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imagine you need to make a payment not just any payment a very important payment maybe you work for a corporation making a major acquisition and a multi-million dollar payment is necessary to seal the deal maybe your son's buying his first home and you've offered to cover the down payment as a gift what's the safest fastest way to get that much money from your account to his maybe you work at the financial institution where these clients hold their accounts and they've reached out to you for guidance the clock is ticking if the funds don't reach the recipient in time there will be significant consequences not only do these payments need to be made as quickly as possible the senders and recipients need absolute confidence that the payments are final and the funds are guaranteed what do you do financial institutions or FIS need a mechanism to make critical time-sensitive payments like these with guaranteed finality both domestically and internationally they also need a mechanism to settle up with each other as a result of their own and their customers transactions to do this they use the Canadian payments associations large value transfer system the L VTS which clears and settles about thirty nine point five trillion dollars in payments every year in Canada owned and operated by the Canadian payments Association or CPA the L VTS is critical to Canada's economy not only as a means to safely send large payments but also as the key mechanism by which the Bank of Canada implements its monetary policy it's Canada's electronic wire transfer system for Canadian dollar payments used to send final irrevocable payments between participating CPA member FIS across the country afi's use the l VTS to provide wire payment services directly to their customers including governments businesses and consumers through these services fi customers can request wire payments to other customers of course wire payment services that each fi are branded with different names a customer wouldn't ask their branch to send an L VTS payment they'd request a wire payment or use the name of the service offered by their own fi customers choose this payment method for critical time-sensitive or large value payments since L VTS payments are fast final and the funds are guaranteed but while customer payments account for approximately 60% of the volume in lv TS they only represent 20% of the value in the system l VT s is a wholesale system used by participating F eyes to send interefere payments to cover their obligations and for settlement transactions these are payments made from one fi to another to settle amounts owing between them as a result of their customers activities wire payments retail transactions credit card payments and securities trades in total interactions account for approximately 80% of the value in lv ts high volume lower value retail payments like point-of-sale transactions online payments direct deposits pre-authorized debits and checks are cleared via the CPAs automated clearing settlement system or a CSS at the end of each day the a CSS calculates the total amounts owing between financial institutions as a result of their own and their customers retail payments and if eyes use the lv TS to make payments to settle that day's retail clearing balances although credit card transactions and securities trades are not cleared via cpa systems l VTS payments are also used to settle amounts owing between f eyes as a result of these transactions so what is it that makes the lv TS so attractive to customers and a Faiza like the strong risk controls built into the system every lv TS payment is exchanged between participating f eyes in real-time and is required to pass strict lv TS risk control tests each lv TS payment is also fully backed by collateral pledged to the bank of canada by participating f eyes before an fi is allowed to participate in lv TS on any given day they are required to pledge sufficient collateral to the Bank of Canada to guarantee their payments this collateral usually consists of low-risk illiquid assets such as government backed securities for example the Bank of Canada approves and determines the value of the collateral provided by each of the participating F i's the L V TS Chris controls ensure that sufficient collateral is pledged to cover each and every payment made that day even if one participating fi were to go into default thereby ensuring the stability of the system and the finality of payments before L V TS f i's exchanged wire or telex payments with each other but settled them using paper debits this was risky business for both F eyes and their customers if one if I failed payments that had been exchanged during that day could be reversed potentially creating a domino effect with other F eyes failing as well wreaking havoc in the payment system this is what is called systemic risk and preventing that risk was one of the primary reasons for developing LV TS since its creation the LV TS has continued to contribute to the growth and stability of the Canadian and international financial sectors it also plays an important role in three of Canada's other systemically important clearing and settlement systems the continuous linked settlement system or CLS the Canadian derivatives clearing service cdcs and the c d sx CLS is a global settlement system for foreign exchange transactions it connects