Welcome back to our Interest Rates Watch series, developed to provide timely updates and practical advice on developments related to interest rates and benchmarks on a regular basis. As always, we are here to help.
In advance of the cessation of the Canadian Dollar Offered Rate (CDOR) following a final publication on June 28, 2024, the Canadian Alternative Reference Rates Working Group (CARR) has released guidance to market participants to address CDOR-linked loans, derivatives and securities that do not have adequate fallback language to address the cessation of CDOR. CARR views the approaches outlined below as commercially reasonable and in line with best market practice.
LOANS
Borrowers that have loan agreements referencing CDOR and/or bankers' acceptances (BAs) will lose the ability to draw by way of these rates after June 28, 2024. CARR has reiterated that loan agreements must be amended to ensure that Canadian-dollar denominated draws linked to CDOR or BAs instead refer to an alternative rate (such as daily compounded Canadian Overnight Repo Rate Average (CORRA) or the forward-looking CORRA term rate (Term CORRA)). For additional guidance on the use of alternative rates in loan agreements, please see our earlier commentary here.
DERIVATIVES
CARR has recommended that all CDOR-linked derivatives transition to Fallback Rate (CORRA), unless otherwise agreed to by the parties to the applicable contract. Fallback Rate (CORRA) is an "all-in" rate published by Bloomberg Index Services Limited, comprised of CORRA compounded over the relevant tenor plus a fixed spread adjustment. The fixed spread adjustments (0.29547% for a 1-month tenor and 0.32138% for a 3-month tenor) represent the median, over a five-year period, of the difference between CDOR of the applicable tenor and CORRA compounded over the same tenor.
CASH SECURITIES
CARR has recommended that all CDOR-linked cash securities without a robust fallback, except National Housing Act mortgage-backed securities (NHA MBS), transition to Fallback Rate (CORRA), with consequential changes to interest determination and observation dates, unless agreed to otherwise by the issuer and investors, with CARR noting that Fallback Rate (CORRA) has been incorporated into the vast majority of existing securities. For NHA MBS, CARR has indicated that issuers should calculate and pay the coupon on the CDOR-linked NHA MBS by applying One-Month Daily Compounded CORRA (as defined in CARR's November 30, 2023 guidance relating to NHA MBS1) with a 0.29547% spread adjustment as the basis to calculate the CDOR fallback rate.
Issuers are also being encouraged to provide CDS Clearing and Depository Services Inc. (or through any other public means) the necessary information to publish summary details, through the CDS Bulletin Service2 (or equivalent), which may include specific CDOR fallback methodology, spread and other adjustments that will be incorporated to implement the replacement reference rate for each issued security.
Issuers and investors should be aware that many securities that convert from a fixed rate to a floating rate at a specified reset date in the future may contain contingent CDOR exposure following CDOR's cessation. In such cases, CARR notes that approaches to address inadequate fallback language may include:
- Working collaboratively (where possible) to restructure or amend the terms of the securities through direct consent or a consent solicitation process to include improved fallback language for both the coupon and the timing of payments, bringing them in line with CARR's recommended fallback language;
- Issuing a statement of intent that the issuer will, if necessary at a future date, seek consent to amend the terms of the securities to reflect CARR's recommended fallback language; or
- At the discretion of the issuer, and after an evaluation of the economic impact and risks, calling or tendering the affected securities prior to the cessation of CDOR.
CARR's commentary that it views the above approaches as commercially reasonable and in line with best market practice may be particularly noteworthy for market participants in respect of securities with fallback language requiring a replacement rate consistent with "accepted market practice" or similar terminology.
We will be issuing further articles relating to interest rates. Find other articles in our Interest Rates Watch Series here.
Footnotes
1. https://www.bankofcanada.ca/wp-content/uploads/2023/11/CARR-amends-recommended-fallback-NHA-MBS.pdf
2.https://www.cds.ca/resource/en/506
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