Financial System

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

Designed and operated by the Canadian Payments Association (CPA), the LVTS was launched on 4 February 1999. The LVTS is a real-time, electronic wire transfer system that processes large-value, time-critical payments quickly and continuously throughout the day. It provides 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. For a discussion of the Bank of Canada's role in the oversight of payment, clearing, and settlement systems, see http://www.bankofcanada.ca/en/fsr/2006/policy.pdf.

More about the LVTS:

Direct participants

Risk-control mechanisms

Tranche 1 and Tranche 2 payments

The core principles and their application to the LVTS

LVTS daily operating schedule

LVTS participants

The Canadian Payments Association sets the requirements that 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.

LVTS participants provide their customers, which include other financial institutions, as well as commercial and government entities, with indirect access to the system.

The LVTS forms the core of Canada's national payments system. It 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, participants pledge to the Bank of Canada appropriate collateral with a value sufficient to cover, at a minimum, the largest permitted net debit position of a single participant. This provides sufficient collateral to make available the necessary liquidity to settle the system even if one of the participants defaults.
• The Bank of Canada guarantees settlement of the system in the extremely unlikely circumstance of more than one participant failing during the LVTS operating day. The guarantee will be called on only 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 pledged to the Bank of Canada.

These four elements provide the participants with certainty of settlement. In turn, this certainty permits institutions to offer their customers intraday finality of payment.

Tranche 1 and Tranche 2 payments

When sending an LVTS payment, the sending participant can choose between two types of payment: Tranche 1 and Tranche 2. Each tranche has a corresponding risk-control limit. A participant can send a Tranche 1 payment as long as its net owing position (as a result of all its Tranche 1 payments sent and received) is no greater than the 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 "defaulter-pays."

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 pro-rate 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 absorb any losses associated with a failure (after the defaulter's collateral is seized and used to meet its obligations). 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.

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 by the Bank of Canada as being in full compliance with the 10 core principles and also exceeding the minimum requirements set out in core principles IV and V. (See also "Does the LVTS comply with the core principles?".) Under the terms of a memorandum of understanding between the Bank and the CPA, the CPA conducts an annual assessment of the LVTS' compliance with the core principles, and this assessment is published on the CPA's website: http://www.cdnpay.ca/publications/public.asp.

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 the IMF's Financial Sector Assessment Program. The results of the assessment are published in a Report on the Observance of Standards and Codes.

LVTS daily operating schedule

• 11 p.m. to 12:30 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. The Bank provides the CPA with an evaluation of pledged collateral by 12:30 a.m. The collateral must be sufficient to cover the largest possible net debit position of any single participant.
• 12:30 a.m. The LVTS opens for CLS and CLS-related payment transactions only.
• 12:30 a.m. to 6 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.
• 6 a.m. The LVTS opens for all other payment transactions.
• 7 a.m. to 8 a.m. All non-CLS 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 the CPA with an evaluation of this collateral.
• 6 p.m. The LVTS closes for third-party payments.
• 6 p.m. The LVTS closes for third-party payments.
• 6 p.m. to 6:30 p.m. During this pre-settlement period, participants may enter into transactions with one another that are 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. During this settlement period, 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, and debit positions must be covered by a collateralized overnight advance from the Bank of Canada. The Bank of Canada makes every effort to complete the settlement procedures well before 7:30 p.m., and in practice settlement is normally completed before 7 p.m. so that, if requested, unused collateral can be released to the participants by 7:30 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

LVTS participants

On 4 February 1999, the CPA launched 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 2008, 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 Québec
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 CPA. The ACSS is a deferred net settlement system that handles all payments not processed by the LVTS, 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 2002, the Bank of Canada examined the ACSS to determine whether it had 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 has not been designated under the Payment Clearing and Settlement Act.

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 or indirect clearers in the ACSS. Eligibility criteria for being a direct clearer include being a CPA member and maintaining a settlement account and loan facility at the Bank of Canada. The entity must also 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 among ACSS direct and indirect participants throughout the day 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 (e.g., whether the payment item is paper based or is sent as an electronic data transmission). But 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 readers/sorters, according to the institutions on which they are drawn. Items drawn on other institutions are then delivered to the data centres of the appropriate direct clearer in the same regional clearing area. The delivering direct clearer enters the information regarding 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 ACSS terminals and, potentially, contesting entries continues on the value day until the final closing time, which is 11 a.m. ET for all regional settlement points. The ACSS calculates the net position across all types of payment items for each direct clearer. 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 reopenings of the clearing may occur to correct errors, if both parties agree. By 11 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 noon ET on the settlement day (T+1), with interest compensation calculated on positions at the Bank Rate minus one-quarter of 1 per cent (25 basis points); that is, the Bank's target for the overnight interest rate. 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.

Direct clearers in the Automated Clearing Settlement System (ACSS)

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

In December 2008, there were 11 direct clearers in addition to the Bank of Canada:

Alberta Treasury Branches
Bank of Montreal
The Bank of Nova Scotia
La Caisse centrale Desjardins du Québec
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

May 2009