IBOR Transition - Moving Away from LIBOR and CDOR

Overview

 

Benchmark Rate Reform (BRR) refers to the global initiative to transition major financial benchmarks – primarily Interbank Offered Rates (IBORs) –  to alternative reference rates (ARRs). IBORs have played a central role in financial markets and act as reference rates to hundreds of trillions of dollars of derivatives and trillions of dollars in bonds, loans, securitizations and deposits. The dependence on IBORs by all sectors of the financial markets is now changing on a massive scale.

 

Why is the change necessary?

 

The need for BRR was brought to light by a lack of market liquidity underpinning IBORs which then enabled fraud and conspiracy scandals surrounding the London Interbank Offered Rate (LIBOR) during the 2008 financial crisis. In 2014, due to IBORs' sustainability concerns in the unsecured banking market, the Financial Stability Board (FSB) looked into risk-free reference rates (RFRs) as alternatives to IBORs. In 2017, the UK’s Financial Conduct Authority (FCA) announced that they will no longer compel or persuade banks to submit quotes to support most LIBOR currency settings after 2021 (and after June 30, 2023, for remaining USD LIBOR tenors).

As LIBOR’s cessation nears, global liquidity is shifting to products referencing ARRs, even in countries like Canada where LIBOR is not a predominant rate.

 

What will IBORs be replaced with?

 

BRR is primarily a business and market transformation initiative. Regulators have deferred to the industry to develop solutions for moving away from IBORs. The first step towards the IBOR transition was the designation of ARRs which have been selected to replace certain IBORs.

LIBOR Cessation

 

On June 30, 2023, the USD LIBOR bank panel ceased. From this date, USD LIBOR is now considered permanently unrepresentative of the underlying market it previously sought to measure. Working in partnership with our Customers, the vast majority of TD products referencing USD LIBOR have transitioned to indices based upon the Secured Overnight Financing Rate (SOFR) as recommended by US regulators, including CME Term SOFR Rates.

Under the US Adjustable Interest Rate (LIBOR) Act (the "Act"), in-scope USD LIBOR contracts governed by US law automatically converted to the relevant SOFR-based fallback rate if an amendment was not completed before July 1, 2023.

"Tough legacy" contracts that reference one or more of the 1-, 3-, or 6-month USD LIBOR settings and are not covered by the LIBOR Act may continue referencing a synthetic version of USD LIBOR, as published by ICE Benchmark Administration, through the end of September 2024. A small number of TD loan contracts are considered "tough legacy" as they cannot easily be amended to include a replacement rate for USD LIBOR and do not fall under the scope of the LIBOR Act. Synthetic USD LIBOR is calculated similarly to adjusted Term SOFR and is therefore not representative of unsecured bank lending markets. Other contracts may fallback to other specified rates.

TD is here to help if you have any questions or need assistance. As always, please reach out to your TD Relationship Manager.

 

Background

 

The Canadian Dollar Offered Rate (CDOR) is the rate at which banks are willing to lend to companies and is a recognized financial benchmark in Canada. It is determined daily from a survey of six principal market-makers including the major Canadian banks. CDOR is currently the primary interest rate benchmark in Canada and is widely used in other Canadian dollar financial instruments including interest rate swaps, exchange-traded futures, loans, and floating rate notes.

On March 5, 2021, ICE Benchmark Administration (IBA), the administrator of LIBOR, finalized its cessation plans and announced that most LIBOR settings would cease publication after December 31, 2021. The Federal Reserve Bank of New York’s (FRBNY) Alternative Reference Rates Committee (ARRC) recommended the Secured Overnight Financing Rate (SOFR) as its preferred RFR and endorsed the CME Term SOFR rates as the forward-looking index to replace USD LIBOR.

 

Why did ARRC select Term SOFR as the preferred rate for lending?

 

Term SOFR represents a market-based indication of the forward-looking measurement of overnight SOFR for one-, three-, six- and twelve-month periods. Term SOFR is based upon more than a trillion dollars in daily, reliably reported SOFR futures transaction volume.

