Understanding The Future of Short-Term Interest Rates in Canada

Following the global financial crisis, many jurisdictions began a worldwide effort to transition from an opinion-based benchmark rate (LIBOR) to alternative reference rates for financial products and derivative contracts.

In a recent episode of TMX Presents: The Podcast, Corey Garriott, Head of Product Research at the Montréal Exchange (MX), spoke with guests David Duggan, Managing Director of Rates Trading and Sales at National Bank Financial and Robert Catani, Head of Institutional Sales, Interest Rate Derivatives at MX about the adoption of alternative reference rates in Canada and considerations for the transition to a new interest rate benchmark.

Here are the highlights from their discussion.

Adopting a New Benchmark Rate

With the LIBOR phase-out scheduled for 2023, the global landscape for financial interest rate benchmarks has been rapidly changing. Most financial products have already begun transitioning from forward-looking reference rates to overnight risk-free rates.

In Canada, the Canadian Alternative Reference Rates (CARR) working group was established to review the interest rate benchmark regime, which is composed of the Canadian Dollar Offered Rate (CDOR) and the Canadian Overnight Repo Rate Average (CORRA) and to evaluate the efficacy of two dual rate jurisdictions.

The working group recommended phasing out CDOR by June 2024 and adopting an enhanced version of CORRA as the new benchmark for all new derivative and securities contracts after June 30, 2023. Originally developed in 1997, CORRA is an overnight risk-free rate benchmark, incorporating neither term nor credit risk.

The panelists outlined the advantages of adopting CORRA, stating that it's more robust, transparent, and based on transactions instead of opinion. As a result, it has the potential to provide more precise exposure to the Bank of Canada's monetary policy and facilitate liquidity.

Trading Short-Term Interest Futures

The transition timeline for reference rate benchmark reform has been a long one. But the panelists assert it was necessary due to the intricacy of CDOR integration in commercial contracts and the complex technical calculations required for corporate lending and funding initiatives.

CDOR is also the recognized financial benchmark in Canada for bankers' acceptances (BAs), and its cessation directly impacts trading of the Three-Month Bankers' Acceptance Futures contracts (BAX™). Recognizing the global transition efforts and timelines, Montréal Exchange launched a new market-making program for the Three-Month CORRA Futures (CRA™) in 2020.

The goal of launching CRA early as an alternative to BAX was to begin building liquidity and minimize future risks from the transition to a new benchmark rate. Investors can currently trade CRA alongside BAX, executing relative cross-market views by spreading CORRA futures against other risk-free rate futures. These trading strategies allow them to hedge repo risk and offset funding risk in cash versus futures basis trades. While BAX has a higher number of contracts traded, the relatively new CORRA Futures contract on MX saw its year-to-date volume increase by 70.6% in 2021 and 350% in the first six of 2022.

The panelists agreed that Canada's relatively small open market economy is advantageous, facilitating deeper relationships among market participants and investors. It also enables MX to quickly consult with clients to innovate its offerings, resulting in derivative products that better address their needs.

Listen to the complete interview and gain valuable insights on short-term interest rate derivatives at MX and the transition from CDOR to CORRA.

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