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Report on Business Bank of Canada to take control of key interest rate benchmark

The Bank of Canada will take over as administrator of a key interest-rate benchmark that is undergoing an overhaul as part of global reforms to benchmarks, some of which have been vulnerable to manipulation.

Canada’s central bank announced on Tuesday that it will assume duties for calculating and publishing the Canadian Overnight Repo Rate Average (CORRA) next year and distribute it at no cost “as a public good.” The reference rate for more than $1-trillion of Canadian financial instruments – mostly derivatives – is currently administered by financial data provider Refinitiv.

A government-led working group that includes officials from banks and pension funds has been revamping the way CORRA is calculated, aiming to make it more reliable and more widely used.

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For years, global regulators and central banks have been pushing to reform interest-rate benchmarks. The London Interbank Offered Rate (LIBOR) – the purported average rate at which banks would borrow unsecured from each other overnight – became the dominant global reference rate, linked to hundreds of trillions of dollars of financial instruments, from complex derivatives to residential mortgages. But LIBOR but was easily gamed by some bankers to their own benefit because it relied on a group of banks estimating borrowing costs underpinned by markets with too few transactions.

As part of a co-ordinated response led by the Swiss-based Financial Stability Board – urging greater use of “risk-free rates" that are more stable and harder to torque – Canada elected to enhance the way CORRA is calculated, rather than build a new benchmark from scratch. Since 1997, CORRA has served as an alternative to the more widely used Canadian Dollar Offered Rate (CDOR), a lending rate that is also based on submissions from a panel of banks, but which meets international standards.

The new CORRA is expected to take effect in the second quarter of 2020. Its main advantage over other benchmarks, including CDOR, is that it is based on a large volume of actual transactions. It is calculated with overnight “repo” (repurchase agreement) market transactions in Government of Canada bonds and treasuries – whereby one entity sells government securities overnight and buys them back the next morning, as a form of short-term borrowing.

As it stands, nearly $12-trillion of financial instruments in Canada are pegged to benchmark interest rates – but only about 10 per cent of those are linked to CORRA. Whereas CORRA has traditionally been calculated using fewer than 5 per cent of daily transactions in the repo market, the revamped benchmark will be based on five to eight times more transactions, depending on daily volumes.

That data will now include a wide array of transactions between banks and pension funds, for instance, but will exclude those between related entities.

Bank of Canada deputy governor Lynn Patterson said the new methodology will make CORRA more “robust, reliable and resilient to market stress,” in a briefing with reporters. Over time, the central bank expects that CORRA "could potentially become the dominant Canadian interest-rate benchmark, particularly in derivatives markets,” she added.

But Ms. Patterson also declined to “guesstimate” how quickly financial instruments currently linked to CDOR might move over to CORRA. “I think there’s a common objective to see this move happen,” she said.

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A Refinitiv spokesperson said the company believes the changes to CORRA “are an important step forward in this broader international process to reform and enhance interest-rate benchmarks.”

In the United States, the most analogous rate to CORRA is the Secured Overnight Financing Rate (SOFR), a new benchmark created more than a year ago, but uptake has been slow. In Britain, however, the Sterling Overnight Index Average (SONIA) has gained traction more quickly.

The enhanced CORRA “is a notable improvement," Andrew Kelvin, chief Canada strategist at TD Securities Inc., said in an interview. But for the foreseeable future, it will co-exist with CDOR, which is still expected to be widely used.

“Given the size of the market that is currently linked to CDOR, it will take quite a bit of time to move away from that, unless market participants are more strongly incentivized to move away," Mr. Kelvin said. “I just don’t think it’s going to [happen with] quite the same urgency that we’re going to see in other jurisdictions.”

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