Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 27 - Evidence - November 21, 2012
OTTAWA, Wednesday, November 21, 2012
The Standing Senate Committee on Banking, Trade and Commerce met this day at
4:18 p.m. to study the subject- matter of those elements contained in Divisions
1, 3, 6 and 14 of part 4 of Bill C-45, A second Act to implement certain
provisions of the budget tabled in Parliament on March 29, 2012 and other
Senator Céline Hervieux-Payette (Deputy Chair) in the chair.
The Deputy Chair: Welcome to the Standing Senate Committee on Banking,
Trade and Commerce. Today, the committee is holding a fourth meeting within the
framework of its study of certain provisions of Bill C-45, A second Act to
implement certain provisions of the budget tabled in Parliament on March 29,
2012 and other measures.
At this meeting, our committee will be looking at one of the provisions of
this act. We shall look at division 3 of part 4 which amends the Canada Deposit
Insurance Corporation Act, to, among other things, provide for a limited,
automatic stay in respect of certain eligible financial contracts when a bridge
institution is established. It also amends the Payment Clearing and Settlement
Act to facilitate central clearing of standardized over-the-counter derivatives.
I will now introduce the witnesses with us today: from the Canadian
Derivatives Clearing Corporation, Glenn Goucher, President and Chief Clearing
Officer, and from the Montreal Exchange, Pauline Ascoli, Vice President, Legal
Welcome to both of our witnesses.
Glenn Goucher, President and Chief Clearing Officer, Canadian Derivatives
Clearing Corporation: Thank you, ladies, gentlemen and members of the
Standing Senate Committee on Banking, Trade and Commerce. I will read a few
prepared remarks; my colleague will join me. At the end, we would be happy to
take your questions.
As President and Chief Clearing Officer of the Canadian Derivatives Clearing
Corporation, it is my pleasure to make some short introductory remarks on Bill
C-45, A second Act to implement certain provisions of the budget tabled in
Parliament on March 29, 2012 and other measures, to be entitled the jobs and
growth act, 2012. My particular focus and interest is on Part 4, Division 3,
entitled ``Preserving the Stability and Strength of Canada's Financial Sector.''
As you well know, at the Pittsburgh Summit in 2009, Canada agreed that:
All standardised OTC derivative contracts should be traded on exchanges or
electronic trading platforms, where appropriate, and cleared through central
counterparties . . .
The CDCC has spent considerable time, energy and resources over the past
three years preparing to become Canada's premier central clearing counterparty.
In order to facilitate the clearing of OTC derivative transactions, it is
imperative that the Canadian legal system provide legal certainty to all
participants in the clearing process. Although the Canadian legal system is
robust, perhaps further amendments to Canadian insolvency legislation — namely
the Bankruptcy and Insolvency Act, the Companies' Creditors Arrangement Act and
the Winding-up and Restructuring Act — are needed to further enhance this legal
We welcome Bill C-45, which recognizes that certain minor gaps needed to be
addressed to give better certainty to market participants. More generally, we
welcome Parliament's recognition that the stability of the financial system and
maintenance of efficient markets are important to the health and strength of the
I would like to address only two aspects of Bill C-45 today. The first is
addressing definitional issues in the Payment Clearing and Settlement Act, and
the second is addressing the effect of stays under the Canada Deposit Insurance
Pauline Ascoli, Vice President, Legal Affairs (Derivatives), Montreal
Exchange: I will first address definitional issues in the Payment Clearing
and Settlement Act. The notion of clearing and settlement system is defined in
section 2 of the PCSA and it includes conditions which must be met.
One condition set forth in c) states that the payment obligations that arise
from clearing within the system or arrangement are ultimately settled through
adjustment of accounts of one of or more of the participants of the bank. Some
commenters have requested that this requirement be removed in respect to a
system or arrangement for the clearing or settlement of derivatives contracts,
and Bill C-45, as it currently reads, removes this requirement.
The effect of this amendment is to remove the need for a designated clearing
and settlement system to settle Canadian dollar payments in central bank money.
This implies that such payments would be settled through a Canadian chartered
bank or perhaps a foreign bank.
The use of non-central bank money will expose the applicable designated
system to greater credit risk and perhaps greater liquidity risk. We note that
this could potentially increase systemic risk in Canada.
