## 1canea2020003

## Source details

**Canonical URL:** [1canea2020003](https://www.imf.org/-/media/files/publications/cr/2020/english/1canea2020003.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/cr/2020/english/1canea2020003.pdf.md)
- [Structured JSON version](/-/media/files/publications/cr/2020/english/1canea2020003.pdf.json)

---

### Overview / Key findings
- The Bank of Canada (BOC)’s framework for market operations and liquidity provision in normal times is comprehensive and well-articulated.
- System-wide liquidity conditions are stable and market rates are closely aligned with the announced policy rate.
- Planned modernization to an RTGS platform will likely result in a substantive increase in demand for collateral; enhanced monitoring of collateral availability is recommended.
- Money markets and public debt markets are functioning well; secured transactions predominate in money markets and repos are largely based on federal government bonds.
- Foreign exchange markets appear liquid with spot and swap transactions each representing 40 percent of the market share.
- External debt liabilities have increased significantly in recent years, driven by banks and other non-government entities issuing bonds in international markets; enhanced monitoring of foreign-currency liquidity is warranted.
- The BOC has a well-defined framework for managing liquidity during stress, including bilateral liquidity support and an amended ELA framework accepting Canadian-dollar mortgages as collateral and clarifying eligibility for provincially regulated entities.
- Contingency planning for market-wide interventions (including securities market interventions and foreign-currency liquidity provision) should be further developed and tested.

### BOC operational framework and liquidity management in normal times
- Legal and policy framework:
  - BOC mandate per Bank of Canada Act (Article 18): “mandate to conduct monetary policy to promote the economic and financial well-being of Canadians.”
  - Inflation-control target: 2 percent midpoint of a 1 percent to 3 percent control range; target set every five years by the Government of Canada and the BOC.
- Operating target and mechanism:
  - Operating target is a secured overnight (repo) rate; policy rate is midpoint of operating band supported by standing deposit and lending facilities accessible to LVTS participants against a broad range of collateral.
  - LVTS end-of-day balances must be zero; positive balances remunerated at “deposit rate” (policy rate minus 25 basis points); negative balances enter standing facility at “bank rate” (policy rate plus 25 basis points).
  - Non-LVTS participant primary dealers may access overnight standing repo facilities.
- Tools to influence structural liquidity:
  - Adjustments to settlement balances: target for LVTS settlement balances set for the following day; current balances stable slightly above zero (currently Can$250 million).
  - Historical example: settlement balances were increased to Can$8 billion during the global financial crisis (GFC) and later reduced (from Can$8 billion to currently Can$250 million) as part of transition from floor to corridor system.
  - Overnight repo and reverse repo operations via competitive auctions against Canadian government bonds; participation limits based on market share.
  - Term repo operations: aggregate outstanding amount Can$9,400 million (1-month Can$5,800 million and 3-month Can$3,600 million).
- Correlation and forecasting:
  - Correlation of policy rate with overnight money market financing rate and CORRA is almost 100 percent; correlation decreases to 96 percent for unsecured rates such as the one-month bankers’ acceptance rate and prime corporate paper rate.
  - Correlation of operational target (CORRA) and policy rate: 99.7 percent.
  - Correlation of 1-month BA rate with policy rate: 97 percent.
  - Correlation of 1-month prime corporate paper rate with policy rate: 96 percent.
  - BOC has very good insight into federal government cash positions and conducts two daily Receiver general cash auctions (including a finetuning afternoon auction).

### Collateral framework, counterparties, and risk controls
- Counterparties and facilities:
  - Securities lending facility lent to primary dealers; actively used until 2015; accessed once in September 2017 and once in March 2019 since then.
  - BOC counterparties currently encompass 16 LVTS participants and 12 different primary dealers.
  - Vast majority of primary dealers are fully consolidated subsidiaries of large banks/LVTS participants; only one primary dealer lacks a parent bank with LVTS access.
- Eligible collateral:
  - Marketable public-sector collateral: securities issued or guaranteed by the GoC (including NHA MBS and CMB), provincial governments, municipal governments, U.S. Treasury marketable securities.
  - Marketable private-sector collateral: bankers’ acceptances (BAs), promissory notes, commercial paper (CPs), corporate bonds, ABCPs, term ABS, covered bonds, special deposit accounts.
  - Non-marketable loan portfolios: non-mortgage loan portfolios (NMLPs) of direct LVTS participants.
  - GoC securities accepted for overnight reverse repo transactions; securities issued or guaranteed by central or provincial governments accepted for term repo operations.
- Risk controls, pricing, and recent adjustments:
  - Minimum credit quality requirements, concentration limits, and haircuts applied by asset category and residual maturity; additional haircuts for foreign-currency U.S. T-bills and government bonds.
  - Marketable collateral priced daily using multiple external price sources; NMLPs priced monthly on outstanding amount with portfolio-weighted average haircuts and distinctions for secured/unsecured and consumer/business loans.
  - Recent adjustments: reduced reliance on external ratings, developed in-house credit risk assessment, terminated acceptance of securities issued by LVTS participants, adjusted haircuts and limits.
  - BOC expects a substantive (up to 50 percent) increase in overall collateral demand in connection with transition to an RTGS system.
  - Termination of LVTS-issued securities acceptance makes BAs practically ineligible given 98 percent share issued by D-SIBs.
- Recommendations (collateral operations):
  - Expand internal capacities to assess and monitor availability of collateral across banks given RTGS transition. (BOC) — Priority: H; Timeframe: I
  - Enhance capacity to price collateral based on theoretical models and increase pricing frequency for loan portfolios. (BOC) — Priority: H; Timeframe: NT
  - Consider conducting the finetuning afternoon general receiver auction on a collateralized basis. (BOC) — Priority: M; Timeframe: I
  - Aggregate and individual levels of unencumbered eligible assets should be used as indicators in early warning systems; consider differentiated treatment of “own-used” retained NHA MBS (higher haircuts/limits).

### Money markets and reference rates
- Structure and scale:
  - Money markets dominated by secured transactions; repo transactions predominantly secured by 3–10 year GoC bonds: 66 percent; 14 percent backed by provincial government bonds.
  - Repo trading mainly bilateral; 10–20 percent of transactions cleared via central counterparty (CCP).
  - Table 2 highlights (June 2018; amounts in billions of Canadian dollar):
    - Treasury bills: 119,300; Government of Canada; ≤12 months.
    - Repo (monthly turnover): 2,488,823; typically large domestic banks, pension funds, insurance companies; ≤120 days.
    - Bankers’ acceptances: 86,452; large banks; ≤1 month.
    - Commercial papers: provincial governments 57,745; municipalities 522; nonfinancial corporations 9,058; financial corporations 11,073; in U.S. dollar 4,090.
    - Asset-backed commercial papers: 33,734; originated by large domestic banks; ≤12 months.
  - T-bills annual issuance: Can$320 billion in 2017; GoC bonds 2-year to 30-year issuance Can$136 billion in 2017; average T-bills outstanding about Can$135 billion in 2017.
  - BAs just over 25 percent of total money market (~Can$86 billion outstanding in June 2018); BA market rebounded since 2010 trough, increasing by slightly less than 70 percent since that trough.
  - ABCPs just over 10 percent of total money market (~Can$34 billion outstanding in June 2018).
- Reference rates and reform:
  - BA market linked to Canadian Dollar Offered Rate (CDOR) used for derivatives and floating-rate notes.
  - Transition to risk-free benchmark: enhanced CORRA in line with IOSCO principles; Canadian Alternative Reference Working Group developing enhanced CORRA.
  - CDOR governance strengthened by appointment of an administrator and oversight committee; OSFI supervises submission governance.
  - Market consultation launched February 2019 on transactions to be included in enhanced CORRA calculation and methodology.
- Assessment and recommendations (money markets):
  - Canadian repo market is robust and resilient; increasing CCP participation should improve resilience.
  - Prioritize transition to a risk-free reference rate; complete work on enhanced CORRA. (BOC) — Priority: H; Timeframe: I
  - Closely monitor BA market liquidity (bid-ask spreads) given new LCR and upcoming NSFR regulations affecting dealer inventories and quarter-end spreads.

