IBOR Transition Overview
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What are IBORs?
Interbank Offered Rates (“IBOR”s) are the average rates at which banks can borrow in the interbank market and range in maturities from overnight to twelve months. The rates are calculated using submissions from a number of panel banks. IBORs were widely used as reference rates by market participants across nearly all asset classes, including derivatives, bonds, lending products, and other financial instruments.
The London Interbank Offered Rate (“LIBOR”) was the most commonly used IBOR. It was an unsecured interbank borrowing rate that relied on the panel banks to accurately report the interest rates that they would have to pay to borrow from each other. LIBOR was based on five currencies (US Dollar, European Euro, British Pound Sterling, Japanese Yen, and Swiss Franc) and seven different maturities (overnight/spot next, one week, and one, two, three, six, and twelve months). The combination of the five currencies and seven maturities created a total of 35 different LIBOR settings that were calculated and reported each business day. As of December 31, 2021 the majority of LIBOR rates stopped being published, the remaining USD LIBOR rates (1-, 3-, 6- and 12-month) ceased publication on June 30, 2023.
If you’d like further information related to LIBOR cessation please click here.
The Canadian Dollar Offered Rate (“CDOR”) is the recognized financial benchmark in Canada for bankers’ acceptances (“BA”s). It is the rate at which banks are willing to lend to companies. CDOR is determined daily from a survey of bid-side rates provided by six principal market-makers, including the major Canadian banks. Refinitiv Benchmark Services (UK) Limited (“Refinitiv”) is the official administrator and calculator of CDOR. Prior to 10:15 ET, submitting banks provide RBSL with the rate that they are willing to lend to corporate borrowers with existing BA facilities that reference CDOR for one, two, and three month terms (six and twelve month terms have already been discontinued).
There is an important distinction between LIBOR and CDOR. While CDOR is a committed lending rate, LIBOR is a borrowing rate. CDOR is the rate at which contributors are willing to extend credit to corporate clients utilizing a BA facility. In contrast, LIBOR is intended to reflect the rate at which a contributor believes it can borrow from other financial institutions.
CDOR Cessation Overview
In December 2021, the Canadian Alternative Reference Rate working group (“CARR”) determined that there are certain aspects of CDOR’s architecture that pose risks to its future robustness. As a result, the publication of all tenors of CDOR will permanently cease after June 28, 2024. This decision has been authorized by the Ontario Securities Commission (“OSC”) and Autorité des marchés financiers (“AMF”).
CARR has stated that the BA lending model, which supports CDOR, is no longer seen as an effective way for banks to provide credit to their corporate clients. Key global interest-rate benchmarks are increasingly being restructured in order to be based primarily on large volumes of underlying transactions rather than relying on expert judgement. Because the determination of CDOR is based predominantly on expert judgement, it is not consistent with evolving global best-practices.
The Canadian Overnight Repo Rate Average (“CORRA”) measures the cost of overnight funding in Canadian dollars using Government of Canada treasury bills and bonds as collateral for repurchase transactions. It’s anticipated that CORRA will likely replace most CDOR-linked products.
There are inherent structural differences between CDOR and CORRA given that CORRA is a risk-free rate (“RFR”). As a result, adjustments are needed to ensure that contracts which reference CDOR or BAs today continue to meet the parties’ original objectives as much as possible once CDOR ceases to exist. As a risk-free (or near risk-free) rate, CORRA will be a lower rate than CDOR. This necessitates a spread adjustment to compensate for the lack of credit and term risk in CORRA, and to help economically neutralize the transition away from CDOR as much as possible.
Key Characteristics of CDOR and CORRA
There are inherent structural differences between IBORs and RFRs. Adjustments are needed to the RFRs to ensure that contracts which reference CDOR continue to meet the parties’ original objectives as much as possible once a fallback takes effect. While the economics of RFR transactions will be similar to those under the existing CDOR product, it is impossible to say on any particular day that they will be identical.
What does it measure?
Credit-based measure that incorporates both term and bank credit risk premium.
Measures the rate that Canadian banks are willing to lend to clients with existing
Risk-free measure that reflects the overnight risk-free rate, closely tracks the Bank of Canada’s Target Rate.