I would like to draw your attention to Principle 9 of the CPSS IOSCO
Principles for Financial Market Infrastructures dated April 2012, which
An FMI (refers to a financial market's infrastructure) should conduct its
money settlements in central bank money, where practical and available, to
avoid credit and liquidity risks.
It also states that if central bank money is not used, an FMI should conduct
its money settlements using a settlement asset with little or no credit or
By removing this condition altogether, the legislation becomes inconsistent
with the PFMI principles. We therefore respectfully submit that this section
should be revised to reflect that as a general principle, central bank money is
to be used in the case of a system or arrangement for the clearing or settlement
of derivative contracts.
It is our view that it is too early to consider exceptions to this principle
and that in the event that Parliament wished to introduce exceptions, further
parameters should be set as to what constitutes using a settlement asset with
little or no credit risk.
In sum, we continue to oppose the implicit carte blanche given to use of
non-central bank money for settlements by an FMI and ask that the Senate
reconsider this provision. .
Mr. Goucher: I would like to move to the second part of our speech now
and address the effects of stays under the Canada Deposit Insurance Corporation
Under existing legislation, when a bank is subject to a receivership under
the Canada Deposit Insurance Corporation Act, the federal government may
incorporate a bridge bank to take over its assets and run the bank until such
time as it can sell the bank.
CDCC welcomes the fact that Bill C-45 now clarifies in a new subsection —
namely subsection 39.15 — that clearing houses whose systems have been
designated as systemically important will not be subject to this temporary
bridge bank stay. CDCC's clearing system was designated systemically important
by the Government of Canada on April 27, 2012. This exception is consistent with
worldwide market reforms and paves the way for standardized OTC derivatives to
be cleared by a Canadian-based clearer.
The proposed changes will enhance the stability of clearing houses by
ensuring they can quickly apply their default rules as against a defaulting
member and, importantly, will better client protection by ensuring that a
clearing member's insolvency will not hinder the transfer to new clearing
members of client positions. In our view, it would be useful to provide express
protection for porting client positions to new clearing members where the
porting process does not involve termination of the cleared transactions.
CDCC also welcomes the broadening of section 13.1, which now references:
. . . collateral that has been granted to it as security for the
performance of an obligation incurred in respect of the clearing and
settlement services provided by the securities and derivatives clearing
We interpret this as applying not only to collateral held by a derivatives
clearing house generally but also to the default funds that mutualize risk of
other clearing members defaulting.
Thank you for your kind attention. That is the end of our prepared remarks.
The Deputy Chair: Ms. Ascoli, you were very clear on the issue of
introducing a risky measure that would put Canada in a separate category. When
you speak of a separate category, are you referring to OECD countries in
Ms. Ascoli: Can you please repeat the question?
Senator Hervieux-Payette: When you say that Canada would not be
respecting the Principles for Financial Market Infrastructures, are we
dealing with a world standard or a standard within OECD countries?
Mr. Goucher: This is a standard that has been developed by these two
separate organizations. CPSS is the Committee on Payment and Settlement Systems
out of Basel, and IOSCO is the International Organization of Securities
Commissions, and they have jointly developed a set of best principles for
clearing houses, which is a global standard applying to every country.
The Deputy Chair: How many countries comply with this principle?
Mr. Goucher: I do not think the question is how many countries. The
question is how many clearing houses. Any clearing house in the process of or
wishing to clear OTC derivatives must respect these principles.
The Deputy Chair: We would be apart?
Mr. Goucher: The principles are guiding principles, and we noted that
there is an option that, if central bank money is not used, there is another
further requirement. In the instance, in our rules, we are recognizing the fact
that it may be possible not to use central bank money for the Canadian
The Deputy Chair: However, representing higher risk than if the
Canadian central bank was involved?
Mr. Goucher: Yes.
The Deputy Chair: Maybe other people want to clarify this because you
have one point where you praise the government and say that everything is fine
and another one where you say that, really, we have to look at it. Maybe look at
what the avenues are or what kinds of amendments we could bring to the
legislation so that we can comply with all other clearing houses.
