Payment Clearing and Settlement Regulations: SOR/2019-257

Canada Gazette, Part II, Volume 153, Number 14

Registration

SOR/2019-257 June 25, 2019

PAYMENT CLEARING AND SETTLEMENT ACT

P.C. 2019-925 June 22, 2019

Her Excellency the Governor General in Council, on the recommendation of the Minister of Finance, pursuant to section 24 ^{footnote a} of the Payment Clearing and Settlement Act ^{footnote b}, makes the annexed Payment Clearing and Settlement Regulations.

Payment Clearing and Settlement Regulations

Definitions

1 (1) The following definitions apply in these Regulations.

Act means the Payment Clearing and Settlement Act. (Loi)

affiliate means an affiliated person or entity within the meaning of subsection (2). (groupe)

Affiliated persons or entities

(2) For the purpose of these Regulations,

• (a) one person or entity is affiliated with another person or entity if one of them is the subsidiary of the other or both are subsidiaries of the same person or entity or each of them is controlled by the same person or entity; and
• (b) if two persons or entities are affiliated with the same person or entity at the same time, they are deemed to be affiliated with each other.

Control

(3) For the purpose of these Regulations,

• (a) a person or entity controls a corporation if shares of the corporation to which are attached more than 50% of the votes that may be cast to elect directors of the corporation are held, directly or indirectly, by the person or entity and the votes attached to those shares are sufficient, if exercised, to elect a majority of the directors of the corporation;
• (b) a person or entity controls a trust, fund or partnership (other than a limited partnership) or an unincorporated association or organization, if more than 50% of the ownership interests, however designated, into which the trust, fund, partnership, association or organization is divided are held, directly or indirectly, by the person or entity and the person or entity is able to direct the business and affairs of the trust, fund, partnership, association or organization; and
• (c) the general partner of a limited partnership controls the limited partnership.

Subsidiary

(4) A person or entity is a subsidiary of another person or entity if

• (a) it is controlled by
  • (i) that other person or entity,
  • (ii) that other person or entity and one or more persons or entities, each of which is controlled by that other person or entity, or
  • (iii) two or more persons or entities, each of which is controlled by that other person or entity; or
• (b) it is a subsidiary of a subsidiary of that other person or entity.

Limited clearing member

(5) For the purposes of subsection 11.11(4) of the Act, a limited clearing member means a participant in a clearing and settlement system designated under subsection 4(1) of the Act who, under the rules of the system,

• (a) is not required to contribute to a default fund;
• (b) is not required to absorb any losses arising from the default of another participant in the system other than a reduction in the amount of variation margin gain that is returnable to the participant if the gain results from a transaction that was entered into by the participant and the defaulting participant and subsequently submitted for clearing to the clearing house of the system; and
• (c) is subject to additional initial margin.

Ownership interest

(6) In these Regulations, a reference to an ownership interest in a clearing house does not include shares of the clearing house.

Conflict of interest

2 For the purposes of subsection 11.04(6) of the Act, no member of the committee shall beneficially own, directly or indirectly, shares of a clearing house of a clearing and settlement system designated under subsection 4(1) of the Act or of an entity that controls such a clearing house.

Contents of resolution plan

3 A resolution plan for a clearing and settlement system referred to in section 11.05 of the Act must include

• (a) a risk profile of the system that describes
  • (i) the design of the system,
  • (ii) the corporate governance or organizational structure of its clearing house,
  • (iii) by way of a diagram or otherwise, the intercorporate relationships between the clearing house of the system and each of its affiliates, including with respect to each affiliate
    • (A) its name and the law by or under which it was incorporated, continued or formed, and
    • (B) the percentage of votes attaching to all voting shares of the affiliate that are held, directly or indirectly, by another affiliate,
  • (iv) the critical clearing and settlement functions performed by the system or its clearing house,
  • (v) the critical services referred to in paragraph 11.07(1)(f) of the Act that are provided to its clearing house by a service provider,
  • (vi) the critical operational resources of the system and its clearing house, including staff and information technology, and
  • (vii) any contractual or operational arrangements between the system or its clearing house with other clearing houses or systems;
• (b) a resolution strategy that sets out the principal measures that could be taken in the event of a declaration of non-viability;
• (c) an assessment of the resources that may be necessary to implement the resolution strategy including the financial resources and loss allocation tools provided for in the rules, by-laws or related arrangements of the system or its clearing house;
• (d) an operational plan that sets out
  • (i) the manner in which the resolution strategy could be implemented, and
  • (ii) any potential barriers to a resolution; and
• (e) a statement that the plan has been approved by the Governor of the Bank.