Measures the cost of overnight lending via general collateral repo transactions secured by Government of Canada debt
Pricing Calculation Methodology
Survey-based rate (submitted by panel banks)
Submitted rates lack transparency
Forward-looking term rate (payment is known in advance) published for 1-, 2- and 3-month tenors
Transparent, transaction-based (i.e., reflects actual market transactions)
Overnight rate compounded in arrears to create tenor
Publication delay for free usage
No publication delay for free usage
As a risk-free (or near risk free) rate, CORRA will be lower than CDOR. This necessitates a spread adjustment to compensate for the lack of credit and term risk in CORRA and help to economically neutralize the transition from CDOR as much as possible.
Regulators have confirmed the “historical median approach” as the recommended fallback spread adjustment methodology for lending and derivatives products. It is based on the median spot spread between CDOR and CORRA calculated over a five-year lookback period prior to the relevant cessation announcement. The industry has developed and finalized this fixed spread adjustment as of May 16, 2022 for CDOR. These spreads are available through Bloomberg Index Services Limited (“Bloomberg”) for derivatives and Refinitiv for lending products.
Unlike CDOR, which has a term component for setting interest rates, CORRA is backward-looking; therefore, systems, models and curves are required to calculate compounded interest in arrears. In Canada, CARR has formally announced the development of an IOSCO-compliant term CORRA benchmark (“Term CORRA”) to be published from Q3 2023 onwards. The use of Term CORRA will be restricted, through a licensing agreement, to lending products, trade finance (i.e., the discounting of receivables), and single currency derivatives for end-users hedging Term CORRA based loans. The long-term viability of Term CORRA will depend on the liquidity of the underlying 1- and 3-month CORRA futures contracts being sufficiently robust to meet regulatory expectations. Therefore, any products referencing Term CORRA are expected to include robust fallbacks; in most cases to overnight CORRA calculated in-arrears. CARR published an overview for the methodology of CORRA compounded-in-arrears in November 2021, which can be found here.
As of July 4th, 2023, a beta version of Term CORRA was released, available on the CanDeal website. These rates are a beta version of Term CORRA which are undergoing final testing. CanDeal Benchmark Solutions and TMX Datalinx have announced that the final version of Term CORRA will officially launch on September 5, 2023.
Impact of CDOR Transition
Transition activities may have an adverse impact on the effectiveness of derivatives trades that are used as cashflow hedges. If the timing of the fallback trigger in each product differs, this could result in the derivative no longer being an effective hedge for the underlying loan.
There is an expectation that Canadian banks will move away from the BA lending model upon CDOR’s cessation. CARR’s recommended fallback language for lending products provides the administrative agent with the option to terminate BA funding once CDOR ceases to exist but does not include amendments that are required to replace the BA lending model with a CORRA lending model.
CFIF have published a paper on the impact of CDOR cessation on Bankers’ Acceptance market which can be found here.
Most financial instruments that reference CDOR only contemplate a temporary cessation of the benchmark rate and not a permanent cessation. In addition, lending products are typically not standardized and thus, like other financial instruments, each loan agreement will need to be negotiated and amended by the parties.
The discontinuance of CDOR may affect products and services that you have previously purchased or entered. You should consult with your own financial and legal advisors on the possible effects of CDOR cessation. If you have products that are impacted by CDOR cessation CIBC will contact you in due course to review our mutual contracts and update them to meet industry best practices.
CARR has published an Impact Assessment Checklist for the CDOR transition, which can be found here.
CARR has published recommended fallback language for new and existing loan agreements where the interest rate benchmark is CDOR. Loan agreements that include the fallback language will automatically transition from CDOR to the applicable benchmark replacement rate on the first reset date post-cessation. Fallback language includes credit spread adjustments which are meant to account for the economic difference between CORRA and CDOR.
CIBC recommends that you review the details of CARR’s fallback language to fully understand the impact on your business from a commercial, legal and operational standpoint. We also recommend (in the case of hedged loans) that you review and amend both the loan and derivative at the same time to avoid potential basis mismatches. CIBC will contact you in due course to review our mutual contracts and update them to meet industry best practices.
The recommended fallback language can be found here.
On July 27, 2023, the Canadian Alternative Reference Rate working group (CARR) released a market notice providing guidance to lenders and borrowers with respect to the transition of loans referencing CDOR and/or Bankers’ Acceptances (BAs), with the following underlying publications:
- Transitioning Loans from CDOR to CORRA – Best Practices
- Recommended CORRA loan agreement definitions and loan mechanics
- CORRA loan conventions comparison table
CDOR based loan facilities, including those offering the option to borrow by way of BAs, will migrate to CORRA using either a forward-looking term rate, Term CORRA, or using the daily CORRA compounded in arrears (which is the recommended replacement option for loans that are hedged with swaps in particular).