Senator Massicotte: Further to that same line of questioning, the part
that you do not like is that a clearing house could be a non-central-bank
guarantee. You are the expert; I am not. However, I would sort of say that that
is right. If you deal with the Bank of Nova Scotia, the credit risk is higher
than with the central bank. Therefore, why do the parties to the transaction not
adjust for that risk? Maybe the stretch would be a bit higher, but it cannot be
that significant. Am I missing something here?
Mr. Goucher: The issue is that, without picking on any particular
financial institution, there is a difference between a commercial bank and a
central bank. The challenge is to guarantee settlements and payments. If a
payment and settlement agent — if it is a commercial bank — is responsible for
systemically important payments and that particular institution is in a credit
crisis, the concern would be how to ensure that the Canadian system works in an
event where a commercial financial institution was, perhaps, in jeopardy. That
is the concern being expressed. It is, we would hope, a low probability event,
but that is what the PFMIs are addressing when they point out that the
preference would always be to use central bank money, where available.
Senator Massicotte: You are concerned that the clearing house per se
could be part of the systemic risk issue, and, therefore, the problem would get
bigger. The objective was to get around that issue, to clear it to know where
Who chooses the clearing house? Is it the Government of Canada who will
choose the clearing house?
Mr. Goucher: As it relates to the OTC derivatives market, there is no
current OTC clearing organization. CDCC is presently not clearing OTC
derivatives. Our banks and financial institutions are using foreign clearing
houses for that activity right now.
Senator Massicotte: Does the government have to approve the solvency
of that entity to allow it to be acceptable?
Mr. Goucher: There is where CPSS-IOSCO kicks in. This is a very small
part of a total framework on safety and soundness for clearing houses in
general; this is one of the requirements. The regulatory environment in Canada
will have some responsibility to ensure that those clearing houses are meeting
Senator Massicotte: Your issue is very appropriate. I presume that the
choice would be made such that that organization would be independent of any
inherent, systemic risk in Canada to avoid the risk that you are talking about.
I agree that there is a covenant risk, which is obviously higher than with the
central bank, but at least you avoid the systemic risk that you are worried
about. Am I correct?
Mr. Goucher: That is correct. The systemic question is being addressed
with the use of the clearing house, regardless of whether it is in Canada or in
another marketplace. This is a small piece of the arrangement that we would be
subject to some incremental risk as a result of.
Senator Massicotte: What did the government officials say to your
Mr. Goucher: The government officials, when we would have this
conversation, would recognize that this is not the best because central bank
money is the best solution. They would likely insist that any other clearing
house using non- central-bank money have certain safeguards and processes in
place to ensure that payment and settlement continues in a stressed environment.
Senator Massicotte: You are concerned that that choice will not be
satisfactory to your clients?
Mr. Goucher: Potentially. That would be the concern that we would like
to highlight for everyone to be aware of in this situation.
Senator Massicotte: Thank you.
Senator L. Smith: Following up on the deputy chair and Senator
Massicotte's questions, as you look at the major financial institutions in
Canada, do you have any input as to which one of them should be deemed a
Mr. Goucher: The clearing house decision is made by all of the banks.
That is not a decision that we make as the clearing house. We have to offer the
service. Today, the Canadian banks could not choose CDCC as a solution for their
interest rate swap clearing. The banks, individually, make those decisions on
the best forms of liquidity and where they have the best entity to support their
customers' activity. They would choose their clearing houses appropriately.
Senator L. Smith: Is it the Bank of Canada or the governor of OSFI who
oversees that function to ensure that they do everything that they are supposed
Mr. Goucher: There is a whole host of regulators that get involved
with that decision making. The Bank of Canada has principal responsibility for
the systemic risk, in conjunction with the Canadian Securities Administrators.
That involves Finance, as well as all of the securities commissions. They are
putting together the regulatory framework now to ensure that those decisions are
the best decisions.
Senator L. Smith: Do you see it evolving to the point that the Bank of
Canada would ultimately be the central clearing house?
Mr. Goucher: I do not think the Bank of Canada will become a central
clearing house. The intention, globally, is that, for the most part, clearing
houses are generally privately owned entities that are held to a series of rules
— the CPSS-IOSCO framework. It is not the role of the central bank to provide
clearing services for the OTC market; that is it not one of its functions.
Senator Massicotte: But you are asking the government to support that
Mr. Goucher: We have an account with the Bank of Canada in making our
payments for our current business. All of our payments are done through the Bank
Senator Massicotte: Through the payment system.