### Bond markets, mortgage securitization, and liquidity
- GoC bond market:
  - Auction formats: multiple price auction for nominal bonds and T-bills; single price auction for real return bonds.
  - Holders: stable concentrated group—large pension funds and banks; nonresident investor share increased from 20 percent (2002) to nearly 40 percent (2017).
  - Secondary trading: largely bilateral; about 40 percent on electronic venues; effective bid-ask spreads estimated between 4 and 6 basis points (all trades), tighter for large trades (e.g., 2-year ~1.5 basis points for Can$50 million+).
  - Analyses show mixed liquidity indicators: price impact of large trades increased; average trade size and trading volumes for benchmark bonds increased since GFC; adverse liquidity movements around stress events but quick rebounds.
- Provincial bonds and other public debt:
  - Provincial bonds less liquid; amounts outstanding of provincial government bonds more than doubled since GFC, reaching Can$827 billion.
  - Ontario and Quebec account for two-thirds of aggregated provincial debt; issuance volumes, credit ratings and liquidity differ across provinces; spreads vary and can widen under stress.
  - CMB spreads less prone to fiscal stress and less volatile.
- Market stocks (Table 3 highlights; June 2018; amounts in billions of Canadian dollar):
  - Federal government bonds: Domestic 572,573; Foreign 13,580; 2–30 years.
  - Provincial government bonds: Domestic 670,102; Foreign 156,739.
  - Municipality bonds: Domestic 62,592; Foreign 846.
  - CMBs: Domestic 236,700; Foreign 0; Mainly 5, 10 years.
  - NHA MBS: Domestic 486,270; Foreign 0; 5 years.
  - Covered bonds: Domestic 9,800; Foreign 137,100; Mainly 5 years.
  - Financial corporation bonds: Domestic 275,849; Foreign 470,168; 1–10 years (mainly).
  - Nonfinancial corporation bonds: Domestic 300,636; Foreign 342,537; >4 years.
- Mortgage securitization:
  - NHA MBS program government-supported; about half of NHA MBS sold to Canada Housing Trust (CHT) immediately after issuance; CHT issues CMB to fund purchases.
  - Large share of NHA MBS retained on originators’ balance sheets as HQLA Level 1; small fraction sold to end investors; perceived liquidity deteriorated and comparable to investment grade corporate bonds.
  - Annual issuance caps: NHA MBS cap Can$80 billion in 2018; cap increased to Can$140 billion for 2019.
  - CMB Program: issuance limited by CHT to Can$40 billion annually since 2013.
  - Covered bonds constrained by prudential limit: maximum 4 percent of bank total assets.
  - Private-label RMBS plays a very minor role.
- Assessment and recommendations (bond and securitization markets):
  - Debt management strategy and well-functioning GoC market support system-wide liquidity.
  - Standardization of securitization supports liquidity but impairs revitalization of private-label MBS; monitor asset encumbrance and market liquidity dynamics.

### Foreign exchange markets and foreign-currency funding
- Market structure and turnover:
  - Canadian dollar: sixth most traded currency globally and second in the Americas.
  - Spot and FX swap transactions each represent nearly 40 percent of daily turnover; outright forwards 13 percent; cross-currency swaps 1.6 percent; FX options 2.2 percent.
  - BIS analysis: turnover increased over past 15 years; FX derivatives turnover exceeds spot turnover.
  - Considerable trading outside Canada and on electronic platforms, including algorithm trading.
- Funding vulnerabilities and exposures:
  - Banking sector external debt liabilities increased about 150 percent over past five years, reaching Can$1 trillion, or 46 percent of GDP, as of 2018Q3.
  - About 40 percent of the increase driven by issuance of long-term debt instruments including covered bonds.
  - Two-thirds of banks’ external borrowing is short-term.
  - As of October 2018, foreign-currency funding amounted to Can$2.9 trillion or 55 percent of total funding.
  - Banks’ foreign-currency assets total Can$3 trillion.
  - Wholesale foreign-currency funding accounts for about 40 percent of total funding.
  - Since end-2013, external debt liabilities to GDP increased by about 30 percentage points, driven by banks (two-thirds) and other non-government entities (one-third).
- Hedging and market indicators:
  - Aggregate foreign-currency exposures appear naturally hedged via overseas earnings; some banks lack meaningful overseas operations.
  - Banks use FX swaps and cross-currency basis swaps; funding programs are reported fully hedged from currency and term basis.
  - 5-year cross-currency basis suggests U.S. dollar funding stress in Canada has been muted relative to other major currencies since 2009.
- Assessment and recommendations (FX and foreign-currency funding):
  - Authorities should enhance monitoring of foreign-currency liquidity, wholesale funding, and derivatives usage.
  - Expand planning and testing exercises for ELA including foreign-currency lending and develop a tested strategy for systemic foreign-currency funding stress. (BOC and DOF) — Priority: M; Timeframe: NT
  - Ensure legal and procedural recourse to Exchange Fund Account (EFA) holdings and standing bilateral swap lines in stress; EFA holdings US$72 billion (5 percent of GDP) with US$60 billion funded through cross-currency swaps and US$12 billion through foreign-denominated debt.

### Measures to deal with market stress: ELA, TRO, CTRF, and market-wide support
- Idiosyncratic ELA (legal basis and eligibility):
  - Section 18(h) of Bank of Canada Act: loans/advances must be collateralized, to Payments Canada members, duration ≤6 months (renewable), at BOC discretion and at rate not lower than bank rate.
  - ELA eligibility: eligible financial institutions or FMIs experiencing liquidity difficulty; distinct requirements for federally and provincially regulated institutions; insurance companies, mutual funds, investment dealers, foreign FMIs and foreign bank branches generally not eligible.
  - Provincial institutions require provincial indemnity and must be members of Payments Canada with credible recovery/resolution framework and assessed importance to broader financial stability.
  - Collateral: broad set including marketable and non-marketable assets; amendments facilitate acceptance of mortgage loans as collateral via assignment and title custodian arrangements (December 2017).
- Assessment and preparedness for ELA:
  - BOC has a credible ELA framework but further preparedness recommended.
  - Conducted an ELA simulation in late 2017; ELA has not been extended in more than 20 years prior to testing.
  - Recommendations:
    - Broaden test participants to include mid-sized banks and large provincially regulated institutions. (BOC) — Priority: H; Timeframe: I
    - Simulate mobilization, legal transfer, pricing and haircut determination for non-standard collateral (mortgage loan portfolios, equities). (BOC) — Priority: H; Timeframe: I
    - Intensify monitoring of standard and ELA-eligible collateral, particularly for D-SIBs; use unencumbered eligible collateral in early warning systems. (BOC) — Priority: M; Timeframe: I
    - Engage with provinces to clarify assessment of provincial institutions’ systemic importance and establish indemnity agreements and MoUs.
- System-wide instruments and framework:
  - Term Repo Operation (TRO):
    - Scalable, competitive multiple-price auctions for 1- and 3-month maturities; eligible collateral: Canadian dollar marketable securities issued/guaranteed by GoC or a provincial government; counterparties currently primary dealers but can be broadened in stress.
  - Contingent Term Repo Facility (CTRF):
    - Standing facility activated in times of stress; broader counterparties if they demonstrate significant market activity and regulatory oversight; bilateral liquidity at set interest rate against eligible collateral determined at activation.
  - Other options: increase settlement balances, broaden counterparties for lending, outright securities purchases, direct interventions (BOC, DOF, provincial governments).
  - Section 18(g) of Bank of Canada Act authorizes buy/sell of any securities in severe and unusual stress as determined necessary by the Governor (no formal restrictions on universe of securities or counterparties).
- Preparedness and coordination gaps:
  - MoU signed with AMF to facilitate ELA decision-making, but provinces (particularly British Columbia, Ontario, and Quebec) have not established indemnity agreements and MoUs with the BOC; eligibility for provincially regulated institutions not yet met.
  - Contingency plans for direct interventions in securities markets and foreign-currency liquidity provision should be developed further and tested.
  - BOC and DOF should jointly develop/test strategy for systemic foreign-currency funding stress, based on reserves and standing bilateral swap agreements.

