IBOR Transition Overview
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.
The Canadian Dollar Offered Rate (“CDOR”) was the recognized financial benchmark in Canada for bankers’ acceptances (“BA”s). It was the rate at which banks were 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”) was the official administrator and calculator of CDOR. Prior to 10:15 ET, submitting banks provided Refinitiv with the rate that they were willing to lend to corporate borrowers with existing BA facilities that referenced CDOR for one, two, three, six and twelve-month terms. As of May 17, 2021, the six and twelve-month tenors stopped being published; the remaining CDOR tenors (1-, 2- and 3-month) ceased publication post June 28, 2024.
There is an important distinction between LIBOR and CDOR. While CDOR was a committed lending rate, LIBOR was a borrowing rate. CDOR was the rate at which contributors are willing to extend credit to corporate clients utilizing a BA facility. In contrast, LIBOR was 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 posed risks to its robustness, and that all tenors of CDOR should permanently cease from June 28, 2024. This decision was authorized by the Ontario Securities Commission (“OSC”) and Autorité des marchés financiers (“AMF”).
CARR stated that the BA lending model, which supported CDOR, was no longer seen as an effective way for banks to provide credit to their corporate clients. Key global interest-rate benchmarks have been increasingly restructured in order to be based primarily on large volumes of underlying transactions rather than relying on expert judgement. Because the determination of CDOR was based predominantly on expert judgement, it was 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, and is intended to replace most CDOR-linked products.
Key Characteristics of CDOR and CORRA
Given that CORRA is a risk-free rate (“RFR”), there are inherent structural differences between CDOR and CORRA. As a result, adjustments are needed to ensure that contracts which referenced CDOR or BAs continue to meet the parties’ original objectives as much as possible post-cessation. While the economics of RFR transactions are similar to those that were under CDOR products, it was impossible to say whether the two rates would be identical on a given day.
As a risk-free (or near risk free) rate, CORRA is now lower than CDOR used to be. This necessitated 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 for CDOR as of May 16, 2022. These spreads are available through Bloomberg Index Services Limited (“Bloomberg”) for derivatives and LSEG for lending products.
Unlike CDOR, which had 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, an IOSCO-compliant term CORRA benchmark (“Term CORRA”) was published from Q3 2023. The use of Term CORRA is 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 of the methodology of CORRA compounded-in-arrears, which can be found here.
For more information regarding Term CORRA, please consult CARR’s announcement here and for CARR’s approved use cases here.
Impact of CDOR Transition
The transition from CDOR may have adversely impacted the effectiveness of derivatives trades that are used as cashflow hedges. Where the timing of the fallback trigger in each product differed, this may have resulted in the derivative no longer being an effective hedge for the underlying loan.
Canadian banks have moved away from the BA lending model since CDOR’s cessation. CARR’s recommended fallback language for lending products provides the administrative agent with the option to terminate BA funding following CDOR cessation 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.
If the discontinuance of CDOR affected products and services that you have previously purchased or entered, CIBC will have already contacted you to review our mutual contracts and update them to meet industry best practices. These contracts would have either been amended to include fallback language which would have taken effect upon CDOR cessation, or have references to CDOR removed and replaced with an explicit reference to CORRA or another alternative reference rate.
If a contract is currently relying on a fallback rate, it’s likely that CIBC will propose an amendment to your contract during the next renewal given that CDOR no longer exists. This amendment would remove the specific references to CDOR in the contract. Alternatively, you may reach out to your Relationship Manager to discuss having your contract amended before the next renewal date.
Industry Recommendations
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.
CDOR based loan facilities, including those that offered the option to borrow by way of BAs, will have migrated 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).
The International Swaps and Derivatives Association (“ISDA”) has published the IBOR Fallbacks Supplement (“Supplement”) which amends the ISDA Definitions (“Definitions”) for interest rate derivatives to include robust fallbacks. All derivatives entered into on or after January 25, 2021 and reference the Definitions automatically include fallbacks and do not require further action. For legacy derivatives, parties were required 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 simply transition their existing CDOR positions by amending them to CORRA positions.
The full Protocol text can be found here.
CARR also published recommended fallback language for Floating Rate Notes (FRN’s) referencing CDOR and CORRA as well as recommended FRN conventions for CORRA.
CARR has published 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.
How CIBC supports the CDOR transition
CIBC is actively engaged 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.
We recommend that you continue to closely monitor market developments – CIBC will make every effort to inform you of any significant market developments.
If you have any questions, please contact us at: [email protected]
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.