Review and modifications

4 The Governor of the Bank must review and make any necessary modifications to the resolution plan

• (a) at least once during each 12-month period following the development or modification of the plan; and
• (b) without delay after any change referred to in any of paragraphs 9(2)(a) to (c) of the Act is made.

Persons from whom costs may be recovered

5 (1) For the purposes of section 11.18 of the Act, the Bank may recover the costs of a resolution from

• (a) a clearing house that has been declared non-viable under section 11.06 of the Act;
• (b) the clearing house of a clearing and settlement system that has been declared non-viable under section 11.06 of the Act; and
• (c) any person or entity who was a participant in a clearing and settlement system on the day on which a declaration of non-viability was made in respect of the system or its clearing house or on any subsequent day.

Costs

(2) The costs of a resolution of a clearing and settlement system or clearing house are the costs incurred, and the amounts paid, by the Bank in order to

• (a) address the financial losses, or shortfalls in liquidity or capital adequacy, of the clearing house;
• (b) maintain the pre-funded financial resources at the level provided for in the by-laws, rules or arrangements that govern the clearing and settlement system or clearing house;
• (c) operate the clearing and settlement system or clearing house;
• (d) meet a participant’s financial obligations to the clearing house;
• (e) administer the compensation process referred to in sections 6 to 18; and
• (f) generally execute the resolution.

Limited clearing member

(3) The costs of a resolution that the Bank may recover from a limited clearing member are limited to the costs incurred, and the amounts paid, by the Bank in order to

• (a) operate the clearing and settlement system or clearing house;
• (b) administer the compensation process referred to in sections 6 to 18; and
• (c) meet the member’s financial obligations to the clearing house.

Amounts not included

(4) The amounts paid under sections 13 and 18 are not included in subsections (2) or (3).

Recovery of certain costs — participant

(5) If the Bank incurs a cost or pays an amount in order to meet a participant’s financial obligations to a clearing house, it must attempt to recover that cost or amount from the participant before attempting to recover it from a clearing house or other participant.

Recovery of certain costs — clearing house

(6) If the Bank incurs a cost or pays an amount referred to in any of paragraphs (2)(a) to (c) and (f) in order to meet the obligations of a clearing house, it must attempt to recover that cost or amount from the clearing house before attempting to recover it from a participant.

Prescribed persons and entities

6 (1) The following persons or entities are prescribed for the purposes of subsection 11.26(1) of the Act:

• (a) any person or entity that was a creditor of a clearing house immediately before a declaration of non-viability was made in respect of the clearing house or its clearing and settlement system;
• (b) any participant that is subject to an order made under subsection 11.11(1) of the Act and was a participant in a clearing and settlement system immediately before a declaration of non-viability was made in respect of the system or its clearing house;
• (c) any shareholder of a clearing house that is subject to an order made under paragraph 11.09(1)(b) of the Act and that was a shareholder of the clearing house immediately before a declaration of non-viability was made in respect of the clearing house or its clearing and settlement system;
• (d) any holder of an ownership interest in a clearing house that is subject to an order made under paragraph 11.09(1)(b) of the Act and that was a holder of an ownership interest in the clearing house immediately before a declaration of non-viability was made in respect of the clearing house or its clearing and settlement system.

Exclusion — creditors

(2) Despite paragraph (1)(a), the following persons or entities are not prescribed:

• (a) a person or entity that continues to receive, during the period beginning at the time the declaration of non-viability is made and ending on the day specified in the notice published under section 11.24 of the Act, payment in respect of the debt in accordance with the terms of the debt; or
• (b) a person or entity to which the clearing house is indebted as a result of the clearing house
  • (i) acting as a central counter-party, or
  • (ii) providing clearing or settlement services for a clearing or settlement system.

Successors, assignees and transferees

(3) A prescribed person or entity referred to in subsection (1) includes the successor of the person or entity but does not include an assignee or transferee.

Compensation — creditors

7 The amount of compensation to which a prescribed person or entity referred to in paragraph 6(1)(a) is entitled is the total of any amounts owing that were not paid by or on behalf of the clearing house to the person or entity in accordance with the terms of their contract during the period beginning at the time the declaration of non-viability was made in respect of the clearing house or its clearing and settlement system and ending on the day the day specified in the notice published under section 11.24 of the Act.

Compensation — participants

8 (1) The amount of compensation to which a participant referred to in paragraph 6(1)(b) is entitled is the amount equal to the estimated value of the net losses incurred by the participant as a result of the making of an order under subsection 11.11(1) of the Act.