### Regulation, institutional arrangements, and sectoral liquidity resilience
- Regulation related to liquidity risk:
  - LCR requirements in force January 2015; OSFI implements via LAR guideline and Guideline D-11; BCBS RCAP assessed OSFI’s LCR regime as compliant in October 2017.
  - LCRs by significant currency implemented as monitoring tool; increased run-off rates for less stable deposits to be implemented January 2020 alongside NSFR requirements.
  - OSFI to make NSFR a minimum standard effective January 1, 2020; NSFR 100 percent initially applied to D-SIBs only.
  - DSIBs’ LCR levels have on aggregate been well above minimum (100 percent) since January 2015.
  - Banks hold sufficient HQLA Level 1 assets; HQLA Level 2 plays a smaller role.
- Nonbanks and funds:
  - Mutual funds regulated by provincial securities commissions and NI 81–102; NI 81–102 limits cash borrowings to 5 percent of assets, illiquid assets to 10 percent of NAV, and imposes leverage/derivative limits.
  - Money market funds minor role; some U.S.-domiciled funds hold low amounts of Canadian fixed income.
  - Mutual fund industry size (net assets; selected figures):
    - Total Long-term Funds: 1,510.10 (August 2019); 1,501.80 (July 2018); 1,452.80 (December 2017); 1,386.70 (August 2017).
    - Total Money-market Funds: 25.50 (August 2019); 25.30 (July 2018); 24.20 (December 2017); 24.10 (August 2017).
    - Total Industry: 1,535.60 (August 2019); 1,527.10 (July 2018); 1,477.00 (December 2017); 1,410.80 (August 2017).
    - Total Industry/ GDP (in percent): 72 (August 2019); 71 (July 2018); 69 (December 2017); 66 (August 2017).
- Institutional arrangements for crisis management:
  - Complex, involving Minister of Finance, BOC, OSFI, CDIC, and provincial governments under Minister of Finance leadership.
  - Coordination forums: Financial Institutions Supervisory Committee (FISC) and Senior Advisory Committee (SAC).
- Sectoral liquidity resilience assessments:
  - Banks: LCR levels and stress tests suggest resilience in Canadian and U.S. dollar liquidity; large banks hold sufficient liquidity buffers.
  - Mutual funds: currently pose little systemic liquidity risk, though fixed-income-focused funds face increased liquidity risk; regulation limits maturity transformation and leverage.
  - Pension funds: not prone to run risk; large and interconnected—require monitoring given borrowing in repo markets and potential forced asset sales under stress.

### Key policy recommendations (excerpted, prioritized)
- BOC Operational Framework—Liquidity Provision in Normal Times:
  - Expand internal capacities to assess and monitor availability of collateral across banks in view of RTGS transition. (BOC) — Priority: H; Timeframe: I
  - Enhance capacity to price collateral using theoretical models and increase pricing frequency for loan portfolios. (BOC) — Priority: H; Timeframe: NT
  - Consider collateralizing finetuning afternoon general receiver auction. (BOC) — Priority: M; Timeframe: I
- Money Market Reference Rates:
  - Continue to accelerate and complete transition towards a risk-free reference rate (enhanced CORRA). (BOC) — Priority: H; Timeframe: I
- BOC Operational Framework—Bilateral Liquidity Provision in Stressed Times:
  - Expand scope of ELA tests: broaden institutions involved, simulate non-standard collateral mobilization and pricing, and simulate inter-agency interactions. (BOC) — Priority: H; Timeframe: I
  - Regularly monitor availability of collateral eligible for ELA, particularly for D-SIBs. (BOC) — Priority: M; Timeframe: I
- BOC Operational Framework—Market-wide Liquidity Provision in Stressed Times:
  - Develop and test institutional coordination for market monitoring and consider a framework for securities market intervention. (BOC lead) — Priority: M; Timeframe: NT
- BOC Operational Framework—Liquidity Provision in Foreign Currency:
  - Expand planning and testing exercises for ELA including foreign-currency lending. (BOC) — Priority: M; Timeframe: I
  - Refine and test strategy to respond to systemic foreign-currency funding issues jointly with DOF. (BOC and DOF) — Priority: M; Timeframe: NT

*Source: EXECUTIVE SUMMARY, Technical Note prepared by Mark Buessing-Loercks (IMF) under guidance of Phakawa Jeasakul (FSAP deputy mission chief) as part of the 2019 Canada FSAP led by Ghiath Shabsigh (FSAP mission chief).*

### EXECUTIVE SUMMARY __________________________________________________________________________ 5

### EXECUTIVE SUMMARY

### Overview / Key findings
- The Bank of Canada (BOC)’s framework for market operations and liquidity provision in normal times is comprehensive and well-articulated.
- System-wide liquidity conditions are stable and market rates are closely aligned with the announced policy rate.
- The planned modernization of payment systems towards the real-time gross settlement (RTGS) platform will likely result in a substantive increase in demand for collateral; enhanced monitoring of collateral availability is recommended.
- Money markets and public debt markets are functioning well; secured transactions predominate in money markets and repos are largely based on federal government bonds.
- Foreign exchange markets appear liquid with spot and swap transactions each representing 40 percent of the market share.
- External debt liabilities have increased significantly in recent years, driven by banks and other non-government entities issuing bonds in international markets; enhanced monitoring of foreign-currency liquidity is warranted.
- The BOC has a well-defined framework for managing liquidity during stress, including bilateral liquidity support and an amended emergency lending assistance (ELA) framework accepting Canadian-dollar mortgages as collateral and clarifying eligibility for provincially regulated entities.
- Contingency planning for market-wide interventions (including securities market interventions and foreign-currency liquidity provision) should be further developed and tested.

### BOC’s operational framework and liquidity management in normal times
- Legal and policy framework:
  - BOC mandate per Bank of Canada Act (Article 18): “mandate to conduct monetary policy to promote the economic and financial well-being of Canadians.”
  - Inflation-control target: 2 percent midpoint of a 1 percent to 3 percent control range; target set every five years by the Government of Canada and the BOC.
- Operating target and mechanism:
  - Operating target is a secured overnight (repo) rate; policy rate is midpoint of operating band supported by standing deposit and lending facilities accessible to LVTS participants against a broad range of collateral.
  - LVTS end-of-day balances must be zero; positive balances remunerated at “deposit rate” (policy rate minus 25 basis points); negative balances enter standing facility at “bank rate” (policy rate plus 25 basis points).
  - Non-LVTS participant primary dealers may access overnight standing repo facilities.
- Tools to influence structural liquidity:
  - Adjustments to settlement balances: target for LVTS settlement balances set for the following day; current balances stable slightly above zero (currently Can$250 million).
  - Historical example: settlement balances were increased to Can$8 billion during the global financial crisis (GFC) and later reduced (from Can$8 billion to currently Can$250 million) as part of transition from floor to corridor system.
  - Overnight repo and reverse repo operations via competitive auctions against Canadian government bonds; participation limits based on market share.
- Correlation and forecasting:
  - Correlation of policy rate with overnight money market financing rate and CORRA is almost 100 percent; correlation decreases to 96 percent for unsecured rates such as the one-month bankers’ acceptance rate and prime corporate paper rate.
  - BOC has very good insight into federal government cash positions and conducts two daily Receiver general cash auctions (including a finetuning afternoon auction).
- Additional market operations:
  - Government bond portfolio: BOC acquires GoC debt securities on a non-competitive basis at each bond auction representing 13 percent (started to gradually reduce from 20 percent in 2015) of government bonds; holdings broadly reflect composition of federal domestic marketable debt.
  - Purchases of treasury bills and on occasion cash management bills based on expected future demand for bank notes and other liabilities.
  - More recently, the BOC started purchasing Canada Mortgage Bonds (CMBs).
  - Term repo operations: BOC conducts term repo operations with primary dealers at 1- and 3-month terms. Aggregate outstanding amount: Can$9,400 million (1-month Can$5,800 million and 3-month Can$3,600 million).

### Money markets and bond markets
- Money markets:
  - Predominance of secured transactions improves resilience of core funding markets; majority of repos are based on federal government bonds.
  - Authorities are transitioning towards an improved risk-free benchmark: enhanced Canadian Overnight Repo Rate Average (CORRA) in line with IOSCO standards.
  - Asset-backed commercial paper market remains small, well below pre-global financial crisis levels.
- Bond markets:
  - Liquidity in the federal government bond market is robust, supported by a sound public debt management strategy.
  - Liquidity in other public debt markets is adequate under normal conditions, but spreads of provincial and government-guaranteed papers (e.g., Canada Mortgage Bond) could widen considerably under market stress due to diverging credit risk (particularly for provincial government bonds) and liquidity risk.

### Foreign exchange markets and foreign-currency funding
- Market structure:
  - Spot and swap transactions each represent 40 percent of the foreign-currency market share.
  - Stress of the Canadian dollar has been relatively limited historically.
- Funding vulnerabilities:
  - External debt liabilities have increased significantly in recent years, driven by banks and other non-government entities (reflecting bond issuances by Canadian firms in international markets).
  - Banks appear to have liquidity buffers to manage sizeable funding outflows, including in foreign currency; nevertheless, enhanced monitoring is warranted, particularly of wholesale funding and derivatives usage.