To support this transition, CARR has introduced a new milestone of “no new CDOR or BA loans” after November 1, 2023. This means that no new contracts, including agreements that would create additional exposure as well as material amendments, changes in pricing, term extensions requiring lender consent, and facility amount increases to existing loan agreements, should be documented using CDOR or BAs after November 1, 2023, and should instead reference CORRA, Term CORRA, or Prime for floating-rate Canadian dollar borrowings. Drawing on existing CDOR/BA loan facilities entered into prior to November 1, 2023, will still be permitted until CDOR’s cessation (June 28, 2024), however such loan facilities will have to be remediated, either at their annual renewal, or by stand-alone amendment by no later than June 28, 2024.
The International Swaps and Derivatives Association (“ISDA”) has published the IBOR Fallbacks Supplement (“Supplement”) which amends the 2006 ISDA Definitions (“Definitions”) for interest rate derivatives to include robust fallbacks. All derivatives that were entered into on or after January 25, 2021 and reference the Definitions automatically include fallbacks and do not require any further action. For legacy derivatives, parties will need to amend their existing agreements to incorporate fallbacks by either choosing to adhere to ISDA’s 2020 IBOR Fallbacks Protocol (“Protocol”) or entering into a bilateral amending agreement. Alternatively, parties can simply transition their existing CDOR positions by amending them to CORRA positions.
Many relevant industry bodies (i.e. ISDA), as well as various central banks, tax authorities and accounting boards strongly encourage widespread and early adherence to the Protocol by all affected financial and non-financial firms. CIBC recommends that you review the details of the Protocol with your professional advisors and take the course of action that best suits your requirements. For clients that elect to not adhere to the Protocol, the parties will need to negotiate a bilateral amendment to their agreement prior to the cessation date.
The full Protocol text can be found here.
In the case of loan-linked derivatives, industry guidance is to transition these financial instruments at the same time using the same/similar convention to avoid any cash flow mismatches. CIBC recommends that you review the details for your loan and swap contracts to fully understand the impact on your business from a commercial, legal and operational standpoint.
On the 2nd August 2023 CARR began publishing FAQ’s related to the CDOR transition. These FAQs cover several key issues including the overall transition, derivatives, loans, fallback language, CORRA, Term CORRA and the disappearance of Bankers’ Acceptances. They can be found here.
CDOR Transition Timeline
On May 16, 2022, Refinitiv announced that the calculation and publication of CDOR will permanently cease after June 28, 2024. In its December 2021 White Paper, CARR outlined a two-stage transition plan where derivatives (bilateral, cleared and exchange-traded) and securities are expected to transition before June 30, 2023, and loans (including loan-linked derivatives) are expected to transition at cessation. The key dates related to this are:
- June 30, 2023 – No new CDOR derivatives & securities trades (with limited exceptions)
- September 5, 2023 – Launch of Term CORRA
- November 1, 2023 – No new CDOR/BA lending products
- April/May 2024 – Clearing houses conversion of CDOR swaps
- Jun 28, 2024 – CDOR publication ceases
CARR has published a transition timeline including milestones, which can be found here.
How CIBC supports the CDOR transition
CIBC is actively engaging with industry bodies and market participants to support a smooth transition away from CDOR. Internally, CIBC has put into place a comprehensive CDOR Transition Program that covers all aspects of the transition, including client communication, contract digitization & remediation, operational readiness, product transition strategy, risk management and financial controls.
CIBC recommends that you review your CDOR exposures, as well as contracts referencing CDOR, and work with your independent financial and legal advisors to ensure you are ready for the transition event. You should also ensure that your systems, models and processes are updated to handle the alternative RFRs. Finally, as there is still some uncertainty around the transition, as highlighted above, we recommend that you continue to closely monitor market developments. CIBC will make every effort to inform you of any significant market developments.
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Useful External Sources
Canadian Alternative Reference Rate Working Group
The Canadian Alternative Reference Rate Working Group (CARR) was created to ensure Canada’s interest rate benchmark regime is robust, relevant and effective in the years ahead.
International Swaps and Derivatives Association (ISDA)
Since 1985, the International Swaps and Derivatives Association has worked to make the global derivatives markets safer and more efficient. ISDA have published work on fallbacks as well as analysis and research on benchmark reform in general.