Mr. Goucher: Yes. This change is allowing for payments to be made
outside of the central bank.
Senator Tkachuk: Your concern is that, for a commercial bank, there
would be a little risk. Not big risk but little risk. Would you not be taking
into account that you are not dealing with the central bank but with the Bank of
Nova Scotia or the Bank of Montreal?
Mr. Goucher: Yes. To be clear, there would be backup banks, and there
are mitigating strategies to avoid that worst- case scenario. Historically,
before these new guidelines were put into place, the practice was that clearing
houses used commercial banks to effect payment and settlement. Moving to central
bank money is a very recent phenomenon in terms of regulatory reform.
Traditionally, commercial banking payment and settlement was the norm. The
principles articulate only that a better situation, where possible, is to use
central bank money where appropriate and, if it is not available, to have other
standards in place.
Senator Tkachuk: That is missing, or that is not missing? I am not
sure exactly what your point is here.
Mr. Goucher: What I am saying is that, in the principles for best
practices, best practices would be to use central bank money, but that is best
In the instance where central bank money was not available for some reason,
it is probable and required that you would have to use a commercial bank. The
system will function as designed; it just has that different and smaller risk
that commercial banks are not central banks; and that is all we are saying.
Senator Tkachuk: If a commercial bank exposed itself, for whatever
reason, to a position where it was in danger of not successfully continuing its
enterprise, would the other banks not step in? Would the central bank not have a
role to play? Would the Government of Canada not have a role to play?
Mr. Goucher: That moves us into a place of moral hazard that we try to
avoid with all of these principles. We try to engineer and develop the central
counterparty role so as to avoid that type of moral hazard. In practice — and
this is where I was suggesting that historically to minimize that commercial
banking risk — we have multiple commercial banking relationships. In the event
that the primary bank was experiencing difficulty, you would move the payment
and settlement function to another bank. We would not step in. We would do that
in advance. I speak broadly from the clearing industry in general.
Senator Tkachuk: When that bank was in trouble, you would remove that
risk to another bank that was not in trouble.
Mr. Goucher: You would mitigate that risk, hopefully. Our job in
running central counterparties is to manage to the worst-case scenarios. We
design ourselves to manage against things that we do not like to think about. We
concern ourselves with having multiple banks in difficulty simultaneously. That
is why, in the end, the best solution is central bank. However, as I said, there
are many different strategies to mitigate that risk from the system as a whole.
Senator Ringuette: You have brought another angle to the clauses that
we are studying.
Essentially we are talking about the clearing of derivatives. You talk about
the Canada Deposit Insurance Corporation Act, which is guaranteed by the
Government of Canada, that is, the taxpayers of Canada, to a certain level of
deposit in our commercial banking system. Are you saying that with these
changes, the taxpayers would be involved, through the Canada Deposit Insurance
Corporation Act, for the clearing of those derivatives?
Mr. Goucher: I absolutely am not saying that. That is the easy part of
Bill C-45 is a large bill with many different components. The piece around
the CDIC is unrelated to that previous discussion. It is related only in the
context of the bridge bank facility when it was originally proposed for the
clearing house to operate so we do not pass on incremental risks. We have to
have the right of the first call on any pledged assets. The original drafting of
the law as proposed made some confusion over who had first priority. It has been
cleared up; and we are happy with where it is now.
Senator Ringuette: Where is it?
Mr. Goucher: The clearing house has first call on deposits to the
clearing house in the event of the insolvency of a bank, which allows us to
manage the risks associated with the unwinding of those positions that are with
the clearing house away from the trustee process for the defaulting bank.
The Deputy Chair: We are talking about derivatives, but not in
general. Who is trading these derivatives and on behalf of whom? Is it just
institutional, or is it also related to individuals?
Mr. Goucher: Generally when we are speaking of OTC derivatives, we are
talking about the largest financial institutions in the country. The market
being serviced here is not for individuals.
The Deputy Chair: Are we talking mainly about banks?
Mr. Goucher: Banks, pension funds, insurance companies.
The Deputy Chair: I suppose you do not exist by prayers alone, and
there is a fee. To operate this clearing house, who is paying what for the
transaction? There must be a small token somewhere. Probably you are paid a
My question is this: If we were switching to another institution, would there
be a benefit to them to do that? Would there be a profit for them?