### Measures to deal with market stress: ELA and market-wide support
- BOC’s stress frameworks:
  - BOC can provide bilateral liquidity support, including in foreign currency, to eligible financial institutions and domestic systemically important FMIs.
  - ELA framework amended to accept Canadian-dollar mortgages as collateral and clarify eligibility requirements for provincially regulated entities, including need for a provincial indemnity.
  - Framework for market-wide liquidity support includes term repo operations and a contingent term repo facility; term repo operations are regularly conducted in normal times and can be scaled up; contingent term repo facility design is flexible to enable nimble response to system-wide stress.
  - In principle the BOC can lend to any counterparty at its own discretion to safeguard financial stability.
- Preparedness and coordination gaps:
  - BOC signed an MoU with AMF to facilitate ELA decision-making, but provinces (particularly British Columbia, Ontario, and Quebec) have not yet established indemnity agreements and MoUs with the BOC, implying eligibility conditions are not yet met for provincially regulated institutions.
  - The BOC should expand ELA simulation exercises to involve a broader set of financial institutions (including relevant credit unions), mobilize non-standard collateral (e.g., mortgages), and simulate interactions among BOC business units, provincial authorities, and inter-agency bodies (e.g., Financial Institutions Supervisory Committee and Senior Advisory Committee).
  - Regular monitoring of ELA-eligible collateral should be conducted for D-SIBs and other relevant institutions.
- Market-wide interventions and foreign-currency strategy:
  - Contingency plans for interventions in securities markets and provisions of foreign-currency liquidity should be developed further and tested.
  - During the GFC, federal and three provincial governments provided support to securities markets while the BOC did not purchase securities outright; some contingency elements exist (e.g., bilateral swap arrangements with other central banks).
  - BOC and Department of Finance (DOF) should jointly develop and test a strategy to handle systemic stress in foreign-currency funding, based on sufficient readily available foreign reserves and standing bilateral currency swap agreements with other major central banks.

### Recommendations on systemic liquidity issues (excerpt from Table 1)
- BOC’s Operational Framework—Liquidity Provision in Normal Times
  - Expand internal capacities to assess and monitor the availability of collateral across banks, given the envisaged transition towards an RTGS system and the expected substantive increase in collateral demand. (BOC) — Priority: H; Timeframe: I
  - Enhance its capacity to price collateral also based on theoretical models and to increase the pricing frequency for loan portfolios. (BOC) — Priority: H; Timeframe: NT
  - Consider conducting the finetuning afternoon general receiver auction on a collateralized basis to mitigate associated risks. (BOC) — Priority: M; Timeframe: I
- Money Market Reference Rates
  - Continue to accelerate and complete the transition work towards a risk-free reference rate. (BOC) — Priority: H; Timeframe: I
- BOC’s Operational Framework—Bilateral Liquidity Provision in Stressed Times
  - Further expand scope of tests on bilateral ELA provision: (i) broaden scope of involved financial institutions, (ii) simulate procedures related to assessment, pricing and mobilization of non-standard ELA collateral, and (iii) simulate interaction of relevant BOC business areas and with relevant agencies. (BOC) — Priority: H; Timeframe: I
  - Regularly monitor the availability of collateral eligible for ELA, in particular for the D-SIBs. (BOC) — Priority: M; Timeframe: I
- BOC’s Operational Framework—Market-wide Liquidity Provision in Stressed Times
  - Develop further and test institutional coordination to ensure adequate monitoring of key markets and consider developing a framework for intervention in securities markets. (BOC lead) — Priority: M; Timeframe: NT
- BOC’s Operational Framework—Liquidity Provision in Foreign Currency
  - Expand ongoing planning and testing exercises for ELA and include ELA lending in foreign currency. (BOC) — Priority: M; Timeframe: I
  - Refine further and test a strategy to respond to systemic issues in foreign-currency funding markets. (BOC and DOF) — Priority: M; Timeframe: NT

*Source: EXECUTIVE SUMMARY, Technical Note prepared by Mark Buessing-Loercks (IMF) under guidance of Phakawa Jeasakul (FSAP deputy mission chief) as part of the 2019 Canada FSAP led by Ghiath Shabsigh (FSAP mission chief).*

### 0.4 percent of GDP).

### 1canea2020003 - 0.4 percent of GDP)

### Liquidity facilities and counterparties
- Securities lending facility: BOC can lend to primary dealers a portion of its government bond holdings to help support liquidity.
- Usage: facility used actively until 2015; accessed only once in September 2017 and once in March 2019 since then.
- BOC is reviewing the program to evaluate if it should be updated to better reflect current market conditions.
- BOC counterparties currently encompass 16 LVTS participants (banks, non-banks) and 12 different primary dealers.
- Observation: vast majority of primary dealers are fully consolidated subsidiaries of the large banks/LVTS participants; only one primary dealer does not have a parent company (bank) with access to the BOC’s liquidity facilities as an LVTS participant.
- Implication: the limited number of counterparties allows BOC to closely monitor individual counterparty’s access to BOC facilities.

### Collateral framework and eligible assets
- Collateral eligibility differs across liquidity operations; broad set of assets accepted for intraday and overnight credit.
- GoC securities accepted for overnight reverse repo transactions; securities issued or guaranteed by the central or provincial government accepted for term repo operations.
- Eligible securities for intraday and overnight facilities encompass issuers and debtors of the public and private sector (marketable and non-marketable).
- Marketable public-sector collateral:
  - securities issued or guaranteed by the GoC, including National Housing Act (NHA) mortgage-back securities (MBS) and CMB,
  - securities issued or guaranteed by provincial governments,
  - securities issued by municipal governments,
  - marketable securities issued by the U.S. Treasury.
- Marketable private-sector collateral:
  - bankers’ acceptances (BAs) and promissory notes (including those of foreign issuers but excluding those of LVTS participants and related entities),
  - commercial paper (CPs) and corporate bonds issued by domestic or foreign issuers,
  - asset-backed commercial paper (ABCPs),
  - term asset-backed securities (ABS),
  - covered bonds,
  - special deposit accounts held at the BOC.
- Non-marketable loan portfolios:
  - non-mortgage loan portfolios (NMLPs) of direct LVTS participants, including loans to individuals for non-business purposes and loans to individuals and others for business purposes.

### Risk controls, pricing, and recent adjustments
- Risk control measures: minimum credit quality requirements, concentration limits, and haircuts.
- Concentration limits applied on single issuers and on specific private sector asset categories to limit use of corporate, municipal, foreign private sector securities, and NMLPs.
- Haircuts applied depending on asset category and residual maturity; additional haircuts applied to foreign-currency U.S. T-bills and government bonds.
- Marketable collateral priced daily using multiple external price sources.
- NMLPs haircuts determined as a portfolio weighted average, with different haircuts for secured/unsecured and consumer and business loans.
- NMLPs priced based on the outstanding amount of portfolio loans, updated on a monthly basis.
- Recent framework adjustments:
  - reduced mechanistic reliance on external ratings and developed in-house credit risk assessment capacity,
  - terminated acceptance of securities issued by LVTS participants (reducing “wrong way risk”),
  - adjusted haircuts and limits for selected issuers.
- BOC expects a substantive (up to 50 percent) increase in overall collateral demand in connection with the transition to a RTGS system envisaged to take place in the next few years.
- Note: termination of LVTS-issued securities acceptance makes BAs practically ineligible, given that a share of 98 percent is issued by D-SIBs.

### Assessment and recommendations (operational framework)
- Assessment:
  - BOC’s operational framework works overall efficiently.
  - Correlation of the operational target (CORRA) and the policy rate (target rate) is very high: 99.7 percent.
  - Correlation of 1-month BA rate with policy rate: 97 percent.
  - Correlation of 1-month prime corporate paper rate with policy rate: 96 percent.
  - BOC keeps actual and target settlement balances low due to good insight into government cash flows.
- Recommendations:
  - Consider conducting the finetuning afternoon general receiver auction on a collateralized basis rather than uncollateralized, to mitigate counterparty default risk; current overall exposure may be limited as about 90 percent of liquidity is provided in the morning, but collateralization should be considered if amounts change.
  - Take operational risks related to auction and settlement procedures into due account when considering collateralization.
  - Assess and monitor more closely the availability of collateral across LVTS participants; aggregate and individual levels of unencumbered assets eligible as collateral should be used as indicators of quantitative impact and effectiveness of collateral measures.
  - Enhance BOC’s capacity to price collateral based on theoretical models because reliable market prices may not always be available, particularly for private sector collateral without state guarantee and for illiquid NHA MBS.
  - Consider differentiated treatment of “own-used” (retained and then mobilized) NHA MBS and apply more restrictive risk control measures (e.g., higher haircuts and/or limits) for retained NHA MBS to avoid preferential treatment.
  - Increase pricing frequency for loan portfolios if concentration limits are relaxed; current concentration limits for this asset class are strict at 20 percent.