By using Term SOFR, loans can be billed on a forward basis (i.e., for each one-month billing period, borrowers and lenders know the interest rate for that upcoming period and it is set at the beginning of the period).

 

TD Adopts SOFR-First Approach

 

TD has adopted a SOFR-first approach, selecting SOFR as the primary ARR for use in existing contracts priced at USD LIBOR. All new deals and most renewals are priced using SOFR. Because SOFR is a nearly risk-free index based on transactions secured by US treasuries, it has historically been a lower rate than USD LIBOR, which is unsecured and sensitive to market credit stress.

As of November 1, 2021, TD no longer issues new LIBOR products, except in certain, narrowly prescribed circumstances (e.g., market making or risk mitigation, etc.). Since 2022, the use of LIBOR in new transactions has been limited to these use cases. On June 30, 2023, the IBA will cease publication of all remaining USD LIBOR tenors (overnight, one month, three months and twelve months). This timing allows existing LIBOR contracts to mature or be modified to an alternative rate before LIBOR becomes unavailable.

 

LIBOR Cessation Timeline

 

Final panel bank submission dates are outlined in the following table:

Additional Information on LIBOR and SOFR

 

Please visit the following links for further information.

 

• Alternative Reference Rates Committee (ARRC) Website
• ARRC Formally Recommends Term SOFR
• CME Term SOFR Reference Rates Benchmark Methodology
• ISDA Benchmark Reform and Transition from LIBOR InfoHub

Background

 

On December 16, 2021, the Bank of Canada's (BoC) Canadian Alternative Reference Rate Working Group (CARR) released a white paper recommending that the administrator of CDOR – Refinitiv Benchmark Services (UK) Limited (RBSL) – cease publication of all three of CDOR’s remaining tenors after the end of June 2024. Following public consultation, RBSL announced that CDOR will cease to be published after a final publication on June 28, 2024. In response, the Office of the Superintendent of Financial Institutions (OSFI) published their expectations that federally regulated financial institutions (FRFIs) and federally regulated private pension plans (FRPPs) with transactions linked to CDOR make every effort to ensure a seamless transition to new reference rates, prior to the respective cessation dates.

 

What is CDOR?

 

CDOR stands for the Canadian Dollar Offered Rate and is currently the primary interest rate benchmark in Canada.  It is a forward-looking survey-based benchmark measuring the average rate at which the six Canadian surveyed banks are willing to lend to corporate borrowers with existing committed Bankers’ Acceptance (BA) credit facilities. CDOR is a unique interest rate benchmark since it measures the average rate at which Canadian banks are willing to lend to corporate borrower while many other global credit sensitive rates, also known as interbank offered rates (IBORs), measure the rate at which banks are able to borrow.

CDOR is used for a variety of purposes, including to:

• Establish the floating-rate component of certain Over-the-Counter (OTC) and exchange-traded derivatives;
• Calculate interest payments on certain floating-rate notes and other securities; and
• Determine the base interest rate on certain loan agreements between corporate borrowers and banks.

CDOR currently comprises three tenors: 1 month, 2 months and 3 months. Two additional tenors, 6 months and 12 months, ceased to be published after May 14, 2021.

 

Why is CDOR Changing?

 

While CDOR has served the Canadian dollar market well for many years, there are certain aspects of CDOR’s architecture that pose risks to its future robustness as outlined in CARR's White Paper on the recommended future of CDOR. Key global interest rate benchmarks are increasingly being restructured to be based on large volumes of underlying transactions rather than expert judgement. CDOR is a lending rate which predominantly relies on expert judgement and cannot be directly tied to observable market transactions which is not consistent with evolving global best-practices.

CARR’s objective has been to analyze these issues in the context of the new, higher standards expected of critical interest rate benchmarks to ensure Canada’s benchmark regime is robust and resilient in the future. The findings and recommendations in the CDOR White Paper reflect global efforts to move from IBORs like CDOR to risk-free rates (RFRs) like the Canadian Overnight Repo Rate Average (CORRA). CARR's recommendation and the associated transition plan have been unanimously endorsed and supported by the members of CARR and the Canadian Fixed Income Forum (CFIF).

