The Canadian Depository for Securities Limited: Operator of CDSX

The Canadian Depository for Securities Limited was incorporated in 1970 as a non-profit corporation. Canadian Depository for Securities Limited is owned by the major Canadian chartered banks, members of the Investment Industry Regulatory Organization of Canada, and the TMX Group. CDS Clearing and Depository Services Inc. (CDS) is a subsidiary of Canadian Depository for Securities Limited.  CDS owns and operates CDSX, implemented in 2003, which clears and settles eligible Canadian exchange-traded and over-the-counter equity, debt and money market transactions.  CDS's depository service provides facilities to deposit and withdraw depository-eligible securities, manage related ledger positions, and use these positions for various business functions.

CDS and its participants are subject to the legislation and regulations of different jurisdictions. At the federal level, CDSX has been designated under the PCSA and is therefore subject to oversight by the Bank of Canada. In Ontario, CDS is regulated by the Ontario Securities Commission under the Ontario Securities Act. The Autorité des marchés financiers (AMF) regulates CDS under the Quebec Securities Act. CDS also works with the Alberta and British Columbia securities commissions as needed. In addition, CDS reports as required to the Canadian Securities Administrators (CSA), an umbrella organization of provincial and territorial securities regulators. Finally, CDS co-operates with federal and provincial financial institution regulators which oversee CDS participants.

Clearing and Settlement

In CDSX, trade transactions are entered by one party and confirmed by the other party. These transactions can be entered into CDSX either via file transmission or by direct access. CDSX netted payment obligations are settled at the end of the day via designated bankers, with payments made through the Large Value Transfer System (LVTS) to the CDS settlement account held at the Bank of Canada. Special procedures have been developed to allow securities that are held in CDSX to secure CDSX intraday payment obligations, to be used as collateral to make the LVTS payments. CDS retains a prior claim on these securities until the LVTS payment is made. LVTS payments are final and irrevocable, allowing final settlement of CDS to occur once all the payment obligations have been received. After settlement, securities that were held in accounts with restricted access become available for use without restriction.

CDS offers two CCP settlement services:  Continuous Net Settlement (CNS) and FINet.  CNS nets eligible exchange-traded equity transactions and FINet nets eligible fixed income trades.  These CCP services are fully integrated with CDS's securities settlement system (sharing the same risk controls).

Risk Management

The risk-containment model developed in CDSX, which is a combination of survivors-pay and defaulters-pay loss-sharing arrangements, runs in real time and is designed to protect CDS from the intraday failure of the participant with the single largest net obligation to CDS.

There are fundamentally two types of participants in CDSX: receivers of credit and extenders of credit. The receivers of credit are the majority of institutions participating in the system, and they receive lines of credit from extenders that enable them to purchase securities during the day. Extenders of credit also collateralize their own intraday payment obligations plus those of receivers of credit to which they have extended lines of credit. At the end of the day, the extenders of credit are required to make payments to the clearing house to cover securities bought on their own behalf and on behalf of their customers. Receivers of credit grant their extender a security interest in the securities delivered to them on that day. If an extender is required to make payment for a receiver that is unable to fulfil its end-of-day payment obligation, the extender is entitled to take possession of those securities (the so-called delivered or "unpaid-for" securities). The amount that each participant can owe the system is capped.

The system also has a loss-allocation procedure in the event that an extender of credit is unable to meet its end-of-day payment obligation, either for its own net purchases or on behalf of receivers of credit that are unable to fulfil their payment obligations.

This procedure is backed by a pool of collateral that all extenders of credit maintain in accordance with the requirements set out in the CDSX Rules. The extenders may also guarantee some of their own payment obligations individually by pledging collateral to CDS on a dollar-for-dollar basis to cover these obligations.

When extenders of credit use the collateral pool to support their intraday payment obligations, the remaining extenders are required to fulfil the obligations of the failed extender arising from the use of that pool.

The sum of these two types of collateral is sufficient to cover the failure of the extender with the single largest net debit to the system. Thus, in the case of the failure of a single extender, CDSX would be expected to be able to settle without causing undue liquidity strains for participating financial institutions. CDSX operates as a delivery versus payment (DVP) type II system (see "Delivery Versus Payment In Securities Settlement Systems"; Bank for International Settlements, 1992). Transactions that have settled intraday in CDSX cannot be unwound.

CDSX incorporates a variety of risk-control mechanisms in its design and operations:

  • CDSX is a real-time on-line facility with the position of each participant calculated on a transaction-by-transaction basis.
  • CDSX has been designed to operate on a DVP (value-for-value) basis. There is gross, or item-by-item, settlement for securities transfers throughout the day and, at the same time, there is continuous netting and novation to the CDS of corresponding payment obligations.
  • All participants' net debit payment positions vis-à-vis CDSX are subject to "system operating caps," i.e., ceilings, with the cap linked to the size of each participant's regulatory capital.
  • Each group of participants has a collateral pool, where members of the pool combine collateral for common use and share risk by guaranteeing the obligations of the other members that arise from use of the pool.
  • The Aggregate Collateral Value (ACV) procedure ensures that any default will be fully collateralized at all times by securities. The system rejects transactions that would cause a participant's payment obligation to exceed the value of securities available and pledged as collateral to cover that payment obligation. The ACV tracks the value of a participant's collateral in real time.
  • The usable value of securities as collateral in the system is the market value of each security less a certain amount (a haircut) to account for day-to-day variability in the market price. The securities eligible as collateral in CDSX are slightly more extensive than the securities allowed for the Bank of Canada's Standing Liquidity Facility.
  • Any transactions that would put a participant outside the limits imposed by the collateralization requirement or system operating caps are placed in a "pending" status until a change would allow the transaction to settle within these limits.
  • All participants in CDSX can calculate exactly their maximum risk exposure at any given time.
  • At the end of the day, the net amounts owed and owing between the CDS (as a result of the novation of obligations to CDS) and the participants are settled by using the LVTS.
  • The system does not permit the reversal or unwinding of transactions as a means of dealing with participant failure.
  • The Bank of Canada acts as settlement agent for CDS in the LVTS, with respect to payment obligations in CDSX. The Bank of Canada, in carrying out this daily function, receives payments from participants that owe money to CDS and makes payments to participants entitled to receive money from CDS. With the Bank acting as settlement agent, so-called "banker risk" is eliminated for CDSX and its participants. Banker risk refers to the possible failure of a private sector institution acting as settlement agent for a clearing and settlement system. (There is no liquidity or credit risk to the Bank of Canada from carrying out this function because the LVTS is used to make end-of-day CDSX payments, and the Bank will make an LVTS payment on behalf of CDS only if there is a sufficient balance in the CDS account to cover the amount of the payment.)

For CDS’s CCP services, (FINet and CNS) the process has additional risk management features that require each FINet/CNS participant to contribute margin collateral to cover the participant’s own risks to CDS for their specific FINet/CNS activities. If a participant fails to fulfil any of its obligations to CDS in FINet or CNS, CDS may suspend the participant and initiate both the CDSX default procedures and the related CCP close-out procedures. The close-out procedures use a defaulters-pay model and the value of the FINet/CNS collateral that CDS has received from the defaulting participant is expected to be sufficient to cover any CCP loss generated by the default of that participant. If it is not sufficient, the survivors share in the losses.

The CLS Bank

The Continuous Linked Settlement (CLS) Bank is an initiative undertaken by the international banking industry to reduce and control the risks associated with the settlement of foreign exchange transactions. The CLS Bank began operations in September 2002. It is wholly owned by CLS Group, whose shareholders are some of the world's largest foreign exchange trading banks, including a number of Canadian banks. The CLS Bank offers a real time electronic system designed to link a number of national payments systems and to simultaneously settle on its books the foreign exchange transactions submitted by its member banks. The CLS Bank is a special-service bank under U.S. federal law and is supervised by the Federal Reserve Bank of New York, which is working with oversight authorities in countries whose currencies are included in the CLS arrangements. The Canadian dollar is one of these currencies, and the Bank of Canada has designated the CLS Bank under the PCSA. The focus of the Bank's oversight is on the safety of the arrangements to settle the Canadian-dollar portion of foreign exchange transactions.

Canadian Derivatives Clearing Corporation (CDCC)

The Canadian Derivatives Clearing Corporation (CDCC) was established in 1975 as a not-for-profit corporation. Today it is a for-profit corporation solely owned by the Montréal Exchange (MX), which is itself owned by the TMX Group. Through its clearing system, called the Canadian Derivatives Clearing Service (CDCS), CDCC provides a central counterparty (CCP) service for all equity derivatives, index derivatives, and interest rate derivatives traded on the MX. As at 21 February, 2012 CDCC also commenced a fixed income CCP service.

CDCC also acts as CCP for over-the-counter equity options contracts traded on its Converge® platform.

At the federal level, the Bank of Canada oversees CDCS under the Payment Clearing and Settlement Act.  At the provincial level, CDCC is regulated by Quebec’s Autorité des marchés financiers (AMF). CDCC co-operates with federal and provincial financial institution regulators that oversee CDCC participants. As well, to support clearing derivative contracts that are registered for sale to U.S. residents, CDCC files documentation in accordance with the Securities and Exchange Commission requirements.

LCH.Clearnet Limited’s SwapClear Service (SwapClear)

Established in the United Kingdom in 1999, SwapClear is a global system for the central clearing of interest rate swaps (IRS) and other over-the-counter (OTC) interest rate derivatives denominated in multiple currencies, including the Canadian dollar.

The Canadian IRS market 1 is central to the Canadian financial system because of its critical role in allowing banks, governments, corporations and institutional investors to manage their interest rate risk. Central clearing improves the market’s ability to absorb financial shocks, reducing the potential for disruptions to be transmitted through the financial system.

SwapClear is operated by LCH.Clearnet Limited (LCH), which also provides central clearing services for a diverse range of financial and commodities markets. LCH is a subsidiary of LCH.Clearnet Group Limited, a U.K.-based holding company owned by its users and various exchanges, and is a regulated clearing house in the United Kingdom.

SwapClear was designated by the Bank of Canada effective 2 April 2013 as a systemically important system under the Payment Clearing and Settlement Act (PCSA) and will also likely be under the purview of securities commissions once their recognition processes are completed. Upon the effective date of designation, the Bank of Canada will fulfill its oversight responsibilities through participation in a multilateral arrangement for oversight co-operation led by SwapClear’s lead regulator, the Bank of England, and through bilateral interaction with the Bank of England and LCH.

More information:

  1. The “Canadian IRS market” refers to the Canadian-dollar IRS market and the portion of foreign currency IRS transacted by Canadian participants. []