### Money markets: structure, instruments, and reference rates
- Overview:
  - Money markets dominated by secured transactions, mainly by large domestic banks, pension funds and insurance companies.
  - Repo transactions predominantly secured by (3–10 year) GoC bonds: 66 percent.
  - 14 percent of repo transactions are backed by provincial government bonds.
  - Repo trading mainly bilateral; 10–20 percent of transactions cleared via central counterparty (CCP).
  - Some large domestic pension funds borrow in the repo market to increase duration; banks are on aggregate cash lenders.
  - Unsecured interbank market used by smaller financial institutions and among LVTS participants for end-of-day adjustment transactions.
- Table 2 highlights (June 2018; amounts in billions of Canadian dollar):
  - Treasury bills: 119,300; Government of Canada; ≤12 months.
  - Repo (monthly turnover): 2,488,823; typically large domestic banks, pension funds, insurance companies; ≤120 days.
  - Bankers’ acceptances: 86,452; large banks; ≤1 month.
  - Commercial papers issued by:
    - Provincial governments: 57,745; ≤12 months.
    - Municipalities: 522.
    - Nonfinancial corporations: 9,058.
    - Financial corporations: 11,073 (large banks).
    - In U.S. dollar: 4,090 (large banks).
  - Asset-backed commercial papers: 33,734; originated by large domestic banks; ≤12 months.
- Additional money market details:
  - T-bills: annual issuance volume generally larger than GoC bonds; Can$320 billion in 2017 (annual issuance volume) vs. Can$136 billion of 2-year to 30-year GoC bonds; average T-bills outstanding stock about Can$135 billion in 2017; banks are the largest holders of T-bills.
  - BAs: just over 25 percent of the total money market, slightly more than Can$86 billion outstanding in June 2018; BA market rebounded since trough in 2010, increasing by slightly less than 70 percent since that trough.
  - ABCPs: just over 10 percent of total money market, about Can$34 billion outstanding in June 2018.
  - CPs issued by financial and nonfinancial corporations: just over 5 percent of total money market, around Can$20 billion outstanding in 2017.
  - Large banks have tapped short term funding markets in the United States recently.
- Reference rates and reforms:
  - BA market linked to Canadian Dollar Offered Rate (CDOR); CDOR represents a committed lending rate at which banks are contractually willing to lend cash to corporate borrowers via BA facilities.
  - CDOR used as main interest rate benchmark for floating-rate component of derivatives and to determine interest payments on floating-rate notes.
  - Progress achieved to enhance interest reference rates (CORRA, CDOR): Canadian Alternative Reference Working Group developing an improved risk-free Canadian dollar benchmark (enhanced CORRA) consistent with IOSCO principles.
  - CDOR strengthened by appointment of an administrator and creation of an oversight committee; OSFI supervising governance and risk controls surrounding submission processes.
  - Market consultations involve participants; a consultation launched in February 2019 to receive feedback on transactions to be included for enhanced CORRA calculation and envisaged methodology.

### Money markets: assessment and recommendations
- Assessment:
  - Canadian repo market is robust and resilient; reliance on secured short-term funding should support financial stability.
  - Increasing number of CCP participants should improve resilience; CCPs should support pension funds’ access to repo in times of market stress if banks reduce repo lending.
  - Banks currently net lenders in repo markets and pension funds net borrowers; supply and demand should be closely monitored as this may change if interest rates rise.
- Recommendations:
  - Prioritize transition work to a risk-free reference rate because CDOR’s main vulnerability is that it is not risk free.
  - Complete BOC’s transition work towards an improved benchmark (enhanced CORRA) with priority to support efficient functioning of financial markets and overall financial stability.
  - Closely monitor liquidity conditions (bid-ask spreads) in BA markets given that new LCR and upcoming NSFR regulations have made holding BAs more capital- and liquidity-intensive, leading dealers to reduce inventories at quarter-end and widen spreads.

### Bond markets: GoC and provincial markets
- Auction and issuance:
  - BOC auctions GoC new issuances (nominal bonds, T-bills, real return bonds) to a limited set of authorized participants on behalf of the GoC.
  - Auctions via multiple price auction for nominal bonds and T-bills; single price auction for real return bonds.
  - Nominal bonds with 2-, 5-, 10-, and 30-year maturity generally receive benchmark status after repeated re-opening.
- Holders and liquidity:
  - GoC bonds held by a stable, relatively concentrated group—particularly large pension funds and banks; foreign public investors (sovereign wealth funds and foreign central banks) have increased purchases.
  - Share of nonresident investors increased from 20 percent (2002) to nearly 40 percent (2017); share of domestic private corporations declined from 60 percent to 40 percent over same period.
  - Secondary market: GoC bonds largely traded bilaterally; about 40 percent of trading activity on electronic venues; market becoming increasingly electronic but not fully centralized.
  - Liquidity: effective bid-ask spreads estimated between 4 and 6 basis points (average of all observed trades), trending downwards since 2014; observed bid-ask spreads much tighter (e.g., 2-year maturity about 1.5 basis points for average trades of Can$50 million or more).
  - Analyses reveal mixed results: price impact of large trades has increased; average trade size and trading volumes increased for benchmark bonds since GFC; liquidity proxies indicate adverse liquidity movements around stress events (2011 euro area crisis, 2013 taper tantrum, 2015 oil price shock) but conditions quickly rebounded.
- Provincial government bonds:
  - Less liquid and complement GoC bonds.
  - Amounts outstanding of provincial government bonds have more than doubled since the GFC, reaching Can$827 billion.
  - Issuance volumes, credit ratings and liquidity differ across provinces, reflected in spreads over GoC yields.
  - Provinces with large issuances (Ontario and Quebec account for two-thirds of aggregated provincial debt) seem to benefit from a liquidity discount.
  - Episodes of spread-widening in 2014–2015 impacted all provinces and came with increased turnover; CMB spreads less prone to fiscal stress and less volatile.
- Table 3 highlights (June 2018; amounts in billions of Canadian dollar):
  - Federal government bonds: Domestic 572,573; Foreign 13,580; Government of Canada; 2–30 years.
  - Provincial government bonds: Domestic 670,102; Foreign 156,739; Provinces (particularly Ontario, Quebec, British Columbia and Alberta).
  - Municipality bonds: Domestic 62,592; Foreign 846; Municipalities.
  - CMBs: Domestic 236,700; Foreign 0; Canada Housing Trust; Mainly 5, 10 years.
  - NHA MBS: Domestic 486,270; Foreign 0; Large banks, mortgage finance companies; 5 years.
  - Covered bonds: Domestic 9,800; Foreign 137,100; Large banks; Mainly 5, also 3, 7 years.
  - Financial corporation bonds: Domestic 275,849; Foreign 470,168; Large banks; 1–10 years (mainly).
  - Term asset-backed securities: Domestic 61,300; maturities -10 years.
  - Nonfinancial corporation bonds: Domestic 300,636; Foreign 342,537; Corporates >4 years.
- Note: NHA MBS issued include those sold to Canada Housing Trust and backing CMBs.

*International Monetary Fund — Canada report excerpt*

### 31.      Analyses on liquidity and resilience reveal a mixed picture. Bid-ask spreads have

### 1canea2020003 - 31.      Analyses on liquidity and resilience reveal a mixed picture. Bid-ask spreads have

### Mortgage Securitization Markets
- Residential mortgage securitization in Canada is largely government supported through the NHA MBS program; large Canadian banks (and some small to medium lenders) issue mortgage backed securities backed by pools of mortgage loans insured under the NHA.
- About half of NHA MBS is sold to the Canada Housing Trust (CHT) immediately after issuance; CHT funds purchases by issuance of CMB.
- A large share of NHA MBS are retained on the balance sheet of the originating bank, mainly for regulatory reasons, as NHA MBS are considered HQLA Level 1 assets.
- Only a small fraction of NHA MBS is sold to end investors; investor demand is muted given prepayment risk inherent to NHA MBS.
- Market perceptions:
  - NHA MBS liquidity is perceived to have deteriorated recently and is comparable to investment grade corporate bonds.
- Issuance limits:
  - Annual issuance of NHA MBS was capped at Can  $80 billion a year in 2018 (departmental decision).
  - For 2019, this cap was substantively increased to  $140 billion.
- Canada Mortgage Bonds (CMBs):
  - CMBs (mainly 5-year fixed, also 10-year fixed and 5-year FRN) trade with lower turnover than provincial government bonds but at lower spreads due to government guarantee.
  - CMB Program converts monthly amortizing cash flows into bond-like payments (semi-annual or quarterly coupons and final principal).
  - Investor base for CMBs is broad and diversified; 11 dealer global syndicates provide market making.
  - Since 2013, CHT has limited annual issuance of CMBs to Can$40 billion.
- Covered bonds:
  - Important for securitizing uninsured mortgages.
  - Prudential regulation limits covered bonds outstanding per bank to a maximum of 4 percent of its total assets.
  - Covered bonds are issued mainly in foreign denomination (mainly euro, also British pound and U.S. dollar) and issuers tap markets mainly in Europe.
- Private-label residential MBS:
  - Plays a very minor role due to uneconomical funding costs.
  - Revitalization efforts could benefit smaller lenders and small/mid-sized banks if access to mortgage insurance tightens and uninsured mortgage volumes increase.
  - Bank of Canada (BOC) has facilitated discussions among counterparties in the Canadian Fixed Income Forum.