TD is adhering to CARR's recommendations for the CDOR to CORRA transition.

 

CARR's Two-Staged Approach to CDOR Transition

 

To prepare for CDOR’s cessation, CARR has recommended a two-staged transition approach, where derivatives and securities will transition from CDOR to CORRA by the end of June 2023, and loan contracts will transition starting November 1, 2023 up until the CDOR cessation date.

 

Stage 1 - Runs until June 30, 2023

Stage 2 - Ends June 28, 2024

All new derivative contracts and securities transitioned to Canadian Overnight Repo Rate Average (CORRA) No new CDOR exposure after June 30, 2023, except with limited exceptions. Those exceptions include derivatives that hedge or reduce CDOR exposures of derivatives or securities transacted before June 30, 2023, or in loan agreements transacted before June 28, 2024

The longer time window allows for more existing CDOR-based securities exposures to mature. Approximately $95 billion in floating rate notes and securitized products referencing CDOR would remain outstanding after the end-date of June 28, 2024. Provides firms with additional time to transition their loan agreements and deal with potential issues related to the redocumentation of “legacy” securities. Interim Milestone:  As of November 1, 2023, new loan agreements or loan agreements undergoing material amendments (which includes key elements such as interest rates, maturities, increases and other critical terms) can no longer reference CDOR or Bankers’ Acceptance (BA).  Note that existing contractual obligations are not impacted by the milestone and 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)

 

Whenever possible, CARR recommends writing new contracts based on CORRA.  For contracts that need to reference CDOR, CARR recommends incorporating robust fallback language provisions such that these contracts fall back to CORRA upon CDOR cessation.

 

What is CORRA?

 

The Canadian Overnight Repo Rate Average is well-known and has been a benchmark since 1997. The Bank of Canada (BoC) became CORRA’s administrator in 2019 and implemented a new calculation methodology developed by CARR.

Unlike CDOR, CORRA is based on actual transactions in the Canadian dollar overnight funding market, making it more robust and transparent than CDOR. Because the underlying transactions are collateralized by high-quality assets such as Government of Canada treasury bills, CORRA includes little or no credit risk component and is referred to as a risk-free rate.

CARR expects that the majority of the financial products (or exposure) currently referencing CDOR will transition to overnight CORRA calculated in-arrears. This is consistent with the practice in other jurisdictions. The importance of adopting overnight risk-free rates, where possible, has been underscored by the Financial Stability Board (FSB) as well as by the BoC and other central banks and regulators.

 

Term CORRA

 

The Term CORRA benchmark officially launched on September 5, 2023, in response to a strong demand from Canadian corporations for a forward-looking term benchmark. 

Term CORRA is a forward-looking measurement of overnight CORRA for 1- and 3-month tenors, based on market-implied expectations from CORRA derivatives markets. The rate is calculated from 1- and 3- month CORRA futures trading on the Montréal Exchange using both transactions and executable bids and offers in the central limit order book over a specific calculation period. As a result, the robustness of the Term CORRA rates relies on the continued existence of a deep and liquid CORRA derivatives market based on overnight CORRA.

Term CORRA is intended to complement overnight CORRA and facilitate CDOR transition where transitioning from a forward-looking term rate (like CDOR) to an overnight rate is difficult. Term CORRA is an attractive replacement for CDOR because, like CDOR, Term CORRA allows borrowers and lenders to know the benchmark interest rate on a loan at the beginning (as opposed to near the end) of each interest period.

