Good morning. Thank you for inviting me to initiate this panel discussion.
And thanks to the International Swaps and Derivatives Association (ISDA) for hosting our event. I am pleased to be here alongside these exceptional panelists to discuss some important changes that may be coming to Canada’s interest rate benchmarks.
In fact, benchmark interest rates are being reformed around the world. Since 2013, the Financial Stability Board’s Official Sector Steering Group has led efforts to build a stronger foundation for financial products globally.
The Bank of Canada is a member of this steering group. One of the bank’s core tasks is to promote a stable and efficient financial system. For this reason, it is important that we support efforts to ensure the architecture that underpins Canada’s financial system is robust and resilient.
And, of course, the bank is a key player in the Canadian Alternative Reference Rate (CARR) working group on benchmark reform. This group was formed in March 2018 and includes many key stakeholders from Canada’s financial system.
In 2020, CARR was commissioned to take a closer look at the Canadian Dollar Offered Rate (CDOR), which is currently the dominant interest rate benchmark in Canada. The group examined how to strengthen the robustness and resilience of the Canadian benchmark system. This included analyzing the effectiveness of CDOR and making recommendations for the future based on that assessment.
Looking at the effectiveness of CDOR
Background: CDOR has been around for about 40 years. It was originally conceived as the basis for pricing credit facilities related to bank acceptances (BAs). It is a forward-looking interest rate that includes bank loans. And it has served us well since its introduction in the 1980s.
Today it is managed by Refinitiv Benchmark Services (UK) Limited and used on transactions valued at more than US$20 trillion – or gross notional value. Derivatives make up 97% of these exposures, although some also relate to floating rate notes and loans.
As I just said, CDOR has served us well. But in the first part of CARR’s review process – analyzing the effectiveness of CDOR – it became clear that some aspects of CDOR’s architecture could pose risks to its future robustness and resiliency.
One concerns the new, higher standards expected of critical interest rate benchmarks around the world. Developed by the International Organization of Securities Commissions (IOSCO), these standards provide the target posts for robust benchmarks.
IOSCO recommends that benchmarks be based on large volumes of underlying transactions at arm’s length. This concept is enshrined in the benchmark rules recently introduced by the Canadian Securities Administrators. However, CDOR is primarily determined based on expert judgment and not on the basis of transactions.
Another risk is that banks will begin to move away from the BA lending model, which was the basis for the development of CDOR. We are seeing more loans pointing to CDOR but not resulting in the creation of BAs. In this case, the BAs issued are increasingly held on the balance sheet rather than being sold in the market. The dwindling supply of BAs on display undermines the foundation on which CDOR is built.
Considering the future
Given these problems, CARR considered whether it would be possible to reform or improve CDOR.
It was determined that this was not a viable option – primarily because CDOR, by definition, could not be tied directly to arm’s length securities transactions without becoming a new interest rate.
In the end, CARR recommended Refinitiv to stop calculating and publishing the CDOR after June 30, 2024. I should note that this is a recommendation only – something for Refinitiv to independently review and decide.
CARR also recommended a two-step approach to transitioning from CDOR.
The first phase would run until June 30, 2023. During this time almost all new derivatives and securities contracts would migrate away from CDOR and into CORRA – the Canadian Overnight Repo Rate Average.
CORRA is the other major Canadian rates benchmark. It measures the overnight cost of funding general collateral in Canadian dollars, using Canadian government treasury bills and bonds as collateral in repo transactions. As a result, it is considered a risk-free overnight rate – in line with international best practices. The bank took over the management of CORRA in June 2020.
For the second phase – between June 2023 and CDOR’s potential decommissioning date of June 2024 – credits would be withdrawn from CDOR. This phase would give companies more time to adjust their loan agreements and deal with potential issues related to the re-documentation of “old” securities.
I would like to emphasize that these recommendations have been unanimously endorsed by CARR members as well as all members of the Canadian Fixed-Income Forum, so they reflect the views of a broad spectrum of CDOR stakeholders. But ultimately, the decision to discontinue CDOR rests solely with Refinitiv. And I’ll get to that in a moment.
First, let’s take a quick look at what might change when Refinitiv CDOR is phased out.
As I have already indicated, the impact would mainly affect the derivatives market. Fortunately, in late 2020, ISDA tightened the rules that would apply to derivatives if a relevant benchmark were to be discontinued.
As we have seen in other jurisdictions transitioning between financial benchmarks, the credit market transition would be more complex. The phasing out of CDOR would certainly have operational implications for financial institutions and businesses that currently use it in borrowing.
We don’t yet have all the answers as to what the financial system might look like after June 2024. For example, what would happen to the BA credit model that forms the basis of CDOR?
Moving away from CDOR would certainly require effort from all participants in the financial system. Therefore, it is important to hear from those who may be impacted by CDOR’s discontinuation.
To that end, Refinitiv recently launched a consultation process to better understand potential impacts. I encourage you all to get involved. This is an important way to ensure we move forward with benchmark reform in Canada that reflects Canadian realities.
And of course we can observe and learn from benchmark reforms taking place elsewhere – like the London Interbank Offered Rate (LIBOR).
I will conclude my comments here so that we can spend more time discussing the details of the CARR recommendations – and what they mean for the future.
I look forward to the contributions from Barbara, Axel, Karl and Tom and the thoughts and contributions of everyone present today.
Thanks very much.
I would like to thank Harri Vikstedt and Thomas Thorn for their help in preparing this speech.