### Assessment and Recommendations (mortgage securitization and government bond markets)
- Findings:
  - Debt management strategy combined with a well-functioning GoC bond market supports system-wide liquidity (cash, repo, and securities lending markets).
  - GoC bond market is resilient; BoC monitoring and support bolster system liquidity.
  - Increasing share of international investors has diversified and strengthened the investor base.
  - Strong government footprint in mortgage securitization (issuance limits on NHA MBS and CMB, OSFI regulatory standards, covered bond law) shapes mortgage financing conditions, market conditions, and asset encumbrance.
  - Standardization of securitization products supports system-wide liquidity and financial stability but impairs revitalization of private market solutions (residential MBS market).

### Foreign Exchange Markets and Foreign-Currency Funding
- Market structure and turnover:
  - The Canadian dollar is the sixth most traded currency globally and the second most traded currency in the Americas.
  - Spot and FX swap transactions each represent nearly 40 percent of daily turnover; outright forwards represent 13 percent. Cross-currency swaps and FX options represent 1.6 percent and 2.2 percent, respectively.
  - BIS analysis: overall market turnover for the Canadian dollar has increased continuously over the past 15 years; turnover in FX derivatives exceeds turnover in the spot market.
  - Typical counterparts in FX hedging: domestic and international banks, pension funds, foreign investors.
  - Large dealer banks provide liquidity for spot, forward, and swap markets; futures widely traded through nonresident accounts.
  - A considerable proportion of trades are conducted outside Canada and on electronic trading platforms, including algorithm trading.
- Liquidity and resilience:
  - Spot market appears liquid and resilient; dedicated liquidity analyses found market stress episodes (e.g., “taper tantrum” in May 2013) did not negatively impact Canadian dollar liquidity.
- Foreign-currency funding for banks:
  - Since the GFC banks have increasingly relied on external funding from foreign investors.
  - Over the past five years, banking sector external debt liabilities increased by about 150 percent, reaching Can  $1 trillion, or 46 percent of GDP, as of 2018Q3.
  - About 40 percent of the increase was driven by issuance of long-term debt instruments, including covered bonds.
  - Currently, two-thirds of banks’ external borrowing is short-term.
  - As of October 2018, foreign-currency funding amounted to Can  $2.9 trillion or 55 percent of total funding.
  - Banks’ foreign-currency assets total Can  $3 trillion (some carried out by U.S. subsidiaries).
  - Banks rely heavily on foreign-currency wholesale funding, which accounted for about 40 percent of total funding; issuances of term deposits are a bulk of this, with increased issuance in European markets more recently.
- Hedging and exposures:
  - Aggregate foreign-currency exposures appear to be hedged naturally through overseas earnings; some banks lack meaningful operations abroad.
  - Banks use FX swaps and other derivatives to hedge exposures; foreign-currency derivatives component has become larger and more volatile over time.
  - BOC indicated Canadian banks do not take meaningful active currency risk; funding programs are fully hedged from currency and term basis using FX forwards and/or cross-currency basis swaps.
- Cross-currency basis analysis:
  - 5-year cross-currency basis suggests U.S. dollar funding stress in Canada has been muted relative to other major currencies, particularly since 2009; levels of volatility have been limited since then.
- Aggregate developments:
  - Since end-2013, external debt liabilities to GDP have increased by about 30 percentage points, driven by banks (two-thirds) and other non-government entities (one-third).

### Regulation Related to Liquidity Risk
- Banks (LCR and NSFR):
  - LCR requirements entered into force in January 2015.
  - OSFI implements LCR via the Liquidity Adequacy Requirement guideline (LAR guideline) and Guideline D-11 on disclosure requirements; applies to all banks, federally regulated trust or loan companies, bank holding companies and cooperative retail associations; excludes provincially regulated credit unions (major credit union in Quebec subject to AMF’s Liquidity Adequacy Guideline).
  - In October 2017, BCBS’s Regulatory Consistency Assessment Program assessed OSFI’s LCR regime as compliant with Basel III standards.
  - LCRs by significant currency are implemented according to Basel standards as a monitoring tool.
  - OSFI updated the LAR guideline with:
    - More differentiated and conservative treatment of less stable retail deposit types and run-off rates in the LCR calculation.
    - Introduction of a Liquidity Activity Monitor (LAM).
  - Increased run-off rates for less stable deposits (brokered deposits and rate-sensitive deposits) to be implemented in January 2020, together with NSFR requirements.
  - LAM to provide timely balances of key accounts for selected institutions, as determined by OSFI.
  - Since January 2015, Canada’s DSIBs’ LCR levels have on aggregate been well above the minimum level (100 percent).
  - Banks have held sufficient HQLA Level 1 assets on their balance sheet, including central and provincial government bonds, CMBs and NHA-MBS.
  - HQLA Level 2 assets (corporate debt, commercial paper, covered bonds and RMBS) play a smaller role.
  - OSFI intends to make the Basel NSFR a minimum standard effective January 1, 2020; NSFR requirements (100 percent) will enter into force as of January 2020, initially applied to D-SIBs only.
  - OSFI expects institutions to adhere to sound liquidity management principles outlined in OSFI’s Guideline B6—Liquidity Principles, including the Net Cumulative Cash Flow (NCCF) domestic liquidity horizon metric.
- Nonbanks (investment funds and mutual funds):
  - Mutual funds are regulated by provincial securities commissions; CSA coordinates provincial securities regulation through national instruments.
  - National Instrument 81–102 on Investment Funds (NI 81–102) is the main framework for open-end mutual funds and includes restrictions on short-sales, ownership concentration, leverage, use of derivatives, and securities-financing transactions.
  - 85 percent of mutual fund assets are managed by fund managers based in Ontario; the Ontario Securities Commission (OSC) is the most important provincial securities regulator.
  - Investment fund industry size and composition (based on net assets):
    - Balanced funds: 788.20 (August 2019); 785.00 (July 2018); 766.10 (December 2017); 736.30 (August 2017).
    - Equity funds: 516.40 (August 2019); 512.00 (July 2018); 484.30 (December 2017); 451.60 (August 2017).
    - Bond funds: 188.30 (August 2019); 187.90 (July 2018); 187.70 (December 2017); 185.80 (August 2017).
    - Specialty funds: 17.20 (August 2019); 16.90 (July 2018); 14.70 (December 2017); 13.00 (August 2017).
    - Total Long-term Funds: 1,510.10 (August 2019); 1,501.80 (July 2018); 1,452.80 (December 2017); 1,386.70 (August 2017).
    - Total Money-market Funds: 25.50 (August 2019); 25.30 (July 2018); 24.20 (December 2017); 24.10 (August 2017).
    - Total Industry: 1,535.60 (August 2019); 1,527.10 (July 2018); 1,477.00 (December 2017); 1,410.80 (August 2017).
    - Total Industry/ GDP (in percent): 72 (August 2019); 71 (July 2018); 69 (December 2017); 66 (August 2017).
  - Money market funds play a minor role in Canada; some U.S.-domiciled mutual funds investing in Canadian bond markets are larger than respective Canadian funds but hold low amounts of Canadian fixed income assets.
- Additional notes:
  - Banks may “issue” NHA-MBS and retain them to transform pools of residential mortgages into HQLA Level 1 assets; the share of NHA-MBS neither sold to CHT nor retained on banks’ balance sheets but sold to investors is below 5 percent—potentially explaining comparatively low secondary market liquidity of NHA-MBS.
  - NCCF metric (per LAR guideline) measures net cumulative cash flows and helps identify gaps between contractual inflows and outflows over up to a 12-month horizon.