Mr. Goucher: Not quite the Tobin tax. Yes, we do work in the financial
services sector; and fees are paid for this service. It is not a public utility.
Every clearing house in general runs with a different commercial model. Some are
member-owned utilities that charge membership fees and then transactions are not
charged on an individual basis. Other clearing houses charge on a
transaction-by-transaction basis for this service. In general, there is a wide
range of different clearing houses, between for-profit, full for-profit and full
industry utility globally that would provide these services.
The Deputy Chair: If we keep the Bank of Canada in the loop, is it an
expense for the bank or a revenue, no matter the amount?
Mr. Goucher: The Bank of Canada oversees another system called the
Large Value Transfer System, LVTS, which effectively is the infrastructure we
speak of right now. I am not aware of the commercial nature of the LVTS service.
There is a fee for participating, but it is not transaction-oriented, so I could
The Deputy Chair: We are talking about a daily operation, something
that happens every day, all the time.
Mr. Goucher: Yes.
The Deputy Chair: What would be the average amount in Canada per day
going through a clearing house?
Mr. Goucher: That depends on how you would like that measured.
The Deputy Chair: Are we talking about hundreds of millions or
Mr. Goucher: In context, on a notional basis at CDCC today for
exchange-traded derivatives, we have notional amounts in the hundreds of
billions of dollars being transacted daily.
The Deputy Chair: My colleague certainly would appreciate knowing that
this is a big figure.
What is the status of U.S., Germany and Japan with the system?
Mr. Goucher: Those are the three jurisdictions that have the most
advanced clearing houses probably in the world. The Europeans, through LCH in
London, have the most advanced OTC clearing infrastructure globally. I will
misquote their actual numbers, but I believe that they have cleared $300
trillion in OTC swaps. In the United States, there are two OTC clearing houses,
CME Group and ICE, with different markets. They are both newer developments but
growing quickly to support their marketplace. The Germans recently launched
interest rate swap clearing last month, I believe; it is a new facility.
There are new clearing houses or existing clearing houses providing OTC
clearing services in Japan, Singapore, and Hong Kong. CDCC will provide OTC
clearing services in the future. It is a fallout from the reform process, but it
is a big part of the financial landscape today.
The Deputy Chair: Which organizations is the Canadian Derivatives
Clearing Corporation attached to?
Mr. Goucher: We are a wholly owned subsidiary of the Montreal
Exchange, which is a member of the TMX Group of companies in Canada. We are
unaffiliated with any of those other organizations.
The Deputy Chair: You are not affiliated to the U.S. or to England?
Mr. Goucher: Not at all.
The Deputy Chair: It is a Canadian —
I think it is important.
Mr. Goucher: I do not want to go back there. That was last year's
The Deputy Chair: We know that if you mention Europe, many countries
are dealing with —
Mr. Goucher: Many countries are dealing with the same issues
simultaneously right now.
The Deputy Chair: What is the point of view of your Canadian banks and
other financial institutions? Do you think they would have some reservations
with the new system, or would they be more inclined to support the system that
is now being proposed in the legislation?
Mr. Goucher: Without representing the Canadian banks, I believe the
only systems that are available to them today for meeting the Canadian G20
commitments and for commercial reasons, since other jurisdictions have adopted
similar legislation — I speak particularly about Dodd-Frank — for commercial
reasons, they have to be clearing their swaps now. I think that if they had a
preference, they would always prefer to settle central bank money, but on a
daily basis they transact billions and billions of dollars through other
commercial arrangements. Therefore, this would not be entirely untoward for the
The Deputy Chair: Could you define the risk? Is the risk related to
the currency? You mentioned in your presentation the Canadian dollar. At least
it is quite a strong currency. Does the euro or any U.S. denomination going up
and down make a difference for a user of the clearing house?
Mr. Goucher: It should not. The derivatives contracts we are speaking
of are denominated in every currency. We are speaking only of the Canadian
dollar-denominated derivatives market in this context, but it is unrelated to
the value of the currency.
The Deputy Chair: That means that even if you talk about the Canadian
dollar, these derivatives are not necessarily in Canadian dollars?
