Guideline Related to Bank of Canada Oversight Activities Under the Payment Clearing and Settlement Act

The Bank may consider other characteristics when conducting its assessment of systemic risk. Different types of FMIs (and the markets they serve) have different characteristics and face different kinds of risk, so it is necessary that the Bank take an FMI’s unique traits into consideration.

If the Governor concludes that an eligible FMI is unlikely to pose systemic risk, it will not be designated. However, the Bank will continue to monitor the FMI to determine whether any conditions have changed that would warrant a reconsideration of this decision.

If the Governor concludes that an eligible FMI may be operated in such a manner as to pose systemic risk, and the Minister of Finance is of the opinion that designation is in the public interest, the Governor will designate the system for oversight.  The Governor then notifies the FMI about its designation in writing. When the designation takes effect, the FMI will be subject to regulatory oversight by the Bank under the PCSA and will be expected to comply with Section 3 of this Guideline, which discusses the Bank’s oversight of designated FMIs. A copy of the designation notice that was provided by the Governor to the FMI will also be published in the Canada Gazette to inform the public of the designation.

2.3 Designation of Eligible Payment Systems That Could Pose Payments System Risk

Under the PCSA the Governor may designate an eligible FMI for Bank oversight when he or she is of the opinion that it could be operated in a manner that poses payments system risk. For designation to take effect, the Minister of Finance must be of the opinion that designation is in the public interest.

The Bank of Canada has established five high-level criteria to help identify prominent payment systems (PPS):

(i) Value and volume of transactions: Value and volume are a proxy for the potential to pose credit, liquidity and operational risk. They reflect the magnitude and potential impact should risks materialize. The larger the value and volume of the transactions processed, the more significant the potential impact on the Canadian economy and financial system in the event of a disruption.

(ii) Availability of substitutes: If a system has limited substitutes, even imperfect substitutes, it is more likely that adverse economic effects, or a generalized loss of confidence, will result in the event of a disruption to that system. The fewer substitutes there are for making payments, the larger the potential impact of a disruption because direct participants and end-users have limited alternatives to effect payments.

(iii) Time criticality of payments: The more time-critical payments are, the larger the potential impact if there is a system disruption. Further, the more time-critical payments a given system clears and settles, the more likely the disruption will result in adverse economic effects. If end-users experience delays in the clearing and settlement of their time-critical payments, they may be more likely to lose confidence in the overall Canadian payments system.

(iv) Centrality: This refers to both a system’s importance in the payments system and its importance to the market it serves. In this regard, centrality is accentuated when multiple stakeholders and payment instruments depend on one platform, with no alternative providers. A central system has a greater potential to have an impact on economic activity because a greater number of payments instruments and end-users could be affected. Similarly, the scope of the impact on confidence is also broadened.

(v) Interdependencies: A payment system that is dependent on other systems has a greater capacity to affect or be affected by those systems on which it is dependent in the event of a disruption. This interdependency has the potential to increase the economic effects of a disruption and broaden the impact on confidence in payment systems.

If the Governor concludes that an FMI is eligible for designation, the Governor will then notify the FMI about its designation in writing. When the designation takes effect, the FMI will be subject to regulatory oversight by the Bank under the PCSA and will be expected to comply with Section 3 of this Guideline, which discusses the Bank’s oversight of designated FMIs. A copy of the designation notice that was provided by the Governor to the FMI will also be published in the Canada Gazette to inform the public of the designation.

3. Oversight of Designated FMIs

3.1 The Bank’s Oversight Objectives

An efficient and stable financial system is critical to the long-run stability and growth of the Canadian economy. The Bank’s primary oversight objective is to be satisfied that systemic risk and payments system risk are being adequately controlled in designated FMIs. Risk control is important to ensure that risks are contained and do not spread through the financial system. The Bank’s secondary oversight objective is efficiency.  Efficiency is important because an FMI that is not practical or cost-effective for its users may lead them to resort to less-costly arrangements that may pose increased risks. The Bank carefully considers the trade-off between risk control and efficiency in the conduct of its oversight responsibilities. Nonetheless, efficiency considerations do not take precedence over prudent risk management.

