On April 30, 2024, the Bank of Canada and the Canadian Alternative Reference Rate Working Group ("CARR") reiterated in a market notice (the "Market Notice") that market participants with Canadian Dollar Offered Rate ("CDOR") based loans, derivatives or securities must prepare for the CDOR's permanent cessation post June 28, 2024. As this cessation date nears, the transition from CDOR to the Canadian Overnight Repo Rate Average ("CORRA") has continued to progress and evolve. The evolution began with the publication by CARR on August 3, 2022 of the recommended fallback language for loan agreements which was followed on July 27, 2023 of the recommended CORRA loan agreement definitions and loan mechanics (collectively, the "CARR Recommended Language"). We have previously written about the upcoming permanent cessation of the use and publication of CDOR after June 28, 2024 and the CARR Recommended Language (see our articles here and here).
Since the publication of the CARR Recommended Language, there have been a number of trends and developments in the implementation of the CDOR to CORRA transition for loan agreements that should be noted, ten of which we have highlighted below for market participants to consider when transitioning to CORRA or negotiating new loan agreements that utilize CORRA as an availment option:
1) CORRA Loan Pricing and Credit Spread Adjustments
Given the difference between CDOR, a rate that included a credit risk component, and CORRA, a risk free rate, CARR recommended that CORRA be used with credit spread adjustments ("CSAs") in order to ensure that the economic impact of the transition on loan transactions was neutral. The CSAs were crystalized in May 2022 at 29.547 basis points for an interest period of one month and 32.138 basis points for an interest period of three months based on the long-term historic spreads between CDOR and CORRA. These spreads are being incorporated into most loan agreements, but there are early indications that the amount of the spreads may change over time as was the case for the Secured Overnight Finance Rate (SOFR) spreads in the United States.
2) TMX Datalinx License
Where Term CORRA loans are being offered, the administrative agent and each lender that is a member of a lending syndicate will require an annual license from TMX Datalinx, the creator of the Term CORRA rate. The need for all parties to have a license, and not just the administrative agent, has been confirmed by CARR in their CDOR transition FAQs (see questions 6.12 and 6.13 here). The obtaining of the license is the responsibility of each lender. It should not be the responsibility of the administrative agent to monitor or verify compliance by the other members of the syndicate. As not all lenders have obtained the required licenses and obtaining a license can take several weeks or months, some loan agreements have been incorporating provisions whereby until such time as all lenders required to provide Term CORRA loans have obtained the required license and provided confirmation thereof to the administrative agent, only loans based on Daily Compounded CORRA or Daily Simple CORRA will be available.
3) To Amend or Not to Amend?
The Market Notice in April 2024 makes clear that the hardwired fallback language in the CARR Recommended Language was intended to provide a mechanism for transition, but does not contain the borrowing mechanics for CORRA to allow a loan agreement to transition automatically. As a result, loan agreements still need to be updated to specify the necessary conforming changes – as a best practice, administrative agents implementing conforming changes should consult and work with the borrower to ensure the CORRA loan mechanics will work for all parties involved in the relevant loan agreement. Typically, conforming changes are implemented through an amendment to the loan agreement.
4) Rate Options/Rate Flip
For many corporate loans, dual availability (i.e. Term CORRA and Daily Compounded CORRA are both available at any time) has become the standard. In some instances, loan agreements are providing for only Term CORRA with a fallback to Daily Compounded CORRA as part of the two-step waterfall set out in the CARR Recommended Language, but the "rate-flip" concept provided for in the CARR Recommended Language has not been widely adopted. Similarly, most loan agreements allow for conversion from Term CORRA to Daily Compounded CORRA and vice versa.
5) Interest Periods
Though some loan agreements have provided for non-standard tenors (i.e. tenors less than one month, greater than one month but less than three months or greater than three months) and, in some cases, provided for an interpolated rate for such non-standard periods, most loan agreements have restricted interest periods for Term CORRA loans and Daily Compounded CORRA loans to periods of one or three months.
6) Lookback Period
The CARR Recommended Language does not provide for a specific number of banking days prior to a particular day on which Daily Compounded CORRA for such day is to be determined (i.e. a lookback period). As a result, there has been some variation in the applicable lookback period. Many loan agreements have been hardwiring a five business day lookback period to conform with CARR's recommended lookback period (which can be found here), others are deferring to the administrative agent's or lender's practice. For hedged loans, a two business day lookback period is often used to better align with the lookbacks provided for under ISDA protocols.
7) Breakage Costs
Similar to the approach used for CDOR loans and consistent with the CARR Recommended Language, loan agreements are providing that the lenders will be indemnified for breakage costs which arise as a result of a lender having to redeploy funds as a result of the early prepayment or repayment by a borrower of Term CORRA loans. Whether indemnification is provided for in respect of payment of Daily Compounded CORRA loans prior to the end of an interest period is less consistent with some loan agreements providing for indemnification if such costs arise and others not requiring it given that such loans are based on a daily overnight rate.
8) Floor
Consistent with what was the case for CDOR based loans, interest rate floors for CORRA based loans are being included in loan agreements. The floors are typically being applied to Term CORRA/Daily Compounded CORRA plus the applicable CSA and not to Term CORRA/Daily Compounded CORRA prior to the CSA. Unless commercially negotiated, consistent with the CARR Recommended Language, floors are typically being set at 0% per annum.
9) Bankers' Acceptances
With the end of CDOR, banker's acceptances will cease to be part of loan transactions in Canada. To the extent that loan agreements have not been amended to effect the transition from CDOR to CORRA and implement loan mechanics for CORRA based loans, lenders will be delivering BA Cessation Notices as contemplated by the CARR Recommended Language to remove bankers' acceptances as a loan mechanic in those agreements.
10) Day Count - 365 vs. 366 days
The Bank of Canada calculates CORRA on the basis of a year of 365 days and does not adjust to 366 days when a calendar year has an additional day for a leap year.
Many lenders, borrowers, regulators and lawyers will be relieved once June 28, 2024 arrives, as we will have reached the end of the road for the CDOR to CORRA transition and the multitude of amendments to loan agreements over the past two years.
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