Mr. Goucher: We speak of the Canadian dollar because in Canada we only
settle Canadian dollar.
The Deputy Chair: I think it is good to know.
Senator L. Smith: I want to ask about the ultimate control mechanism
to ensure the integrity of the system for derivatives. We heard about the crash
in 2008 and all the problems in the U.S. and throughout the world. What
mechanism is the ultimate control lever, if you want, for the Canadian banks
that are playing in this market?
Mr. Goucher: There is the banking oversight through OSFI, because
there is a tie-in in terms of capital and charges for capital for the use of
non-cleared versus cleared derivatives. That is a newer form that starts as
well. The ultimate control rests with groups like the Financial Stability Board,
globally, which sets those best practices conditions for the use of a CCP. The
CCPs themselves are highly regulated entities.
Our ability to perform the systematically important function is subject to
oversight by the Bank of Canada, as well as the securities regulators in our
country. In other countries, they have similar oversight regimes.
Senator L. Smith: There seem to be some players involved in this
process. Is the system going to be effective enough to ensure there will be no
manipulation? I am sorry to be stupid, but I do not have the same sense of
sophistication you guys have.
Mr. Goucher: It is the world we live in, and what you speak of is
regulatory arbitrage. It is a bit off-topic, but it is a concern for all of us
in terms of the changing regulatory regimes, globally, right now and the ability
for participants to move their OTC business to one jurisdiction or another to
perhaps avoid some higher oversight regime.
All the reforms that have been designed to date have been very tailored to
ensure as much as possible that such a thing cannot happen. Home jurisdiction
regulation is designed to ensure that business cannot move to less regulated
Senator L. Smith: Within the system that exists as you see right now,
will it be agile enough and responsive enough to oversee and assure the
integrity of the system, or will that evolve over time?
Mr. Goucher: We are talking about global financial reform, and saying
that would be agile is probably a bit of a stretch. I do believe that the
commitment and effort is there to ensure harmonization of regulatory regimes to
allow us to have that type of flexibility you are speaking about in the future.
Senator L. Smith: Or to make sure you do not play in areas that do not
have that, correct?
Mr. Goucher: Regulatory arbitrage is a very focused part of any
conversation that is going on in the reform process to ensure that this does not
Senator Massicotte: I am curious: Who is looking to create these
clearing houses? They must be subsidiaries of large, existing financial houses.
Mr. Goucher: Regarding the evolution of clearing houses, regulatory
reform and change in general spawns, I would say, innovation. Prior to this
reform, there existed many clearing houses, generally attached to exchange
groups; the CME, Eurex, the New York Stock Exchange, NASDAQ all had clearing
houses for different businesses, not for the OTC markets. However, in general,
most countries and most exchange infrastructure had clearing capacity.
In every country, clearing houses are developing either as
government-sponsored industry utilities or for-profit enterprises, subject to
the same regulation, where they believe they offer some form of competitive
advantage vis-à-vis their peers.
The market is evolving. Clearing, in general, is effectively the plumbing of
our system. The nice thing about plumbing is you can add different pipes to the
plumbing and it still works.
Senator Massicotte: I suspect it is a big back-room operation, and I
suspect there must be economies of scales. I gather some other witnesses are
saying maybe this will be an international group, not necessarily a Canadian
group. Is it coming out that we have three or four persons offering the service
Mr. Goucher: That is a fair comment. In general, this is evolving.
There are two or three institutions that are offering effectively global
services, and there are benefits to the Canadian participants for being in these
These are competitive clearing houses in some instances for us. However, it
is clear that they offer economies, because of these scale issues and the
business they are doing, to our Canadian participants, which means there is some
value for them to participate in this global infrastructure.
Senator Massicotte: Much of the role of those clearing houses is what
I call a transparency accounting thing. They do not guarantee obligations of one
insurance swap from one institution to another. They just assure full
transparency of where we are at with net payments; is that accurate?
Mr. Goucher: No, that is not accurate. This is what we think about
then we go to sleep every night. We do guarantee the payments through a process
called novation. Every time a transaction is done and brought to the clearing
house, it is a contract, especially in derivatives.
The buyer and seller, when the contract comes to the clearing house, are
novated — or split in half — and the clearing house becomes the buyer to every
seller and the seller to every buyer.
