The Bank of Canada called on financial institutions to get up to speed on changes that global regulators are making to interest rate benchmarks that underpin trillions of dollars in securities.
In an update on the Canadian central bank’s work on the issue of benchmarks, Deputy Governor Lynn Patterson said financial organizations need to begin considering their “readiness” for coming changes, including potential enhancements to the current benchmark regime in Canada.
“I realize I am giving you more work to do, but it is important that you keep up with these developments and ensure you are operationally prepared,” Patterson said in a prepared text of a speech she is giving in Toronto to the Investment Industry Association of Canada.
Tarred by rate-fixing scandals that struck at the height of the financial crisis, bankers and investors for years have been grappling with finding a replacement for benchmarks like the London Interbank Offered Rate, which Patterson said is supporting a US$350 trillion market of loans and derivatives.
In the U.S. for example, an alternative benchmark has been created called the Secured Overnight Financing Rate that is already generating US$800 billion in daily transactions.
The pace of work on new benchmarks accelerated last year when Libor’s regulator -- the U.K.’s Financial Conduct Authority -- announced that benchmark may be sustainable only until the end of 2021, Patterson said.
“This announcement came as a surprise to those who had not been closely following benchmark developments,” Patterson said. “Now, roughly a year later, there appears to be wider acceptance of what needs to be done, and progress is continuing despite the significant complexities.”
In Canada, the central bank set up a working group in March to determine how to proceed. It will need to decide whether the current risk-free overnight benchmark -- the Canadian Overnight Repo Rate Average -- needs enhancements, and whether a separate benchmark needs to be created, Patterson said.
An enhanced Corra could help replace trades now being done on the other Canadian benchmark, the Canadian Dealer Offered Rate.
“Should we be satisfied that this is enough?” Patterson asked. “We don’t know the answer to this question, but to help work through the issues we recently set up the Canadian Alternative Reference Rate Working Group.”
The group -- which has 21 members including representation from the nation’s banks, pension funds and investment firms -- will have a recommendation by the end of the year on enhancements toward the Canadian overnight benchmark.
Patterson also said that if a new benchmark is developed, “market adoption will be critical” and market participants will need to be patient as liquidity gets built.
“That means starting work relatively soon, or as soon as we know what reference rates we will be using in the future,” Patterson said, and called on market players not involved in the consultation process to participate in some of the subgroups.