Assumption

(2) The value of the net losses referred to in subsection (1) must be estimated

• (a) as if the measures to address financial loss, or shortfalls in liquidity or capital adequacy, that were specified in the by-laws or rules of the clearing house, or in an arrangement that relates to its clearing and settlement system, were exhausted; and
• (b) without taking into consideration any assistance, financial or other, that is or may be provided to the participant, directly or indirectly, by the Bank or by Her Majesty in right of Canada or a province after the declaration of non-viability was made.

Resolution and liquidation values

9 (1) For the purposes of determining the amount of compensation to which a prescribed person or entity referred to in paragraph 6(1)(c) or (d) is entitled, the Bank must estimate the applicable resolution and liquidation values referred to in this section.

Resolution value in respect of a share

(2) The resolution value in respect of a share is the total of the estimated value of

• (a) the share on the day specified in the notice published under section 11.24 of the Act,
• (b) any dividend paid after the declaration of non-viability was made with respect to the share, and
• (c) any other cash, securities or other rights or interests that are received or are to be received with respect to the share as a direct or indirect result of the making of an order under paragraph 11.09(1)(b) of the Act and any actions taken in furtherance of the order.

Resolution value in respect of an ownership interest

(3) The resolution value in respect of an ownership interest in a clearing house is the total of the estimated value of

• (a) the ownership interest on the day specified in the notice published under section 11.24 of the Act,
• (b) any amount received after the declaration of non-viability was made with respect to the ownership interest, and
• (c) any cash, securities or other rights or interests that are received or are to be received with respect to the ownership interest as a direct or indirect result of the making of an order under paragraph 11.09(1)(b) of the Act and any actions taken in furtherance of the order.

Liquidation value in respect of a share or ownership interest

(4) The liquidation value in respect of a share or ownership interest in a clearing house is the estimated value that the shareholder or holder of the ownership interest would have received in respect of the share or ownership interest if

• (a) the clearing house had become bankrupt and been liquidated at the time a declaration of non-viability was made; and
• (b) the measures to address financial losses, or shortfalls in liquidity or capital adequacy, that were specified in its by-laws or rules, or in an arrangement that relates to the clearing and settlement system, were exhausted.

Assumptions

(5) The liquidation value referred to in subsection (4) must be estimated

• (a) as if no declaration of non-viability was made; and
• (b) without taking into consideration any assistance, financial or other, that is or may be provided to the clearing house, directly or indirectly, by the Bank or by Her Majesty in right of Canada or a province after the declaration of non-viability was made.

Compensation — shareholders

10 (1) The amount of compensation to which a shareholder referred to in paragraph 6(1)(c) is entitled is determined by the formula

A − B

where

• A is the estimated liquidation value in respect of their shares; and
• B is the estimated resolution value in respect of their shares.

Compensation — holders of ownership interests

(2) The amount of compensation to which a holder of an ownership interest referred to in paragraph 6(1)(d) is entitled is determined by the formula

A − B

where

• A is the estimated liquidation value in respect of the ownership interest; and
• B is the estimated resolution value in respect of the ownership interest.

Negative value

(3) For greater certainty, if the amount of compensation determined under this section is a negative value, the amount of compensation is zero.

Notice — offer of compensation

11 (1) Within a reasonable period of time after the day specified in the notice published under section 11.24 of the Act, the Bank must give each person or entity that was prescribed in respect of the clearing and settlement system or clearing house a notice containing an offer of compensation in an amount equal to, or of a value estimated by the Bank to be equal to, the compensation to which that person or entity is entitled.

Contents of notice

(2) The notice must

• (a) state that an order has been made under paragraph 11.09(1)(b) or subsection 11.11(1) of the Act;
• (b) describe the order’s effects;
• (c) state that the prescribed person or entity has 45 days beginning on the day on which a summary of the notice is published in the Canada Gazette to notify the Bank of their decision to accept or object to the offer, or to object to the absence of an offer;
• (d) state that if the offer or the absence of an offer is objected to by the prescribed person or entity, the compensation to be paid will be determined by an assessor; and
• (e) state that if the prescribed person or entity does not notify the Bank of their objection within the period set out in paragraph (c), the person or entity will receive the compensation offered or no compensation, as the case may be, and will not be permitted to contest its amount or value or the fact that no compensation is offered.

Publication

12 A summary of the notice given under subsection 11(1) must be published in the Canada Gazette and on the website of the clearing house.

Payment of compensation

13 The Bank must pay a prescribed person or entity referred to in section 6 any compensation offered under subsection 11(1) if

• (a) the person or entity notifies the Bank of its acceptance of the offer within the period set out in paragraph 11(2)(c); or
• (b) the person or entity does not notify the Bank of its acceptance of, or objection to, the offer within that period.