Under the guidance and oversight of the Bank, FMIs and their participants are responsible for operating their systems in a safe, sound and efficient manner and for determining how they will meet the applicable standards set by the Bank. While the FMI itself is ultimately responsible for managing its risks, the Bank, as overseer, is responsible for conducting consistent and effective oversight of FMIs and validating the adequacy of their risk-management practices.

The Bank exercises its oversight in a manner that is consistent with the responsibilities for authorities contained within the Principles for FMIs, which require that authorities have the appropriate powers and resources to oversee FMIs, that they clearly disclose their oversight policies, that they apply the Principles for Financial Market Infrastructures to applicable FMIs, and that they co-operate with each other to promote the safety and efficiency of FMIs.6 The Bank endeavours to carry out its oversight responsibilities in a co-operative manner, and regularly holds meeting with FMIs and other regulatory bodies to achieve that objective. Consistent with the responsibilities for authorities, the Bank co-operates with other domestic and international authorities that also have responsibility for oversight and regulation of FMIs overseen by the Bank.

It is important that the Bank’s oversight policies are clear and well-articulated. To promote transparency to FMIs, their participants and the public, the Bank publishes information and research pertaining to FMIs on its website. The Bank also publishes an annual oversight report on its website to provide transparency and accountability for the Bank’s oversight views and activities. The report summarizes the Bank’s main views with respect to oversight and designated FMIs.  The report includes information about the Bank’s activities and key developments over the course of the year in respect of each designated FMI and other financial market infrastructures, as well as Canadian and international initiatives relevant to Bank oversight.

3.2 Responsibilities of Designated FMIs

All FMIs and their participants are responsible for understanding and managing the risks to which they are exposed. FMIs need to have the capacity to proactively anticipate and identify risks incurred through their system and determine how those risks should be managed. The Bank expects designated FMIs to have an organizational culture and practices that are commensurate with their role as prominent payment system or as systemically important FMIs. Therefore, designated FMIs need to be aware of their role in the financial system and the Canadian economy and the implications this has for their management of risks. They need to place a high priority on risk management at all levels of their organizations.

Designated FMIs are required to adequately manage systemic risk or payment system risk in their systems and are responsible for taking the actions necessary to address any shortcomings identified in their risk management.

Designated FMIs must meet a number of responsibilities to satisfy the Bank that they are adequately managing systemic risk for systemically important FMIs, and payments system risk for prominent payment systems. In particular, FMIs are required to maintain appropriate risk-management practices and to provide the Bank with all the information necessary for it to assess whether the FMI is operating in a safe and efficient manner. The Bank may enter into a legal agreement with designated FMIs to formalize and clearly articulate its expectations regarding the Bank’s oversight activities and the FMI’s responsibilities to the Bank.

(i) Observe applicable risk-management standards

The Bank requires that all FMIs designated as systemically important observe the Bank of Canada risk-management standards and associated guidance. These standards fully incorporate the Principles and Key Considerations articulated in the Principles for Financial Market Infrastructures (PFMIs), which are international standards related to the risk management, efficiency and transparency of systemically important FMIs developed jointly by the Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization of Securities Commissions (IOSCO). The PFMIs also contain explanatory notes that describe how an FMI may implement particular aspects of the standards. See the risk-management standards for systemically important FMIs. The designated systemic FMI were expected to broadly observe all the principles since 31 December 2016.

The Bank has also developed risk-management standards for prominent payment systems. These standards are also based on the PFMIs; however, they are adapted to be proportionate to the nature and magnitude of payments system risk. As a result, the standards for prominent payment systems are less stringent in some areas than those in the PFMI. See the risk-management standards for prominent payment systems.

(ii) Provide the Bank with information as requested

FMIs are required to provide the Bank with any information that it may reasonably request in writing. The Bank may set out expectations for certain information to be provided on a routine basis, but may also request information on an ad hoc basis.

Routine information may include reports on the performance of the FMI’s risk controls, such as stress-test results and reports on the management of operational incidents. Routine information could also consist of system data used by the Bank to conduct analysis and research.

