Jack Rando is managing director of the Investment Industry Association of Canada.
The Canadian dollar offered rate (CDOR) has been Canada’s predominant interest rate benchmark for decades. First tasked some 40 years ago as a reference rate for pricing bankers’ acceptance (BA) borrowings, it now underpins more than $20 trillion (notional) in financial contracts — mostly derivatives, but a wide range of other financial products too. From interest rate swaps to wholesale loans, it’s difficult to find a class of borrowing in Canada’s capital markets that isn’t inextricably tied to CDOR.
During its tenure, CDOR has served the Canadian market well and avoided the scandals afflicting other global benchmarks during the 2008 financial crisis. Nonetheless, CDOR is showing its age, a perceived dinosaur in the rapidly changing global landscape for financial interest rate benchmarks.
At its core, CDOR is a survey-based benchmark, with a panel of six banks each morning contributing the rate at which they are willing to lend to corporate borrowers with existing committed BA credit facilities. While CDOR is an executable rate for corporate borrowers, the setting is, to varying degrees, based on expert judgment, as it cannot be directly tied to transparent market transactions. Transactions have become the preferred approach globally by regulators and increasingly entrenched in other credit-sensitive benchmarks.
Because its construct is no longer aligned with the higher international standards, as well as other contributing factors, CDOR’s administrator recently announced it will cease calculation and publication of the benchmark effective June 28, 2024 (I sit on the oversight committee that contributed to that discussion).
The end of CDOR will be the biggest change to Canadian capital markets in recent memory and, therefore, requires careful execution. CDOR’s cessation raises many issues to address and for which Canada is now on the clock.
A principal concern is that CDOR’s disappearance will shutter Canada’s BA lending model, with banks potentially forced to move away from issuing short-dated BAs. These instruments are both a popular funding vehicle for mid- to large-sized corporations and important assets for investors ranging from sophisticated pension plans to the money market mutual funds held by retail investors. In fact, BAs represent the largest sector of Canadian money markets after Government of Canada Treasury bills. Their disappearance, therefore, would leave a substantial hole in need of filling.
It is without debate that an alternative reference rate(s) will be required to fill the voids left by CDOR’s cessation. Checking most of the boxes and the heir apparent is CORRA — the Canadian overnight repo rate average.
Administered by the Bank of Canada as a public good, CORRA is a purely transaction-based benchmark based on activity in the overnight Government of Canada repurchase (“repo”) market. In other words, CORRA is a risk-free measure, anchored in observable market transactions, that tracks the Bank of Canada’s target rate and has a construct that aligns with the new international principles.
But, unlike CDOR, it lacks both a risk and term component — things that some users require in their choice of benchmark. CORRA alone may, therefore, not suffice. Additional benchmarks may have to be formed to meet market needs — and soon.
The move away from CDOR to these alternative benchmarks would be a substantial undertaking for the Canadian market, with a host of operational, legal and business considerations. Comprehensive transition plans will need to be prepared for all products currently referencing CDOR, including “legacy” products that expire post the June 28, 2024, cessation date. Educating clients and assisting them in their transitions will be another key component.
Yes, it will undoubtedly get complicated, but this is not a reason to hit pause. Instead, we must accelerate by leveraging the learnings from other jurisdictions that have already followed a similar course with their interest rate benchmarks. They have shown that strong stakeholder collaboration is instrumental for a successful execution.
The Canadian Alternative Reference Rate working group (CARR) was created to support the transition to CORRA and brings together representatives from various subsets of our capital markets to work on developing Canada’s interest rate regime post CDOR. We are encouraged by the work underway to identify the gaps and develop possible solutions.
Our collective goal should be for CDOR’s replacement(s) to serve Canada’s financial markets well for at least the next 40 years.