CARR Recommends Hardwire Fallback Language for CDOR Based Loans
While much ink has been spilled on the subject of LIBOR transition globally, the market impetus to move towards alternative risk free rates is also true in respect of the Canadian Dollar Offered Rate (“CDOR”). Further to its announcement in November 2020 that it would cease publication of 6-month and 12-month CDOR tenors effective May 17, 2021, Refinitiv Benchmark Services Limited (“RBSL”), the administrator of CDOR, announced on May 16, 2022 that the calculation and publication of all tenors of CDOR will permanently cease immediately following a final publication on Friday, June 28, 2024 (the “CDOR Cessation Date”).
In anticipation of the cessation of all tenors of CDOR, the Canadian Alternative Reference Rate Working Group (“CARR”) recently published its recommended fallback language for loan agreements (“CARR Recommended Language”) in August, 2022. Further to CARR’s original mandate to support the adoption of, and transition to, the Canadian Overnight Repo Rate Average (“CORRA”) as a key financial benchmark for Canadian derivatives and securities, the CARR Recommended Language provides for an automatic transition from CDOR to CORRA on the CDOR Cessation Date (which is defined in the CARR Recommended Language to be the date on which publication of all CDOR tenors ceases in June 2024).
It should be noted that on July 6, 2021 CARR published recommended fallback language for floating rate notes referencing CDOR providing for a transition to CORRA (“FRN Fallback Language”). The FRN Fallback Language and the LIBOR replacement language developed by the Loan Syndications & Trading Association and Alternative Reference Rates Committee (“ARRC”) were used in the development of the CARR Recommended Language.
Summary of the CARR Recommended Language
Key features of the CARR Recommended Language include:
- Hardwired approach: CARR’s language follows the ARRC’s “hardwired approach” to LIBOR replacement. CARR does not intend to publish or recommend any “amendment approach” language. Accordingly, loan agreements that include the CARR Recommended Language will automatically transition from CDOR to the “Benchmark Replacement” (as explained below) on the CDOR Cessation Date.
- Two-Step “Benchmark Replacement” Waterfall: CARR’s language includes a two-step waterfall to determine the appropriate successor rate to replace CDOR:
First: Term CORRA + credit spread adjustment
Second: Daily CORRA Compounded + credit spread adjustment
Note that Term CORRA is not yet available, but is expected to be published in September 2023 ahead of the CDOR Cessation Date. The consultation period to CARR's Term CORRA consultation closed on June 30, 2022. If Term CORRA is not available by the CDOR Cessation Date, the CARR Recommended Language contains the ability to “flip forward” or “climb the waterfall” in scenarios where CDOR has initially been replaced by CORRA Compounded in Arrears but Term CORRA subsequently becomes available.
- Daily Simple vs. Compounded CORRA. The ARRC fallback language published in connection with the transition from LIBOR to SOFR recommends Daily Simple SOFR if Term SOFR is unavailable, whereas the CARR Recommended Language recommends Daily Compounded CORRA if Term CORRA is unavailable. CARR's rationale for this deviation from the U.S. loan market convention recommended by ARRC for SOFR is that it is consistent with the FRN Fallback Language, ISDA's market convention for Canadian dollars and other currency derivatives and the methodology recommended by the London Market Associate for global syndicated lending in a number of currencies.
- Credit Spread Adjustments: The CARR Recommended Language incorporates hard-coded credit spread adjustments for CORRA. These adjustments were published by Bloomberg Index Services Limited and reflect the historic economic difference between CORRA and CDOR calculated as of the date of RBSL’s announcement on May 16, 2022 regarding the cessation of CDOR. These credit spread adjustments are consistent with the adjustments that apply under ISDA documentation. These spreads may ultimately be adjusted over time based on market practice as has been the case with Term SOFR where spreads have continued to narrow since the original ARRC language was published.
- No Early Opt-In: Unlike the ARRC fallback language published in connection with the transition from LIBOR to SOFR, the CARR Recommended Language does not expressly provide a mechanism to allow the parties to opt-in to CORRA ahead of the CDOR Cessation Date. However, parties can still elect to amend their agreements prior to the CDOR Cessation Date to opt-in early if they so choose instead of using the CARR Recommended Language.
How does the CARR Fallback Language impact existing Derivative Transactions related to CDOR-based Loans?
Market participants should consider what fallback provisions apply to their CDOR-based payments under existing credit agreements and derivatives transactions, including whether derivatives transactions related to CDOR-based loans will continue to provide an effective hedge.
Generally speaking, CDOR-based derivatives entered into before January 25, 2021 will not fallback to the more robust CORRA benchmark upon the CDOR Cessation Date unless both parties have adhered to the International Swaps and Derivatives Association (“ISDA”) 2020 IBOR Fallbacks Protocol (the “Protocol”) or otherwise agreed to the Protocol provisions. If the parties have not adhered to the Protocol, they should consider entering into bilateral amendments to implement an agreed upon fallback rate. If parties have adhered to the Protocol (or have otherwise agreed to the Protocol provisions), the overnight CORRA compounded in arrears will apply to the floating leg instead of CDOR as of the CDOR Cessation Date.
It is worth noting that the CARR Recommend Language provides for a different (and simpler) waterfall than ISDA’s replacement rate waterfall (which was largely replicated in the FRN Fallback Language previously published by CARR), which could lead to potential additional basis-rate risk for derivatives transactions linked to existing CDOR-linked loans. Accordingly, market participants may wish to proactively renegotiate their trades to include new rates ahead of the existing rate’s cessation.
As we approach the 2024 deadline for CDOR cessation, market participants are encouraged to review their contracts and assess the need for fallback language to help prepare for the transition from CDOR to CORRA, and to consider the impact of the transition on derivatives transactions related to CDOR-based loans. Together with the Protocol, the CARR Recommended Language now provides the market with a standardized fallback language for the upcoming replacement of CDOR, which can be tailored to suite to the specific needs of the parties and circumstances. However, the CARR Recommended Language does not entirely address the transition from CDOR to CORRA:
- Impact on Bankers’ Acceptances (BA): Once the move from CDOR to CORRA becomes effective, CARR has noted that parties may elect to switch from BA funding mechanics to a loan mechanic.
- Borrowing Mechanics for CORRA: The borrowing mechanics for CORRA loans are not provided for in the CARR Recommended Language, but CARR has indicated that it expects that the CORRA borrowing mechanics will look substantially similar to those used for LIBOR or SOFR loans.
- Single Lender Language: The CARR Recommended Language was drafted for use in syndicated loans. The language will need slight amendments for use in bilateral deals.
- Multi-Currency Credit Facilities. The CARR Recommended Language was drafted for a single currency credit facility utilizing CDOR-based loans, with similar concepts as found in the ARRC fallback language published in connection with the transition from LIBOR to SOFR. As a result, for multi-currency credit agreements, certain drafting changes to the CARR Recommended Language will be required to ensure that any fallback language used for other interest rate benchmarks (such as Term SOFR) do not use duplicative defined terms or otherwise create unintended consequences as a result of overlapping concepts.
Market participants should continue to follow these developments closely and prepare their own playbook to ensure a successful and smooth transition to CORRA.