Mod Blog: The formalities and informalities of risk

By Jan Pilbauer, Executive Director, Modernization and CIO and Antoinette Leung, Director, Regulatory Modernization

As a financial market infrastructure, managing risk is foundational to what we do. It is also, understandably, a frequent topic of conversation as we discuss modern payments with members and stakeholders. While we at Payments Canada often think of risk quite formally – in terms of defined risk models for modern systems, for example – we know that people identify with risk more broadly. Generally speaking, risk refers to the uncertainty that surrounds future events and outcomes, which makes it an inevitable element of any transformation journey. To reduce uncertainty on our journey, our approach is to share early and often what we know and our plans to solve for what we don’t yet know. And today we are talking risks.

Risk Modelling for Modern Payments

In our Industry Roadmap & High Level Plan for Modernization, we committed to aligning our new or modernized systems with global regulatory and risk management standards. That includes developing models that address credit, liquidity and settlement risks in line with global standards and the Principles for Financial Market Infrastructures (PFMI), as outlined by the Bank of Canada.

For Lynx, Canada’s new core clearing and settlement system, that means the adoption of a Real-time Gross Settlement (RTGS) design and a cover-all defaulter pay model, features chosen based on direction from the Bank of Canada. They require all payments to be fully covered by liquidity. Given the increased liquidity requirements, we will be exploring what liquidity savings mechanisms (LSMs) can be built into Lynx, so that only payments that are sent for immediate settlement need to be covered 100 per cent by liquidity, and payments that are sent to the LSMs only need to be covered by liquidity on a net basis.

Before the model is finalized, some key decisions must be made in regards to the LSMs, the access model as well as operating hours and settlement times, which we are exploring with our members. It is important to recognize that we are designing Lynx for the future and many aspects can change over time, so flexibility of the new system is very important.

The Settlement Optimization Engine (SOE) – the element of the new core clearing and settlement system that will replace the Automated Clearing Settlement System (ACSS) and will be considered for US Bulk Exchange (USBE) functions – will calculate multilateral net positions for settlement. It will meet the Bank of Canada’s risk standards for prominent payment systems and will continue to be a deferred net settlement system, with a collateral pool sufficient to cover the credit exposure from the default of the largest participant (currently at 97 per cent confidence). Upon a default, the defaulter’s collateral is first used to cover any losses. If there is a shortfall, survivors’ collateral will be used to determine their default and additional contributions to effect settlement.

As part of Modernization, we will also implement same day settlement for current ACSS payment streams and open, risk-based access. We will revisit whether the ACSS interim credit risk (PDF)  model needs to be adjusted as a result of these changes.

We are also developing a risk model for the new Real-Time Rail, Canada’s faster payments clearing capability. Details of the risk model for this system are in the early stages of development, but we expect to see the most open access criteria for this system to enable innovation.

From Uncertain to Certain

Clearly, we are managing the formalities of financial risk modelling, but what about other risks – the uncertainties that remain? What is the migration strategy of the legacy volumes to new systems? What the specifics of ISO 20022 payment messages look like across all platforms? How will data be managed? With a transformation as large as payments system Modernization, there come complex issues and points for discussion.

Our approach to transformation is rooted in research and consultation and that will continue to guide us as we work through some of these outstanding issues.  In that vein, we are hosting a series of workshops with our members and we look forward to sharing the outcomes of these discussions over the coming months. So, keep an eye on this space for new developments on the path to modern payments, and never hesitate to reach out – let us help to answer questions and increase the certainty!

Antoinette & Jan