financial centers around the world which serve as anchors for the trading of 17 different currencies between certain F is in a typical foreign exchange transaction a buyer purchasing one type of currency pays for the purchase using another type of currency CLS was created to reduce settlement risk in foreign exchange transactions which is the risk that a buyer could pay the seller the currency it is trading without receiving the currency it purchased because of the different time zones in which the currency must settle CLS reduces this risk through direct links to settlement systems in the currencies it settles when CLS began operations in 2002 LVT s assumed the role of the link that enables Canadian F eyes to participate the CD SX is Canada's clearing and settlement system for debt and equity securities such as bonds and common stocks it was implemented in 2003 to risk proof securities trades which are typically very high in value transactions in C DSX securities are not physically exchanged between the buyer and the seller the transfer of ownership is recorded electronically and the securities are frozen in the system which allows for efficient and cost-effective processing a secure funds exchange takes place at the end of the day via lv TS and the c d sx account at the Bank of Canada the Bank of Canada acts as a settlement agent for C D s X since a private sector fi acting in that role would be too risky a private sector fi going into default would leave everyone engaged in C DSX in a precarious position having the Bank of Canada act as settlement agent mitigates this banker risk since the Bank of Canada won't initiate any LVT S payments for C DSX settlement unless there are sufficient funds in that account to begin with the Canadian derivatives Clearing Corporation is a central clearing counterparty in Canada for exchange-traded derivatives such as options and futures and also settles using LVT s there are four key players in lv TS each of which plays an important role in supporting its operations the CPA Swift the Bank of Canada and LV TS participants let's take a look at each of these parties and the roles they play the first and foremost key player is the CPA the owner and operator of LV TS this differs from clearing arrangements in most other countries where the high value system is usually operated by the central bank with this in mind the CPA carries major responsibilities for LV TS the first of these is the administration of the system this includes running LV TS on a daily basis ensuring the security of the system keeping the system up-to-date and compliant with legal requirements coordinating the various participant groups publishing rules and guidelines providing ongoing training to participants and improving the system as necessary the second key player in LV TS is Swift the Society for worldwide interbank financial telecommunication Swift provides the payments network over which LV TS participants exchange payment instructions and also provides monitoring of the network for payment processing swift is also responsible for overall management and maintenance of the standard message types or empties that are processed through LV TS the third key player in LV TS is the Bank of Canada which plays a number of important roles from an operational perspective the bank is a participant just like the other financial institutions taking part in LV TS it must prepare submit and reconcile its payments on behalf of its customers such as the Government of Canada and other central banks in the same manner as any other fi the Bank of Canada is also responsible for monitoring settlement positions of the participants as well as determining which instruments are eligible to be pledged as collateral for LV TS earlier we mentioned that the Bank of Canada also uses the lv TS to implement monetary policy and control inflation in Canada here's how during a typical business day F that participate in lv TS send payments back and forth to each other through the system at the end of the day Summa files will have sent more value in lv TS payments than they've received while others will have received more value than they've sent since l VTS participants are not allowed to have a negative LV TS balance at the end of the day f is in a negative or short position we'll need to borrow funds until the next day to settle their obligations fi is in a positive or long position can either deposit those funds overnight at the Bank of Canada or lend funds to one or more FIS who find themselves in a short position on a one-day overnight basis the Bank of Canada sets a target for the overnight interest rate on these loans and deposits the target for the overnight rate influences the interest rates charged by F eyes to their customers for other short-term loans and mortgages so the Bank of Canada chooses a rate it believes will help keep future inflation low stable and predictable let's take a closer look at the center of a 50 basis point operating band is the target for the overnight rate the bank rate at the top of the operating band is the interest rate that the Bank of Canada charges on one day loans 2f eyes in a short position the deposit rate at the bottom of the band is the interest rate that the Bank of Canada will pay F is in a long position that deposit these funds with the central bank overnight now let's see this monetary policy in action fi number one is in a long