Senator Massicotte: It guarantees the obligation of every buyer to
Mr. Goucher: When we are talking about affecting settlements — getting
back to where we are today from a clearing house perspective — the ability to
ensure that you can make the payment through the process is why we are talking
about this today. The CCP — the clearing house — is responsible for making all
of the payments.
Senator Massicotte: If I look at your own exchange and so on, relative
to the things that you are talking about, these are not huge entities with
immense covenant. I presume that, before you assume the responsibility, you
ensure that you have a proper match. If you are going to take on this
responsibility, you ensure that the other contractor is such that it is like
most investment houses; every night you come out to zero.
Mr. Goucher: Yes. The clearing house, by design, has a buyer and a
seller. We would never accept a transaction that is half of a transaction. By
design — and that is where the risk mitigation comes in at the clearing house —
we have, as the central counterparty, both sides to every transaction. The risk
we face is when one of those sides is in default and we have to fulfil their
obligations vis-à-vis the other counterparties.
Senator Massicotte: When you close your books every day, I will not
name a bank, but let us say a bank is a party to 40 swaps that day. You must
ensure that, at the end of the day, your 40 swaps are close to zero because, if
they are billions of dollars, you are exposed.
Mr. Goucher: No, we have a process. Vis-à-vis any bank, they would
have risk with us. We collect margin, just like at the retail level when you
are, perhaps, trading on margin. A clearing house does it at a much larger
level. We would never expect any one clearing member to have zero risk. They all
come with risk, which we margin, and we ensure that we have enough margin to
cover their exposure to the clearing house.
Senator Massicotte: Margin includes physical collateral?
Mr. Goucher: Cash and treasury bills pledged in the name of the CCP.
In the event of default, the CCP collects those assets. Again, thank you for not
allowing CDIC to take those assets before the clearing house. That is the point
Senator Ringuette: I am getting a clearer picture. When you say that
you act as the balance, I am supposing that the derivatives that you are
clearing are rated.
Mr. Goucher: No.
Senator Ringuette: They are not?
Mr. Goucher: No.
Senator Ringuette: The derivatives are not rated.
Mr. Goucher: No. The first line of protection for the CCP and my first
line of defence in managing the system is to ensure that the participants in the
system meet certain qualifications. In the case of a Canadian bank, we would do
a credit check on the Canadian bank. We would look at their balance sheet and
their eligibility to participate. We have control mechanisms inside the clearing
house; if someone takes on more risk than is appropriate for the size of the
institution, we extract more margin or stop them from participating. The
instruments themselves, however, are not rated.
Senator Ringuette: That is no certainly no consolation prize with
regard to the world banking system. Essentially, it was the poor rating of the
derivatives that were swapped in 2008 and prior to that that caused the chaos.
Now, you are saying that the derivatives are not rated.
Mr. Goucher: I will clarify that point as well.
Senator Ringuette: Please do. Reassure me.
Mr. Goucher: There is a broad range of derivatives. It is a term that
is loosely used and often abused. The instruments that you are speaking to that
were rated were actually structured products; they were not the derivatives
themselves. There was some financial engineering that pooled together a bunch of
financial instruments and created an asset. That asset was rated. The ratings
were not properly understood, or there was some discussion about the way those
ratings were done.
Senator Ringuette: You are very polite.
Mr. Goucher: I am very polite about the ratings process because it is
a complicated process. I am not here to either defend or abuse the rating
agencies for the work that they did; they would have a story to tell on that.
Senator Massicotte: A rating of that kind of instrument is irrelevant.
You are talking about two large institutions trading with each other. They know
each other's credit covenant. The full covenant of the bank is behind the
contract. It is not sold to the public. There is no reason to have it rated.
Mr. Goucher: No. To be precise about central clearing of OTC
derivatives, it is designed only for the most standardized and plain OTC
derivatives. The derivative instruments or the packages that you are referring
to would never come to a clearing house. They would be bilateral obligations
between those counterparties.
Senator Ringuette: Give us an example of the derivatives that would be
Mr. Goucher: Generally speaking, the largest derivatives market in the
world that is being cleared is called an interest rate swap. This is just, in
its most basic form, a promise from one party to the other that one party is
making a fixed payment on an obligation for a date. If it is for two years, one
party is saying, ``I will pay you, at a fixed rate, 6 per cent a year for two
years.'' The other party to that swap is saying, ``In return for that, I will
pay you a floating rate of interest of whatever.'' The promise will be from the
other party to make the commitment to meet those floating rate requirements.
