RBA’s Guy Debelle, Assistant Governor (Financial Markets) has been speaking about benchmark currency and interest rates. Benchmarks only work if they are trusted, and transparent. Of note are his comments on the local market, where the primary interest rate benchmark is the bank bill swap rate (BBSW).
As you may be aware, a few weeks ago, the Council of Financial Regulators issued a consultation paper on possible reforms to BBSW. I will run through the motivation for doing so as well as the possible options we canvassed in the consultation paper.
Given its wide usage, BBSW has been identified by ASIC as a financial benchmark of systemic importance in our market. Hence it is important there is ongoing confidence in it.
As you may know, BBSW was calculated for a number of years by, each day, asking a panel of banks to submit their assessment of where the market was trading in Prime Bank paper at a particular time of the day. While it was a submission-based process, it was different from LIBOR in that it was the assessment of the borrowing cost of a notional Prime Bank, informed by observable transactions, rather than an assessment of a submitting bank’s own borrowing costs.
In response to the prospect of a large number of the banks on the submission panel no longer being willing to provide submissions, the calculation of BBSW was reformed in 2013 in line with the International Organization of Securities Commissions’ (IOSCO) Principles for Financial Benchmarks, which were issued in July 2013.
Since 2013, the Australian Financial Markets Association (AFMA) calculates BBSW benchmark rates as the midpoint of the nationally observed best bid and best offer (NBBO) for Prime Bank Eligible Securities, which are bank accepted bills and negotiable certificates of deposit (NCDs). Currently, the prime banks are the four major Australian banks. The rate set process uses live and executable bid and offer prices sourced from interbank trading venues approved by AFMA, which are currently ICAP, Tullett Prebon and Yieldbroker. The bids and offers are sourced from three times around 10am each day.
While the outstanding stock of bills and NCDs issued by the Prime Banks has increased since 2013 to around $140 billion, trading activity during the daily BBSW rate set has declined over recent years. The consultation paper illustrates how low the turnover currently is. There are quite a number of days were there is no turnover at all at the rate set. The low turnover in the interbank market raises the risk that market participants may at some point be less willing to use BBSW.
This is the motivation for the CFR’s consultation to ensure that BBSW remains a trusted, reliable and robust financial benchmark.
Some preliminary data collected from the four major Australian banks indicate that there is substantially more activity in the NCD market than is being measured at the rate set, with the activity mainly occurring outside the interbank market. At least $100 million in NCDs were bought or sold on almost all business days, with activity almost entirely at the 1-, 3- and 6- month tenors. However, the non-bank participants that buy and sell NCDs tend to transact bilaterally with the issuing bank, with the price struck at the (yet to be determined) BBSW ahead of the actual rate set, rather than at a directly negotiated rate. If these participants could be encouraged to buy and sell NCDs at outright yields, then these transactions may have the potential to underpin the BBSW benchmark.
Hence the consultation paper proposes one option for reform which would be to continue with the current NBBO calculation methodology, but to underpin the executable prices with a broader set of NCD market transactions contracted up to the time of the rate set. By more firmly anchoring the BBSW benchmark to observable transactions entered into at arm’s length between buyers and sellers in the market, this may ensure that the benchmark remains a credible indicator of rates in the market.
For this option to be feasible, it would be necessary for the banks to directly negotiate the interest rates on their NCDs with third parties, rather than linking the rate to BBSW. This would require a change to the existing market practice. (In this regard this option has some similarities with the FX benchmark reforms where prior to the reforms, participants also agreed to transact at a yet to be determined price and at the midpoint of the fix.)
Another option for reform, akin to the proposed methodology for LIBOR, would be for the banks to submit to the benchmark administrator their assessment of their aggregate cost of wholesale funding, based on their transactions in a particular window. That is, the banks would do the aggregation and the administrator would only need to average the (currently) four submissions. An alternative option would be for the banks to submit all their transactional data to the benchmark administrator who would then itself do the aggregation. Both of these options would need to provide for circumstances in which the Prime Banks had not executed any transactions in the relevant window.
The final option would be to accept the current system as it is, notwithstanding the very low turnover at the rate set.
The consultation is open until 3 December.