(iii)  Advance notice of significant changes

Designated FMIs are required to provide the Bank with reasonable advance notice of any significant changes to operations, arrangements, rules, procedures or other documentation in relation to the FMI. When submitting a proposed change, at a minimum, the FMI is expected to provide a motivation for the change; a description of the change; and an assessment of the risk implications of the change.

(iv) Bank may impose fees

The Bank of Canada may impose an annual fee on designated FMIs to cover the administrative costs of services provided under the PCSA. In the event that the Bank imposes a fee, an explanation of the basis for the calculation of this fee will be provided to the FMI.

3.3  The Bank’s Main Oversight Activities

The Bank’s main oversight activities relate to monitoring and evaluating risk in designated FMIs to satisfy itself that systemic risk and payments system risk are being adequately controlled in an efficient manner. The Bank does this by conducting assessments of designated FMIs against the corresponding set of Bank of Canada risk management standards and requiring FMIs to undergo periodic audits and inspections. The Bank also regularly monitors FMIs and engages with their management. These are the processes generally followed by the Bank in its oversight of the domestic FMIs it has designated. However, not all of these monitoring activities are expected to be applied to foreign-domiciled FMIs, where the Bank conducts its oversight predominantly through co-operative oversight arrangements with the FMI’s other regulators.

(i) Application of international and national risk-control standards

The Bank requires that all designated FMIs observe its risk-control standards. These standards are the CPSS‐IOSCO Principles for FMIs for systemically important FMIs and the Bank of Canada risk-management standards for prominent payment systems. The Bank conducts regular assessments of FMIs’ observance with these standards. Full assessments are done (i) when an FMI is first designated; (ii) when new standards are implemented; and (iii) on a periodic basis to ensure that FMIs continue to meet the standards. In addition, as part of its process to review all significant changes to FMI rules, procedures and operations, the Bank considers whether proposed changes are consistent with the relevant principles and standards. FMIs are also required to complete periodic self-assessments against the PFMIs and the Bank of Canada’s risk-management standards.

(ii) Periodic audits and inspections

To carry out its responsibilities under the PCSA, the Bank (or a third party on the Bank’s behalf) may conduct audits and inspections of a designated FMI.

At a minimum, the Bank requires that an external independent audit of the controls in place at each designated FMI be conducted annually. As part of this audit, the FMI’s management provides the auditor with written descriptions of the designated system, its control objectives and the related controls it has in place. An independent examination is performed to obtain assurance of the existence of the documented controls, the suitability of the controls and their operational effectiveness during a specific period. The Bank approves the scope and control objectives of the audit.

The annual audit of internal controls is an important tool in verifying the effectiveness of the control environment for each designated system.

(iii) Priority setting

The Bank sets priorities for each designated FMI in consultation with the FMI and its other regulators and sets priorities for its own oversight work. Some priorities will be concrete actions aiming to improve the FMI’s risk-management practices, while others will involve further analysis to improve the Bank’s assessment of a particular risk. The Bank’s oversight efforts will focus on areas where the Bank judges there is a material risk (i.e., those with high severity or high likelihood of occurring) and where a better understanding of particular aspects of the FMI’s risk-management process is required.

(iv) Regular monitoring and engagement

The Bank regularly engages with and reviews information provided by designated FMIs in order to monitor whether they are maintaining appropriate risk‐control standards and to determine when corrective actions are necessary. For example, the Bank may require designated FMIs to provide reports detailing the performance of their risk‐control measures against stated targets and describe the nature and resolution of operational events. The Bank then reviews and discusses these reports with designated FMIs. In addition, the Bank engages in dialogue with FMIs through the following mechanisms.

• The Bank’s deputy governor primarily responsible for oversight meets periodically with the board of each designated FMI to ensure that the board understands the Bank’s expectations and priorities, as well as any concerns the Bank may have regarding the FMI’s operations or practices.
• The Bank has periodic formal meetings with the senior management of a designated FMI to discuss the FMI’s operations, important past and future developments, and areas where the Bank requires the FMI to take certain actions.
• The Bank regularly engages with FMIs to discuss developments and ongoing issues and provide oversight perspectives.