*Source: IMF staff and documents as provided in the content unit.*

### 54.      The individual size of mutual funds and in particular fixed income funds in Canada is

### 1canea2020003 - 54.      The individual size of mutual funds and in particular fixed income funds in Canada is

### Mutual funds: size, structure, and regulation
- Individual mutual funds, and in particular fixed income funds, are relatively small and do not play a dominant role in the markets they invest in or relative to other mutual funds investing in Canada.
- Several mutual funds are managed by and affiliated with large banks in Canada (D-SIBs); deposit-taking institutions are sponsors for funds accounting for about half of all mutual fund assets in Canada.
- Key regulatory limits (NI 81–102):
  - Cash borrowings and the provision of security interest over any of its portfolio assets must not exceed 5 percent of the fund’s assets.
  - Illiquid assets should not represent more than 10 percent of the fund’s net asset value (NAV).
  - Leverage restrictions include limits on derivatives exposures, short-selling and securities financing transactions; large fixed income mutual funds have leverage ratios of below 1 percent.
  - Regulation allows for suspension of redemptions (upon approval of the regulator) to mitigate run risk.
  - Money market funds are obliged to apply fair value valuation, which reduces run risks.
- NI 81-102 has been updated recently to cover more broadly alternative mutual funds that are allowed to follow short selling and derivative strategies, and increased leverage.
- Definitions from NI 81–102:
  - Illiquid assets: “a portfolio asset that cannot be readily disposed of through market facilities on which public quotations in common use are widely available” or “a restricted security for which the resale is prohibited”.

### Pension funds: role, interconnections, and risks
- The Canadian pension funds sector is slightly larger than the mutual fund sector and is closely interconnected with other financial institutions in Canada.
- Public pension funds were established under federal or provincial legislation specifying mandate, oversight and governance; they follow a long-term investment strategy, are highly rated, and are not susceptible to a run (outflows are based on pension payouts).
- Pension funds play a considerable role as institutional investors in Canadian securities markets and as counterparties in Canadian repo markets (net borrowers) and derivative markets.
- Sector concentration: the largest ten pension plans manage 35 percent of pension assets.
- While individual pension funds are not prone to runs and have long-term horizons, their increased overall size, increased risk taking, and strong interconnectedness with other key participants in core funding markets require close monitoring.
- Pension funds as borrowers in the repo market may be impacted by stress in the repo market segment and possibly be forced to sell assets, with negative impact on asset prices.

### Assessment of liquidity resilience (banks, mutual funds, pension funds)
- Banks:
  - LCR levels and liquidity stress testing results in domestic and foreign currency reveal banks are overall resilient to liquidity shocks in Canadian dollar or U.S. dollar.
  - Based on bank liquidity stress test results, large banks (only captured in the exercise) hold sufficient liquidity buffers to withstand severe funding shocks in total and by significant currencies.
  - Continued adequacy of foreign exchange market liquidity—particularly for cross-currency swaps—is important for banks and nonbanks to manage foreign-currency funding risks.
- Mutual funds:
  - The mutual fund sector currently appears to pose little systemic liquidity risk, although liquidity risk has increased for funds with fixed income focus.
  - Vulnerabilities are contained given the size and structure of the sector and the regulatory regime that limits liquidity risk from maturity transformation; nevertheless monitoring remains relevant because fixed-income-focused funds face increased liquidity risk potentially triggered by large-scale redemptions during stress.
- Pension funds:
  - The pension fund sector is not prone to substantive systemic liquidity risk due to lack of run risk and long-term investment horizons.
  - However, pension funds’ increased size, increased risk taking, and strong interconnectedness with other key participants in core funding markets require close monitoring.

### Measures to deal with market stress: overview of instruments
- Liquidity stress events matrix (type × currency): idiosyncratic vs systemic; Canadian dollar vs foreign currency.
  - Idiosyncratic—ELA (Canadian dollar): Financial institutions—ELA policy updated 2015; Financial Market Infrastructures—ELA policy updated 2015.
  - Systemic (Canadian dollar): Institutions — Term Repo Operations; Contingent Term Repo Facility; Markets — Direct intervention in securities markets: BOC, DOF, provincial governments.
  - Foreign currency: Updated ELA policy includes provision in foreign exchange for idiosyncratic events; None specifically articulated for systemic events.
- The Bank of Canada (BOC) has updated its ELA policy and introduced new instruments to deal with idiosyncratic liquidity events in Canadian dollar; less clear are articulated approaches for systemic disruptions to foreign-currency funding markets or systemic disruption to foreign-currency funding through market-wide FX liquidity support.

### Institutional arrangements for crisis management
- The institutional framework for crisis management in Canada is complex and fragmented, involving several agencies under the leadership of the Minister of Finance; provincial governments, the BOC, OSFI, and CDIC have roles allowing intervention to provide liquidity support.
- Liquidity support can be provided by the Minister of Finance, BOC, and provincial governments in three circumstances:
  - (i) to support recovery for individual institutions,
  - (ii) to support a resolution strategy for individual institutions,
  - (iii) to maintain financial stability more broadly.
- Coordination forums:
  - Financial Institutions Supervisory Committee (FISC), chaired by the Superintendent of Financial Institutions, facilitates consultation and exchange of information on supervision and dealing with institution-specific problems.
  - Senior Advisory Committee (SAC) is the main forum to discuss financial sector policy issues and address systemic matters, including crisis preparedness, at the federal level.

### Idiosyncratic liquidity support (ELA) — legal basis, eligibility, collateral, and practice
- Legal basis:
  - Section 18(h) of the Bank of Canada Act provides the BOC power to make loans or advances to a financial institution subject to conditions:
    - such loan or advance must be collateralized;
    - must be made to a member of Payments Canada;
    - duration of the loan or advance must not exceed 6 months (loans can be renewed);
    - any loan is at the discretion of the BOC and at a rate not lower than the BOC’s bank rate (the bank rate is the rate applied for the overnight standing lending facility).
  - The Payment, Clearing and Settlement Act establishes the BOC’s power to provide liquidity support to eligible FMIs.
- Eligibility:
  - ELA is a collateralized loan to an eligible financial institution or financial market infrastructure (FMI) experiencing liquidity difficulty.
  - ELA framework includes distinct requirements for federally and provincially regulated financial institutions.
  - ELA support is explicitly allowed for institutions in recovery and in resolution, provided a credible recovery and resolution framework exists.
  - Insurance companies, mutual funds, investment dealers, foreign FMIs and foreign bank branches would not generally be eligible for ELA.
- FMIs eligible for ELA:
  - Canadian-domiciled and designated for BOC oversight, including LVTS, CDSX, and Canadian Derivatives Clearing Service (CDCS).
  - The framework assumes FMIs may experience liquidity shortages under extreme scenarios (e.g., multiple member defaults).
- Provincial institutions:
  - Additional eligibility requirements: must be members of Payments Canada, have a credible recovery and resolution framework, be considered “important to the stability of the broader financial system” (assessed by the BOC), and ELA is provided only where an indemnity is provided by the provincial government.
  - The indemnity should protect the BOC against potential losses if the financial institution defaults and collateral is insufficient.
- Collateral:
  - Eligible collateral for ELA comprises a broad set of marketable and non-marketable assets beyond the scope of collateral accepted for BOC’s standing liquidity facility.
  - The BOC has undertaken work to facilitate acceptance of mortgage loans as collateral (increasing eligible ELA collateral); mortgage loans can be transferred via assignment of mortgage loan portfolios (requiring amendments to the Bank of Canada Act, December 2017), a title custodian, and direct registration.

### Idiosyncratic ELA: assessment and recommendations
- Assessment:
  - The BOC has established a credible ELA framework but further work may be needed on preparedness.
  - The BOC conducted an ELA simulation in late 2017 featuring an extension of a small loan to D-SIBs against marketable collateral; ELA has not been extended in more than 20 years prior to that testing.
- Recommendations for further preparedness and testing:
  - Broadening the range of financial institutions in future tests to include selected mid-sized banks and possibly large provincially regulated financial institutions.
  - Simulating procedures related to mobilization of non-standard ELA collateral (e.g., mortgage loan portfolios or equities), including legal transfer, collateral eligibility assessment by the BOC, and pricing and haircut determination of such collateral.
  - Simulating interaction not only of relevant BOC business areas but also interaction with relevant agencies (FISC; CDIC, DOF, and OSFI), including information sharing, coordination, and decision making.
- Operational recommendations:
  - The BOC should intensify monitoring of standard and ELA-eligible collateral, in particular for the D-SIBs; understanding unencumbered eligible collateral should feed into an early warning system for liquidity stress.
  - Further engagement with provincial regulators and governments to clarify the BOC’s approach to providing ELA to provincially regulated institutions, specifically:
    - (i) clarify assessment of a provincially regulated institution’s importance to the “stability of the broader financial system,” and
    - (ii) continue efforts to establish indemnity agreements with provinces and arrange Memorandums of Understanding (MoUs) with provincial authorities to facilitate information sharing.
  - Further specification may be necessary related to ELA for FMIs, particularly CCPs where a default of one or multiple CCP member(s) could leave a CCP unable to re-establish a matched book or liquidate collateral without considerable price/market distortions; scenarios for temporary liquidity need are less obvious for payment systems and securities settlement systems/central securities depositories.
- Note: Such tests must preserve the core principle that ELA is provided at the full discretion of the BOC; participation in tests does not confer any right to receive ELA.