Appointment of assessor

14 An assessor must be appointed under section 11.28 of the Act if the person or entity notifies the Bank that it objects to the offer, or the absence of an offer, within the period set out in paragraph 11(2)(c).

Notice of appointment

15 Within 45 days after the day on which an assessor is appointed, the Bank must provide, to each person and entity whose compensation is to be determined by the assessor, a notice of the appointment that states that the person or entity is bound by the assessor’s determination of the amount of compensation to be paid which may be lower or higher than that contained in the offer.

Assessor’s determination

16 The assessor must determine the amount of compensation to be paid in accordance with sections 7 to 10.

Assessor’s notice

17 (1) The assessor must provide, to every prescribed person or entity whose compensation is determined by the assessor, a notice

• (a) setting out the assessor’s determination of the amount of compensation to which the person or entity is entitled;
• (b) stating that the person or entity is bound by the assessor’s determination as to the amount of compensation to be paid; and
• (c) stating that the Bank must pay the compensation within 90 days after the date of the notice.

Copy to Bank

(2) The assessor must provide a copy of each notice to the Bank.

Payment of compensation

18 The Bank must pay a prescribed person or entity the compensation that it is entitled to receive within

• (a) if a notice referred to in subsection 17(1) is provided to the person or entity, 90 days after the date of that notice; or
• (b) in any other case, 135 days after the day on which a summary of the notice given under subsection 11(1) is published in the Canada Gazette.

Oversight information

19 For the purposes of section 2 of the Act, oversight information means any information contained in the following documents:

• (a) directives issued by the Governor of the Bank under subsection 6(1) or (2) of the Act to a clearing house or a participant and any correspondence to or from the directors or officers of the clearing house or the participant that is related to the directive;
• (b) reports prepared by or at the request of the Bank, including any written recommendations prepared by the Bank, as a result of an audit, inspection or other oversight review of a clearing and settlement system;
• (c) any correspondence to or from the directors or officers of a clearing house that is related to a report or recommendation referred to in paragraph (b);
• (d) resolution plans referred to in subsection 11.05(1) of the Act;
• (e) documents that are prepared by or at the request of the Bank for the purpose of advising the Governor of the Bank on whether to make a declaration of non-viability under section 11.06 of the Act.

Disclosure to affiliates

20 A clearing house may disclose oversight information in respect of its clearing and settlement system to its affiliates, its directors, officers, employees, auditors, securities underwriters and legal advisors and those of its affiliates, if the clearing house ensures that the information remains confidential.

Disclosure to government or regulatory body

21 A clearing house may disclose oversight information in respect of its clearing and settlement system to any government authority or regulatory body that

• (a) regulates the system; and
• (b) has entered into an agreement or arrangement with the Bank under section 13.3 of the Act in respect of the system and oversight information.

Coming into force

22 These Regulations come into force on the first day on which both sections 237 and 242 of the Budget Implementation Act, 2018, No. 1, chapter 12 of the Statutes of Canada, 2018, come into force, but if they are registered after that day, they come into force on the day on which they are registered.

REGULATORY IMPACT ANALYSIS STATEMENT

(This statement is not part of the Regulations.)

Issues

Financial market infrastructures (FMIs) contribute to financial stability by supporting the continuous functioning of payment systems and financial markets, which is especially important in times of severe financial system stress. FMIs also reduce uncertainty in times of financial system stress by having robust and transparent default management mechanisms in place.

However, in the unlikely event that a systemically important FMI should fail, a disruption in its critical economic functions could lead to significant adverse effects on the functioning of the financial system and economic activity in Canada (e.g. basic financial transactions could become difficult or impossible). These FMIs are typically large, lack substitutes in the markets they serve, and have strong links to banks and other financial institutions, including other FMIs.

Background

An FMI is a system that facilitates the clearing, settling or recording of payments, securities, derivatives or other financial transactions among participating entities. FMIs are also called a “clearing and settlement system,” or a “clearing house” if referring to the corporation or other form of entity that operates the clearing and settlement system. FMIs are the backbone of the financial system, providing these essential payment clearing and settlement services to their participants, that are primarily large financial institutions. FMIs provide the infrastructure through which consumers and firms safely and efficiently purchase goods and services, make financial investments, manage risks and transfer funds. Certain FMIs are critical to the stability of the Canadian financial system. If such an FMI were to fail, it could impair the functioning of financial markets, the ability of other financial institutions to carry out their business activities and the ability of Canadians to make or receive timely payments.