position they've received five hundred million dollars more in LVT s payments than they've sent out that day if they know that the Bank of Canada will pay them 3.75 percent interest on these funds if they leave them on deposit overnight fi number two is in a short position they've sent out two hundred and fifty million dollars more in LVT s payments than they've received that day they know that they will need to fully collateralized an overnight loan from the Bank of Canada at four point two five percent interest to cover this short position but they have another option available to them fi number two can request a two hundred and fifty million dollar loan from fi number one if fi number one agrees based on its risk tolerance and credit limits it will send a two hundred and fifty million dollar lv TS payment for that amount - fi number two typically fi is charged interest for these loans at or near the overnight rate and the loans are usually uncollateralized in this scenario both sides gain a quarter percentage point advantage fi number one will earn four percent interest on the funds it lends to fi number two as opposed to the 3.75 percent it would earn from those funds on an overnight deposit at the Bank of Canada fi number two will only pay four percent on the loan from fi number one as opposed to the four point two five percent it would pay the Bank of Canada for an overnight advance the overnight rate typically stays within the operating band since participants know they will earn at least the bank rate less fifty basis points on positive balances and that they will not have to pay more than the bank rate on loans to cover their negative balances knowing the overnight rate in turn influences the rates that FIS will charge their own customers for short-term loans and mortgages the fourth key player is the group of CPA member FIS who directly participate in LV TS these include all of the major domestic chartered banks some foreign bank branches and other financial institutions a complete list of the direct participants in LV TS is available on the CPA website WWC d NP CA these direct participants make LV TS payments on behalf of themselves and their clients other CPA members that need to make payments through LV TS enter into arrangements with one of the direct participants participants are responsible for pledging required collateral to the Bank of Canada and confirming how it is to be allocated and managed payments units of participating F eyes are responsible for preparing payment transactions while cash management representatives forecast and there F eyes positions during the day ensuring that sufficient collateral exists to meet that day's payment needs participants also contribute to the various CPA advisory committees used to capture feedback on the operation of L BTS l VTS was designed as an open and accessible system to capture most of the value exchange daily through the payment system in Canada there are no minimum volume or value requirements for participation any member of the CPA can participate in L VT s provided it maintains a settlement account at the Bank of Canada has the facilities to pledge collateral to the Bank of Canada for L VT s purposes and meet certain technical requirements set out in the CPAs LVT s rules each participant must also be a member of Swift L VT s is a credit push system meaning that the FI sending the payment submits the payment message into L VT s l v TS payments are individual payments in Canadian dollars and must be entered into the system as individual payment messages multiple payment transactions cannot be batched or bundled together into a single bulk payment message this would not be practical in L VT s as each individual L VT s payment must be fully backed by collateral and every payment has real-time finality and certainty of settlement the two Swift message types or mts that are processed through L VT s are the MT 103 and MT 205 as you can see the majority of payments settled through L VT s by volume r mt 103 payments or customer or corporate client payments such as mortgage closings or time-sensitive or large value business transactions for example but the majority of the value in the lv TS is reflected in mt 205 payments which are fi - fi payments to offset their obligations LVT s payments can be initiated a number of ways depending on the services offered by individual financial institutions the average consumer sending in lv TS payment at the retail level would typically visit their local branch where they would request a wire transfer businesses and corporate clients that have access to their F i's online payment solution might have the ability to submit payment instructions to their fi via the F i's web portal the CPA doesn't play a role in setting fi prices for LVT s services each financial institution establishes its own pricing structure for LVT S payments just as they do for other products and services before sending an LVT s payment for a customer the sending institution must first ensure that enough funds to cover that payment are available in the account of the customer initiating the payment or the credit is available the debit to the customer initiating the payment will be processed immediately the funds will be removed from the customer account before the LVT s payment instruction can be released once availability has been confirmed and the debit has been processed the