CORRA: Explaining the rise in volumes and resulting upward pressure

The Canadian Overnight Repo Rate Average (CORRA) measures the interest rate for Government of Canada (GoC) securities traded in the overnight lending market. Specifically, the Bank of Canada calculates CORRA based on the Canadian-dollar transactions of GoC treasury bills and bonds in the overnight repurchase (repo) market. Because CORRA can influence other interest rates throughout the economy, it is important to understand why CORRA differs from the overnight policy interest rate.

On May 27, 2024, the settlement period for trading GoC bonds in the secondary market in Canada moved from two days to one day. This was an industry-wide decision to align with North American standards. Having trades settle in one day instead of two helps reduce counterparty and settlement risks that market participants face when trading in financial securities.

This shortened time for settling secondary cash bond trades caused CORRA volumes to rise significantly, and they have remained elevated since. Alongside the increased volume, CORRA started being consistently above the Bank’s policy interest rate. As a result of these new dynamics, the Bank amended the terms of its overnight repo operations and conducted a series of repo operations to help reinforce the target for the overnight rate. These routine overnight repos are part of the Bank’s operational framework for implementing monetary policy and reinforcing the target policy interest rate.

On May 28, 2024, the volume of repos with underlying collateral consisting of GoC Securities:

• increased for overnight repos that settle on the same day and have a term of one day—these are eligible CORRA transactions
• declined by a comparable amount for tomorrow-next repos—these are not eligible CORRA transactions

This shift in volume reflects the shortened time frame for settling trades of cash bonds. As a result of the transition to a one-day settlement period, market participants that rely on the repo market to fund their purchases and sales in the bond market began to trade in the overnight market instead of the tomorrow-next market. Hedge fund activity in the overnight repo market picked up immediately and at higher interest rates.

These higher rates for repos reflect the bulk of trades that shifted to the overnight market after May 27. This increased activity is putting upward pressure on CORRA from the net increase in funding liquidity now being sought in the overnight repo market (which is CORRA-eligible) that was previously transacted in the tomorrow-next (which is not CORRA-eligible).

In this paper, we find that if we remove these new overnight hedge fund trades from CORRA calculations for the period since May 27, CORRA would be up to 3 basis points lower than its current level. We find that the recent upward pressure on CORRA since the transition to a one-day settlement period is due to both:

• the transition of volumes from the tomorrow-next market into the overnight market and thus an increase in the number of trades now included in CORRA calculations; and
• the additional volumes of overnight repo market funding from market participants, namely demand from hedge funds to fund their long positions in the bond market. This existed before but these transactions were previously conducted in the tomorrow-next market.

These repos are now traded in the overnight repo market because of the change to a one-day settlement period for secondary cash bond trades. We find no indications that any other factors are contributing to the most recent pressures on CORRA.