Following the decision of British regulators to regulate the London Interbank Offered Rate (LIBOR), the Office of the Superintendent of Financial Institutions of Canada (OSFI) has announced it will oversee the rate-setting process of the Canadian Dealer Offered Rate (CDOR).

CDOR is the Canadian index rate most comparable to LIBOR. It is an industry-determined financial benchmark, and the recognized benchmark index for Canadian bankers’ acceptances with a term to maturity of one year or less. CDOR is the rate at which a financial institution would fund a corporate loan without regard to the creditworthiness of the borrower.

Prior to OSFI’s announcement, the CDOR rate has been set daily from a panel of eight participants and is publicly disseminated by Reuters. CDOR has been reported to affect some C$6-trillion of outstanding loans, commercial paper rates and derivatives.

INTERNATIONAL CONTEXT

Prior to 2012, major global financial benchmarks, including LIBOR, have generally not been subject to specific regulatory requirements. In June 2012, a series of investigations and announced settlements regarding the alleged manipulation of LIBOR caused the British Chancellor of the Exchequer to establish The Wheatley Review of LIBOR (Wheatley Review).

In September 2012, the Wheatley Review released conclusions and recommendations regarding the system used to determine LIBOR. Thereafter, LIBOR continued to be a rate determined from a compilation of submissions by private banks, administered by a private central authority, but a number of significant changes resulted:

  • the process of setting LIBOR was tendered to an external, transparent organization with government and regulatory representation;
  • banks that make submissions to LIBOR are now required to base their submissions on actual transaction data from the unsecured interbank deposit market and other related markets;
  • individual LIBOR submissions are now published only after three months, to reduce the risk that published submissions will be used as a measure of a bank’s creditworthiness (giving banks an incentive to show strong credit); and
  • publication ceased for LIBOR in a number of currencies and maturities that were underused, including Canadian Dollar LIBOR.

CANADIAN CONTEXT

In January 2013, the Investment Industry Regulatory Organization of Canada (IIROC) published the results of its formal review of the CDOR rate-setting process. That review was launched in 2012 in response to both the international LIBOR investigation and similar Canadian investigations.

The IIROC review notes an important distinction between LIBOR and CDOR. CDOR is a lending rate, whereas LIBOR is a borrowing rate. CDOR is “the rate at which contributors are willing to extend credit to corporate clients utilizing a Bankers’ Acceptance facility.” By contrast, “LIBOR is intended to reflect the rate at which a contributor believes it can borrow from other financial institutions.” Both the IIROC review and the OSFI announcement indicate that “given the differences between the two benchmark rates, certain issues that have been identified regarding LIBOR do not apply to the same extent in the case of CDOR.” In other words, the alleged incentive of a bank to adjust the rate to reflect its own credit does not apply.

IIROC’s review concluded that there is a case for reforming CDOR as a benchmark. As with the Wheatley Review, IIROC concluded that market participants should continue to play a significant role in the “production and oversight of CDOR.” IIROC called for regulations to be developed to govern survey participation, CDOR calculation, and transparency.

The recommendations made by IIROC include:

  • specific documented criteria for participation in the rate-setting process;
  • clarity regarding the definition, calculation methodology and transparency of CDOR; and
  • documented regulatory expectations for participants’ supervision of rate-setting activity and controls to prevent manipulation, including rules and/or guidance.

The IIROC report appears to be the impetus for the current announcement naming OSFI as regulator of CDOR. In a letter to the banks submitting rates to CDOR benchmark, OSFI announced that it will assume the role of regulator of CDOR. It announced that the Canadian Heads of Regulatory Agencies (HoA), which consists of the Bank of Canada, Department of Finance, OSFI, Ontario Securities Commission, Autorité des marchés financiers, Alberta Securities Commission, and British Columbia Securities Commission, determined that OSFI is best placed to take on this role, especially since CDOR submissions are made by Canadian banks.

OSFI is currently developing an oversight framework for CDOR that will be informed by international expectations and developments that will be adapted to the unique aspects of CDOR. OSFI’s expectations of CDOR submitters will be “principles-based and focused on their internal benchmark submission activities and processes.” OSFI will outline its expectations for CDOR submitters in more detail throughout 2014.