The Canadian Alternative Reference Rate working group (
What you need to know
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On
- In order to extrapolate term rates from an overnight rate, a yield curve must be constructed based on 1- and 3-month CORRA futures trading on the Montréal Exchange (reflecting the market's forward projection of what interest rates will be for the corresponding periods).
- The use of Term CORRA will be restricted to trade finance, loans and derivatives associated with loans through licensing agreements available at a "commercially reasonable cost" for the purpose of constraining the use of Term CORRA to those counterparties that have a real commercial need for the rate.
- Among the shortfalls of interbank rates, including the Canadian Dollar Offered Rate (CDOR), are their inherent reliance on human forecasting and susceptibility to manipulation1.
- Following a public consultation initiative in
May 2022 ,CARR 2 published inAugust 2022 its recommended fallback language which provides a contractual framework for CDOR-based financial products to transition off CDOR to a risk-free rate of CORRA. - CORRA is an overnight risk-free rate administered by the
Bank of Canada that measures the cost of overnight general collateral funding in Canadian dollars usingGovernment of Canada treasury bills and bonds as collateral for repurchase transactions3. - Currently, the CORRA rate is only available as a daily rate, whereas the CDOR rate it is replacing is published in term rates, most typically for 1-month and 3-month terms.
- Trade finance (i.e. the discounting of receivables)
- Single currency derivatives for end-users hedging Term CORRA based loans, where the end user is the lender, borrower or guarantor under such loans4
- Securitizations
- Capital securities
- Structured notes
- Derivative uses not explicitly identified as eligible, including cross-currency basis swaps5
Background
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Because of the LIBOR manipulation scandals nearly a decade ago, global loan markets have been moving away from interbank offered rates (IBORs) towards so called "risk-free rates" (RFRs), which are more stable and resilient during credit shocks, such as the 2008 financial crisis and the initial COVID lockdowns in the first half of 2020.
Term CORRA benchmark rates available in Q3-2023
The
Pay-to-Play
Entities that provide or originate financial products referencing the Term CORRA benchmark, or those that redistribute it, will be required to enter into licensing agreements with the TMX (or an affiliate) in order to gain access to the real-time published benchmark rates. Access to the licensing agreements and published rates by market participants will be subject to payment of a licensing fee at a commercially reasonable cost. However, Term CORRA will be available for free viewing on either or both of the
The licensing agreements will prescribe the classes of financial products permitted to use Term CORRA as a reference interest rate, namely loans and derivatives associated with loans, similar to Term SOFR. (See table below for reference5.)
Approved uses for Term CORRA | Not approved uses for Term CORRA |
| All other uses of Term CORRA, including but not limited to:
|
The decision of whether to add inter-dealer single currency derivative transactions into the Term CORRA approved use cases will be made by |
End-users of Term CORRA products (e.g., corporate borrowers) will not need to have a license through to the CDOR sunset date (
Restrictions on usage of Term CORRA rates
The reason underpinning these constraints to limit the use of Term CORRA stems from a principle of proportionality stipulated in the IOSCO Principles which is concerned with the "inverted pyramid" issue. This reflects a lesson largely informed by the earlier LIBOR scandals where there was a staggering asymmetry between the size of the
Replacement of the replacement rate
Notwithstanding the significant level of effort and consideration deployed by the Canadian loan market industry in arriving at Term CORRA as the best suited replacement rate for CDOR,
In that regard, the
A final word on ISDAs
Market participants engaged in loan facilities with accompanying interest rate hedges should be mindful of avoiding the potential for introducing basis risk between the reference rate on the underlying loan exposure and the reference rate under the corresponding interest rate swap. The potential for basis differential is more of a concern for LIBOR-based loans transitioning to SOFR because the related LIBOR fallback language permits counterparties to make the transition at any time prior to the LIBOR cessation date, whereas the CDOR loan market is binary in that all CDOR loans will toggle to CORRA concurrently on
Borrowers that wish to hedge Term CORRA loans with Term CORRA derivatives could see higher hedging costs than if they were using overnight CORRA for both their loan and their derivative hedge. This is due to the one-sided nature of the hedging demand from bank loan end-user clients. The higher hedging costs would be in the form of a positive basis (additional spread relative to overnight CORRA derivatives), similar to that seen in the Term SOFR derivative market. To encourage a more balanced market for Term CORRA derivatives,
Footnotes
1. For a more detailed discussion on the differences between IBORs and RFRs, please see prior
2. More on
3. Canadian Overnight Repo Rate Average -
4. The administration of Term CORRA (bankofcanada.ca)
5. The administration of Term CORRA (bankofcanada.ca)
6.
7. William C Dudley: The transition to a robust reference rate regime (bis.org)
8.
9.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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