A New Milestone before the end of the CDOR Road: “No New CDOR or BA Loan” Milestone to further ease the transition from CDOR to CORRA
We have previously written about the milestone dates related to the upcoming permanent cessation of the use and publication of the Canadian Dollar Offered Rate (CDOR) after June 28, 2024 (CDOR Cessation Date) (see our article here). As mentioned in that article, the Canadian Alternative Reference Rate working group (CARR) proposed a two-stage transition approach, which was adopted by the Office of the Superintendent of Financial Institutions (OSFI), the prudential regulator of Canadian federally regulated financial institutions (FRFIs), where certain contracts were expected to transition to alternative reference rates, such as the Canadian Overnight Repo Rate Average (CORRA), by June 30, 2023, one year ahead of the CDOR Cessation Date. However, that earlier transition date was not applied to loan agreements. This meant that new loan contracts could be entered into referencing CDOR or BA rates until the CDOR Cessation Date and existing loan contracts could continue to refer to CDOR and BA rates until that time. This has now changed with respect to new loan contracts and certain amendments to existing loan contracts. On July 27, 2023, CARR published a notice introducing a “no new CDOR or BA Loan” milestone date of November 1, 2023, as well as the following documents in order to help support the transition of the Canadian loan market from CDOR to CORRA:
- Transitioning Loans from CDOR to CORRA – Best Practices;
- Recommended CORRA Loan Agreement Definitions and Loan Mechanics; and
- Table comparing recommended conventions for overnight CORRA compounded-in-arrears and Term CORRA.
“No new CDOR or BA loan” Milestone – Effective November 1, 2023
After November 1, 2023, new loan contracts can no longer reference CDOR or bankers’ acceptance (BA) loans. The only acceptable reference rates for Canadian dollar loans after November 1, 2023 are overnight CORRA compounded in-arrears, Term CORRA or prime. The purpose of this new milestone date is to further ease the transition to alternative reference rates by ensuring that the number of loans that need to be amended to include alternative reference rates before the CDOR Cessation Date does not grow.
CARR clarifies that “new loan contracts” include any agreements that create additional CDOR or BA exposure, material amendments, changes in pricing, term extensions requiring lender consent and facility amount increases to existing loan agreements. Further, CARR clarifies that this new milestone does not have an impact on the ability to draw/rollover on existing CDOR or BA loan facilities (until the CDOR Cessation Date) where the facilities have not yet matured, or where the facilities have been extended or have been the subject of material amendments prior to November 1, 2023. Also permitted after November 1, 2023 (until the CDOR Cessation Date) are the following: (i) new loan agreements and extensions of the maturity of existing loan agreements that were underwritten or committed prior to November 1, 2023, but close after that date, (ii) the exercise by a borrower of a pre-existing right to extend the maturity of a loan, where the term extension option does not require additional lender consent, (iii) the exercise by a borrower of a previously documented right to increase the amount of a loan or credit facility where that increase is not accompanied by an extension of the maturity (such as the exercise of an accordion feature), and (iv) the purchase of existing CDOR loans in the secondary market.
Recommended Best Practices for Transitioning Loans from CDOR to CORRA
CARR has recommended that market participants proceed as follows when remediating existing financial contracts, instruments and loan agreements referencing CDOR or a BA rate:
- Evaluate exposure to CDOR or BAs by reviewing relevant contracts taking into consideration:
- Loan Maturity – if the loans mature after the CDOR Cessation Date, remediate them ahead of time at routine annual or scheduled negotiations to actively transition them away from CDOR;
- Fallback Language – contracts with amendment fallback language or no fallback language should be prioritized for remediation over those that contain hardwired fallback language;
- Dollar Volume – prioritize remediation of contracts having exposure with larger dollar volumes; and
- Corresponding Hedges – proactively renegotiate hedging transactions to avoid a mismatch between the swap contract and the obligations being hedged.
