Royal Bank: Guide to Canada's Large Value Transfer System

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	Introduction to Canada's
	Large Value Transfer System

The fully electronic Large Value Transfer System, Canada's Real Time Gross Settlement equivalent, became operational on February 4, 1999. It was expressly designed for the purpose of making large or urgent payments with finality, and with the utmost security. LVTS eliminates settlement risk and provides customers with finality of payment on the same day.


	LVTS and the Canadian
	Payments System

Canada's national payments clearing and settlement system has been run by the Canadian Payments Association (CPA) since 1980. The CPA is made up of banks and other deposit-taking institutions that have deposit insurance. Together with its members, the CPA is responsible for the development of clearing and settlement rules and standards.

In Canada, the LVTS settles all electronic payments while the Automated Clearing and Settlement System (ACSS) is used to settle all paper payment items such as cheques and drafts. Each evening, the ACSS records the long and short positions resulting from the exchange of paper payment items by each of 11 direct clearers. The next morning, the ACSS makes available the preliminary net gain or loss of each direct clearer. Until 11:00 a.m. Toronto time, under certain conditions, and provided both parties concerned agree, bilateral re-openings of the clearings can occur, to make any necessary corrections.

Shortly after 11:00, The Bank of Canada receives the final long and short positions and adjusts the balances of each clearer on its own books, under the previous day's date. After final adjustments, the Bank establishes the closing balances of each direct clearer as of the end of the previous day. Thus settlement of paper items occurs on a retroactive basis in Canada.


	A diagram of the
	LVTS system

LVTS Payment Mechanisms

LVTS provides two mechanisms for sending payments, Tranche 1, a defaulter-pays system, and Tranche 2, a survivors-pay system, based on bilateral limits. Tranche 2 is used more frequently, as it minimizes the overall collateral requirements for participants. In the event of a participant's default, its collateral is the first to be applied to any outstanding obligations. If the defaulter's collateral is not sufficient, the surviving participants will be called upon to contribute their pro-rata share of the Additional Settlement Obligation (ASO).

Tranche 1 Basic Elements

Sender's payments are fully collateralized with the Bank of Canada
Allows opportunity for additional payments once Tranche 2 cap is reached
Ensures access to the LVTS for participants without bilateral credit lines

Tranche 2 Basic Elements

Bilateral limits established daily, changeable intra-day (increases apply same day, decreases next day)
Sender's cap is a fixed percentage of all limits granted to them by the other participants
Additional Settlement Obligation (ASO) as a fixed percentage of the largest line granted to another participant is collateralized with the Bank of Canada

Underpinning the system is a real-time, transaction by transaction calculation of cumulative net positions of all participants. A risk-proofing mechanism provides explicit and binding loss-allocation arrangements. These are backed by collateral, and involve all CPA members that participate directly in the system. As a result, participants are assured of receiving payments that are not subject to reversal if either the remitter or its financial institution can’t meet its obligation. LVTS fully meets -- and in fact exceeds -- the recommendations made in the BIS-published "Lamfalussy Report".

How do clients benefit?

Clients who send or receive payments benefit from finality of payment. Once a payment is sent and passes the system’s risk tests, it cannot be returned or unwound -- settlement becomes certain. In the extremely unlikely possibility of the failure of more than one participant, in the same LVTS operating cycle, where the sum of the exposure to the LVTS at the time of failure exceeded the available collateral, the Bank of Canada, Canada’s central bank, has agreed to guarantee settlement in all circumstances. Thus, the LVTS also meets the requirements for a Real-Time Gross Settlement system -- guaranteed settlement between participants and finality of payment to payees.

Who may participate in the LVTS?

Any CPA member that can demonstrate sufficient technical competence, and has a settlement account with the Bank of Canada can be an LVTS participant. All other financial institutions and their clients may direct their transactions via the LVTS through a CPA member that participates in the system. Royal Bank of Canada, as a direct clearer, is a direct participant in the new LVTS. If fact, we process more CAD payments through LVTS than any other bank, accounting for nearly 30% of all payments volume.

LVTS and the Clearing System

Paper-based payment items are cleared overnight through ACSS. This system settles at the Bank of Canada by noon the next day, with settlement retroactive to the previous business day. Under this structure, a shortfall in a direct LVTS participant's LVTS account cannot be offset or netted with a long ACSS position in their account. Each payment stream must be settled individually at the Bank of Canada.

Similarly, direct participants cannot convert ACSS funds to LVTS funds on an intra-day basis. Instead, direct ACSS and LVTS participants wishing to flatten out their positions can borrow from and lend to other participants for settlement through ACSS or LVTS as required.

The Bank of Canada has set specific interest rates for any positive or negative balances that result from both the LVTS and ACSS (paper) clearings. The rate spread at the Bank of Canada is wider for ACSS balances than for LVTS balances, which makes the LVTS a more attractive option.

For Example:

Bank A, being short LVTS funds, must raise LVTS funds. Otherwise, their LVTS account will be in a deficit position and will be financed at the Bank of Canada rate (Bank Rate). If Bank A does not lend its ACSS funds, its ACSS account with the Bank of Canada will be in a surplus position and will earn interest at the Bank Rate less 200 basis points.

Bank B, being short ACSS funds, must either raise ACSS funds in the market or finance its deficit position at Bank Rate plus 150 basis points. If Bank B does not lend its long LVTS position, it will be in a surplus LVTS position and earn interest at Bank Rate less 50 basis points.

XYZ Co. deposits a cheque for $5 million at Bank A, drawn on Bank B.
ABC Co. sends a wire transfer for $7 million from Bank A to Bank B.

	Long ACSS	Short ACSS	Long LVTS	Short LVTS	Spread
Interest	B.R.^* - 200 b.p.	B.R.^* + 150 b.p.	B.R.^* - 50 b.p.	B.R.^*
Bank A	+ $5MM (3%)			- $5MM (5%)	- 2%
Bank B		- $5MM (6.5%)	+ $5MM (4.5%)		- 2%

^* B.R. - Bank of Canada Rate at 5% for this example

LVTS/ACSS and their Impact on You

Where this may have an impact, is on banks whose clients typically deposit large value paper clearing items such as drafts or certified cheques, and then wire the funds elsewhere. This results in a long ACSS or paper balance, and a short LVTS or wire balance. Credit balances earn much lower rates of interest from the Bank of Canada than the proposed charges by the Bank of Canada for deficits. By identifying who needs to transfer funds using both methods, banks can work with their clients to determine how to overcome this imbalance.

Securities Settlement and the LVTS

Securities trades also have an impact on ACSS and LVTS balances. However, the Canadian Depository for Securities is currently working to develop a single securities ettlement system using LVTS by late 2002.


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