payment instruction is released by the sending institution via the Swift Network all payments are also scanned for anti money laundering and anti terrorist financing purposes in accordance with Canadian and applicable international law swift receives the payment message from the sending participant if the information in the payment message meets the criteria established by CPA for LVT s payments swift will hold the original message and make a copy of certain fields which it passes to LVT s the only fields from the payment message that are related to LVT s are sending and receiving fi amount value date and currency this is the minimum information required for LVT s to perform its risk control evaluation of a payment no client information regarding account numbers or remittance information is provided to the CPA so privacy and confidentiality between the customer and its fi is maintained if the payment passes the risk controls LVT s assigns a payment confirmation reference number or pcr n and sends an authorization message back to Swift Swift forwards the message the receiving fi along with the PCR n and generates a notification back to the sending fi with the PCR n once a payment has been approved by lv TS it is final and irrevocable and the receiving fi is required to provide credit to the beneficiary before the end of the business day however credit is typically provided to the beneficiary in near-real-time if a payment does not pass the risk control tests Swift will not pass the payment on to the receiving fi and will generate a rejection notice to the sending fi the processing of payments between lv TS participants takes place in a matter of seconds regardless of where the FI is located in canada full end-to-end time between the payment requests and the beneficiary receiving the funds will be influenced by a number of factors including whether the payment is formatted properly LVT s is very efficient in its use of collateral on an average day only 15 billion dollars in collateral is required to settle 155 billion dollars worth of payments participants can send payments through lv TS using one of two equally secure options now you'd think we'd call these option one and option two but we call the options touch one and touch two in finance fancy speak both houses provide real time finality of payment to the receiver as well as guaranteed same-day certainty of settlement so what's the difference between the two tausha's it's the way in which the sending participant allocates collateral to guarantee the payments lv TS offers the flexibility for each sending participant to choose which touch they want to use based on their own assessment of the receiving participants creditworthiness two important factors must be considered by the sending participant in choosing cash one or two risk and cost plus one the de fall for pay scenario is a zero risk option that involves high collateral costs for the sending participant every payment sent via cash one must be fully collateralized by the sending participant alone on a dollar-for-dollar basis for example to send a 100 million dollar payment to another participant via Tosh 1 the sending participant must first allocate 100 million dollars of the collateral it pledged to the Bank of Canada for that day to toss one remember once a payment has been approved by lv TS it is final and irrevocable and the receiving fi is required to provide credit to the beneficiary before the end of the business day well by using cash 1 the receiving participant completely eliminates the risk of unexpectedly having to cover any payments if the sending participant goes into default and can't meet its obligations less than 2% of the lv TS payments representing about 18% of LVT s daily value are sent using cash 1 this is mainly due to the high collateral requirements tongues 2 is a limited risk option that offers lower collateral costs for the sending participant it's a survivor pay scenario where the responsibility for providing collateral to back payments is shared between all of the participants in lv TS including the Bank of Canada kind of like the three musketeers one for all and all for one house to payments involve bilateral credit limits that the participants extend to each other to indicate the exposure limit one participant is willing to accept from another requirements for cash two are determined on a daily basis via several mathematical formulas set out in the CPA rules these calculations ensure that there is always sufficient collateral available to cover any losses in the unlikely event that one participant should go into default primarily because of the lower collateral cost of participants pouch 2 is used for processing over 98% LVT s payments representing roughly 82 percent of daily value the real benefit of this to Township Roche is the flexibility it offers to participating financial institutions on a daily basis each participant can adjust its approach to meet evolving business needs let's take a closer look at the daily operations of the lv TS the system is operational from 11:00 p.m. on day one until 7:30 p.m. on day two there are four distinct cycle states or periods within an LV TS cycle from 11:00 p.m. on day 1 to 12:30 a.m. on day 2 the cycle state is initialization within this cycle state participants who are involved in CLS related payment processing for foreign exchange trades get ready to become active in LV