CDOR, CARR, CORRA, CAG? What’s really happening in Canada?
The Canadian Alternative Reference Rate working group (CARR) was first established in March 2018 with a remit not dissimilar to the ARRC of the US Fed, to “guide benchmark reform efforts in Canada.”
In this blog I attempt to cut an explanatory path through the maze of acronyms that loom in Canadian finance, and distil what’s really going on with Canadian benchmarks, and try to gain a better understanding of the fundamental, underlying problem with CDOR.
Are there important lessons from the Canadian experience?
Why so many acronyms?
In every jurisdiction where benchmark reform has been attempted, new market acronyms abound.
This has been without exception, though we’d concede that the Bank of England Working Group on Sterling Risk-Free Reference Rates has seemed to defy market ‘acronymisation’!
Canada has been no Robinson Crusoe in this evolution, though the list of reform acronyms could be said to have been taken to new lengths in terms of sheer number. We’re sure this was not deliberate, but with so many new terms mixing with old terms it’s somewhat instructive to recap what they all stand for, and what role they play:
Canadian Dollar Offered Rate, CDOR, is administered and published daily by Refinitiv Benchmark Services. The rate was developed in the 1980s as the basis for pricing Bankers’ Acceptance supported credit facilities (short-term corporate promissory notes backed by an unconditional payment obligation of a bank). It has remained the primary interest rate benchmark in Canada since inception and is referenced in over $20 trillion of gross notional exposure across the Canadian wholesale financial system.
Canadian Alternative Reference Rate Working Group, CARR, was created through the sponsorship of the Canadian Fixed-Income Forum, to coordinate Canadian interest rate reform and “ensure Canada’s interest rate benchmark regime is robust, relevant and effective in the years ahead,” with objectives to:
o support and encourage the adoption of, and transition to, the Canadian Overnight Repo Rate Average (CORRA) as a key financial benchmark for Canadian derivatives and securities; and
o analyse the current status of the Canadian Dollar Offered Rate (CDOR) and its efficacy as a benchmark, as well as make recommendations on the basis of that analysis.
Canadian Overnight Repo Rate Average, CORRA, Canada’s official risk-free rate based on daily transaction-level data on repo trades that measure “the cost of overnight general collateral funding in Canadian dollars using Government of Canada treasury bills and bonds as collateral for repurchase transactions”. The Bank of Canada considers CORRA a public good and publishes rates at no cost to users and data distributors each business day at 11:30 am Canada Eastern Time.
CORRA Advisory Group, CAG, was initially established to advise the Bank of Canada’s CORRA Oversight Committee on potential adjustments to the CORRA methodology, “stemming from changes in repo market functioning and from any emerging methodology issues, as well as on any changes undertaken as part of regular methodology reviews.” A key role of CAG is to assess if CORRA continues to represent the overnight general collateral funding rate where Government of Canada securities are posted as collateral.
While to-date no formal Term CORRA rate has emerged, I note that Canadian industry demand for a CAD term rate is like that found in other jurisdictions (high, reasonable, and in our view very rational), and that CARR has a Term CORRA subgroup reviewing the need for “a complementary term rate to overnight CORRA for loan and related hedging products.” This welcome group is also expected to develop an appropriate methodology.
So, what’s the plan?
Similar to the approach taken in both the UK and US, and mirrored elsewhere, CARR has published its own well-laid transition roadmap.
Source: https://www.bankofcanada.ca/wp-content/uploads/2022/05/transition-roadmap.pdf
Readers with experience of the Bank of England roadmap to GBP LIBOR’s cessation will note the similarities:
announce a formal cessation trigger;
establish a ‘no new LIBOR (CDOR)’ exposure cut-off date; and
set a formal publication cessation date in stone.
We see no reason for Canadian markets to struggle with any of this, and market disruption should be minimal; the global template for cessation has essentially been set.
What’s the problem with CDOR?
Helpfully, CARR’s formal review of CDOR is available on-line, and I am leaning on it heavily through this section
After consulting with industry through 2021, and as outlined in the transition roadmap, CARR formed the view that Refinitiv Benchmark Services (RBSL) should cease the calculation and publication of CDOR after June 30, 2024.
My key question is, why was this?
CARR is explicit here, saying that “there are certain aspects of CDOR’s architecture that pose risks to its future robustness.”
What risks?
Here I paraphrase the two key risks CARR found, and which we believe are fundamental, to make summary easy:
Input rates crucial to CDOR’s publication cannot be directly tied to observable transactions, and are hence “based predominantly on expert judgement”. CARR decided that this was “not consistent with evolving global best-practices” nor, we would add, was this consistent with IOSCO Principles for Financial Benchmarks.
CARR noted that Bank funding has evolved to “better match the term of their funding to the term of their loans, and this practice is now codified in Basel III regulation”. Further, CARR noted that “BA loans are “term” or “committed” facilities, bank treasuries no longer fund them through the issuance of BA securities that are generated through the loan drawdown”. The reduction of bank acceptance issuance tolls a rather obvious bell.
CARR also noted that the move away from CDOR “aligns Canada with the heightened standards other jurisdictions began adopting in 2018,” and that the rate’s “contributing member banks may decide they no longer wish to continue submitting rates voluntarily.”
These are interesting other riders; hinting at a desire on behalf of the working group, and presumably others across Canadian finance, to follow the benchmark modernisation path seen across the US, UK, Japan, and Switzerland.
Boiling it all down?
When CARR tell us that “there are certain aspects of CDOR’s architecture that pose risks to its future robustness,” I am at once reminded of the fall in interbank (LIBOR) lending that has occurred since the mid-90s, and prominently since the GFC, as displayed in the classic St Louis Fed graphic on the topic:
Source: https://fred.stlouisfed.org
In Canada, the pattern has been familiar; bankers’ acceptances are simply no longer playing the significant role they once played in Canadian finance.
Short-term paper held on financial balance sheets has fallen to around 1% of the national balance sheet since Y2k:
Source: Statistics Canada. Table 36-10-0580-01 National Balance Sheet Accounts
Perhaps more interestingly, since the GFC short-term Canadian paper has hardly registered as meaningful liabilities on the non-financial sectors cumulative balance sheet either:
Whichever way CARR may like to couch it, dire levels of actual BA activity really has spelled the end of CDOR.
Important Lessons?
Our interest in Canada as a benchmark test-case stems from the similarities between Australian and Canadian finance, where bank accepted securities play and have played a key role in benchmark formation in both countries.
We will look more closely at the Australian benchmarks in the next blog.
Perhaps the most important lesson from Canada is that times change, and that rational actors will act rationally. Market evolution, some pushed along by natural market evolution, and some pushed along by regulators, needs to be carefully watched, and shouldn’t be ignored.
We continue to watch this space with deep interest.