- Identify whether robust fallback language applies to CDOR or BA rate cessation and where there is no robust fallback language, amend the agreement to include the CARR recommended fallback language. Fallback language is intended to be an intermediate step, applicable in the event the loan cannot be transitioned in time.
- Although agreements may already contain fallback language which include benchmark conforming changes language, some borrowers may require formal amendments to agreements prior to the CDOR Cessation Date for the addition of overnight CORRA compounded in-arrears or Term CORRA, or both, in agreements.
- Even if Term CORRA is being used, borrowers should become familiar with CORRA compounded in-arrears methodology as the long-term sustainability of Term CORRA is not guaranteed and users of Term CORRA should have robust fallback language in place, in most cases referencing overnight CORRA compounded in-arrears.
- CARR encourages the use of overnight CORRA where possible rather than Term CORRA as the overnight CORRA derivatives market will likely be much deeper and more liquid than the Term CORRA derivatives market which may result in higher costs to borrowers hedging Term CORRA loans with Term CORRA derivatives. To encourage a more balanced market for Term CORRA derivatives, CARR has included lenders’ Term CORRA hedging transactions in the approved Term CORRA derivatives use cases which may provide an offset to borrower hedging and potentially reduce the cost of using Term CORRA derivatives.
- CARR encourages firms to actively engage with providers of third-party systems that are used to support their business activities to assess their own readiness to support CORRA-based loan products, including via activation of fallbacks. CARR recommends that firms use reference material published by them, such as the Impact Assessment Checklist and the Aid to Transition document (to be published in late summer 2023) in order to assist firms in planning for the cessation of CDOR and assessing their own readiness for CORRA-based loan products.
Recommended CORRA Loan Agreement Definitions and Loan Mechanics
To assist the Canadian loan market in transitioning from CDOR to CORRA reference rates, and to promote market standard provisions, CARR has developed, through a consultative process, CORRA loan agreement definitions and provisions (CARR Loan Mechanics) where the borrower and lenders have agreed to reference CORRA. The CARR Loan Mechanics are only recommendations, and parties are, of course, free to modify the recommended language. In addition, the wording may be subject to change as market practices evolve. The CARR Loan Mechanics take into account provisions developed in other jurisdictions, such as the US with respect to various SOFR credit agreements. In addition, the CARR Loan Mechanics include a concept unique to the Canadian loan market called the “Rate Flip”. This was developed in response to an emerging trend in the US loan market where borrowers amend their credit agreements to replace their original choice of Term SOFR with daily SOFR compounded in-arrears as a result of lower hedging costs of daily SOFR. However, if lenders introduce “Rate Flip” provisions in Canadian loan agreements, they may wish to ensure that their systems are able to process any “Rate Flips” and the potential for both Term CORRA loans and overnight CORRA compounded in-arrears loans to be outstanding at the same time.
Comparison of Conventions for Overnight CORRA Compounded In-Arrears and Term CORRA
This table published by CARR helpfully compares the CARR recommended conventions for overnight CORRA compounded in-arrears and Term CORRA, covering items such as the publication time, business day convention, rounding convention and notice of elections.
Although the cessation of all tenors of CDOR, which will effectively end the BA loan market in Canada, will not take place until June 28, 2024, CARR has announced milestone dates in advance of the cessation of CDOR in order to facilitate the transition from CDOR to CORRA rates. The latest milestone date announced by CARR is the “no new CDOR or BA loan” milestone, effective November 1, 2023. In addition, CARR has published (i) a best practices paper to assist Canadian loan market participants to prepare and transition their loans to CORRA in advance of the CDOR Cessation Date, (ii) recommended CORRA loan agreement definitions and loan mechanics provisions which Canadian loan market participants can use to remediate their CDOR or BA rate loans to CORRA, and (iii) a table comparing its recommended conventions for loans referencing overnight CORRA compounded in-arrears and Term CORRA to assist Canadian loan market participants in understanding the differences between these two CORRA rates.
For more information on interest rate reform and our Firm’s expertise, please see the webpage of McCarthy Tétrault’s Financial Services group.