A recent article in the Globe and Mail suggested that the banking industry is about to suffer a huge upheaval from the impact of digital technology. In part, this upheaval is to come from the rapid grow of mobile payments apps. At the same time, it is anticipated that, sometime later this year, amendments to the Canadian Payments Act will come into effect which will significantly change the manner in which the Canadian Payments Association (CPA) is governed. Today, the CPA is an association created by statute and operated by its members, which has the mandate of running a national payment clearing and settlement system. At present, the payment systems run by the CPA clear and settle the vast majority of payment items in Canada.
When the CPA amendments come into force, the governance structure of the CPA will be substantially altered. Until now, the CPA has been governed by a board of directors the majority of whom are representatives of its members. Under the new governance structure, the members will continue to elect directors, but a majority of the directors will be required to be independent of the CPA and its members. The principal objective of the CPA will remain the same – namely, to operate a national payment clearing and settlement system – but these governance changes are likely to result in the board’s membership becoming significantly more diverse.
How these governance changes will ultimately affect the future of Canada’s payment clearing and settlement systems, of course, remains to be seen. However, it is clear that a new era of clearing and settlement system governance has been ushered in.
A Brief History of Canada’s Payments Systems
To understand the significance of the governance changes, it is useful to review the current payment clearing and settlement landscape.
The current structure for the clearing and settlement of payment items in Canada was essentially established in 1980 with the enactment of the Canadian Payments Association Act. The Act created the Canadian Payments Association (CPA) and charged it with the mandate to operate a national clearing and settlement system. Prior to 1980, the Canadian Bankers Association ran a national clearing and settlement system for its bank members. Other non-bank deposit-taking institutions of the time, such as credit unions, that wished to participate in the system did so by making arrangements with a bank.
The decision to create the CPA had a fairly long gestation. In 1961, the federal government established a Royal Commission on Banking and Finance to make recommendations for improving the structure and operations of Canada’s financial system (the Commission is commonly referred to as the Porter Commission, named after Commission chair, Dana Harris Porter). The Commission’s report, issued in 1964, recommended that all deposit-taking institutions be required to hold their reserves at the Bank of Canada. The Commission saw it as a necessary and beneficial consequence of this requirement that the clearing of payments items would take place at the Bank. The Commission also noted that this change would eliminate the need for non-bank deposit-taking institutions to make arrangements with other banks, which would introduce an element of fairness into the settlement system.
The Government of the day chose not to act on this recommendation of the Porter Commission. However, in 1972, a report sponsored by the federal Department of Communications observed that the arrival of computing technology was having an important impact on payment systems. In 1975, the Department of Finance and the Department of Communications jointly published further thoughts on the payments system and, in particular, the emergence of electronic payments. The Government thereafter sponsored the formation of the Canadian Payments System Standards Group, comprised of representatives of the deposit-taking institutions, common carriers and computer manufacturers, to further consider the issues related to the emerging computer technologies.
In a White Paper issued in 1976, the Government formally stated its intention to form the CPA. The Government indicated that the CPA would assume responsibility for running a national payments system. Presumably in recognition of the uncertain impact of the ongoing development of computer technologies, the CPA mandate also included planning for the “evolution of the national payments system”.
In accordance with the Porter Commission’s earlier recommendation, all banks were to be members of the CPA, and non-banks that met specified conditions were also permitted to become members. The newly-created CPA was to be governed by a board of directors elected by its members, with banks and non-banks having the right to separately elect their representatives. The Bank of Canada was given the right to appoint one director. Later, the Minister of Finance was given the right to appoint three members to the board. Despite the CPA’s mandate to plan for the evolution of the payments system, the computer industry was not given any direct representation on the board of the CPA.
Evolution of Objects
When the CPA was first created, it had the dual objectives of operating a national clearing and settlement system and planning for the evolution of that system. By 2001, the latter objective was changed to provide that the CPA’s mandate was to facilitate the interaction of its systems with other systems and the development of new payment methods and technologies.
The Payment Clearing and Settlement Act
In 1999, the CPA launched the Large Value Transfer System (LVTS) to enhance its settlement capabilities with respect to large value transfers. The Government introduced the Payment Clearing and Settlement Act (PCSA) in 1996, in part, to provide some of the legal framework necessary to support the functioning of LVTS. Additionally, the PCSA also provided the Bank of Canada with the authority to regulate payment clearing and settlement systems under the PCSA if the Governor of the Bank believed that a system posed a systemic risk.
The New Governance Structure
Under the amendments being introduced to the Canadian Payments Act, CPA members will continue to elect its board of directors. However, seven of the 13 members of the board must be independent of the CPA or its members. Only three of the directors will be elected by the direct clearers (principally the large banks). Two directors will be elected by the members that are indirect clearers. The president of the CPA will also be a director. Neither the Bank of Canada nor the Minister of Finance will appoint members to the board.
To further assure that the seven independent members are independent, all nominees are to be identified by a nominating committee of the board comprised of a majority of independent members. Draft regulations have been released that elaborate further on the meaning of independence. Notably, there is a three year cooling off period for individuals that were previously associated with the CPA or one of its members. There is also a three year cooling off period for individuals that have had contractual or business relationships with the CPA or one of its members if the nominating committee believes that the relationship could interfere with the director’s independent judgment.
Clearly, the amendments are intended to change the voices at the board table, as the deposit-taking institutions that comprise the membership of the CPA will no longer be in a majority position on the board. The changes also address the perception that the CPA was being run for the benefit of its members rather than a broader list of stakeholders, including Canadian businesses and consumers.
At the same time, the Government made a move to mitigate some of the risks that may arise in a more liberal regulatory environment. The PCSA amendments expand the Bank of Canada’s power to designate payment systems for regulation: in addition to the current power to designate systems that pose “systemic risk”, systems can now be designated if they pose “payments system risk”. While “systemic risk” is defined in terms of the potential for the disruption or failure of a system to transmit financial problems through the system, “payments system risk” is defined as arising where the failure or disruption of a system would impair the ability of individuals or businesses to make payments or result in a general loss of confidence in the overall payments system. Essentially, this expanded concept of risk provides the Government (with the assistance of the Bank of Canada) much greater control over the development of unregulated payment systems.
Looking forward, it appears that there will be interesting times ahead. Much has been written about the interest that technology companies and other innovators have expressed in payments. For now, it appears that these innovators are content to develop technologies that run off current payments systems. Only time will tell whether the current payments structure will survive.