TS they pledge the required amount of collateral and confirm how much will be assigned to cash 1 at the beginning of the cycle a process known as apportionment LV TS automatically assigns cash to collateral based on the bilateral limits the participant has established and confirmed for that cycle the Bank of Canada provides valuation for the collateral and LV TS tells the participant whether they have sufficient collateral value to meet their minimum requirements at 12:30 a.m. the CPA changes the cycle state from initialization to open for payments processing any participant who has indicated their participation and confirm their collateral information may now begin to exchange payments between 12:30 a.m. and 6:00 a.m. LVT s is typically used to process CLS related payments only participants can send any type of payments during this time but will typically wait until around 5:00 or 6:00 a.m. before they begin to exchanged on CLS payment messages FIS that are not involved in CLS related payment processing become active and complete their collateral arrangements by 7:45 a.m. and must be ready to begin payment processing by 8:00 a.m. payment exchange continues until 6:00 p.m. when the CPA changes the cycle state to pre settlement this is the deadline for participants to send customer payments but participants typically implement an earlier cutoff time of 4:30 or 5:00 p.m. for their clients to ensure that the payments are qualified and can be released to LV TS prior to 6:00 p.m. during pre settlement participants other than the Bank of Canada attempt to flatten their multilateral net positions by exchanging interefere payments MT 205's flattening means bringing their net position as close to zero as possible the FIS will trade in the overnight markets later to cover the amounts they owe a cheddar even though they can borrow funds from the Bank of Canada overnight or let the bank hold excess funds on deposit they will typically find a better rate in the market at 6:30 p.m. the CPA changes a psycho state to settlement started no more payments are processed after this point LVT s is zero sum meaning that the sum of all debits and credits in the system must equal zero the FIS have already begun this process by attempting to flatten their positions during pre settlement and the Bank of Canada completes the process by making a single credit or debit entry for each participant on its books participants who end up in a negative position at settlements must arrange for a loan from the Bank of Canada to cover the amount this loan will be paid back the next day through L V TS with interest participants in a positive position at settlements must leave the funds on deposit with the Bank of Canada overnight the Bank of Canada will repay the balance with interest at the start of the next LVT s cycle when the entries have been made for all of the participants the Bank of Canada advises participants that settlement has been completed typically around 6:45 p.m. a strong legal framework underpins the operation of lv TS let's take a look at the key components the lv TS by law lv TS rules and the payments clearing and settlement act the lv TS by law defines and enables the operation of lv TS by the cpa the bylaw also lays out the responsibilities of the participants with regard to the irrevocability of payments the finality of payment to the recipient and the timing for making funds available to the recipient this bylaw is approved by the federal government the lv TS rules describe the practices associated with the day-to-day operation and administration of lv TS such as technical requirements and allowable message formats to ensure consistency of processing unlike the bylaw which remains relatively unchanged once enacted the lv TS rules evolve as the payments landscape changes the lv TS rules can be amended by agreement of the cpa board of directors and are reviewed by the bank of canada under a Memorandum of Understanding in place between the Bank of Canada and the CPA the payment clearing and settlement Act gives the Bank of Canada responsibility for oversight of designated systems those which are considered systemically important to Canada LVT s clearly falls into this oversight designation since the Bank of Canada has designated LVT s as a systemically important system under the payment clearing and settlement Act the CPA is required to conduct an annual review of control procedures in place for LVT s operations the CPA contracts a third party to perform this audit and communicates the results to the Bank of Canada the Bank of Canada can request changes in LVT s rules procedures or even in the system itself if it feels that such changes will reduce systemic risk the LD TS by law and rules are available on the CPA website WWC dn PCA we hope you've enjoyed this module and that you learned a few things you didn't know about our large value transfer system if you'd like to learn more about lv TS please visit the cpa website actin rules section where you can find more information on the lv TS by law and operating rules the answers to many frequently asked questions are also available in the FAQ section of the CPA website if you have a question we haven't addressed please feel free to contact us and we'll be happy to provide you with the information you need you can reach us by email at info at CDN page CA or by phone at six one three two three eight four one seven three