Mr. Speaker, a potential cost to these clearing houses is the risk that any member may default before a transaction is settled which would result in a financial loss to both the clearing house and its members.
As a central counter party, securities and derivatives clearing houses take measures to reduce this risk. For example, members are required to post collateral and to net their payment and delivery obligations with the clearing house.
By way of explanation netting is a way to significantly reduce the net payment and delivery obligations of members of the clearing house, in some cases by tenfold. If, for example, a member of a clearing house buys a security for $1,000 and sells another for $900, the member's net obligation to the clearing house is $100.
Collateral, as hon. members know, is an asset that is posted, in this case with securities and derivatives clearing house, to partially offset members' obligations to the clearing house in case they cannot fulfil their obligation. Collateral is usually provided in the form of a cash deposit or the transfer or pledge of a security.
Like many of its counterparts in other countries, the Canadian securities and derivatives industry has been faced with the challenges of globalization, rapid technological change and consolidation.
Proximity to the United States and relatively low barriers to entry for foreign securities dealers, free movement of capital and an increasingly North American focus of many large Canadian corporations have made the securities and derivatives markets be more competitive. As a response, larger Canadian securities firms have been improving their quality to service clients on a North American basis. Canadian exchanges have also been facing this intensifying competitive environment.
Issuers of capital are increasingly able to access global markets, bypassing local markets and intermediaries. A growing number of Canadian firms are choosing to list their stock on U.S. exchanges. In addition, U.S. derivatives exchanges offer derivatives on Canadian indexes, commodities and companies.
It is imperative then that the Canadian securities and derivatives industry be able to compete with other countries, particularly with the United States where a significant portion of Canadian securities and derivatives trading occurs.
The industry needs a competitive legal regime that lowers settlement risks and the associated costs to these clearing houses. Such a change will make these clearing houses in Canada more efficient and competitive with the United States and other G-7 countries and help to keep trading activity here at home.
Without these changes, more securities and derivatives trading will occur outside of Canada, primarily in the United States where bankruptcy and insolvency legislation generally exempts securities and derivatives clearing organizations from court ordered stays and allows them to net the obligations of members and realize their members' collateral.
Recent changes in Europe also reaffirm the importance of keeping our industry competitive.
The settlement finality directive which came into force in 1998 established a legal framework for payment and securities settlement systems in the European Union. EU member states must ensure that securities settlement systems can net obligations and that the netting is legally enforceable and binding on third parties in the event of insolvency. The directive also provides for collateral to be realized in a timely manner in any wind-up procedure.
Laws in Canada do not fully protect netting agreements and collateral posted with securities and derivatives clearing houses to the same extent.
Stakeholders in Canada have raised concerns that current federal legislation does not prevent court imposed stays from securities and derivatives clearing houses realizing collateral in the event of their members becoming bankrupt or insolvent.
The Bourse de Montréal, on behalf of the CDCC, along with the WCE Clearing Corporation and the Canadian Depository for Securities have all requested that the Payment Clearing and Settlement Act be amended to cover securities and derivatives clearing houses. They are concerned that Canadian bankruptcy and insolvency laws add to the cost of their clearing house operations and to their members by increasing the costs related to the risk of a failure of one of their members.
It is difficult to attract large international dealers and trades to Canada if these Canadian clearing houses face higher costs because they cannot enforce their netting and collateral agreements with members in the event of the insolvency of one or more members.
Given how our competitors function, it is imperative that changes be made to ensure that Canadian securities and derivatives clearing houses can compete with those in the United States and in Europe.
Bill S-40 addresses these issues. The amendments in Bill S-40 will make Canadian securities and derivatives clearing houses more efficient and competitive with the United States and the other G-7 countries, allow them to lower their costs and help to keep trading activity in Canada. This is accomplished by amending the Payment Clearing and Settlement Act to include legal protections for securities and derivatives clearing houses of their netting agreements and collateral posted by their members.
These amendments protect netting agreements and prevent stays imposed by a court on the ability of securities and derivatives clearing houses to realize collateral in case of bankruptcy or insolvency of one of their members.
Hon. members should bear in mind that the protections being sought through this bill are over federal bankruptcy and insolvency laws. These legal protections will allow Canadian securities and derivatives clearing houses to lower their settlement risks and settlement costs, thereby making them more efficient and competitive with the United States and other G-7 countries.
Before closing I want to draw the attention of hon. members to recent recommendations made by the Bank for International Settlements, the BIS, to which the amendments of the bill adhere.
The BIS is an important forum for international monetary and financial co-operation between central bankers and other regulators and supervisors. Its work has contributed to the setting of standards, codes and best practices that are deemed essential for strengthening the financial architecture worldwide.
Last November the BIS made recommendations about securities settlement systems, including securities clearing houses. These recommendations support a well-founded legal basis for securities settlement systems so that rules and procedures can be enforced with a high degree of certainty. In particular, it favours the enforceability of netting arrangements and the ability to realize assets pledged as collateral.
As I mentioned earlier, securities and derivatives clearing houses are important to the efficient operation of our financial markets.
First, securities and derivatives markets are critical in providing opportunities to raise capital for investments and hedging financial risks.
Second, securities and derivatives clearing houses take measures to reduce settlement risks and associated costs through netting and requiring members to post collateral.
Third, it is important that the measures taken by these clearing houses to reduce risks are supported by a sound and competitive legal regime.
In considering the bill, I urge hon. members to keep these three additional points in mind: First, that these amendments are in keeping with recommendations by the Bank for International Settlements regarding securities settlement systems; second, that they are supported in Canada by financial sector participants and their associations, by provincial governments and by the insolvency community; and third, that they help meet a throne speech commitment to keep Canadian laws competitive.
It is essential that Canada's financial sector remains strong and efficient. The amendments in Bill S-40 will help to ensure this. A competitive legal regime will help keep securities and derivatives trading in Canada and assist the industry in attracting international deals and brokers here.
For those reasons, I urge hon. members to pass the legislation without delay.