If the Bank considers it necessary, it may request additional meetings between the FMI and the Bank’s staff, management or deputy governor to discuss any concerns regarding systemic risk or payments system risk.

Finally, the Bank closely monitors any changes proposed by FMIs, including the development of new products and services and modifications to the FMIs’ rules, procedures and operations. The Bank conducts reviews of proposed changes to determine whether those changes would be acceptable from the perspective of systemic risk or payments system risk.

3.4 Oversight of Foreign-Domiciled FMIs

Where the Governor designates a foreign-domiciled FMI, the focus of the Bank's oversight activities will be on the Canadian aspects of the FMI’s operations (particularly the arrangements for clearing and settling Canadian-dollar payment obligations). The Bank expects to work closely with the central bank (and other regulators) in the country where the FMI is located, using formal co-operative oversight arrangements rather than independently overseeing the designated FMI.

To support the control of systemic risk to Canada that could originate in foreign-domiciled FMIs, the PCSA provides that Canadian participants in foreign-domiciled FMIs shall comply with the obligations that the Act imposes on the FMI and shall have all the rights that the Act confers on FMIs. For example, participants will obtain the rights regarding the enforceability of netting, but they will also be obliged to provide information to the Bank, as required, regarding their participation in the FMI to support the Bank’s monitoring activities regarding the control of systemic risk.

3.5 Review of Risks Associated with Foreign Participants in Designated FMIs

Authorized foreign banks (i.e., those doing business in Canada through a branch) and other foreign financial institutions may wish to participate directly in Canadian FMIs.  Because these entities are subject to the laws of their home jurisdictions, which may differ from those in Canada, there is a risk that their participation could expose the Canadian FMI, its other participants and other linked entities to additional risks.

Under the PCSA, when a foreign institution wishes to participate in a designated FMI located in Canada, the Bank assesses whether the foreign institution’s participation could lead to systemic risk in the Canadian financial system or payments system risk to Canadian economic activity, or pose an unacceptable risk to the Bank in guaranteeing the settlement of obligations in the FMI (if applicable). If the Governor is of the opinion that the foreign institution's participation could pose unacceptable risk, he or she may prohibit it from participating or impose conditions on its participation in the designated FMI. As part of this assessment and under the PCSA, foreign entities wishing to participate in a designated FMI located in Canada are required to provide the Bank with a satisfactory legal opinion from their home jurisdiction as to the applicability of foreign laws to their participation in the FMI. The legal opinion should address, among other things, the enforceability of collateral security and netting (if the FMI is a netting system) under the home jurisdiction's laws. The opinion should be prepared in consultation with the Bank and submitted to the Bank well in advance of the time that the authorized foreign institution wishes to start participating in the FMI. The requisite forms of legal opinions for participation in specific FMIs are available from the Bank upon request by authorized foreign banks and other financial institutions wishing to participate in a designated FMI.

3.6 Compliance and Directives

The Bank works with designated FMIs to ensure that any concerns related to systemic risk or payments system risk are understood and addressed by the FMI. If an FMI is not controlling systemic risk or payments system risk to the Bank’s satisfaction, the PCSA provides powers to the Governor to direct an FMI to take appropriate action. If the Governor is of the opinion that systemic risk or payments system risk are being, or are likely to be, inadequately controlled by a designated FMI, he or she may issue a directive in writing to the FMI requiring it to cease and refrain from such actions, or to carry out certain actions within a time frame set by the Governor.7 The Governor may also issue a directive to an FMI’s participants with respect to their participation in the FMI if (i) the FMI is not complying with an issued directive; (ii) the FMI has a clearing house located in a foreign jurisdiction; or (iii) the participant(s) actions have resulted in inadequate control of systemic risk or payments system risk in the FMI and those actions are not subject to the rules governing the FMI.

In the event that an FMI or participant fails to comply with (i) the PCSA; (ii) a directive issued by the Governor; or (iii) a binding agreement entered into with the Bank under the PCSA, the Governor may then apply to a superior court for an order directing the FMI or participant to comply.