The Governor of the Bank of Canada (the Bank) has designated the most critical FMIs as systemically important.  ^{footnote 1} Prominent payment systems, while not systemically important, are also critical for economic activity in Canada. They are designated by the Governor for oversight by the Bank if their disruption or failure has the potential to pose risks to Canadian economic activity. ^{footnote 2}

As part of the Bank’s oversight, designated FMIs are required to meet the Bank’s standards for addressing financial, operational and business risk. These standards fully encompass the Principles for Financial Market Infrastructures, ^{footnote 3} established by the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions. The FMIs must operate with controls to allow them to effectively manage risks under a variety of scenarios designed to incorporate extreme but plausible stress events, including the default of their largest participants.

Designated FMIs are also required to develop a recovery plan that includes tools that would allow the FMI to access additional financial resources, if necessary. For example, a central counter party (CCP) must have robust risk-management controls that cover expected losses and liquidity shortfalls with a very high degree of confidence. Pre-funded resources should be in place to cover the losses arising from the default of the single largest participant. If these resources are exhausted, the CCP will implement its recovery plan and call on its participants to contribute additional resources, as defined in this plan, and may also contribute additional resources itself.

The likelihood of an FMI failing is remote, and historically, there have been very few failures of an FMI — since 1974 there have been only three such events worldwide. Nevertheless, it is possible that a designated FMI may find itself in a situation when neither its risk-management actions nor recovery plan is adequate to allow it to continue operating without disrupting the financial system. Scenarios that could potentially trigger an FMI failure include multiple participant defaults within a short period, a material loss of confidence in the FMI, a severe operational failure that cannot be resolved through business continuity arrangements, or a failure of the FMI’s parent company.

Existing bankruptcy procedures are not designed to protect the stability of the financial system when a systemically important institution fails. They may not prevent a loss of crucial services to the financial system, which could result in the transmission of financial stress to market participants and amplify the adverse effect of the FMI’s failure.

International guidance

In 2008, the G20 initiated a comprehensive program of regulatory reforms to address the underlying causes of the financial crisis. Canada’s financial system performed well during the 2008 global financial crisis and since that time, Canada has been an active participant in the G20’s financial sector reform agenda. This includes the G20 commitment to establish effective resolution regimes for systemically important institutions such as banks, insurance companies and FMIs.

The first suite of major reforms was agreed upon as outlined in the Financial Stability Board (FSB) document titled Key Attributes of Effective Resolution Regimes for Financial Institutions (the Key Attributes). On October 15, 2014, the FSB adopted additional guidance, including an annex with sector-specific guidance on how the Key Attributes should be applied for FMIs. The latest supplementary Guidance on CCP Resolution and Resolution Planning was issued on July 5, 2017, by the FSB.

The FMI resolution framework put forward through amendments to the Payment Clearing and Settlement Act (PCSA) takes into account international guidance as appropriate in the Canadian context. Regulations are required to finalize the implementation of the framework for FMI resolution.

Canadian FMI resolution legislative framework

In Budgets 2017 and 2018, the Government of Canada committed to introducing legislative amendments to implement an FMI resolution framework.

The Budget Implementation Act, 2018, No. 1 amends the PCSA to implement an FMI resolution framework so that the appropriate tool kit is in place to intervene in the unlikely event that a systemically important FMI fails. The Budget Implementation Act, 2018, No. 1 received royal assent on June 21, 2018. These amendments to the PCSA (PCSA amendments) come into force on a day to be fixed by order of the Governor in Council. It is intended that these amendments would be brought into force concurrently with the Payment Clearing and Settlement Regulations (the Regulations).

Objectives

The main policy objectives of the FMI resolution regime are to maintain the critical services of an FMI, to promote financial stability and to minimize the potential exposure of public funds to loss. Although the regime shares common elements with Canada’s resolution regime for systemically important Canadian banks, it is tailored with specific features to reflect the unique role, structure and business model of FMIs.

The Regulations provide further details of the FMI resolution regime implemented in the PCSA in the areas of limited clearing members, conflict of interest, resolution plans, cost recovery, compensation, and oversight information.

Full implementation of the FMI resolution regime requires implementation of the Regulations.

Description

The Regulations would be new regulations under the PCSA, which currently does not have regulations. Throughout the Regulations, FMIs are referred to as a “clearing and settlement system” (which refers to a system or arrangement for the clearing and settlement of payment obligations or payment messages) or a “clearing house,” which is the entity that operates a system (a provider of clearing and settlement services) to align the terminology with that used in the PCSA.

The Regulations begin by defining a number of terms.

