating institution begins the day by granting a bilateral line of credit to every other institution (which can be zero), i.e., the largest net exposure that it is prepared to accept vis-à-vis that institution on that day. In addition, each participant (as a sender) has a multilateral net debit cap, calculated as the sum of all bilateral lines extended to it, multiplied by a specified percentage set by the CPA. Each participating financial institution pledges to the Bank of Canada collateral equal to the largest bilateral line of credit it has extended to any other institution multiplied by the specified percentage. If a participating institution fails, the loss-allocation procedures prorate any losses on the basis of the bilateral lines of credit established by survivors vis-à-vis the failed institution. The collateral pledged by the participants is sufficient to cover the failure of the institution with the largest possible amount owing to the system, i.e., the institution with the largest sender net debit cap. This part of the system has been described as "survivors-pay," since surviving financial institutions largely absorb the losses associated with a failure. Tranche 2 payments make up the great majority of the volume and value of payment transfers in the LVTS, principally because of savings in collateral relative to Tranche 1 operations.

LVTS daily operating schedule

• 12:30 a.m. to 1 a.m. Participants sending payments related to the CLS Bank set their sender net debit caps for Tranche 1 activity and their bilateral lines, if any, for Tranche 2 transfers. Appropriate collateral is pledged to the Bank of Canada, and the Bank provides an evaluation of this collateral to the CPA. The collateral must be sufficient to cover the largest possible net debit position of any single participant.
• 1 a.m. The LVTS opens for CLS and CLS-related payment transactions only.
• 1 a.m. to 7 a.m. Participants send payments to the CLS Bank and receive payments from the CLS Bank through the Bank of Canada, either on their own account or for third-party clients. Participants may also send other CLS-related payments to one another. Receivers make incoming funds available to payees. Participants may adjust their Tranche 1 limits (and increase their pledged collateral if needed). They may also reduce any bilateral lines extended to other participants, although this does not change the calculated shares of any loss.
• 7 a.m. to 8 a.m. All other participants set their sender net debit caps for Tranche 1 activity and their bilateral lines for Tranche 2 transfers. Appropriate collateral is pledged to the Bank of Canada, and the Bank provides an evaluation of this collateral to the CPA. The collateral must be sufficient to cover the largest possible net debit position of any single participant.
• 7 a.m. The LVTS opens for all other payment transactions.
• 7 a.m. to 6 p.m. Participants send payments to one another, either on their own account or for third-party clients. Receivers make incoming funds available to payees. Participants track their Tranche 1, Tranche 2, and overall positions throughout the day so they can respond if they are nearing a cap amount. They may adjust their Tranche 1 limits (and increase their pledged collateral if needed). They may also reduce any bilateral lines extended to other participants, although this does not change the calculated shares of any loss.
• 6 p.m. The LVTS closes for third-party payments.
• 6 p.m. to 6:30 p.m. Pre-settlement period during which participants may enter into transactions with each other designed to even out "long" and "short" LVTS positions and reduce any need to borrow from the central bank overnight.
• 6:30 p.m. to 7:30 p.m. Settlement period during which the Bank of Canada enters the multilateral net position (either a credit for a gain, or a debit for a loss of funds) of each participant into its settlement account at the central bank. The entries in the settlement accounts are final and irrevocable. The Bank of Canada makes every effort to complete the settlement procedures by 7:30 p.m. so that unused collateral can be released to the participants by 8 p.m.

See also: "The LVTS—Canada's large value transfer system" and A Primer on Canada's Large Value Transfer System, by Neville Arjani and Darcey McVanel

The core principles and their application to the LVTS

In May 1998, the G-10 central banks' Committee on Payment and Settlement Systems (CPSS) established a task force to develop a framework of core principles for the design, operation, and oversight of payments systems in all countries. In January 2001, the task force published its final report, "Core principles for Systemically Important Payment Systems," Report No. 43. Basel: Bank for International Settlements. The report is available on the BIS website. The report sets out 10 core principles for the safe and efficient operation of systemically important payments systems.

The Large Value Transfer System (LVTS) is Canada's "systemically important" payments system. The LVTS is assessed as being in full compliance with the 10 core principles and also exceeds the minimum requirements set out in core principles IV and V. (See also "Does the LVTS comply with the core principles?")

In late 1999, Canada participated in a pilot project administered by the International Monetary Fund (IMF) and the World Bank that assessed a country's compliance with a number of international standards and codes. This included an assessment of LVTS compliance with the core principles for systemically important payments systems. The IMF concluded that the LVTS is in full compliance with the core principles. These assessments are part of what is known as a Financial Sector Assessment Program (FSAP). The results of the assessment are published in a Report on the Observance of Standards and Codes.

LVTS participants

On 4 February 1999, the Canadian Payments Association (CPA) introduced the Large Value Transfer System (LVTS), an electronic system for the transfer of payments. An LVTS participant is a member of the CPA who participates in the LVTS and maintains a settlement account at the Bank of Canada. In December 2004, there were 14 LVTS participants in addition to the Bank of Canada

Alberta Treasury Branches
Bank of America, National Association
Bank of Montreal
The Bank of Nova Scotia
BNP Paribas (Canada)
La Caisse centrale Desjardins du Quebec
Canadian Imperial Bank of Commerce
Credit Union Central of Canada
HSBC Bank Canada
Laurentian Bank of Canada
National Bank of Canada
Royal Bank of Canada
State Street Bank and Trust Company
The Toronto-Dominion Bank

The Automated Clearing Settlement System (ACSS)

The Automated Clearing Settlement System (ACSS) is owned and operated by the Canadian Payments Association (CPA). The ACSS is a deferred net settlement system through which all payments not processed by the LVTS are handled, including paper-based payment items (mostly cheques) as well as small-value electronic payment items, such as point-of-sale (e.g., debit card) or automated banking machine transactions, and pre-authorized debits and credits.

