Financial System

• The Payment Clearing and Settlement Act (PCSA)
• Designating at-risk systems
• Guideline Related to Bank of Canada Oversight Activities under the Payment Clearing and Settlement Act (PCSA)
• Reponsibilities of the Minister of Finance under the Canadian Payments Act (CPA)

This act was proclaimed by Parliament in July 1996. It gives the Bank of Canada responsibility for the oversight of payments and other clearing and settlement systems in Canada, for the purpose of controlling systemic risk. (Systemic risk refers to domino or spillover effects where the inability of one financial institution to fulfil its payment obligations results in the inability of other financial institutions to fulfil theirs, or in the failure of a clearing house.)

The PCSA is the government's recognition of the essential role of the major clearing and settlement systems in the Canadian economy, and of the importance of regulatory oversight of these systems. Canada was the first G-10 country to adopt legislation that specifically requires the central bank to oversee the control of systemic risk in major payment and other clearing and settlement systems.

The PCSA formally recognizes the oversight role of the Bank of Canada with regard to the design and operation of clearing and settlement systems by:

• providing for the collection of information from systems to determine their eligibility for oversight under the PCSA and to determine whether the operation of an eligible system has the potential to create systemic risk as defined in the Act
• empowering the Bank to designate an eligible clearing and settlement system as being subject to Bank of Canada oversight under the PCSA where the Governor is of the opinion that such a system may be operated in such a manner as to pose a systemic risk¹
• requiring the Bank to satisfy itself that designated systems have appropriate risk controls in place to deal with potential systemic-risk concerns.
• requiring the clearing house of every designated system to provide the Bank of Canada 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
• providing the Governor of the Bank with the power to issue written directives to the operator of a designated clearing and settlement system to refrain from actions that are likely to result in systemic risk being inadequately controlled or to take actions to remedy a stiaution in which the Governor is of the opinion that systemic risk is likely being inadequately controlled.

In addition, the PCSA contains provisions that, when combined with federal insolvency legislation, reinforce the legal enforceability of netting in designated payments and other clearing and settlement systems. The PCSA also provides that the settlement rules of designated systems are immune to legal stays or other legal challenges, even in cases where a participant in one of these systems fails. This increases the certainty that the legal arrangements governing the operations of a designated clearing and settlement system will produce the expected outcome in periods of financial stress.

Matters that are not directly related to an institution's participation in a designated clearing and settlement system are not subject to the Bank's oversight under the PCSA. For example, the PCSA specifically precludes the Governor from issuing a directive with respect to a participant's capital adequacy, the management of its investments, or its relations with its own customers.

The PCSA also provides the Bank of Canada with two other noteworthy powers: the ability to provide a guarantee of settlement to designated systems, and the ability to pay interest on special deposits accepted from the participants in systems.

Under the PCSA, the Bank of Canada reviews all eligible payments and other clearing and settlement systems for their potential to pose systemic risk. A system is eligible for review by the Bank if

• it has three or more participants, one of which is a bank
• it clears or settles Canadian-dollar payment obligations, and
• the payment obligations are ultimately settled through accounts at the Bank of Canada.

The PCSA provides a definition of systemic risk that is consistent with the definition used in many international reports. If the Governor of the Bank forms the opinion that a system has the potential to pose systemic risk, the system may be designated as subject to the Act, provided the Minister of Finance believes that this is in the public interest. Once designated, a system has to satisfy the Bank that it has mechanisms in place to control systemic risk. In extreme situations—where the Governor judges that systemic risk is being inadequately controlled—the Bank may issue directives to the system operators or to participants in a designated system.

When deciding if a system should be designated under the PCSA, the Bank considers

• the size of individual payment obligations and the size of the aggregate value of payment obligations on any given day
• the size of payment obligations owed to and by participants in the system relative to each participant's capital, and
• the role played by the system in supporting transactions in financial markets or the economy more generally.

Systems that handle small-value payments (either as individual payments or aggregate payment obligations) are unlikely to be designated, since they typically do not pose systemic risk. Nevertheless, the Bank monitors such systems for changes in their situation. Systems that handle large-value payment obligations are much more likely to generate systemic risk, and so are much more likely to be designated.

The following payment and other clearing and settlement systems are eligible for review under the PCSA:

• the Large Value Transfer System
• the Automated Clearing Settlement System
• the CDSX (operated by the Canadian Depository for Securities Limited)
• the CLS Bank
• the Canadian Derivatives Clearing Corporation

The following systems have been designated as being subject to the PCSA:

• The Large Value Transfer System
• CDSX
• CLS Bank

This Guideline, issued by the Bank, describes how the Bank operates under the PCSA, particularly in gathering information to identify eligible systems and in determining whether eligible systems will be designated. The Guideline also indicates the minimum standards that the Bank applies to designated systems.

Under the Canadian Payments Act, all CPA rules and standards, including any amendments, are subject to a 30-day-review period by the Minister of Finance, who has the power to disallow any rule that is not deemed to be in the public interest. The Minister also has the authority to issue a directive to the CPA to make, amend, or repeal a bylaw, rule, or standard.

The Minister also has the authority to designate and oversee a payments system that is national in scope or which plays a major role in supporting transactions in the Canadian financial markets or the Canadian economy. In designating a payments system, the Minister would consider

• the level of financial safety provided by the payments system to the participants and users
• the efficiency and competitiveness of payments systems in Canada
• the best interests of the Canadian financial system.

The Minister can issue directives to designated payments systems regarding the conditions for becoming a participant in the system, the operation of the payments system, its interaction with other Canadian payments systems, and the relationship of the system with users. To date, the Minister has not designated any systems.

Finally, a non-statutory body called the Payments Advisory Committee (PAC) has been formed to minimize any duplication of oversight activities by the Minister of Finance under the CPA and the Bank of Canada's oversight responsibilities under the PCSA. The PAC is co-chaired by senior officers of the Department of Finance and of the Bank of Canada.