In endorsing the Term CORRA rates, the CARR recommended that its use remain limited, particularly in derivatives markets. Following CARR’s recommendations, CanDeal Benchmark Administration Services Inc. is restricting uses of Term CORRA (through its licensing agreement) to specific use cases, including loans, trade finance, and associated derivative hedges for those loans and CORRA-Term CORRA basis risk. Furthermore, CARR expects any users of Term CORRA to have robust fallback language in place that uses, in most cases, overnight CORRA calculated in-arrears, and to build the operational capacity to transact in these fallbacks should Term CORRA cease to be published in the future.

For more information and developments around Term CORRA, please refer to the following publications and websites

 

• CARR announces development of a Term CORRA benchmark
• Term CORRA Methodology - CARR Recommended Approach
• CARR’s approved use cases for Term CORRA

 

Will Bankers' Acceptances be impacted when CDOR is discontinued?

 

With the cessation of CDOR’s publication, the Bankers’ Acceptance (BA) based lending model, which is responsible for creating the BAs that are sold to money market investors, will be discontinued. TD is working with the Canadian Fixed-Income Forum (CFIF) as well as market participants to identify potential alternatives or replacements for Bankers' Acceptances.

BAs are a discount instrument whereby interest is paid upfront, and the borrower is advanced the discounted proceeds (principal loan amount less interest expense). CORRA loans, whether overnight CORRA or Term CORRA, will require the borrower to pay interest "in arrears", that is, at the end of the interest period. 

Please refer to CFIF’s white papers on the Impact of CDOR Cessation on Bankers’ Acceptance Market and Update from the BA Transition Virtual Network for further information on the topic.

 

Additional Information on CDOR and CORRA

 

Canadian Alternative Reference Rate Working Group (CARR)

• Canadian Alternative Reference Rate (CARR) Working Group Website
• Canadian interest rate benchmark reform
• Recommended terms for CORRA-based loans
• CARR publishes White Paper on the recommended future of CDOR
• Refinitiv announcement of cessation of CDOR in June 2024
• OSFI’s expectations for CDOR Transition
• TMX CDOR Transition Webcast Series
• CARR announces development of a Term CORRA benchmark
• Term CORRA Methodology - CARR Recommended Approach
• Transitioning Loans from CDOR to CORRA – Best Practices
• Recommended CORRA loan agreement definitions and loan mechanics
• CORRA loan conventions comparison table
• CARR’s allowable use cases for Term CORRA

 

Refinitiv

• Refinitiv announcement of cessation of CDOR in June 2024

OSFI

• OSFI’s expectations for CDOR Transition

TMX

• TMX CDOR Transition Webcast Series

TD's enterprise-wide BRR Initiative provides support and strategic direction to all areas of the Bank impacted by the IBOR transition by offering new ARR-based products and actively engaging clients to transition existing ("legacy") products to ARRs.

TD is actively participating in industry working groups to help drive solutions and constantly adapting as market information becomes available. These groups include the Federal Reserve Bank of New York’s (FRBNY) Alternative Reference Rates Committee (ARRC) and the Bank of Canada's (BoC) Canadian Alternative Reference Rate Working Group (CARR).

TD also monitors information from other sources, such as the International Swaps and Derivatives Association (ISDA), the Working Group on Euro Risk-Free Rates led by the European Securities and Market Authority, and the Working Group on Sterling Risk-Free Reference Rates led by the Bank of England.

Up to date information from some of the key working groups focusing on benchmark rate reform can be found at:

 

TD is working with clients throughout this transition

 

TD aims to provide clients with accurate, up-to-date information throughout the transition. Sales, Account, and Relationship Managers are actively engaging with clients to provide education and discuss contract amendments in a manner consistent with market directions as solutions are available and practical to implement.

Accounting and tax bodies have developed guidance to address the implications related to legacy contract transitions from IBOR to new ARRs. The general objective of the guidance is to provide accommodations for the move from IBORs to ARRs to mitigate unintended consequences, such as net income volatility or termination of certain hedge accounting relationships.

Clients will need to identify the changes made to their contracts to assess if they fall within the explicit guidance of the relevant body in their jurisdiction to determine the accounting and tax impacts. Clients should engage their legal, tax and accounting advisors for guidance.