In November 2002, the Bank of Canada examined the ACSS to see if it has the potential to pose systemic risk (see Systemic Risk, Designation, and the ACSS). The Governor of the Bank is of the opinion that the ACSS does not pose systemic risk, and it will not be designated under the Payment Clearing and Settlement Act at this time.

More about the ACSS:

Direct and indirect clearers

ACSS clearing and settlement cycle

Direct clearers in the Automated Clearing Settlement System

Direct and indirect clearers

Members of the CPA may be either direct clearers or indirect clearers in the ACSS. Eligibility criteria for being a direct clearer in the ACSS include being a CPA member and maintaining a settlement account and loan facility at the Bank of Canada. Also, the entity must account for at least one-half of 1 per cent of the total volume of ACSS clearings. An indirect clearer is a member of the CPA that does not maintain a settlement account or loan facility at the Bank of Canada and has a direct clearer acting as its agent in the ACSS clearing and settlement process.

ACSS clearing and settlement cycle

In the ACSS, payment items that are exchanged throughout the day among ACSS direct and indirect participants are cleared overnight and are settled with interest compensation on the next business day across the settlement accounts of the Bank of Canada. The specifics of the exchange and clearing of the items vary depending on the item, for example, whether the payment item is paper-based or is sent as an electronic data transmission. Nevertheless, all items follow a similar path.

Clearing is handled through six regional settlement points across the country, and the specifics differ according to the type of payment item. Generally, items collected at CPA members previous to and throughout the value day (T) are forwarded to a local data centre operated, or contracted, by a direct clearer. Direct clearers are increasingly contracting out the processing of payment items. The items are sorted at the data centre. Paper items are sorted by high-speed computerized reader/sorter equipment, according to the institutions on which they are drawn. Once sorted, the items drawn on other institutions are delivered to the data centres of the appropriate direct clearer in the same regional clearing area. The delivering direct clearer enters the information of the exchanged items, including the volume and value of various types of payment items, into its ACSS terminal. This information can be checked at the receiving direct clearer's data centre and disputed if necessary. The next day, the payment items are returned to the branches of the institutions on which they are drawn according to the type of payment item. Most cheques are returned to branches no later than two days after they are deposited.

This process of exchanging items, entering information into the ACSS terminals and, potentially, contesting entries continues on the value day until the final closing time, which is 11 p.m. E.T. for all regional settlement points. The ACSS calculates net position across all types of payment items for each of the direct clearers. By 8 a.m. the next business day (T+1), the financial institutions have typically finished making adjustments to their clients' accounts; debiting payors' accounts and crediting payees' accounts. At approximately 9:30 a.m., initial net balances are available to all the direct clearers and bilateral re-openings of the clearing may occur to correct errors if both parties agree. By 11:00 a.m., the final multilateral positions of the direct clearers are calculated and made known to the Bank of Canada.

Direct clearers' net positions are settled by adjustments to their settlement accounts at the Bank of Canada. This is typically completed by 12:00 E.T. on the settlement day (T+1) with interest compensation calculated on positions at the Bank Rate minus one quarter of one percent (25 basis points). Direct clearers in a net debit position make an LVTS payment to their settlement account at the Bank to cover their ACSS position plus calculated interest compensation. Direct clearers in a net credit position have the funds plus interest compensation credited to their account, and value is returned to them through an LVTS payment on T+1. Note that although the exchange process begins on day T, settlement is completed the next business day for value T+1; hence the interest compensation component.

As for the handling of small-value electronic items in the ACSS, the payment process is somewhat different than for cheques with respect to the information flow. For example, in the case of direct debits, such as pre-authorized bill payments, the transfers are recorded individually on magnetic tape and are entered into the system on the morning that the transaction is to take place by the payee's institution (or direct clearer). Direct credit transfers, such as direct payroll deposit, are entered into the system on magnetic tape by the payor's institution (or direct clearer) also on the morning that the transaction is to take place. Once these electronic transactions are entered on-line into the system, the settlement process for these items in the ACSS is similar to that for cheques.

Direct clearers in the Automated Clearing Settlement System (ACSS)

A direct clearer is a member of the Canadian Payments Association (CPA), participating directly in the Automated Clearing Settlement System and maintaining a settlement account at the Bank of Canada. The direct clearers act as clearing agents for other members of the CPA (indirect clearers).

In December 2004, there were 11 direct clearers in addition to the Bank of Canada:

Alberta Treasury Branches
Bank of Montreal
Bank of Nova Scotia
La Caisse centrale Desjardins du Quebec
Canadian Imperial Bank of Commerce
Credit Union Central of Canada
HSBC Bank Canada
Laurentian Bank of Canada
National Bank of Canada
Royal Bank of Canada
The Toronto-Dominion Bank