### System-wide liquidity support in Canadian dollar: framework and instruments
- The BOC has a well-defined strategy for system-wide liquidity stress, guided by five principles:
  - (i) targeted to the market failure,
  - (ii) graduated to the severity of the problem,
  - (iii) well-designed,
  - (iv) non-distortionary using market determined prices where possible,
  - (v) mitigating moral hazard.
- Instruments and features:
  - Term Repo Operation (TRO):
    - Scalable and can be used to counter system-wide liquidity stress.
    - Objectives: increase flexibility in management of domestic assets on the BOC balance sheet; promote orderly functioning of financial markets; provide information on short-term funding market conditions.
    - Counterparties currently are primary dealers but can be broadened in stress situations.
    - Multiple-price auction mechanism with securities offered for one and three-month maturities.
    - Eligible collateral: Canadian dollar marketable securities directly issued by or explicitly guaranteed by the GoC or a provincial government; eligible collateral and counterparties can be broadened in times of stress; TRO can be expanded in size, terms and frequency.
  - Contingent Term Repo Facility (CTRF):
    - Can be activated in times of liquidity stress though it is yet to be used.
    - Differs from TRO: only available during times of stress and can be offered to a broader range of counterparties provided they demonstrate significant activity in Canadian money and/or bond markets, are subject to federal or provincial regulation, and meet any other conditions set by the BOC.
    - When activated, the CTRF is a standing facility providing bilateral liquidity at a set interest rate against eligible collateral determined at the time of offering.
  - Other options include increasing settlement balances, lending to a broader range of financial institutions (beyond LVTS participants), outright purchases of securities, and direct intervention in securities markets (BOC, DOF, provincial governments) as warranted by the market failure.

*Source: Excerpt from IMF Canada Financial Sector Assessment Program (FSAP) chapter on liquidity and crisis management.*

### 77.      During the GFC the DOF and three provincial governments provided support to

### 1canea2020003 - 77.      During the GFC the DOF and three provincial governments provided support to

### During the GFC: authorities' actions and market context
- The banking sector accounted for only around 40 percent of the financial sector assets.
- Dominant securitized funding in housing finance made well-functioning securities markets vital for financial stability.
- The Department of Finance (DOF) provided funding for key financial institutions, thereby supporting (indirectly) the securitized mortgage market.
- Three provincial governments provided support to ABCP Markets.
- The Bank of Canada (BOC) did not purchase securities outright during the GFC, although it has explicit powers to do so.
- Footnote: Two federal programs noted: the Insured Mortgage Purchase Program (IMPP) (direct purchase of NHA MBS) and the Canadian Lenders Assurance Facility and Canadian Life Insurers Assurance Facility (offered but not used).

### F. System-wide Liquidity Support in Canadian Dollar: legal capacity and instruments
- Section 18(g) of the Bank of Canada Act provides that, "in the event that the Governor is of the opinion that there is a severe and unusual stress on a financial market or the financial system, the Bank of Canada may buy and sell from or to any person any securities and any other financial instruments, to the extent determined necessary by the Governor,” implying no restrictions with regard to the universe of eligible securities or markets and with regard to eligible counterparties for such support transactions.
- The BOC’s two lending instruments are well-designed to counter system-wide liquidity stress:
  - TRO (Temporary Repo Operation):
    - Use in normal times creates an instrument that can be scaled up in response to broad-based liquidity stress.
    - Issued through competitive price-based auctions; challenge is estimating the magnitude of liquidity required, though additional auctions can be conducted.
  - CTRF (Contingent Term Repo Facility):
    - Appropriate to address systemic liquidity stress when TRO may be insufficient or more urgent/direct action required.
    - Allows targeted response regarding counterparties, collateral and price.
    - By setting the interest rate on the CTRF the BOC does not need to estimate the quantity of liquidity required; challenge remains to set an appropriate interest rate.

### G. Liquidity Support in Foreign Currency: framework (idiosyncratic and system-wide)
- ELA framework changes in 2015:
  - Allowed BOC to extend ELA in foreign currency under some circumstances.
  - Financial institutions could borrow Canadian dollar via ELA and swap into desired currency; framework now also allows direct provision of ELA in foreign currency if relevant foreign exchange markets become under stress.
  - ELA could be provided to FMIs to prevent eligible FMIs from failing to meet foreign-currency obligations.
- No specific arrangements for providing system-wide liquidity support in foreign currency, despite banks relying heavily on foreign-currency funding:
  - Slightly more than half of bank funding is denominated in foreign currency (mainly U.S. dollar).
  - Wholesale funding in foreign currency on average represents 22 percent of total funding.
- BOC’s ability to provide foreign-currency funding depends on:
  - Level of Canada’s foreign reserves.
  - Access to foreign currency swap lines with foreign central banks.
- Exchange Fund Account (EFA) holdings and structure:
  - EFA contains reserves of US$72 billion (5 percent of GDP).
  - Reserves are diversified across currencies, with more than half in U.S. dollar.
  - Reserve assets are funded mainly through cross-currency swaps (US$60 billion) and through the issuance of foreign denominated debt (US$12 billion).
  - An asset-liability matching framework is in place to limit exposure to interest rate, exchange rate and liquidity risk.
  - Note: BOC has not intervened in the FX market to support the Canadian dollar since 1998.
  - Standing bilateral currency swap agreements were established during the crisis with central banks in the euro area, Japan, Korea, Switzerland, the United Kingdom, and the United States; these were never drawn.

### H. Liquidity Support in Foreign Currency: assessment and recommendations
- Preparedness and planning:
  - Legal framework exists to provide support in foreign currency, but little preparation appears to have been carried out for idiosyncratic or system-wide events.
  - Recommendation: expand planning and testing exercises for ELA with authorities and counterparties and include ELA lending in foreign currency.
  - Recommendation: preparatory work to respond to systemic issues in foreign-currency funding markets, including assessing how to provide foreign-currency funding via the TRO and how to broaden eligible collateral to include additional foreign-currency denominated securities.
- Reserves management and access:
  - The BOC and the DOF manage the comparatively modest amount of international reserves in a sophisticated manner.
  - The BOC’s recourse and timely access to these government reserves should be ensured legally and procedurally in case market stress warrants foreign-currency liquidity support.
  - Reliance on cross-currency swaps as a means of funding has increased over time; access to this source may be impaired in times of market stress and requires close monitoring and reflection in the asset-liability matching framework.
  - Comparative reserve shares: Canada’s foreign exchange reserves represent a share of 5 percent of its GDP, compared to about 13 per cent of GDP for other advanced economies and 20 per cent for emerging-market economies (10-year average).

### Appendix I. Overview of Agencies’ Liquidity Facilities and Legal Basis (selected points)
- Bank of Canada:
  - Emergency liquidity assistance (ELA), known as Emergency Lending Assistance in Canada — Pursuant to s. 18(h) of the Bank of Canada Act at the discretion of the Governor.
  - Extraordinary Market-Wide Facilities (MWF) — Pursuant to s. 18(g) of the Bank of Canada Act at the discretion of the Governor.
  - Bilateral liquidity swap facilities with other central banks — implementation conditional on mutual acceptance.
- Minister of Finance / Exchange Fund Account:
  - Securities purchase programs—Insured Mortgage Purchase Program (IMPP) and Canadian Secured Credit Facility (CSCF) — Governor-in-Council and Minister of Finance approvals noted (pursuant to s. 60.2 and other provisions).
  - Direct lending to financial institutions — Pursuant to s. 60.2(2)(c) and s. 60.2(2)(d) of the FAA, subject to approval by the Minister of Finance and the Governor-in-Council.
  - Government Debt Guarantees (CLAF and CLIAF) — Governor-in-Council and Minister of Finance, pursuant to s. 60.2(2)(e) of the FAA.

*Source: 1canea2020003 - 77.      During the GFC the DOF and three provincial governments provided support to*

---


_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1canea2020003.pdf_