ANALYSIS: Market braces for Canadian Libor conversion next month

North American banks are in the final stages of preparing for the conversion next month of their Canadian derivatives from the legacy reference rate to the new risk-free rate, marking the latest in a series of international migrations away from Libor benchmarks.

The Canadian market is set to move to the new Canadian Overnight Repo Rate Average (CORRA) from the legacy, Libor-based Canadian Dollar Offered Rate (CDOR) on June 28.

This means new derivatives must be based on CORRA from the start of July, which represents a major operational and legal undertaking for banks active in the Canadian market.

But Erik Petri, the head of optimisation at OSTTRA, a post-trade solutions provider that has been working with the banks ahead of the conversion, said firms have learned lessons from earlier and larger projects.

“Some of the biggest markets have already been through their transition from a legacy benchmark to a new benchmark, so the industry has a lot of experience from the sterling and Dollar transitions over the past couple of years which is of course helpful as we prepare for yet another benchmark transition from CDOR to CORRA.”

Particularly relevant in this instance is the US dollar conversion to the Secured Overnight Financing Rate (SOFR), a multi-year process that concluded in June last year.

OSTTRA, which offers various services to banks and non-banks holding over-the-counter and listed derivatives contracts, said the play-book for these conversions is to establish first the size of the problem then take steps to reduce the magnitude of the problem.

Petri said: “The size of the problem is related to the number of line items that refer to the legacy benchmark and, once you have identified that, then is there a way you can reduce the number of line items, which is where compression comes in.”

OSTTRA has run in recent months compression cycles with the two main clearing houses in Canadian derivatives – CME Clearing and LCH – which have reduced the notional of the positions sitting on clients’ books, which is helpful when it comes to the later conversion to the new rate.

The OSTTRA triReduce service, which covers interest rate swaps, cross-currency swaps, credit default swaps, FX forwards and commodity swaps, compressed in the first quarter of this year Canadian dollar trades by over 70%, which was higher than in other, earlier Libor conversions.

“The recent runs that we have done in Canada show the participation and interest in compression have increased incredibly in the first half of this year,” said Petri.

“In a normal year, we would typically do two compression runs a year, whereas so far this year we have done two compression runs with LCH in the first quarter and one with CME, which is the first time we have done that, and there is another one with LCH today. So that is four runs this year compared to two in a normal twelve month period.”

OSTTRA has also participated in dress rehearsals ahead of the all-important CORRA conversions by CME on May 17 and LCH on June 8. These trials involved 40 firms and generated more than 200,000 messages through the OSTTRA MarkitWire platform, the firm said.

Petri said: “The industry is definitely getting better but there are always risks around these types of activities. This is a smaller event and banks now know quite well what they need to do in order to prepare, which is why we have seen increased demand for compression and a lot of banks taking part in the CCP conversion dress rehearsals. In general, I think the industry is well-prepared which is to a large extent down to some of the events that have already taken place.”

The Canadian CORRA conversion has been supported by the wholesale adoption of the futures contract based on the new Canadian lending rate. The TMX three-month CORRA future traded 2.7 million lots last month, according to FOW Data, compared to just 194,000 contract in April last year, an increase of over 1,300%.

But Petri warned against complacency: “Once the industry has come through this period however, the banks will still have remaining on their books the non-converted, uncleared transactions that will remain on the legacy benchmark. Those positions will be less liquid and, therefore, more challenging to manage over time.”

While most of the larger derivatives markets, such as the US, UK, Swiss and Japanese, have now converted to their risk-free rates, there are some markets still to complete that process.

Petri said: “There are a few more coming down the line, so we have Mexico at the end of the year, Israel by the middle of next year, South Africa is expected in 2026 and Poland we are expecting around 2027.”