Generally speaking, there is a reason why someone would like to swap a fixed
rate obligation and receive floating rate obligations. The two counterparties
agree to that transaction. In its most basic form, that is the simplest of
interest rate swaps. Those are going into clearing houses, and that is the large
amount of —
Senator Ringuette: I am assuming that it is an interest rate that
would also be attached to a fixed amount of —
Mr. Goucher: A fixed, notional amount. They would agree that, if the
number was for $100 million, someone would pay 3 per cent interest on $100
million for that period, and someone would receive the floating equivalent on
the same amount. There are many variations; that is the simplest version.
However, that is effectively what it is.
Senator Ringuette: In that scenario, I could see that the only risk
involved would be the potential insolvency of one of the partners.
Mr. Goucher: This is why those instruments are not rated. They have
obligations to each other, and it is not an instrument that is being rated.
Senator Oliver: May I ask a quick question about that?
The Deputy Chair: Go ahead.
Senator Oliver: If there is a major swing in the interest rates in
relation to the hypothetical that you gave us, say, in one week, a 3 per cent
change in the rate up or down, will that not affect the transaction?
Mr. Goucher: It affects the value of the transaction. In its simplest
form, let us assume that both sides are equal when they enter into that
transaction. The next day, regardless of whether or not it is 3 per cent or some
other thing, one of the participants will be a winner, and one will be a loser.
Senator Oliver: Well, the floating one will be.
Mr. Goucher: One way or the other. The clearing house is looking at
the market-to-market value and collecting additional margin against the loser
because that, when you are guaranteeing the payment, is what the clearing house
does. When you talk about a 3 per cent shock, which is one of those extreme
events, that is what the clearing house has to manage.
We look at extreme but plausible events and ask whether we have enough margin
to ensure that, in the case where interest rates move substantively over a week,
we will have enough resources to cover that risk. That is effectively how we
risk manage those positions.
Senator Oliver: How does a rating agency, an underwriter or anyone
else find out the total amount of an exposure of one of our banks? Is the
information from the clearing house available publicly?
Mr. Goucher: This is another element of the financial reform. There
were three pieces: transparency in execution; clearing, where appropriate; and
the development of trade repositories. The trade repository piece goes to your
question: Where do you get a central look at all of the activity of all of our
participants? Those are being built now to deal with that particular concern.
Senator Oliver: Who would oversee that? Would it be OSFI and other
Mr. Goucher: OSFI looks at the balance sheets of the banks and their
reported exposures individually on a bank-by- bank basis. On the regulatory
framework, the Bank of Canada and the securities regulators are responsible for
the oversight of the trade repository in that trade process.
The Deputy Chair: I thank all the witnesses who made an excellent
presentation. We are more informed about this section of the bill. Perhaps Ms.
Ascoli could work with you and propose some amendments to the bill that would
reflect your desired direction. The committee has great staff, but you know best
what would be needed to comply with the international rules that were adopted
and that most advanced countries will respect. I do not think Canada would want
to fall behind.
Mr. Goucher: They will not.
The Deputy Chair: Certainly, there is an interest. I sit on the
Finance Committee as well, which will eventually look at this section. Within a
reasonable time frame, later this week or the beginning of next week, perhaps
you could propose an amendment that would comply with what you are recommending.
Thank you so much.
Senator Tkachuk: One moment, chair. We did not ask for any amendments.
If you want to ask them for amendments, you can ask them after the meeting. The
committee is not asking for amendments.
The Deputy Chair: He made a general proposal.
Senator Tkachuk: I know. If he has any, he can forward them to the
The Deputy Chair: I am not asking on behalf of anyone. I am asking on
my own. I am a member of this committee also.
Senator Tkachuk: There you go — much clearer.
The Deputy Chair: I do not feel that I have the credentials in law.
Ms. Ascoli, who is a lawyer, could give us a sense of the desired direction, if
the government and Parliament would like to go with what they are proposing, and
how we could amend the bill.
On behalf of all the members, thank you for your presentation and assistance.