Limited clearing member

“Limited clearing members” (LCMs) is among the terms defined in the Regulations. LCMs are participants in certain FMIs that are subject to modified risk controls for default management and recovery. These alternate risk controls are designed so that LCMs do not participate in arrangements that mutualize any losses that arise from the default of another participant. LCMs have a fiduciary obligation to prudently manage the financial assets under their management, including avoiding this type of exposure to loss. The PCSA amendments to subsection 11.11(4) allow for the FMI resolution regime to respect this legal arrangement. The Regulations specify that LCMs are participants in a designated clearing and settlement system that have opted into this alternate risk control arrangement. An LCM is not required to contribute to a default fund and to absorb losses arising from the default of another participant (other than a certain type of reduction in an LCM’s variation margin gains). Furthermore, an LCM is subject to additional margin compared to other non-LCM participants.

Conflict of interest provisions

The PCSA amendments establish an FMI resolution committee under section 11.04. The legislation provides that those on the committee should be subject to conflict of interest rules that are to be prescribed in regulations. The Regulations therefore require that members of the committee not beneficially own, directly or indirectly, any shares of a clearing house or parent companies of a clearing house if the clearing house is the clearing house of a designated system.

Resolution plans

The PCSA amendments (section 11.05) require the Bank to develop and maintain resolution plans in accordance with the Regulations. The Regulations specify the key elements the Bank must include in a resolution plan, such as

• Risk profile of the system — The risk profile should describe the FMI in detail, including its design; its corporate governance and organizational structure; its intercorporate relationships; the critical functions performed by the FMI; third-party services provided to the FMI that are critical; its critical operational resources, including staff and infrastructure; and any interoperability arrangements and links with other FMIs.
• Resolution strategy — The strategy should contemplate various scenarios, such as the default of a participant or other non-default scenarios that could result in the making of a declaration of non-viability. The strategy should also set out the principal measures that could be taken to resolve an FMI.
• Assessment of the adequacy of the resources — The assessment should list all the resources that may be available to implement the resolution strategy.
• Operational plan — The plan should set out what actions need to be taken to implement the resolution strategy and identify any potential barriers to the plan’s implementation.

The Governor of the Bank will be responsible for approving resolution plans, and a statement of the Governor’s approval must also be included in an approved plan. The Governor must review and make any necessary modification to the plans on an annual basis and after a significant change to the FMI occurs.

Cost recovery

The PCSA amendments give the Bank the ability to recover the costs associated with operationalizing the resolution of an FMI. The objective is to have robust cost recovery mechanisms in place so that even if public money is required in the short term, it will always be repaid over the long term, which would minimize the potential exposure of public funds to loss.

The Regulations would provide the Bank with flexibility for cost recovery, while still clarifying in the Regulations which costs they can recover and who may be subject to cost recovery.

The Regulations specify that the Bank may recover costs from clearing houses and participants, specifically

• a clearing house that has been declared non-viable under section 11.06;
• a clearing house of a clearing and settlement system that has been declared non-viable under section 11.06; and
• any party who was a participant in a clearing and settlement system when it was declared non-viable or when its clearing house was declared non-viable or a participant that subsequently joins the system.

The Regulations further specify that the Bank may generally recover the costs of executing an FMI resolution. In particular, this includes the costs incurred, and the amounts paid, by the Bank in order to

• address financial losses and liquidity shortfalls of the clearing house;
• maintain the pre-funded financial resources at the level provided for in the by-laws, rules or arrangements that govern the FMI;
• operate the FMI;
• meet a participant’s financial obligations to the FMI; and
• administer the compensation process.

A special rule for LCMs limits the costs the Bank can recover from LCMs to the costs of operating the FMI; of administering the compensation process; and if the Bank covered the LCM’s obligations to the FMI. The Regulations also exclude the amounts of compensation paid under the compensation scheme from being costs of an FMI resolution. Finally, the Bank must first attempt to recover a cost from a participant or clearing house that originally owed that amount.

Compensation

The PCSA amendments include provisions setting out a process for providing creditors, participants, shareholders and owners of FMIs with compensation from the Bank following a resolution process for the FMI. Consistent with international guidance, creditors, participants, shareholders and owners should not be made worse off in resolution than if the FMI had been liquidated under the applicable insolvency laws (owners other than shareholders, such as partners, have been included in case in the future an FMI is owned in this manner).

The Regulations prescribe the persons or entities who could be eligible to access compensation: creditors, participants, shareholders, or owners of the FMI. There are exceptions to this list:

• creditors of a clearing house would not be entitled to compensation if the amounts owing under the liability’s terms are subsequently paid off in full (i.e. if they were made whole); and
• creditors are also not entitled to compensation if the debt is owed by the clearing house as a result of it acting as a central counter-party or providing clearing and settlement services (i.e. with regard to a creditor’s transactions in the clearing and settlement system).

The right to compensation would be a personal right of those eligible for compensation — it would not be transferable. This is intended to reduce the potential role of speculators in the compensation process, support administrative simplicity of the process, and ensure greater alignment between those entitled to compensation and the creditors, participants, shareholders and owners actually affected by the Bank’s resolution actions.

