On January 11, 2023, in a highly anticipated development, the Canadian Alternative Reference Rate working group (“CARR”) announced that efforts are underway to develop a one- and three-month Term CORRA benchmark to replace CDOR (the rate banks charge to their corporate clients for the use of the bank’s credit). This announcement follows publication of the responses from CARR’s May 16, 2022, public consultation, in which Canadian companies showed strong support for replacing CDOR with a fully secured forward-looking term rate. CARR has since been working on the feasibility, construction and parameters of Term CORRA. Term CORRA will complement the overnight CORRA and the CORRA Compounded Index administered and published by the Bank of Canada.
The notice highlighted the following:
- CARR’s recommended methodology for calculating a robust Term CORRA benchmark: Term CORRA will be calculated on a forward-looking measurement of overnight CORRA for one- and three-month tenors. It will be based on interest rate futures traded on the Montréal Exchange, using both transactions and executable bids and offers in the central limit order book (“CLOB”) over a specified calculation period.
- The production and management of Term CORRA: While still subject to all necessary regulatory approvals, CARR expects that the provision of Term CORRA will be produced and managed by CanDeal Innovations Inc. (“CanDeal”) with TSX Inc. (“TSX”), through its information services division TMX Datalinx, providing licensing and distribution capabilities. CanDeal will offer extensive expertise in the construction of Canadian yield curves and the publication of benchmark bond prices that comply with International Organization of Securities Commissions Principles for Financial Benchmarks (“IOSCO Principles”), and TMX Datalinx will be able to provide a broad range of real-time and historical data products and services. CARR expects that Term CORRA and its administrator will be regulated by the Ontario Securities Commission and the Autorité des marchés financiers under Multilateral Instrument 25-102 Designated Benchmarks and Benchmark Administrators (“MI-25-102”).
- CARR’s approved use cases for Term CORRA: The use of Term CORRA will be restricted through its licensing agreement to trade finance, loans and derivatives associated with loans. CARR has designed Term CORRA to be a robust benchmark adhering to the IOSCO Principles, which stipulate that the design of a benchmark should take into account the relative size of the underlying market from which the benchmark is created compared to the exposure that references the benchmark. Limiting the use of Term CORRA will ensure that the majority of Canadian financial products reference overnight CORRA rather than Term CORRA. Approved uses for Term CORRA include, in part, loan products and trade finance (i.e., the discounting of receivables). Term CORRA is not approved for use in, among other things, securitization, capital securities or floating rate loans. Notwithstanding the use cases, CARR encourages borrowers that have the operational and technical capacity to use overnight CORRA, particularly those that hedge their loans with derivatives. The overnight CORRA will likely be much deeper and more liquid than the Term CORRA derivate market.
The future of Term CORRA: The long-term sustainability of Term CORRA will depend on the liquidity of the underlying CORRA futures contracts that are used to derive Term CORRA and the Term CORRA administrator will be required to amend the methodology if the depth of the liquidity in these contracts is not sufficient. If such changes do not result in a sufficiently robust benchmark, in accordance with MI 25-102, the benchmark administrator will need to (i) take steps necessary to ensure that the benchmark accurately and reliably represents that part of the market or the economy that it is intended to represent, or (ii) cease the publication of Term CORRA with appropriate notice. Accordingly, CARR expects that any users of Term CORRA remain agile to change by having robust fallback language in place, likely referencing overnight CORRA calculated in arrears, and that users build operational capacity to transact in the fallback rates should the need arise.
One of the benefits of Term CORRA will be that it is more easily comparable to other rates, such as the prime rate. However, as we saw with the transition from LIBOR to SOFR, transition rates within existing credit agreements can require substantial overhaul. In addition, the conventions associated with CDOR are different from those associated with CORRA, so quite a bit of adjustment will be required to make CORRA operate smoothly within existing credit agreements.