The determination of the amount of the compensation that the Bank is required to make in accordance with the Regulations is based on the type of person or entity claiming compensation. The Regulations set out certain assumptions that the Bank must take into account when determining the offer of compensation. For example, in estimating the losses of a participant or the liquidation value of a share, partnership or ownership interest, the Bank would be required to assume that in the counterfactual scenario of the FMI being liquidated, the FMI would not have received any financial assistance or support from the Bank, the Government of Canada or a province in the process.

The compensation to which a creditor is entitled is the total of any amounts that are still owing under the terms and conditions of their contract.

The compensation to which a participant is entitled is the estimated value of the net losses of the participant that result from an order under subsection 11.11(1) of the PCSA allowing the Governor to use certain additional powers outlined in that subsection that go beyond the FMI rules and other arrangements for loss allocation agreed to by participants. In estimating the value of the losses, the Bank must assume the full execution of the FMI rules and other arrangements for loss allocation and that no financial assistance is forthcoming from a federal or provincial government.

For shareholders or owners of the clearing house, the amount of compensation to which they are entitled would be determined by comparing the estimated value of the person’s share or ownership interest in liquidation with its estimated value in resolution. In estimating the liquidation value, the Bank must assume that no declaration of non-viability was made; that the FMI rules and other arrangements for loss allocation have been fully executed; and that no financial assistance is forthcoming from a federal or provincial government.

The Bank would provide a notice to prescribed persons or entities with an offer of compensation within a reasonable period of time following the completion of the resolution process. No fixed time limit is proposed, given the significant expected differences in time required by the Bank to prepare offers in different circumstances (e.g. depending on the size and complexity of the FMI, the resolution strategy or tool applied to the FMI, and the number of prescribed persons or entities involved). Prescribed persons or entities would have 45 days to notify the Bank of their acceptance of, or objection to, the offer once received. Failure to notify the Bank would be deemed as an acceptance of the offer.

An assessor ^{footnote 4} will be appointed if any prescribed person or entity rejects the Bank’s offer of compensation. The assessor is required to determine the amount of compensation owed in accordance with the Regulations, just as the Bank is when making its determination of compensation. Pursuant to the PCSA, the assessor’s own determination of compensation owed would be final and binding.

The Bank would be required to pay prescribed persons or entities their entitled compensation within 90 days of the expiry of the Bank’s offer of compensation (if the offer was accepted) or the final determination of the assessor, as the case may be.

Oversight information

The PCSA amendments require that a clearing house not disclose certain types of information defined as oversight information. The PCSA amendments provide that “oversight information” must be defined in regulations.

The Regulations define oversight information as

• any directive made in respect of the FMI under section 6 of the PCSA; ^{footnote 5}
• any report prepared by or at the request of the Bank or any recommendation made by the Bank as a result of an audit, inspection or other oversight review of an FMI, including any related correspondence to or from the directors or officers of the FMI;
• any resolution plan for an FMI; and
• any document prepared for the purpose of advising the Governor of the Bank on whether to make a declaration of non-viability.

There are two exceptions to the disclosure prohibition. The first exception authorizes an FMI to disclose oversight information to certain “insiders” such as employees, auditors and legal advisors on the condition that they continue to treat the information as confidential.

The second exception authorizes FMIs to disclose oversight information to certain government authorities or regulatory bodies.

“One-for-One” Rule

The “One-for-One” Rule does not apply to this proposal, as the Regulations do not impose any new administrative burden that businesses, such as financial institutions, would not otherwise already face as part of their usual business practices.

Small business lens

The small business lens does not apply to this proposal, as designated FMIs are large organizations (they are not small businesses).

Consultation

The Department of Finance Canada and the Bank consulted stakeholders in November 2016 about legislative amendments to the PCSA to implement an FMI resolution regime and enhance the oversight powers of the Bank (i.e. the resolution authority). Key issues identified by stakeholders were funding models, transparency of the resolution authority’s power and tools, and stakeholder participation in the resolution planning process. Input from the consultations in fall 2016 was taken into account when designing the legal framework for the Canadian FMI resolution regime.

The Department of Finance Canada and the Bank also held targeted consultations with stakeholders throughout the FMI industry in September 2018 on the policy scope of the Regulations for the FMI resolution regime. Key issues identified by stakeholders were the need for transparency surrounding cost recovery and the compensation process (e.g. suggestions were made to improve the compensation calculation to make it clearer and more in line with industry terminology); the need for stakeholder engagement in developing resolution plans; the process of defining critical services provided to an FMI; the definition of LCM; and responsibility for losses in a resolution triggered for reasons not related to a participant default. Stakeholders were generally supportive of the FMI resolution regime and the Regulations, and their comments were incorporated where possible into the design of the regulatory proposal.

Canada Gazette, Part I

On March 9, 2019, draft regulations were published in the Canada Gazette, Part I, for a 30-day public comment period. Two submissions were received from industry associations and FMIs. Stakeholders continued to express support for the implementation of an FMI resolution regime and its conformity with international guidance. Both submissions emphasized the importance of ensuring the FMI resolution regime continues to be consistent with international guidance as it evolves. Canada has been an active participant in the G20’s financial sector reform agenda and the Department of Finance is committed to implementing and maintaining an FMI resolution regime that takes into account international guidance as appropriate in the Canadian context. Both submissions also advocated for additional transparency around resolution plans, loss allocation, and the assessor methodology, either through future amendments to the Regulations or through Bank guidance documents. The Department of Finance and the Bank are of the view that this level of detail is more appropriate for guidance. Following implementation of the Regulations, the Bank is expected to issue guidance to provide further detail and clarity to stakeholders.

One submission also noted that firms should have the ability to sell or transfer their right to compensation under the regime. However, the Department of Finance continues to be of the view that the right to compensation should be a personal right of those eligible for compensation — it should not be transferable. This is intended to reduce the potential role of speculators in the compensation process, support administrative simplicity of the process, and ensure greater alignment between those entitled to compensation and the creditors, shareholders and participants actually affected by the Bank’s resolution actions.

Rationale

The Government announced in Budgets 2017 and 2018 that it would introduce legislative amendments to implement an FMI resolution framework, and a legislative framework for the regime was put in place via the PCSA amendments. Adoption of the Regulations is necessary for the full implementation of the regime.

Implementation of the FMI resolution regime would also be consistent with international standards and best practices. Specifically, an FMI resolution regime is an important component of the Key Attributes, which was endorsed by G20 leaders in November 2011 as part of the G20’s broader financial sector reform agenda.

The Regulations support the objectives of the FMI resolution regime, which are to maintain the critical services of an FMI, to promote financial stability, and to minimize the potential exposure of public funds to loss through credible cost recovery and compensation mechanisms.

Enhanced financial stability

The FMI resolution regime benefits the economy in the unlikely event of the failure of a designated FMI by maintaining financial stability and allowing the FMI to continue to provide critical services. This would minimize disruptions for participants and the public in the event of a crisis.

As the resolution authority, the Bank will have the necessary power and authority to plan for and address an FMI that has been placed into resolution in advance. The FMI resolution regime also ensures that the appropriate tool kit is in place to intervene in the unlikely event that a systemically important FMI fails.

Reduction in government exposure

The introduction of the FMI resolution regime provides a significant benefit to the Government (and, by extension, to public funds) because in the event that an FMI were to become non-viable without a specialized resolution regime, there would be two alternatives: it would either be wound down through existing corporate bankruptcy procedures or rescued through a public bailout.

Existing bankruptcy procedures are not designed to protect the stability of the financial system when a systemically important institution fails. They would likely not prevent a loss of crucial services to the financial system, which would result in the transmission of financial stress to market participants and amplify the adverse effect of the FMI’s failure on the financial system and the economy.

Consequently, there may be an expectation that government intervention in the form of a public guarantee or bailout using public dollars would be forthcoming to prevent severe financial system disruptions. The absence of a resolution regime could therefore reduce the incentives for FMIs and their participants to appropriately manage their risks, which could potentially create significant cost to taxpayers.

Also, given that shareholders, participants, and creditors would be responsible for the FMI’s risks and not the Government, risks would be borne by those who have agreed to take them, and not the public at large.

Costs

The Regulations are expected to result in costs for the Bank of Canada stemming from the exercise of its resolution function (e.g. drawing up resolution plans, preparation/practice in case of an FMI resolution). The Bank of Canada will absorb any costs within its existing resources; no incremental funding is expected to be required.

There are no anticipated compliance costs or administrative costs for businesses. A resolution of an FMI is a low-probability event that will be administered by the Bank as resolution authority.

Implementation, enforcement and service standards

The Bank of Canada intends to issue guidance soon after the Regulations take effect to provide further details and assist stakeholders with implementation of the Regulations.

Contact

Yuki Bourdeau
Senior Advisor
Financial Stability
Capital Markets Division
Financial Sector Policy Branch
Department of Finance
90 Elgin Street
Ottawa, Ontario
K1A 0G5
Email: financialmarketinfrastructures-infrastructuresdesmarchesfinaciers@canada.ca